Related parties are those parties considered to be related if one party has the ability to control or exercise significant influence over the other party in making financial decisions. In the context of above, a related party could be management, owner or any person who is in a position to influence an entity’s operating policies and financial decisions.
Related party transactions refer to the transfer of resources or obligations between related parties irrespective of the value of these transactions.
circumstances which indicates the existences of related party transactions:
- Economic substance of the transaction differs from form. In situations where the substance and economic reality of a transaction is different from the legal form, the possibility of a related party exists and it becomes necessary to assess the transaction on its substance and economic reality.
- No logical business reason. The auditor can identify the transaction where there is no logical business reason to effect the particular transaction
- Not adhering to the set methods of processing transactions . Transactions that are not processed in the routine manner may be on account of related party transactions
- Terms of trade different from normal . If the terms of trade are different and not according to routine business transactions, there can be a related party transaction.
- High volume with one customer / supplier . An extraordinary high volume of sales or purchases with one customer or vendor is also a risky area as this can be construed as a related party transaction.
- Unrecorded transaction . If there are any unrecorded transactions, the auditor can assess whether there is a genuine error or whether the mistake had been made on purpose.
- Transactions not having adequate evidence . An auditor always asks for the audit evidence which is sufficient and reasonable to cover the risk. If any particular transaction is effected without adequate documentary evidence, there is a probability of the transaction being a related party transaction e.g. absence of documentary evidence to support an investment made in the shares of a company.
- Unusual transactions entered at the start and end of year