Annual Audit Manual

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7531 General considerations required for related party relationships and transactions
Oct-2012

In This Section

Nature of related party transactions

Responsibilities of the auditor

Definitions and related guidance

Framework considerations

Overview

This topic explains:

  • What our objectives are with regards to related party transactions,
  • What is the nature of related party transactions,
  • Our responsibilities in relation to related parties,
  • Who is considered to be a related party and examples of related parties,
  • What are the Framework considerations which we need to consider.

CAS Objective

The objectives of the auditor are (CAS 550.9):

(a) Irrespective of whether the applicable financial reporting framework establishes related party requirements, to obtain an understanding of related party relationships and transactions sufficient to be able:

(i) To recognize fraud risk factors, if any, arising from related party relationships and transactions that are relevant to the identification and assessment of the risks of material misstatement due to fraud; and

(ii) To conclude, based on the audit evidence obtained, whether the financial statements, insofar as they are affected by those relationships and transactions:

a. Achieve fair presentation (for fair presentation frameworks); or

b. Are not misleading (for compliance frameworks); and

(b) In addition, where the applicable financial reporting framework establishes related party requirements, to obtain sufficient appropriate audit evidence about whether related party relationships and transactions have been appropriately identified, accounted for and disclosed in the financial statements in accordance with the framework.

Nature of related party transactions

CAS Guidance

Many related party transactions are in the normal course of business. In such circumstances, they may carry no higher risk of material misstatement of the financial statements than similar transactions with unrelated parties. However, the nature of related party relationships and transactions may, in some circumstances, give rise to higher risks of material misstatement of the financial statements than transactions with unrelated parties. For example (CAS 550.2):

  • Related parties may operate through an extensive and complex range of relationships and structures, with a corresponding increase in the complexity of related party transactions.

  • Information systems may be ineffective at identifying or summarizing transactions and outstanding balances between an entity and its related parties.

  • Related party transactions may not be conducted under normal market terms and conditions; for example, some related party transactions may be conducted with no exchange of consideration.

Responsibilities of the auditor

CAS Guidance

Because related parties are not independent of each other, many financial reporting frameworks establish specific accounting and disclosure requirements for related party relationships, transactions and balances to enable users of the financial statements to understand their nature and actual or potential effects on the financial statements. Where the applicable financial reporting framework establishes such requirements, the auditor has a responsibility to perform audit procedures to identify, assess and respond to the risks of material misstatement arising from the entity’s failure to appropriately account for or disclose related party relationships, transactions or balances in accordance with the requirements of the framework. (CAS 550.3)

OAG Guidance

In conducting an audit, a level of knowledge of the client’s business and industry is needed to allow for identification of the events, transactions and practices that will have a material effect on the financial statements. While the existence of related parties and transactions between such parties are considered ordinary features of business be aware of such matters for the following reasons:

  • Disclosure of related parties and transactions may be required in the financial statements.

  • The existence of related parties or related party transactions may affect the financial statements.

  • The extent of audit evidence obtained may be affected by related party considerations, related party transaction may be motivated by other than ordinary business considerations for example, profit sharing or even fraud. For guidance on fraud risk consideration, see OAG Audit 5500.

Definitions and related guidance

CAS Guidance

Definitions

For purposes of the CASs, the following terms have the meanings attributed below (CAS 550.10):

(a) Arm’s length transaction - A transaction conducted on such terms and conditions as between a willing buyer and a willing seller who are unrelated and are acting independently of each other and pursuing their own best interests.

(b) Related party—A party that is either:

(i) A related party as defined in the applicable financial reporting framework; or

(ii) Where the applicable financial reporting framework establishes minimal or no related party requirements:

a. A person or other entity that has control or significant influence, directly or indirectly through one or more intermediaries, over the reporting entity;

b. Another entity over which the reporting entity has control or significant influence, directly or indirectly through one or more intermediaries; or

c. Another entity that is under common control with the reporting entity through having:

i. Common controlling ownership;

ii. Owners who are close family members; or

iii. Common key management.

However, entities that are under common control by a state (that is, a national, regional or local government) are not considered related unless they engage in significant transactions or share resources to a significant extent with one another.

Related Guidance

Many financial reporting frameworks discuss the concepts of control and significant influence. Although they may discuss these concepts using different terms, they generally explain that (CAS 550.A4):

(a) Control is the power to govern the financial and operating policies of an entity so as to obtain benefits from its activities; and

(b) Significant influence (which may be gained by share ownership, statute or agreement) is the power to participate in the financial and operating policy decisions of an entity, but is not control over those policies.

The existence of the following relationships may indicate the presence of control or significant influence (CAS 550.A5):

(a) Direct or indirect equity holdings or other financial interests in the entity

(b) The entity’s holdings of direct or indirect equity or other financial interests in other entities

(c) Being part of those charged with governance or key management (that is, those members of management who have the authority and responsibility for planning, directing and controlling the activities of the entity)

(d) Being a close family member of any person referred to in subparagraph (c)

(e) Having a significant business relationship with any person referred to in subparagraph (c)

Related Parties with Dominant Influence

Related parties, by virtue of their ability to exert control or significant influence, may be in a position to exert dominant influence over the entity or its management. Consideration of such behavior is relevant when identifying and assessing the risks of material misstatement due to fraud, as further explained in paragraphs A29-A30. (CAS 550.A6)

Section 3840.03(g) and IAS 24 states that immediate family members of management are considered related parties under both Canadian GAAP and Accounting Standards for Private Enterprises.

Special-Purpose Entities as Related Parties

In some circumstances, a special-purpose entity may be a related party of the entity because the entity may in substance control it, even if the entity owns little or none of the special-purpose entity’s equity. (CAS 550.A7)

OAG Guidance

Examples of Related Parties

Financial reporting frameworks often define or describe when parties are considered to be related to each other for the purpose of accounting for and disclosing related party relationships and transactions. Examples of relationships that constitute related parties include:

  • An entity or individual that directly or indirectly, controls, or is controlled by, or is under common control with, the client;

  • An entity (or individual) which directly or indirectly invests in the client, or is invested in by the client, where the investor has significant influence or joint control and the equity accounting or proportionate consolidation method of accounting is used;

  • An associate of the entity or a joint venture in which the entity is a venturer;

  • Directors, officers and other persons fulfilling a senior management function of the entity or its parent;

  • Members of the immediate family of individuals described above;

  • Any entity with which the client has a management contract; the client may either be the manager or be managed;

  • Post-employment benefit plan for the benefit of employees of the entity, or of an entity that is a related party of the entity.

Framework considerations

CAS Guidance

Even if the applicable financial reporting framework establishes minimal or no related party requirements, the auditor nevertheless needs to obtain an understanding of the entity’s related party relationships and transactions sufficient to be able to conclude whether the financial statements, insofar as they are affected by those relationships and transactions (CAS 550.4):

(a) Achieve fair presentation (for fair presentation frameworks); or

(b) Are not misleading (for compliance frameworks).

An applicable financial reporting framework that establishes minimal related party requirements is one that defines the meaning of a related party but that definition has a substantially narrower scope than the definition set out in paragraph 10(b)(ii) of this CAS, so that a requirement in the framework to disclose related party relationships and transactions would apply to substantially fewer related party relationships and transactions. (CAS 550.A1)

In the context of a fair presentation framework, related party relationships and transactions may cause the financial statements to fail to achieve fair presentation if, for example, the economic reality of such relationships and transactions is not appropriately reflected in the financial statements. For instance, fair presentation may not be achieved if the sale of a property by the entity to a controlling shareholder at a price above or below fair market value has been accounted for as a transaction involving a profit or loss for the entity when it may constitute a contribution or return of capital or the payment of a dividend. (CAS 550.A2)

In the context of a compliance framework, whether related party relationships and transactions cause the financial statements to be misleading as discussed in CAS 700 depends upon the particular circumstances of the engagement. For example, even if non-disclosure of related party transactions in the financial statements is in compliance with the framework and applicable law or regulation, the financial statements could be misleading if the entity derives a very substantial portion of its revenue from transactions with related parties, and that fact is not disclosed. However, it will be extremely rare for the auditor to consider financial statements that are prepared and presented in accordance with a compliance framework to be misleading if in accordance with CAS 210 the auditor determined that the framework is acceptable. (CAS 550.A3)