ISA-550ISA-550

RELATED PARTIESRELATED PARTIES

Presenter . Mirza Imran AliPresenter . Mirza Imran Ali

OVER VIEWOVER VIEW

• ScopeScope• IntroductionIntroduction• ObjectivesObjectives• DefinitionsDefinitions• RequirementsRequirements• Written Representation Written Representation • CommunicationCommunication• DocumentationDocumentation

ScopeScope

This standard deals with the auditor’s This standard deals with the auditor’s responsibility relating to related responsibility relating to related party relationship and transactions in party relationship and transactions in audit of financial statements.audit of financial statements.

IntroductionIntroduction

• Nature of Related Party Relationship Nature of Related Party Relationship and Transactionsand Transactions

• Responsibility of auditorResponsibility of auditor

Nature of Related Party Nature of Related Party Relationship and TransactionsRelationship and Transactions

Related party Transaction

Normal Course of Business Other than

Normal Course of Business

No higher risk of material misstatement

Higher risk of material misstatement

Extensive and complex range of Relationship

Ineffective Information System

Transactions at abnormal Market terms

Responsibilities of auditorResponsibilities of auditorApplicable

Financial Reporting Standard

Establishes Specific Requirements

Establishes no/minimal Requirements

Achieve fair Presentation

Are not misleading

Accounting Requirements

Disclosure Requirements

Is there any situation in which Is there any situation in which a non-disclosure of related a non-disclosure of related party is in compliance of party is in compliance of relevant Framework but is relevant Framework but is misleading ?????misleading ?????

Question…Question…

AnswerAnswer

If the entity derives a very If the entity derives a very substantial portion of its revenue substantial portion of its revenue from transaction with related parties, from transaction with related parties, and that fact is not disclosed.and that fact is not disclosed.

Some other considerationsSome other considerations

• Fraud risk factorsFraud risk factors

• Professional SkepticismProfessional Skepticism

• Inherent LimitationsInherent Limitations– Management is unaware.Management is unaware.– Concealment by managementConcealment by management

ObjectivesObjectives

• Obtain appropriate audit evidence Obtain appropriate audit evidence that all related party transactions that all related party transactions have been identified and accounted have been identified and accounted for.for.

• Recognized fraud risk factors.Recognized fraud risk factors.

• To conclude that Financial To conclude that Financial Statements are fairly presented or Statements are fairly presented or not misleading.not misleading.

DefinitionsDefinitions

• Arm’s length transaction.Arm’s length transaction.

• Related PartyRelated Party

Arm’s length transaction.Arm’s length transaction.

• Willing buyer and Willing buyer and willing seller.willing seller.

• Unrelated .Unrelated .

• Acting Acting independently.independently.

• Pursuing their own Pursuing their own best interest.best interest.

Related partyRelated party• As defined in applicable As defined in applicable

Financial Reporting Financial Reporting Framework.Framework.

• A person or other entity hasA person or other entity has– Direct or indirect controlDirect or indirect control– Significant influenceSignificant influenceOver reporting entity or vice versa.Over reporting entity or vice versa.

• Another Entity under common Another Entity under common control with the reporting control with the reporting entity through havingentity through having– Common controlling ownershipCommon controlling ownership– Owners who are close family Owners who are close family

members ormembers or– Common key managementCommon key management

controlcontrol

• Power to govern financial and Power to govern financial and operating policies of an entityoperating policies of an entity

Significant influenceSignificant influence

• Power to participate in financial and Power to participate in financial and operating policy decisions of the entityoperating policy decisions of the entity

• But is not control over such policies But is not control over such policies

Question.Question.

If two entities are under common If two entities are under common control by estate or local government control by estate or local government whether those can be called related whether those can be called related parties???parties???

Common control by stateCommon control by state

Such entities are not considered Such entities are not considered related unless they engage in related unless they engage in

• significant transitions significant transitions

• share resources to a significant share resources to a significant extent with one anotherextent with one another

Risk Assessment ProceduresRisk Assessment Procedures

• Discussion Among Discussion Among the engagement the engagement teamteam

• Inquiries from Inquiries from managementmanagement

• Understanding of Understanding of control control environmentenvironment

Discussion Among the engagement Discussion Among the engagement teamteam• Nature and extent of entity’s relationship.Nature and extent of entity’s relationship.

• Importance of professional Skepticism.Importance of professional Skepticism.

• Record and document indicating relationship.Record and document indicating relationship.

• How related party may be involved in fraud.How related party may be involved in fraud.

• Related party relation indicatorsRelated party relation indicators– Organizational structureOrganizational structure– Inadequate information systemInadequate information system– Special purpose entities for earning managementSpecial purpose entities for earning management

Earning Earning managementmanagement ? ?

AnswerAnswer

Earnings management is a strategy Earnings management is a strategy used by the management of a used by the management of a company to deliberately manipulate company to deliberately manipulate the company's earnings so that the the company's earnings so that the figures match a pre-determined figures match a pre-determined target.target.

Inquiries from managementInquiries from management

• Identity of entity’s Identity of entity’s related partyrelated party

• Nature of relationshipNature of relationship

• Transactions with Transactions with related party if anyrelated party if any

• Internal control Internal control

• Transactions inTransactions in– Normal course of Normal course of

businessbusiness– Other than normal Other than normal

course of businesscourse of business

Understanding of control Understanding of control environmentenvironment

• Internal ethical codesInternal ethical codes

• Policies and procedures for disclosuresPolicies and procedures for disclosures

• Responsibility assignmentResponsibility assignment

• Management’s discussionsManagement’s discussions

• Transaction’s approval methodTransaction’s approval method

• Internal auditor’s reviewsInternal auditor’s reviews

• Actions taken by management Actions taken by management

• Whistle-blowing policiesWhistle-blowing policies

Reasons for deficiency of Reasons for deficiency of controlscontrols

• Low importanceLow importance

• Lack of over sightLack of over sight

• Intentional disregardIntentional disregard

• Insufficient understanding of Insufficient understanding of frameworkframework

• Absence of disclosure requirement in Absence of disclosure requirement in framework framework

Indicators of related party Indicators of related party relationships and transactionsrelationships and transactions

• Bank and legal conformationBank and legal conformation

• Minutes of the meetingMinutes of the meeting

• Entity’s income tax returnEntity’s income tax return

• Share holders registerShare holders register

• Records of investmentsRecords of investments

• Contracts and agreements with related Contracts and agreements with related partyparty

• Correspondence of legal advisersCorrespondence of legal advisers

• Life insurance policyLife insurance policy

• Internal auditor reportInternal auditor report

Related parties with dominant Related parties with dominant influenceinfluence

•Domination of management by one or more person is a fraud risk factor

•Take appropriate action in accordance with ISA 240

Indicators of dominant Indicators of dominant influenceinfluence

• Veto powerVeto power

• Control over final approvalControl over final approval

• Unquestioned decisionsUnquestioned decisions

• Approval of Transaction without Approval of Transaction without review review

Indicators of material Indicators of material misstatementmisstatement

• High turnover of senior managementHigh turnover of senior management

• Unjustified transactions through Unjustified transactions through intermediariesintermediaries

• Excessive participation in selection of Excessive participation in selection of accounting polices accounting polices

Responses to the assessed Responses to the assessed riskrisk

• Auditor should reassess the nature, Auditor should reassess the nature, timing & extent of further audit timing & extent of further audit procedures procedures

Substantive audit Substantive audit proceduresprocedures

• Confirmations from third partiesConfirmations from third parties

• Inquires from managementInquires from management

• Inquires from related partiesInquires from related parties

• Reading Financial StatementsReading Financial Statements

• Inspections of significant contractsInspections of significant contracts

• Appropriate background research Appropriate background research

Discovery of UndisclosedDiscovery of UndisclosedRelated PartiesRelated Parties

• Communicate to engagement team Communicate to engagement team membersmembers

• Identification of all transactions with such Identification of all transactions with such partiesparties

• Inquiry about internal control failureInquiry about internal control failure

• Apply substantive proceduresApply substantive procedures

• Reassess risk that other unidentified or Reassess risk that other unidentified or undisclosed RPs or RPTs may existundisclosed RPs or RPTs may exist

Intentional Non DisclosureIntentional Non Disclosure

• Indicative of material misstatement Indicative of material misstatement due to fraud and error.due to fraud and error.

• Consider requirements of ISA-240Consider requirements of ISA-240

• Re-evaluate reliability of Re-evaluate reliability of management’s responses.management’s responses.

Significant RPTs Outside Significant RPTs Outside Normal BusinessNormal Business

• Inspection ofInspection of– Business rationalesBusiness rationales– Terms of transactionsTerms of transactions– Transactions accounted for and Transactions accounted for and

disclosed disclosed

• Transactions are authorized and Transactions are authorized and approved.approved.

Evaluation of business Evaluation of business rationalesrationales

• Consider weather Transactions Consider weather Transactions – Is overly complexIs overly complex– Has unusual terms of tradeHas unusual terms of trade– Lacks logical business reasonsLacks logical business reasons– Involves unidentified parties Involves unidentified parties – Processed in unusual mannerProcessed in unusual manner

Evaluation of Accounting and Evaluation of Accounting and Disclosures of TransactionsDisclosures of Transactions

• Transactions should be accounted for Transactions should be accounted for and disclosed in accordance with and disclosed in accordance with applicable Financial Reporting applicable Financial Reporting Framework. Framework.

• The disclosures should be The disclosures should be understandable and should includeunderstandable and should include– Business rationalesBusiness rationales– Key termsKey terms– conditionsconditions

Written RepresentationWritten Representation

There are some circumstances in which There are some circumstances in which it is appropriate to obtained written it is appropriate to obtained written representation from those charge with representation from those charge with governance.governance.

CircumstancesCircumstances

• Approval of specific transaction Approval of specific transaction – having material effect on the financial having material effect on the financial

statement statement – Involvement of managementInvolvement of management

• Oral representations by managementOral representations by management

• Financial or other interest in RPFinancial or other interest in RP

Communication with TCWGCommunication with TCWG

• Non disclosures by managementNon disclosures by management

• Inappropriately authorized and Inappropriately authorized and approved transactionsapproved transactions

• Disagreement with managementDisagreement with management

• Non compliance with applicable lawsNon compliance with applicable laws

• Difficulties in identifying the Difficulties in identifying the controlling entitycontrolling entity

Thank You for Your AttentionThank You for Your Attention

•Any Any Questions????Questions????