Important definitions

Arm’s length transaction—This refers to the terms and conditions of the transaction between independent and informed parties in the market.

Related party– The Party is related if it has significant control/influence directly or indirectly on the reporting entity. Additionally, the party is related in the following ways.

• Common controlling ownership.
• Owners are family members.
• Key management is common.

Scope of ISA 550

This ISA defines the auditor’s responsibility concerning auditor’s responsibility for auditing transactions with related parties.

Objectives of ISA 550

The following are the objectives of ISA 550.

• To obtain an understanding sufficient to recognize and identify related parties’ transactions and assess the related risk of material misstatement.
• Conclude on the audit evidence whether related party transactions are fairly presented and not misleading (for compliance with the related financial reporting framework).

Requirements of ISA 550

Following are the requirements of ISA 550.

• Assess the risk of material misstatement concerning related party transactions in the financial statement.
• Identify related parties, nature of relationship, type, and purpose of transactions.
• Inquire management about controls implemented to identify related parties and approve transactions in and outside the normal course of action.
• Remain alert while going through related accounting and business records.
• Inspection of business and accounting records, such as bank/legal confirmations, meeting minutes, and any other record the auditor considers necessary. 

If the auditor finds related party transactions outside normal business, in this case, the auditor shall inquire management about the nature of the transactions.

• If the auditor concludes related party transactions are not at arm’s length, it will be considered a significant risk.
• If fraud risk is identified, reviewing related party transactions will be considered in line with ISA 240.   
• If related party transactions remain undetected, inquire with management and understand why controls failed to detect them. Consider the same as a significant risk and even risk of fraud if the auditor determines related party transactions were intentionally concealed.

If related party transactions are identified outside the business’s normal course of action, the following audit procedures will be performed.

• Inspect contracts/agreements with related parties and understand their business rationale. They may be designed to conceal some misappropriation. In this case, a significant risk of material misstatement arises.
• Understand if management’s explanations are consistent with the terms of transactions.
• Ensure these transactions have been appropriately approved.
• Ensure these transactions have been disclosed in line with the financial reporting framework.

Evaluation of accounting for the related party transaction

The auditor is required to evaluate.

1. If related party transactions have been appropriately accounted for.
2. If the effect of related party transactions prevents financial statements from being presented fairly or creates any misleading in terms of compliance.

Written representation

The auditor must obtain a written representation from management/those charged with governance in the following aspects.

1. They have identified and disclosed all related party transactions they know of.
2. All transactions were appropriately accounted for in the financial statement.

Documentation

The auditor must document the names and nature of the related party transactions.

Wrap up

ISA 550 requires auditors to assess the risk of material misstatement and design sufficient & appropriate audit procedures.

The auditor is required to test the operational effectiveness of the controls implemented for detecting related party transactions. The auditor is further required to remain alert, inquire with management, and inspect documents to identify related parties.

Similarly, the auditor must evaluate accounting processes, review contracts with related parties, make fair presentations, and assess if related party transactions are misleading compliance.