Central to a number of government investigations in Ghana have been companies trading with organisations or individuals other than at arm’s length. Such transactions were made possible by a degree of control or influence by directors over both parties to the transactions. ISA 550: Related parties covers this area.
Management is responsible for the identification of related party transactions. Such transactions should be properly approved as they are frequently not at arm’s length. Management is also responsible for the disclosure of related party transactions.
As a senior partner of your audit firm, you are considering how to identify all the related party transactions of your audit client whose financial statement for the year ended December 31, 2017 you are about to audit.
Required:
Discuss FOUR (4) reasons why the auditor needs to identify related parties transactions during an audit. (8 marks)
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- Identification of fraud risk factor. The ISA requires that irrespective of whether the reporting framework established related party requirements, the auditor is required to obtain an understanding of related party relationships and transactions sufficient to be able to recognise fraud risk factors arising from related party relationships and transactions that are relevant to the identification and assessment of the risks of material misstatement due to fraud.
- Determine compliance with the applicable reporting framework. Where the applicable financial reporting framework establishes related party requirements to obtain sufficient appropriate evidence about whether related party relationships and transactions have been appropriately identified, accounted for and disclosed in the financial statements in accordance with the reporting framework.
- To aid risk assessment. As part of the risk assessment procedures required by ISA 315, the auditor must carry out procedures to obtain information relevant to identifying risks associated with related parties and their transactions.
- To determine appropriate risk responses. Responses to the risk: As part of the ISA 330 requirements that auditors respond to assessment risks, the auditors must design and perform further procedures to obtain sufficient appropriate audit evidence about the assessed risk of material misstatements associated with related party relationships and transactions.
- To discover management awareness of related parties or bias. In many cases the financial statements must include related party disclosures but management may be ignorant of the requirements or may be biased and these may increase the risk of fraud and risk of misstatement of financial statements. Identification of related party transactions may enable the auditors to assess the significance of the risks and the appropriate opinion to issue.
- To obtain written representations. Identification of related party relationships and transaction will enable the auditor to demand written representations from the management that they have disclosed to the auditor the identity of the entity’s related parties and all related party relationships and transaction of which they are aware of and they have appropriately accounted for and disclosed such relationships and transactions in accordance with the requirements of the reporting framework.
- To draw the right conclusion and form the right opinion- with audit conclusion and reporting, identification of related party relationships and transaction together with the accompanying risk assessment and risk response will enable the auditor to draw the right conclusions and determine the appropriate opinion to issue. (Any 4 points)