Related Party Transactions Audit Checklist

Auditors strive for an in-depth knowledge of all related party relationships and transactions, in particular those between related parties that could lead to inflated earnings or fraud, as well as whether one exerts dominant influence over an entity and its management.

Practical constraints may make it impossible to fully verify other terms and conditions (e.g. credit terms or contingencies). This checklist helps audit procedures.

Identification
At times, owners and managers may conduct transactions with companies they have financial relationships with; such arrangements are known as related party transactions. Unfortunately, when unchecked they can lead to inflated earnings or even fraud – therefore making the identification and evaluation of these arrangements a crucial component of the audit process.

Identification involves identifying relationships or transactions, understanding how they are recorded and disclosed according to applicable financial reporting frameworks, assessing any related party risks involved, as well as understanding their business rationale and terms and conditions – including any consideration received or paid – prior to entering into them.

Analysis includes reviewing information and sources such as: the company payroll system, treasury management systems and bank statements; each related party’s list of KMP declarations; as well as searching trading creditors and accounts payable ledgers to identify any transactions recorded in these accounts.

Authorization
Establishing and executing identification, authorization and approval procedures as well as documenting them for all entities should be a top priority. Otherwise, transactions could go undetected, potentially leading to improperly inflated earnings or even fraud.

Auditors strive to gain an in-depth knowledge of every related-party financial relationship and transaction, including its nature, terms and business purposes. Auditors examine documents such as tax filings, corporate life insurance policies, contracts and organizational charts before conducting inquiries into whether processes and controls of a company are efficient.

Additionally, auditors conduct examinations of transactions outside the normal course of business in order to understand their rationale and whether they appear devoid of business purpose. Furthermore, auditors identify any deviations from company policy and evaluate reasons behind any exceptions; then report these procedures back to the Audit Committee.

Recording
An audited entity must record transactions with related parties according to accounting standards for risk of material misstatement. Failing to do so increases this risk.

Auditing procedures must include gathering an understanding of every transaction recorded in the accounting records, its nature and reasons behind its inclusion in those records. To facilitate this effort, discussions may take place with management, those charged with governance or any authorized to sign major transactions as well as inspection of relevant documents like contracts, financial agreements, corporate life insurance policies and organizational charts.

Auditors should evaluate whether related party transactions recorded by management reflect economic reality and are appropriate given the circumstances of an entity. Furthermore, auditors should look for signs that transactions haven’t been discussed and approved by those charged with governance as this could indicate fraud.

Disclosure
Some financial reporting frameworks mandate disclosure by related parties regarding transactions and arrangements between them, if relevant. If an auditor discovers significant relationships or transactions have been hidden from management, he or she must take appropriate actions and follow procedures that mitigate their associated risks, such as:

Auditors select additional audit procedures based on an assessment of risk factors, which includes evidence that controls were not implemented effectively in related party transactions. This may have occurred because management failed to fully grasp applicable requirements or gave lesser priority than necessary to related party controls.

Disclosure and additional information can be gathered from various sources, including investment statements, the accounts payable ledger, investor listings, D&O questionnaires and Board meetings. Additional audit procedures may also be needed to evaluate whether management’s assertion that the transaction was at arm’s length by comparing its terms to market rates for broadly similar transactions with unrelated parties.