International Auditing and Assurance Standards Board

Related Parties

ISA Implementation Support Module

Prepared by IAASB Staff

October 2009

• Introduction

• Significant Features of New Standard– New Related Party Definition– A Risk-Based Approach– Identifying Undisclosed RPs or Significant RPTs– Significant Transactions Outside Normal Business– Fraud Risk Factors– Related Party with Dominant Influence– Discovery of Undisclosed RPs or Significant RPTs– Additional Aspects

• Practical Considerations

Overview

2

• Rationale for disclosure requirements under most financial reporting frameworks– Related parties (RPs) are not independent of each other– Disclosure of RP relationships and related party

transactions (RPTs) necessary for a proper understanding of financial results and position

• RPTs often part of normal business

• Audit significance of RPs and RPTs– Risks from inappropriate accounting– Risks from non-identification or non-disclosure– Risks of fraud

The Context for ISA 550

Introduction

3

• Inherent difficulty in identifying undisclosed RPs/RPTs– E.g., management itself may be unaware of RPs and

RPTs (especially if framework does not require disclosure)

• Heightened risk of fraud– RPs present greater opportunities for collusion,

concealment, or manipulation by management– RPs involved in a number of corporate reporting

scandals in recent times

• New standard provides robust basis for identifying risks of material misstatement from RPs

The Context for ISA 550

Introduction

4

• Frameworks that require RP disclosures generally define meaning of a RP

• For frameworks that contain minimal or no RP requirements– Standard provides a RP definition and related guidance– Definition not for accounting purposes but for

complying with requirements of the ISA

• Effect of new RP definition– Ensures minimum audit work with regard to RPs, even

if framework contains no RP requirements

New Related Party Definition

Significant Features of New Standard

5

• Risk-based approach requires a thorough understanding of RPs and RPTs to identify and assess risks– Consider RPs in engagement team discussion– Inquire into changes in RPs from prior period, nature of

RP relationships, and type and purpose of RPTs– Understand controls to identify, account for, and disclose

RPs and RPTs; and to authorize and approve significant RPTs

• Determine whether any of the assessed risks are significant risks

• Respond appropriately to assessed risks

A Risk-Based Approach

Significant Features of New Standard

6

• Searching for unidentified or undisclosed RPs or RPTs can be an onerous task

• Standard takes a robust but practicable approach– Mandatory document inspection limited to a few

document types

Bank and legal confirmations and minutes

– However, required to consider which other records or documents should be inspected in the circumstances

– Required to remain alert to undisclosed RPs or RPTs

Identifying Undisclosed RPs or Significant RPTs

Significant Features of New Standard

7

• Standard places specific focus on significant transactions outside normal course of business

– As a means to help identify undisclosed RPs

• No requirement to search for these transactions but understand how they are authorized and approved

• Probe into the transactions when identified

– Make specific inquiries of management

– Understand nature of the transactions

– Determine whether RPs are involved

Significant Transactions Outside Normal Business

Significant Features of New Standard

8

• Treated as significant risks• If these are identified– Understand controls over them

– Obtain substantive audit evidence about them Inspect supporting contracts or agreements Does business rationale of the RPTs suggest possibility of

fraud? Are their terms consistent with management’s explanations? Have they been appropriately accounted for and disclosed? Have they been appropriately authorized and approved?

Significant RPTs Outside Normal Business

Significant Features of New Standard

9

• Be especially alert to fraud risk factors from RPs

• Standard directs auditor in various ways on this, e.g.,– Consider fraud potential of RPs in engagement team

discussion– Consider features of the control environment that may deter or

facilitate fraud– Consider fraud implications if non-disclosure of RPs or RPTs

by management appears intentional– Evaluate business rationale of significant RPTs outside

normal business

• Emphasis on fraud applies even if framework does not deal with RPs

Fraud Risk Factors

Significant Features of New Standard

10

• “Dominant influence” introduced as a new term– A RP with dominant influence is a fraud risk factor– Indicator approach to recognizing dominant

influence

• Significant risks of material misstatement due to fraud when other risk factors are also present– E.g., the RP is unduly involved in the determination

of accounting estimates

• If significant risk of material misstatement due to fraud is assessed, take appropriate action in accordance with ISA 240

Related Party with Dominant Influence

Significant Features of New Standard

11

• Treated as a red flag– Probe the underlying circumstances– Communicate newly identified RPs to the team– Ask management to identify all transactions with the

newly identified RPs– Perform substantive procedures in relation to newly

identified RPs/RPTs– Reassess risk that other unidentified or undisclosed

RPs or RPTs may exist– If non-disclosure appears intentional, evaluate audit

implications

Discovery of Undisclosed RPs or Significant RPTs

Significant Features of New Standard

12

• Evaluate whether– Accounting and disclosure of RP relationships

and transactions comply with framework requirements

– The effects of the RPs and RPTs Prevent the financial statements from achieving fair

presentation (for fair presentation frameworks) or

Cause the financial statements to be misleading (for compliance frameworks)

Forming an Opinion on the Financial Statements

Additional Aspects

13

• Obtain audit evidence about arm’s-length assertions

• Obtain written representations that

– All RPs and RPTs have been disclosed to auditor

– RP relationships and transactions have been appropriately accounted for and disclosed

• Communicate significant RP matters with TCWG

• Document

– The names of identified RPs

– The nature of the RP relationships

Other Requirements

Additional Aspects

14

• Integrate work required by new standard with other risk assessment procedures

• Open and timely communication on RP matters within engagement team is vital– RPs can have pervasive effects throughout the entity– Share knowledge and insights about entity’s RPs– Agree on approach to inspecting records and

documents– Share relevant RP information obtained from risk

assessment process– Promptly communicate newly identified RPs to team

Practical Considerations

Practical Considerations

15

• Given potential for unidentified/undisclosed RPs/RPTs

– Maintain attitude of professional skepticism

– Be alert to significant transactions outside normal business

• RP disclosures may require special attention

– Disclosures may be complex and are often a source of material misstatement

– Complexity and excessive detail may obscure substance of RPTs

– Evaluate disclosures for adequacy and understandability

Practical Considerations

Practical Considerations

16

• Include relevant RP considerations in early communications with TCWG– Input from TCWG feeds into risk assessment process

– Early dialogue helps avoid later surprises

• Discuss significant RP matters arising during audit with TCWG– Reach common understanding of facts and

circumstances

– Helps to address RP issues on a timely basis

Practical Considerations

Practical Considerations

17

Note

This set of support slides does not amend or override the ISAs, the texts of which alone are authoritative. Reading the slides is not a substitute for reading the ISAs. The slides are not meant to be exhaustive and reference to the ISAs themselves should always be made. In conducting an audit in accordance with ISAs, the auditor is required to comply with all the ISAs that are relevant to the engagement.

18

Copyright © October 2009 by the International Federation of Accountants (IFAC). All rights reserved. Permission is granted to make copies of this work provided that such copies are for use in academic classrooms or for personal use and are not sold or disseminated and provided that each copy bears the following credit line: “Copyright © October 2009 by the International Federation of Accountants (IFAC). All rights reserved. Used with permission of IFAC. Contact permissions@ifac.org for permission to reproduce, store, or transmit this work.” Otherwise, written permission from IFAC is required to reproduce, store, or transmit, or to make other similar uses of, this work, except as permitted by law. Contact permissions@ifac.org.

International Federationof Accountants

ISBN: 978-1-60815-041-0

www.ifac.org