Related Parties Transactions are transactions that take place within an organization that takes place with other organizations that are directly, or indirectly related to the organization in question.
As a matter of fact, related party transactions might include transactions between a parent entity and its subsidiaries, subsidiaries of a common parent, an entity, and related entities for the benefits of stakeholders (mainly employees), an entity and the principal owners and managers, and other affiliated entities.
Importance of Audit Procedures for Related Party Transactions
There is a need to ensure that related party transactions are properly adhered to because it is important for the stakeholders to be aware of the existing negotiations that might take place between an entity and its relevant parties.
Also, the overall scope of a potential collaborative behavior in this regard is also highly likely, as a result of which it becomes important to notify the stakeholders of the affiliation, so that any red flags can subsequently be identified.
Additionally, it can be seen that related party transactions mainly involve contracts for goods and services that are mainly priced at lesser amount, as compared to the transactions that take place between unrelated third parties.
The reason that these transactions need to be closely monitored lies on the realms of ensuring that there are no kickbacks, or uncalled for advantages taken in this regard. Therefore, it becomes the responsibility of the auditors to take these issues into account so that there are no red flags for that matter.
Audit Procedure for Related Party Transactions
The audit procedures for related party transactions are highly important to be considered because of the fact that there is an underlying potential for undisclosed related party transactions that need to be accounted for by auditors to look for probable incidents of fraud. Certain examples pertaining to related party transactions can be as follows:
- Firstly, auditors are required to obtain a list of the company’s current related parties and associated transactions.
- Subsequently, they also obtain minutes from the board of directors’ meetings, especially in the cases when the board discusses significant business transactions.
- It is also useful to consider disclosures from board members, as well as senior executives pertaining to the existing ownership of other entities.
- Bank statements and transaction records, which comprise of intercompany wires are also helpful because they provide certain automated clearing house (ACH) transfers, as well as check payments.
Therefore, specific audit procedures that target related-party transactions in this regard include the following specific steps:
- The need to test the overall viability of related party transactions, and subsequently identifying them to be coded in the ERP system.
- Conducting interviews with accounting personnel that is responsible for reported related-party transactions in the company’s financial statements
- Critically analyzing presentation of related-party transactions in the financial statements
Objectives to be considered when designing Audit Procedure for Related Party Transactions
When auditing related parties, the fundamental aspects that should be considered by auditors are two-fold. Firstly, they are supposed to recognize fraud risk factors that may lead to material misstatement of the accounts, owing to the act of fraud itself.
Secondly, they are also supposed to conclude if there is fair representation of the related party transactions in the financial statements, and if the disclosures meet applicable financial reporting framework.
Audit Skepticism in Related Party Transactions
Professional skepticism in related party transactions is a very important phenomenon that needs to be withheld when it comes to designing procedures and protocol for related party transactions.
As a matter of fact, it can be seen that it calls for auditors to remain vigilant and alert about any undisclosed related party transactions, as well as maintaining skepticism when it comes to identifying material misstatements in the transactions.
Therefore, it can be concluded that it is very important for audit procedures to be designed carefully when it comes to related party transactions.
As a matter of fact, it is highly important to recognize the fact that related party transactions pose a higher risk because there are possibilities of inappropriate accounting, non-identification or non-disclosure, fraud, and the underlying ability of the business to be safely regarded as a growing concern.
The possibility of a coordinated effort towards collusive behavior within affiliated parties of the company has continued to be a pressing cause of concern which also poses increased risks.
Therefore, auditors are required to create procedures for related party transactions with relative ease, so that they are able to assess and disclose any material misstatement or activity from the financial statements.