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804 Related Parties
804.1 Most business transactions
result from bargained dealing. When the parties to a transaction are
related, the objectivity expected in unrelated bargaining may be lost.
Because of the loss of objectivity, knowledge of the nature and volume
of transactions with related parties may be necessary for financial
statement users to properly evaluate the company's financial condition
and results of operations.
- Consequently, FASB ASC 850 (formerly SFAS No. 57, Related Party Disclosures,
- requires that material related party transactions be disclosed. In this
- area, an auditor's primary objective is to determine that all
- significant transactions with related parties have been identified (completeness). Once those transactions have been identified, attention focuses primarily on the adequacy of presentation and disclosure. 7
804.2 Under FASB ASC 850 (formerly SFAS No. 57),
related parties include affiliates; equity investees; pension,
profit-sharing, and similar trusts managed by or under the trusteeship
of management; principal owners, management, and members of their
immediate families; other parties if one party controls or can
significantly influence the management or operating policies of the
- to an extent that one of the parties might be prevented from pursuing
- its own separate interest; another party that can significantly
- influence the management or operating policies of the transacting
- parties or that has an ownership interest in one of the transacting
- parties and can significantly influence the other to an extent that one
- or more of the transacting parties might be prevented from pursuing its
- own separate interests. Section 605 gives examples of related parties and related-party transactions in a CIRA.
804.3 Audit procedures for related parties are applied at all audit stages. As discussed in section 605,
at the start of the audit, procedures include identifying obvious or
known related parties and transactions (or updating information obtained
in previous audits) and communicating that information to the audit
staff to consider as other procedures are applied during the audit
- Inquiry of predecessor auditors and management; review of prior audit
- workpapers, minutes, contracts, and agreements; etc., are sources of
- information about related parties and transactions with such parties.
804.4 Known related parties can be documented in HOA-CX-3.1.
The authors recommend updating the list of related parties throughout
the engagement and communicating changes to all engagement team members
- If other auditors are involved in the engagement, auditors can use HOA-CL-14.5,
- “Letter from Principal Auditor to Other Auditors Regarding Related
- Parties” to help facilitate timely communication with other auditors
- regarding known related parties and related party transactions.
804.5 When examining transactions
in the audit of specific accounts or in the subsequent events review,
the auditor should consider whether the transactions involve related
parties. Generally, the same audit procedures are applied to substantive
material related-party transactions that are applied to other material
transactions. Procedures include
- vouching, examining authorizations,
- confirmation, recomputation, etc., to obtain an understanding of the
- transaction's nature, extent, and business purpose, and to obtain
- reasonable assurance that the transactions do not contain misstatements
- that could be material to the financial statements. The auditor should
- also be sure to understand that proper authorization of related-party
- transactions, such as by the board of directors or audit committee (if
- the CIRA has one), is more important than for similar transactions with
- unrelated parties
804.6 Generally, the purpose of
final review procedures is to evaluate whether there are major
transactions with undisclosed related parties and to evaluate the
adequacy of disclosure of identified transactions.
- Some audit procedures of an
- overall review or analytical nature that are performed near the end of
- the audit may disclose related party transactions. Generally, those
- procedures include scanning accounting records for large, unusual, or
- nonrecurring transactions or balances, particularly those around the end
- of the period; considering the nature and extent of business with the
- CIRA's officers, the developer/sponsor, and major suppliers, borrowers,
- or lenders for undisclosed relationships; and considering whether
- transactions are occurring, but not being given accounting recognition,
- e.g., the transfer of a unit in development from the developer to the
- CIRA in settlement of litigation.
804.7 To obtain an understanding
of a transaction's nature or purpose, it may be necessary to apply
additional procedures. Examples of such procedures include inspecting
evidence possessed by the other party to the transaction;
- discussing relevant information
- with intermediaries, such as banks, agents, or attorneys; referring to
- financial publications, credit agencies, and other sources for
- information about unfamiliar parties to the transaction; etc. The
- authors believe the auditor should consider whether any related-party
- transactions are occurring that are not being recognized in the
- accounting records.
804.8 Also, an auditing interpretation at AU 9334.16-.21
discusses other procedures that may be necessary to understand the
transaction or obtain evidence about it, such as consultation with
persons knowledgeable about a particular specialized type of
transaction, application of audit procedures at the related party, or
even audit of the related party's financial statements.
- The interpretation also suggests obtaining representations from senior
- management and directors about whether they, or any other related
- parties, engaged in any transactions with the company during the period.
- The “Related Party Confirmation” at HOA-CL-12.4
- can be used to obtain information from the developer/sponsor, officers,
- directors, or others about the existence of related party transactions.
804.9 Auditors do not have a duty
to substantiate the arm's-length equivalence of related party
transactions unless representations of equivalence are made in the
financial statements. FASB ASC 850 (formerly SFAS No. 57)
indicates that representations about related-party transactions should
not imply that the transactions were consummated on an arm's-length
basis unless those representations can be substantiated
- An auditing interpretation at AU 9334.22-.23
- addresses the situation where management discloses in the financial
- statements that a related-party transaction was consummated on an
- arm's-length basis, but prefaces that representation with a phrase such
- as “Management believes that . . .” or “It is the Association's belief
- that . . .” The interpretation indicates that prefacing a disclosure
- about related-party transactions with such a phrase does not change
- management's responsibility to substantiate the representation. Also,
- the auditor should treat wording that is potentially ambiguous about
- arm's-length status in the same manner. For example, management might
- state that the transactions are consummated on a reasonable basis.
- Because there are no criteria for the reasonableness of related party
- transactions, the assertion cannot be substantiated and should be
804.10 However, auditors should
understand the business purpose of related party transactions and should
understand that proper authorization of such transactions, such as by
- CIRA management, board of
- directors, or those charged with governance, is more important than for
- similar transactions with unrelated parties (AU 334.09).
804.11 Related-Party Transactions and Fraud As discussed in Chapter 6, SAS No. 99, Consideration of Fraud in a Financial Statement Audit (AU 316),
requires the auditor to consider the existence of fraud risk factors
when identifying and assessing risks of material misstatement due to
- A common thread in many frauds is the use of related parties unknown to
- the auditor to facilitate management intentionally misstating the
- financial statements (for example, selling real estate or other assets
- to a related party for artificial gain).
804.12 FASB ASC 850 (formerly SFAS No. 57) requires certain note disclosures about related parties.
Those disclosures are summarized in the disclosure checklist at HOA-CX-13.