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Clarified Auditing Standards: Related Parties Redrafted

Aug 27th 2015
CPA Firm Support Services, LLC
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While AU-C Section 550 is a redrafted standard, there are a few changes and clarifications of importance to consider. This standard is focused on the related party requirements in Financial Accounting Standards Board Accounting Standards Codification Topic 850, Related Party Disclosures.

This SAS is framework neutral so it applies to all approved financial reporting frameworks, including special purpose frameworks described in AU-C Section 800, Special Considerations—Audits of Financial Statements Prepared in Accordance with Special Purpose Frameworks. The applicability of the objectives, requirements, and definitions in the standard are irrespective of whether the framework establishes such requirements.

The standard contains significant sections on the following:

Nature of related party relationships and transactions. Many related party transactions are in the normal course of business, and 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 give rise to higher risks of material misstatement of the financial statements than transactions with unrelated parties.

Responsibilities of the auditor. Because related parties are not independent of each other, 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. Therefore, 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.

An understanding of the entity's related party relationships and transactions is relevant to the auditor's evaluation of whether one or more fraud risk factors are present, as required by AU-C Section 240, Consideration of Fraud in a Financial Statement Audit (Redrafted), because fraud may be more easily committed or disguised through related parties.

An audit has inherent limitations, so an unavoidable risk exists that some material misstatements of the financial statements may not be detected, even though the audit is properly planned and performed in accordance with US GAAS. In the context of related parties, the potential effects of inherent limitations on the auditor's ability to detect material misstatements are greater because management may be unaware of the existence of all related party relationships and transactions. Related party relationships may present a greater opportunity for collusion, concealment, or manipulation by management.

Planning and performing the audit with professional skepticism.AU-C Section 200, Overall Objectives of the Independent Auditor and the Conduct of an Audit in Accordance With Generally Accepted Auditing Standards, requires the auditor to plan and perform the audit with professional skepticism. This, of course, applies to related party transactions, given the potential for undisclosed related party relationships and transactions.

Practical Note
Even though this is a redrafted standard, it specifically requires that an auditor perform risk assessment procedures for related party transactions. While risk assessment may be performed for transactions with related parties when scanning the general ledger for transactions greater than the lower limit for individually significant items, it is probable transactions below that amount may not be considered.

Because related party transactions must be considered in the aggregate when determining materiality, related party transactions should be identified early in the planning phase of an engagement. After making inquiries of management and accounting personnel, reading minutes of directors' meetings, and reviewing the prior year's engagement files, all transactions – large and small – with related parties should be considered.

More Information
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