THE AUDIT OF RELATED PARTIES AND THE APPLICATION OF

PROFESSIONAL SKEPTICISM
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The audit of related party relationships and transactions is a crucial aspect in the
performance of an audit of financial statements under the International Standards on
Auditing (UK and Ireland) (ISAs). Massimo Laudato, technical adviser at ACCA, explains
the main points.
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Many financial reporting frameworks, including UK GAAP and IFRS, include specific
requirements in respect of accounting for and disclosing related party relationships,
transactions and balances. The rationale for these requirements is grounded in the fact that
related parties by their nature are not independent of each other and, therefore, additional
disclosures and more stringent rules should apply to relationships and transactions between
the entity and related parties in order to enable users of the financial statements to understand
their nature and the actual or potential effects on the business.
ACCA has published Technical Factsheet 180 that deals with reporting requirements in
respect of related parties. The document can be accessed here.
HIGHER RISK
In many cases related party transactions are undertaken in the course of the normal business
of an entity, for instance a company may perform the acquisition of certain items for all the
entities in a group or, rather, members of the management of an entity may occasionally buy
the same goods or services offered to the entitys clients with the same staff discount
applicable to other employees.
In such a case, related party transactions may not pose a higher risk of material misstatement
of the financial statements than similar transactions with unrelated parties.
However, in other circumstances, in view of the nature of related party relationships and
transactions, they may carry a higher risk of material misstatement in respect of:
Risks from inappropriate accounting;

 Risks from non-identification or non-disclosure;

Risks of fraud;
Risks about the ability of the company to continue in business as a going concern if
the entitys interest is constantly subordinated to that of related parties.
Related party relationships and transactions may be difficult to identify and report by the
entity, and subject to an increased risk of fraud, for various reasons, including:
The entitys related parties may operate via an extensive and complex network of
relationships, sometimes put in place to obfuscate control of the entity, making related
party transactions difficult to unravel.
The entitys information systems may not be effective in identifying and recording
related party relationships and transactions.
Transactions with related parties may not take place on normal commercial terms,
even though, prima facie, the price charged may be in line with that of similar arms
length transactions.
Additionally, in respect of related parties, the detection risk faced by the auditor is generally
greater than for other assertions in the financial statements. The inherent limitations of an
audit, whereby some material misstatement may not be identified even if the audit is
properly planned and performed under the ISAs, are magnified by peculiar causes such as:
Management may be unaware of the existence of some related party relationships and
transactions because it may not grasp the complexity of their structure and the
interaction with relevant reporting requirements.
Related party relationships may offer the opportunity for collusion, manipulation or
concealment by management and, consequently, present a heightened risk of fraud.
ISA (UK AND IRELAND) 550
The auditing standard that deals with the auditors responsibilities relating to related party
relationships and transactions is ISA (UK and Ireland) 550, Related parties. The standard
effectively expands on how other standards, namely ISA 315 and ISA 330, which require and
explain how to perform risk assessment procedures and further audit procedures to respond
to assessed risks, should be applied in the context of related parties.
ISA 550 therefore requires a risk-based approach for the audit of related parties; one where
the procedures performed by the auditor are aimed at identifying, assessing and responding
to the risks of material misstatement connected with the entitys failure to account for and
disclose related party relationships and transactions in line with the applicable financial
reporting framework.

A risk-based approach implies gaining a thorough understanding of related parties to be able

to perform an effective risk assessment. For such purpose ISA 550 indicates specific audit
procedures and illustrates a number of common situations to help the auditor recognize
significant risks and respond appropriately.
Gaining a detailed understanding of related party relationships and transactions is also
important for the auditors evaluation of whether fraud risk factors are present, as required
by ISA (UK and Ireland) 240, The auditors responsibilities relating to fraud in an audit of
financial statements, since, as mentioned, related party relationships carry a higher risk of
fraud.
When auditing related parties, the objectives for the auditor are those of:
Recognising fraud risk factors that may lead to material misstatement of the accounts
due to fraud, and
To conclude whether, on the basis of the evidence obtained, the financial statements
achieve fair presentation, as far as related parties are concerned, and the related party
requirements in the applicable financial reporting framework have been met.
ISA 550 stresses the importance of planning and performing the audit with professional
skepticism, particularly in the context of related parties, given the inherent potential for
unidentified and undisclosed related party relationships and transactions.
PROFESSIONAL SKEPTICISM
Professional skepticism is an attitude, or a mindset, of the auditor that drives him to adopt a
questioning approach when considering information or forming conclusions; therefore
enhancing the auditors ability to identify and respond to conditions that may indicate
possible misstatement due to error or fraud.
Professional skepticism also includes being alert to audit evidence that contradicts other
audit evidence obtained or information that brings into question the reliability of documents
or of responses to inquiries obtained from management or directors. It also involves being
alert to conditions that may indicate possible fraud.
Another essential aspect of professional skepticism is a critical assessment of audit evidence,
which comprises both information that supports and corroborates managements assertions
and any information that contradicts them. A critical assessment of audit evidence implies
questioning and considering whether the evidence is sufficient and appropriate in light of the
circumstances. For instance a material amount in the financial statements may be supported
by a single document, susceptible to fraud, in a context where fraud risk factors exist. In such
a case the auditor should question the reliability of the information, further investigate and
determine what modifications or additions to the audit procedures are necessary to resolve
the matter.

While the auditor should not disregard past experience with management and directors of an
entity, believing that they are honest and have integrity does not relieve the auditor from
maintaining professional skepticism or accepting audit evidence that is not persuasive.
The application of professional skepticism in the audit of related party relationships and
transactions is particularly relevant in a number of circumstances, such as:
While remaining alert during the audit for information that may indicate previously
unidentified or undisclosed related parties or transactions;
In respect of identified significant related party transactions outside the normal course
of the entitys business, when evaluating whether the business rationale, or lack of it,
of the transactions suggests that they may have been used to misappropriate assets or
for fraudulent financial reporting;
When assessing significant risks of material misstatement due to fraud as a result of
the presence on a related party with dominant influence.
In view of the susceptibility of related party relationships and transactions to fraud, the
exercise of professional skepticism is also especially relevant in dealing with the risks of
management manipulation or override of controls. In that respect ISA 240 notes that the risk
of not detecting a material misstatement resulting from management fraud is greater than for
employee fraud, as management is frequently in a position to directly or indirectly
manipulate accounting records, present fraudulent financial information or override controls
designed to prevent similar frauds by other employees.
In the audit of related parties professional skepticism should therefore be incorporated, as an
auditors attitude, in the performance of all the procedures outlined below.
The performance of audit procedures in respect of related parties, the audit evidence
obtained from them and the conclusions drawn by the auditor will have to be duly
documented in the audit file, as that will be significant in understanding how the engagement
was planned and performed and in supporting the auditors opinion.
RISK ASSESSMENT UNDERSTANDING THE ENTITYS RELATED PARTIES
Obtaining a detailed understanding of related parties is essential to adopt a risk-based
approach to the audit of related party relationships and transactions and needs to involve the
following procedures:
Discussion among the engagement team of related parties issues;
Inquiry of management about the identity of related parties, the nature of relationships
and the type and purpose of related party transactions;
Inquiry of management and others within the entity to understand the entitys controls
on related party relationships and transactions.

ENGAGEMENT TEAM DISCUSSION

The discussion among the engagement team, which needs to be undertaken at the planning
stage of the audit and suitably documented, needs to expressly consider whether the financial
statements may be materially misstated because of fraud or error resulting from related party
relationships or transactions.
In particular the issues that could be addressed at the meeting may include a review of the
entitys relationships and transactions with related parties, possibly starting from the
auditors register of related parties that were identified in previous audits, as well as
discussing the importance to management and directors of the requirements to identify and
disclose related parties.
The existence of complex relationships and structures, including the use of special purpose
entities, which may indicate related parties not identified or disclosed by management should
be also discussed.
In respect of the possibility of material misstatement due to fraud the engagement team
should specifically consider whether related parties may be involved in fraud. For instance if
there are transactions between the entity and somebody that can be associated with a member
of management, like a known business partner or an entity controlled by a known friend or,
rather, by a non-close relative of the member of management, the team should discuss how
such transactions may be based on collusion to facilitate the misappropriation of the entitys
assets.
IDENTIFICATION OF RELATED PARTIES
In order to identify related parties, including changes from the prior period, and to
understand the nature of their relationship with the entity, as well as to establish whether
transactions have been entered with these related parties during the audited period and, if so,
the type and purpose of the transactions, ISA 550 requires the auditor to inquire
management.
The reason for this approach is that management is normally in the best position to identify
related party relationships and transactions than any other subject, notwithstanding the risk
of manipulation and concealment posed by management override of controls. In particular
management is likely to be aware of the relationships that have economic significance to the
entity and that are more likely to carry a risk of material misstatement.
In case of recurring audits of the same entity, management inquires provide a basis for
testing the consistency of the information provided by management for the current year with
the auditors record of related parties noted in previous audits. The identity of related parties
and the nature of their relationship with the entity is, in fact, normally documented in the
permanent section of the audit file and updated for each year.
RELATED PARTIES CONTROLS
The inquiry of management and others within the entity who are likely to have knowledge of
the entitys related party relationships and transactions is also essential in obtaining an

understanding of the controls, or rather lack of them, that the entity has in place in respect of
related parties for the purpose of:
Identifying and disclosing parties and transactions under accounting requirements;
Authorising and approving significant transactions and arrangements with related
parties and
Authorising significant transactions outside the entitys normal course of business.
Apart from management, those that may know about the entitys related parties and controls
on them may include internal auditors, in-house legal counsel or employees with the
authority to initiate, process or record significant transactions outside the normal course of
business.
As part of gaining an understanding of the overall control environment of the entity it is
important for the auditor to take into account whether features of such environment may
mitigate the risk of related parties material misstatement.
For instance that would be the case if the entity had policies in place for the timely disclosure
of interests that management and directors have in related party transactions. Likewise a
positive aspect of the tone at the top would be the fact that management has taken proactive
action to resolve related party disclosure issues by seeking advice from the auditor or
external lawyers.
However in some cases the auditor may gather that related parties controls are deficient or
non-existent for an entity. That may happen for a number of reasons, such as that the
management does not grasp the related party requirements under the applicable financial
reporting framework, or rather that it attaches low importance to such requirements. More
concerning is the possibility that controls may not be implemented or operated intentionally
because, for example, related party disclosures may reveal information, like transactions
with family members of management, that management may not want to divulge.
If the auditor encounters deficient or non-existent controls, it may not be possible to obtain
sufficient appropriate audit evidence about related party relationships and transactions and
the auditor should consider the implication for the auditors report, including qualification.
When assessing an entitys control on related parties, the auditor should also be alert to the
possibility of management override of controls that may otherwise appear to be designed and
operating effectively.
The risk of fraud arising from management override of controls is difficult to assess given
the higher potential of collusion with other parties, manipulation and concealment that is
available to management. However if it is ascertained that the entity does business with other
entities controlled by management, or a member of it, the risk would be greater as, for
instance, management may be incentivised to conclude transactions for the benefit of the
other parties. That may be achieved by creating fictitious terms of transactions with related
parties in order to misrepresent their business rationale.

When auditing a smaller entity the auditor may find that there are less formal controls or no
documented processes to identify related parties and authorise transactions with them.
Sometimes the direct involvement of an owner-manager may reduce the risks in respect of
related party transactions or may instead increase them, given the greater potential for
override of any controls. For the auditor of a smaller entity, inquiry of management would
not be enough to obtain an understanding of related parties and any related controls and
further procedures should be performed, for example inspection of relevant documentation
for related party transactions and observation of how management supervises or unduly
influences the work of the entitys personnel.
REVIEWING RECORDS AND DOCUMENTS FOR UNIDENTIFIED OR
UNDISCLOSED RELATED PARTIES OR TRANSACTIONS
Searching for related party relationships or transactions that management has not identified
or disclosed to the auditor is likely to be an onerous task, especially as management may be
unaware or may be trying to conceal them. ISA 550 takes a robust but practical approach to
the problem by mandating the inspection of limited types of documents, such as:
Bank and legal confirmations obtained as part of the audit procedures, and
Minutes of shareholders and board of directors meetings.
However the standard requires the exercise of the auditors professional judgement to
consider which other records or documents should be inspected, by taking into account the
specific circumstances of the entity.
There is a vast array of records and documents potentially capable of providing information
about related parties that the auditor may consider inspecting. Some of them include:
Other third party confirmations obtained by the auditor;
Returns made by the entity to regulatory authorities;
Shareholder registers to identify significant shareholders;
Records of the entitys investments;
Contracts and agreements with key management and directors;
Contracts and agreements with other entities that have directors in common;
Significant contracts and agreements outside the entitys normal course of business;
Specific invoices and correspondence from the entitys professional advisers (perhaps
in respect of the sale of the entitys assets).

The auditor may encounter certain arrangements that, by virtue of their peculiarity, may
indicate the existence of unidentified or undisclosed related party relationships or
transactions. That could be the case for instance for:
Agreements for the provision of services to certain parties under terms and conditions
that are outside the entitys normal course of business;
Relationships of guarantees and guarantor.
It is important for the auditor to remain alert throughout the performance of the engagement
for information that may indicate the existence of unidentified or undisclosed related parties.
SIGNIFICANT TRANSACTIONS OUTSIDE NORMAL BUSINESS
Consideration of significant transactions outside the entitys normal course of business is
very important in the audit of related parties as it is a means to help identifying undisclosed
related party relationship and transactions and fraud risk factors.
ISA 550 does not specifically require the auditor to search for these transactions but rather to
understand which controls are in place to authorise and approve them.
If the auditor identifies significant transactions outside the entitys normal business, when
inspecting records or documents or when performing other audit procedures, it will be
necessary to make specific inquiries of management about:
The nature of these transactions, ie understand their business rationale and the terms
and conditions involved;
Whether related parties may be involved.
Examples of significant transactions outside normal business that may require inquiry of
management may include:
Complex equity transactions like corporate restructuring or acquisitions;
Transactions with offshore entities in jurisdictions with weak corporate law;
Sales transactions with large discounts or returns;
Transactions with circular arrangements, like sale and repurchase agreements.
By obtaining further information on significant transactions outside normal business, the
auditor would be able to evaluate whether fraud risk factors are present. For instance a
related party may be involved in such a transaction not only directly, by being party to it, but
also indirectly, by influencing the transaction via the use of an intermediary. Such influence
may be an indication of the existence of a fraud risk factor.

SIGNIFICANT RELATED PARTY TRANSACTIONS OUTSIDE NORMAL

BUSINESS
Apart from gaining an understanding of related parties, the auditor is required, by ISA 315,
to identify and assess the risks of material misstatement associated with related party
relationships and transactions and to determine which of those risks are significant.
The auditor is also required, by ISA 330, to design and perform further audit procedures in
response to the assessed risks of material misstatement involving related parties.
When significant related party transactions outside the normal course of the entitys business
are identified, they should be treated as significant risks. That implies that the auditor will
need to perform substantive procedures that are specifically responsive to those risks.
The substantive procedures that have to be performed to obtain sufficient appropriate
evidence about related party transactions outside normal business include:
Inspecting underlying contracts or agreements, if any;
Evaluating the business rationale, or rather lack of it, of the transactions to see whether
they may have been initiated to engage in fraudulent financial reporting or to conceal
misappropriation of assets;
Considering whether the terms of the transactions are consistent with managements
explanations;
Verifying if the transactions have been appropriately accounted for and disclosed in
accordance with the applicable financial reporting requirements; and
Obtaining evidence that the transactions have been appropriately authorised and
approved.
When evaluating if the business rationale of a related party transaction outside the entitys
normal business suggests the possibility of fraud, the auditor may consider a number of
aspects such as:
Whether the transaction is excessively complex;
If it lacks an apparent logical business reason;
If it carries unusual terms of trade, like unusual prices, interest rates, repayment terms
or guarantees;
Whether it involves related parties that were not previously identified by management.
Whether management is placing more emphasis on a particular accounting treatment
rather than giving regard to the underlying economics of the transaction.

If the managements explanations of the transaction is inconsistent with the its actual terms,
the auditor should consider the reliability of other managements explanations and
representations on other significant matters.
When it is possible to establish that significant related party transactions outside the entitys
normal business have been authorised and approved by management, directors, or
shareholders in certain circumstances, the auditor may infer that these have been properly
considered at the appropriate level within the entity and the approval may also provide audit
evidence that they have been properly disclosed in the financial statements.
On the other hand when such transactions are not subject to authorisation and approval and
in the absence of rational explanations, they may represent a risk of material misstatement
due to error or fraud. In any case, if the entity is subject to dominant influence by a related
party or in view of the possibility of collusion between related parties, authorisation and
approval may not be effective and may not provide sufficient evidence to exclude the risk of
misstatement due to fraud.
When auditing a smaller entity the auditor may rely less on authorisation and approval to
obtain audit evidence in respect of significant related party transactions outside the entitys
normal business. In fact a smaller entity is unlikely to have the type of controls available in a
larger entity with different levels of authority and approval. In such circumstances the
auditor may perform other procedures like inspecting relevant documentation, confirming
aspects of the transactions with relevant parties or observing the involvement of the ownermanager with the transactions.
FRAUD RISK FACTORS
One of the objectives of the audit is that of identifying fraud risk factors arising from related
parties and assessing the probability that they can lead to fraudulent financial reporting.
For such purpose the auditor should remain alert to fraud risk factors throughout the audit
and, as already mentioned, especially when:
Considering the fraud potential of related parties at the engagement team discussion;
Considering whether the features of the entitys control environment may deter or
facilitate fraud, especially in terms of potential management override of controls;
Considering the fraud implications of the intentional non-disclosure by management
of related party relationships or transactions; and
The business rationale of significant related party transactions outside the normal
business of the entity is evaluated.
RELATED PARTY WITH DOMINANT INFLUENCE

Related parties may be in a position to exert dominant influence over an entity or its
management and, when a single person or small group of persons is capable of exerting such
influence, that represents a fraud risk factor.
The auditor may recognise the existence of dominant influence by a related party when some
indicators, suggested by ISA 550, are present. That could be the case when, for instance:
The related party has vetoed some significant business decisions taken by management
or directors;
Significant transactions require final approval by the related party;
When business proposals are initiated by the related party they are not questioned by
management or directors;
Transactions involving the related party are not independently authorised or approved.
Dominant influence may also exist when the related party has been a founder of the entity
and continues to be significantly involved in its management. That could often be the case
for the owner-manager of a smaller entity and the auditor should consider that dominant
influence is more likely than not to exist in owner-managed entities.
When other risk factors are present alongside the fraud risk factor of a related party with
dominant influence, that may indicate significant risks of material misstatement due to
fraud.
Such significant risk may exist if there is a high turnover of management or professional
advisers, as in certain cases that may suggest that the related party is imposing unethical or
fraudulent business practices to serve its own purposes.
Similarly, if business intermediaries are used for significant transactions that do not have a
clear business rationale, that may indicate that the dominant related party may have an
interest in such transactions and may control the intermediaries for fraudulent purposes.
If the auditor has assessed a significant risk of misstatement due to fraud as a result of the
existence of a related party with dominant influence, the auditor should apply the
requirements of ISA 240, which deals specifically with fraud. The procedures required by
ISA 240 may include, among others, testing of the appropriateness of journal entries and
other adjustments in the preparation of the financial statements and reviewing accounting
estimates for bias.
In addition to applying the requirements of ISA 240, the auditor may perform some other
procedures to understand what business relationships the dominant related party may have
established, directly or indirectly, with the entity and to determine whether further
substantive procedures are needed.
The procedures that can be performed to obtain such understanding may include:

 Direct enquiry of the related party

Background research of certain transactions, for instance control of intermediaries
may be researched using company registrars information or business information
databases
Review of significant contracts with related parties or intermediaries
Review of employee whistle-blowing reports if available.
Discovery of unidentified or undisclosed related parties or transactions
The auditor may discover information or arrangements indicating the existence of related
party relationships or significant transactions that have not been previously identified or
disclosed by management.
In such a case, the auditor should probe the underlying circumstances and, if previously
undisclosed related parties or significant transactions are identified, it will be necessary to
take action and perform various procedures to respond to the risks that the discovery
involves.
In particular the auditor will have to:
Communicate promptly the newly identified related parties to the engagement team as
this may affect the results of risk assessment already performed and the further audit
procedures needed;
Ask management to identify all transactions with the newly identified related parties
and inquire why the entitys controls failed to detect the party or transactions;
Perform substantive audit procedures in respect of the identified parties or
transactions;
Reconsider the risk that other unidentified related parties or transactions may exist and
perform further procedures to identify them if necessary; and
If the non-disclosure by management appears intentional, therefore indicating a risk of
material misstatement due to fraud, evaluate the implications for the audit.
Substantive audit procedures that can be performed in respect of the newly identified related
parties or transactions can include:
Enquiries about the nature of the relationships with the newly identified related
parties, including inquiring parties outside the entity who may have significant
knowledge of the entity and its business; these could be legal advisers, agents,
consultants or other close business partners;

 Analysing accounting records to identify further transactions with the newly identified
related parties;
Checking the terms and conditions of transactions with the newly identified related
parties and verifying if they have been accounted for and disclosed in line with the
applicable financial reporting requirements.
If management has intentionally not disclosed to the auditor-related party relationships or
significant transactions, the omission would represent a considerable risk of material
misstatement due to fraud. In such a case the requirements and guidance in ISA 240 in
respect of the auditors responsibilities relating to fraud in an audit of financial statements
will apply.
In particular the possible involvement of management in a misstatement due to fraud
requires reconsidering the reliability of the audit evidence previously obtained, as this may
raise doubts about the completeness and truthfulness of the representations made by
management and the genuineness of accounting records and documentation. In turn, this will
require the auditor to re-evaluate the assessment of the risks of material misstatement due to
fraud and the nature, timing and extent of the audit procedures to respond to the assessed
risks. In other words the intentional non-disclosure by management of related parties and its
potential involvement in fraud requires a substantial re-planning of the audit.
Additionally, in accordance with ISA 240, the fact that the auditor has significant concern
about the integrity of management or the directors of the entity, as it could the case if
management intentionally omitted to disclose related party information to the auditor for
fraudulent purposes, is one of the exceptional circumstances that brings into question the
auditors ability to continue performing the audit. In such circumstances the auditor should
consider whether it is appropriate to withdraw from the engagement.
ARMS-LENGTH ASSERTIONS FOR RELATED PARTY TRANSACTIONS
An entity could make a statement in the financial statements that a related party transaction
was conducted on terms equivalent to those that prevail in an arms-length transaction. When
these types of statements are included in the financial statements, the auditor should obtain
sufficient appropriate audit evidence to verify the assertion.
The auditor may face some practical difficulties when trying to obtain audit evidence in
respect of all the various aspects of a related party transaction. In fact, while the auditor may
be able to confirm that such a transaction has been conducted at market price, like a similar
arms-length transaction, as audit evidence in that respect may be readily available, it may be
difficult to confirm whether other terms and conditions are equivalent to those that would
apply with an independent party. For instance the transaction may feature different credit
terms or provisions for contingencies or charges.
However financial reporting frameworks normally require management to make an armslength statement in respect of related party transactions only if such assertion can be
substantiated, as it is the case for FRS 102 and IAS 24, Related Party Disclosures. The

auditor should therefore be able to obtain sufficient appropriate audit evidence by testing the
managements support for the arms-length assertion.
If, for instance, management has based its assertion on comparing the terms of the related
party transaction with those of an identical or similar one with unrelated parties or with the
known market terms for broadly similar transactions, the auditor may consider whether the
approach taken by management is appropriate to support the assertion and may verify the
source of the internal or external data and check whether the data is accurate, complete and
relevant.
EVALUATION OF THE ACCOUNTING FOR AND DISCLOSURE OF RELATED
PARTIES
In forming an opinion on the overall financial statements the auditor will need to evaluate
whether:
1. Accounting and disclosure of related party relationships and transactions comply with
the requirements of the applicable financial reporting framework, and
2. The effects of the related party relationships and transactions prevent the financial
statements to achieve fair presentation.
The evaluation of related party disclosures in respect of the applicable financial reporting
requirements may need special attention by the auditor as they may be complex and are often
a source of material misstatement. The same complexity and excessive detail of the
disclosures may actually obscure the substance of the related party transactions.
Related party disclosures should be evaluated considering whether the facts and
circumstances of the entity have been appropriately summarised and presented so that
disclosures are understandable. Disclosures may not be understandable if the business
rationale and the effects of the transactions on the financial statements are unclear or if the
key terms, conditions or other important elements necessary for understanding the
transactions are not appropriately disclosed.
OTHER REQUIREMENTS IN ISA 550
The auditor is required to obtain written representations from the entitys management, and
in certain circumstances from directors when these are not involved in managing the entity,
that:
1. They have disclosed to the auditor the identity of related parties and all the related
party relationships and transactions they are aware of; and
2. They have accounted for and disclosed such relationships and transactions as required
by the reporting framework.
The auditor may request written representations from directors to confirm oral
representations on details of certain related party transactions or when they have interests in
related party transactions.

Additionally, unless all the directors are involved in managing the entity, the auditor is
required to communicate with directors (those charged with governance) significant related
party matters arising during the audit.
Discussing with directors significant related party issues, as they arise during the audit, helps
in reaching a common understanding of facts and circumstances and in finding a resolution
to these issues on a timely basis.
Significant related party matters that can be discussed with directors include non-disclosure
(intentional or not) by the management of related parties or significant transactions, which
may alert directors of the existence of relationships or transactions of which they were not
aware.
Similarly the auditor may point out to directors significant related party transactions not
appropriately authorised and approved, which may indicate suspected fraud.
The auditor should also discuss with directors any disagreement with management about the
disclosure of related party transactions under the applicable financial reporting requirements.
In respect of related parties documentation, ISA 550 requires the auditor to document the
names of the identified related parties and the nature of the related party relationships.
The schedule below illustrates the documentation requirements in respect of related parties
included in ISA 550 and relates to a family-owned/managed business consisting of a hotel
and leisure centre.
Name of
related
party

Nature of
relationship

Types of transactions

Uses the restaurant on a

regular basis

Likely value of
transactions
2-3,000 per annum
through the DLA

Some large functions held at

Non-executive director hotel in the past at reduced
Toby Hamilton
and 20% shareholder
rates

Dividend

Wilma
Hamilton

Non-executive director
Uses the restaurant and spa
and 20% shareholder
on a regular basis

20,000 per annum

through his DLA
3-4,000 per annum

Name of
related
party

Nature of
relationship

Types of transactions

Likely value of
transactions
through the DLA

Dividend

Uses the restaurant on a

regular basis

Frank
Hamilton

Managing director and

20% shareholder

20,000 per annum

through her DLA

2-3,000 per annum

through the DLA

Dividend
20,000 per annum
through his DLA

50,000 per annum

Salary
Uses the restaurant on a
regular basis

Jack Hamilton

Marketing director and Dividend

20% shareholder

2-3,000 per annum

through the DLA

20,000 per annum

through his DLA

50,000 per annum

Salary
Edwina
Hamilton

Finance director and

20% shareholder

Uses the restaurant and spa

on a regular basis.

3-4,000 per annum

through the DLA

Name of
related
party

Nature of
relationship

Types of transactions

Likely value of
transactions

Large function held at hotel

in audit period at reduced
10,000 invoiced and
rates
promptly paid

Dividend

Salary

20,000 per annum

through her DLA

50,000 per annum

Steps taken to ensure completeness

eg inspection of documents, observation of processes, further management enquiries.
The booking schedules for the restaurants and spa and diaries are reviewed by Tess Foreman
on a weekly basis to ensure that there is a value against all transactions.
Specific risk areas identified
eg transactions outside the entitys normal business activity, fraud risk from management
override of internal controls, etc.
No major risk areas anticipated and related parties appear to be limited to family members.
Discussions with client
Sufficient understanding of related parties requirements
The clients control environment is conducive to compliance with financial reporting
requirements for related parties with clear cut policies and procedures for related party

transactions and responsibilities assigned to senior employees for identifying, recording,

summarising, and disclosing such transactions.
Importance attached to identification and disclosure of related parties
The use of a qualified member of the team to review for transactions reflects how seriously
they take this matter.
Intentional disregard of controls or requirements
None identified.
Audit impact of the above
Audit procedures should include ensuring that the controls identified have been applied.