ISA 550

Related Parties

1Objective and scope

ISA 550 deals with the auditor's responsibilities regarding related party relationships and transactions in an audit of financial statements, expanding on how ISA 315, ISA 330 and ISA 240 apply to them. Many frameworks (IAS 24 Related Party Disclosures) establish specific requirements; where the framework has minimal or no related party requirements, the auditor still needs an understanding sufficient to conclude whether the financial statements, insofar as they are affected, achieve fair presentation or are not misleading. Related party transactions carry higher inherent risk because they may not be at arm's length, may be motivated by profit sharing or tax planning, may be concealed, and may be effected through complex structures; the entity's information systems may not identify them; and management may not be aware of, or may be motivated to conceal, all of them.

The objectives are to obtain an understanding of related party relationships and transactions sufficient to recognise fraud risk factors arising from them and to conclude whether the financial statements achieve fair presentation or are not misleading; and to obtain sufficient appropriate evidence about whether related party relationships and transactions have been appropriately identified, accounted for and disclosed in accordance with the framework.

2Key definitions

3Requirements

Risk assessment procedures

• In the engagement team discussion under ISA 315 and ISA 240, include specific consideration of the susceptibility of the financial statements to material misstatement due to fraud or error arising from related party relationships and transactions.
• Inquire of management regarding the identity of the entity's related parties, including changes from the prior period; the nature of the relationships; and whether the entity entered into any transactions with them during the period and, if so, their type and purpose.
• Inquire of management and others within the entity, and perform other risk assessment procedures, to understand the controls management has established to identify, account for and disclose related party relationships and transactions, to authorise and approve significant transactions with related parties, and to authorise and approve significant transactions outside the normal course of business.
• Remain alert, when inspecting records or documents during the audit, for arrangements or information that may indicate unidentified or undisclosed related parties or transactions, and in particular inspect bank and legal confirmations, minutes of shareholder and governance meetings, and other records the auditor considers necessary (the register of members, the register of directors' interests, group structure charts, tax returns, regulatory filings, contracts with unusual terms).
• If significant transactions outside the normal course of business are identified, inquire of management about their nature and whether related parties could be involved.
• Share information about related parties with the other members of the engagement team, and with component auditors in a group audit.

Identifying and assessing risks; responses

• Identify and assess the risks of material misstatement associated with related party relationships and transactions, determine whether any are significant risks, and treat identified significant related party transactions outside the normal course of business as giving rise to significant risks.
• If fraud risk factors are identified (a dominant related party, transactions with no apparent business rationale), consider them in the fraud risk assessment under ISA 240.
• Design and perform procedures responsive to the assessed risks under ISA 330.
• If the auditor identifies arrangements or information suggesting related parties or transactions management has not previously identified or disclosed, determine whether the underlying circumstances confirm their existence; if so, promptly communicate the information to the engagement team, request management to identify all transactions with the newly identified party, inquire why the controls failed to identify or disclose it, perform substantive procedures on the newly identified party and transactions, reconsider the risk that other undisclosed related parties exist, and evaluate the implications for the audit if the non-disclosure appears intentional (fraud).
• For identified significant related party transactions outside the normal course of business: inspect the underlying contracts or agreements and evaluate whether the business rationale (or lack of it) suggests fraudulent financial reporting or concealment of misappropriation, whether the terms are consistent with management's explanations, and whether the transactions have been appropriately accounted for and disclosed; and obtain evidence that they have been appropriately authorised and approved (board minutes, shareholder approval where required by the Companies Act for substantial property transactions with directors).
• If management has made an assertion in the financial statements that a related party transaction was conducted on terms equivalent to those prevailing in an arm's length transaction, obtain sufficient appropriate evidence about the assertion; if it cannot be substantiated, the assertion is a misstatement.

Evaluation and representations

In forming the opinion the auditor evaluates whether the identified related party relationships and transactions have been appropriately accounted for and disclosed in accordance with the framework, and whether their effects prevent the financial statements from achieving fair presentation or cause them to be misleading. Where the framework establishes related party requirements, the auditor obtains written representations that management has disclosed to the auditor the identity of related parties and all related party relationships and transactions of which it is aware, and has appropriately accounted for and disclosed them.

4Documentation and reporting

The auditor documents the names of the identified related parties and the nature of the related party relationships, in a schedule updated each period and carried in the permanent file, together with the inquiries made, the records inspected, the evaluation of significant transactions outside the normal course of business, the evidence for any arm's length assertion, and the written representations. Significant matters arising in connection with related parties are communicated to those charged with governance under ISA 260, unless all of those charged with governance are involved in managing the entity: non-disclosure by management (intentional or not), significant transactions not appropriately authorised, disagreement over the accounting or disclosure, and non-compliance with law relating to related party transactions. Inadequate disclosure or accounting leads to a qualified or adverse opinion under ISA 705; an inability to obtain evidence about the completeness of related parties leads to a qualified opinion or disclaimer.

5Examinable focus