THE AUDIT OF RELATED PARTIES AND THE APPLICATION OF PROFESSIONAL SKEPTICISM

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The audit of related party relationships and transactions is a crucial aspect in the performance of an audit of financial statements under the International Standards on Auditing (UK and Ireland) (ISAs). Massimo Laudato, technical adviser at ACCA, explains the main points.

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Many financial reporting frameworks, including UK GAAP and IFRS, include specific requirements in respect of accounting for and disclosing related party relationships, transactions and balances. The rationale for these requirements is grounded in the fact that related parties by their nature are not independent of each other and, therefore, additional disclosures and more stringent rules should apply to relationships and transactions between the entity and related parties in order to enable users of the financial statements to understand their nature and the actual or potential effects on the business.

ACCA has published Technical Factsheet 180 that deals with reporting requirements in respect of related parties. The document can be accessed here.

HIGHER RISK

In many cases related party transactions are undertaken in the course of the normal business of an entity, for instance a company may perform the acquisition of certain items for all the entities in a group or, rather, members of the management of an entity may occasionally buy the same goods or services offered to the entity’s clients with the same ‘staff discount’ applicable to other employees.

In such a case, related party transactions may not pose a higher risk of material misstatement of the financial statements than similar transactions with unrelated parties.

However, in other circumstances, in view of the nature of related party relationships and transactions, they may carry a higher risk of material misstatement in respect of:

  • Risks from inappropriate accounting;
  • Risks from non-identification or non-disclosure;
  • Risks of fraud;
  • Risks about the ability of the company to continue in business as a going concern – if the entity’s interest is constantly subordinated to that of related parties.

Related party relationships and transactions may be difficult to identify and report by the entity, and subject to an increased risk of fraud, for various reasons, including:

  • The entity’s related parties may operate via an extensive and complex network of relationships, sometimes put in place to obfuscate control of the entity, making related party transactions difficult to unravel.
  • The entity’s information systems may not be effective in identifying and recording related party relationships and transactions.
  • Transactions with related parties may not take place on normal commercial terms, even though, prima facie, the price charged may be in line with that of similar arm’s length transactions.

Additionally, in respect of related parties, the detection risk faced by the auditor is generally greater than for other assertions in the financial statements. The inherent limitations of an audit, whereby some material misstatement may not be identified even if the audit is properly planned and performed under the ISAs, are magnified by peculiar causes such as:

  • Management may be unaware of the existence of some related party relationships and transactions because it may not grasp the complexity of their structure and the interaction with relevant reporting requirements.
  • Related party relationships may offer the opportunity for collusion, manipulation or concealment by management and, consequently, present a heightened risk of fraud.

ISA (UK AND IRELAND) 550

The auditing standard that deals with the auditor’s responsibilities relating to related party relationships and transactions is ISA (UK and Ireland) 550, Related parties. The standard effectively expands on how other standards, namely ISA 315 and ISA 330, which require and explain how to perform risk assessment procedures and further audit procedures to respond to assessed risks, should be applied in the context of related parties.

ISA 550 therefore requires a risk-based approach for the audit of related parties; one where the procedures performed by the auditor are aimed at identifying, assessing and responding to the risks of material misstatement connected with the entity’s failure to account for and disclose related party relationships and transactions in line with the applicable financial reporting framework.

A risk-based approach implies gaining a thorough understanding of related parties to be able to perform an effective risk assessment. For such purpose ISA 550 indicates specific audit procedures and illustrates a number of common situations to help the auditor recognize significant risks and respond appropriately.

Gaining a detailed understanding of related party relationships and transactions is also important for the auditor’s evaluation of whether fraud risk factors are present, as required by ISA (UK and Ireland) 240, The auditor’s responsibilities relating to fraud in an audit of financial statements, since, as mentioned, related party relationships carry a higher risk of fraud.

When auditing related parties, the objectives for the auditor are those of:

  • Recognising fraud risk factors that may lead to material misstatement of the accounts due to fraud, and
  • To conclude whether, on the basis of the evidence obtained, the financial statements achieve fair presentation, as far as related parties are concerned, and the related party requirements in the applicable financial reporting framework have been met.

ISA 550 stresses the importance of planning and performing the audit with professional skepticism, particularly in the context of related parties, given the inherent potential for unidentified and undisclosed related party relationships and transactions.

PROFESSIONAL SKEPTICISM

Professional skepticism is an attitude, or a mindset, of the auditor that drives him to adopt a questioning approach when considering information or forming conclusions; therefore enhancing the auditor’s ability to identify and respond to conditions that may indicate possible misstatement due to error or fraud.

Professional skepticism also includes being alert to audit evidence that contradicts other audit evidence obtained or information that brings into question the reliability of documents or of responses to inquiries obtained from management or directors. It also involves being alert to conditions that may indicate possible fraud.

Another essential aspect of professional skepticism is a critical assessment of audit evidence, which comprises both information that supports and corroborates management’s assertions and any information that contradicts them. A critical assessment of audit evidence implies questioning and considering whether the evidence is sufficient and appropriate in light of the circumstances. For instance a material amount in the financial statements may be supported by a single document, susceptible to fraud, in a context where fraud risk factors exist. In such a case the auditor should question the reliability of the information, further investigate and determine what modifications or additions to the audit procedures are necessary to resolve the matter.

While the auditor should not disregard past experience with management and directors of an entity, believing that they are honest and have integrity does not relieve the auditor from maintaining professional skepticism or accepting audit evidence that is not persuasive.

The application of professional skepticism in the audit of related party relationships and transactions is particularly relevant in a number of circumstances, such as:

  • While remaining alert during the audit for information that may indicate previously unidentified or undisclosed related parties or transactions;
  • In respect of identified significant related party transactions outside the normal course of the entity’s business, when evaluating whether the business rationale, or lack of it, of the transactions suggests that they may have been used to misappropriate assets or for fraudulent financial reporting;
  • When assessing significant risks of material misstatement due to fraud as a result of the presence on a related party with dominant influence.

In view of the susceptibility of related party relationships and transactions to fraud, the exercise of professional skepticism is also especially relevant in dealing with the risks of management manipulation or override of controls. In that respect ISA 240 notes that the risk of not detecting a material misstatement resulting from management fraud is greater than for employee fraud, as management is frequently in a position to directly or indirectly manipulate accounting records, present fraudulent financial information or override controls designed to prevent similar frauds by other employees.

In the audit of related parties professional skepticism should therefore be incorporated, as an auditor’s attitude, in the performance of all the procedures outlined below.

The performance of audit procedures in respect of related parties, the audit evidence obtained from them and the conclusions drawn by the auditor will have to be duly documented in the audit file, as that will be significant in understanding how the engagement was planned and performed and in supporting the auditor’s opinion.

RISK ASSESSMENT – UNDERSTANDING THE ENTITY’S RELATED PARTIES

Obtaining a detailed understanding of related parties is essential to adopt a risk-based approach to the audit of related party relationships and transactions and needs to involve the following procedures:

  • Discussion among the engagement team of related parties’ issues;
  • Inquiry of management about the identity of related parties, the nature of relationships and the type and purpose of related party transactions;
  • Inquiry of management and others within the entity to understand the entity’scontrols on related party relationships and transactions.

ENGAGEMENT TEAM DISCUSSION

The discussion among the engagement team, which needs to be undertaken at the planning stage of the audit and suitably documented, needs to expressly consider whether the financial statements may be materially misstated because of fraud or error resulting from related party relationships or transactions.

In particular the issues that could be addressed at the meeting may include a review of the entity’s relationships and transactions with related parties, possibly starting from the auditor’s register of related parties that were identified in previous audits, as well as discussing the importance to management and directors of the requirements to identify and disclose related parties.

The existence of complex relationships and structures, including the use of special purpose entities, which may indicate related parties not identified or disclosed by management should be also discussed.

In respect of the possibility of material misstatement due to fraud the engagement team should specifically consider whether related parties may be involved in fraud. For instance if there are transactions between the entity and somebody that can be associated with a member of management, like a known business partner or an entity controlled by a known friend or, rather, by a non-close relative of the member of management, the team should discuss how such transactions may be based on collusion to facilitate the misappropriation of the entity’s assets.

IDENTIFICATION OF RELATED PARTIES

In order to identify related parties, including changes from the prior period, and to understand the nature of their relationship with the entity, as well as to establish whether transactions have been entered with these related parties during the audited period and, if so, the type and purpose of the transactions, ISA 550 requires the auditor to inquire management.

The reason for this approach is that management is normally in the best position to identify related party relationships and transactions than any other subject, notwithstanding the risk of manipulation and concealment posed by management override of controls. In particular management is likely to be aware of the relationships that have economic significance to the entity and that are more likely to carry a risk of material misstatement.

In case of recurring audits of the same entity, management inquires provide a basis for testing the consistency of the information provided by management for the current year with the auditor’s record of related parties noted in previous audits. The identity of related parties and the nature of their relationship with the entity is, in fact, normally documented in the permanent section of the audit file and updated for each year.

RELATED PARTIES CONTROLS

The inquiry of management and others within the entity who are likely to have knowledge of the entity’s related party relationships and transactions is also essential in obtaining an understanding of the controls, or rather lack of them, that the entity has in place in respect of related parties for the purpose of:

  • Identifying and disclosing parties and transactions under accounting requirements;
  • Authorising and approving significant transactions and arrangements with related parties and
  • Authorising significant transactions outside the entity’s normal course of business.

Apart from management, those that may know about the entity’s related parties and controls on them may include internal auditors, in-house legal counsel or employees with the authority to initiate, process or record significant transactions outside the normal course of business.

As part of gaining an understanding of the overall control environment of the entity it is important for the auditor to take into account whether features of such environment may mitigate the risk of related parties’ material misstatement.

For instance that would be the case if the entity had policies in place for the timely disclosure of interests that management and directors have in related party transactions. Likewise a positive aspect of the ‘tone at the top’ would be the fact that management has taken proactive action to resolve related party disclosure issues by seeking advice from the auditor or external lawyers.

However in some cases the auditor may gather that related parties’ controls are deficient or non-existent for an entity. That may happen for a number of reasons, such as that the management does not grasp the related party requirements under the applicable financial reporting framework, or rather that it attaches low importance to such requirements. More concerning is the possibility that controls may not be implemented or operated intentionally because, for example, related party disclosures may reveal information, like transactions with family members of management, that management may not want to divulge.

If the auditor encounters deficient or non-existent controls, it may not be possible to obtain sufficient appropriate audit evidence about related party relationships and transactions and the auditor should consider the implication for the auditor’s report, including qualification.

When assessing an entity’s control on related parties, the auditor should also be alert to the possibility of management override of controls that may otherwise appear to be designed and operating effectively.

The risk of fraud arising from management override of controls is difficult to assess given the higher potential of collusion with other parties, manipulation and concealment that is available to management. However if it is ascertained that the entity does business with other entities controlled by management, or a member of it, the risk would be greater as, for instance, management may be incentivised to conclude transactions for the benefit of the other parties. That may be achieved by creating fictitious terms of transactions with related parties in order to misrepresent their business rationale.

When auditing a smaller entity the auditor may find that there are less formal controls or no documented processes to identify related parties and authorise transactions with them. Sometimes the direct involvement of an owner-manager may reduce the risks in respect of related party transactions or may instead increase them, given the greater potential for override of any controls. For the auditor of a smaller entity, inquiry of management would not be enough to obtain an understanding of related parties and any related controls and further procedures should be performed, for example inspection of relevant documentation for related party transactions and observation of how management supervises or unduly influences the work of the entity’s personnel.

REVIEWING RECORDS AND DOCUMENTS FOR UNIDENTIFIED OR UNDISCLOSED RELATED PARTIES OR TRANSACTIONS

Searching for related party relationships or transactions that management has not identified or disclosed to the auditor is likely to be an onerous task, especially as management may be unaware or may be trying to conceal them. ISA 550 takes a robust but practical approach to the problem by mandating the inspection of limited types of documents, such as:

  • Bank and legal confirmations obtained as part of the audit procedures, and
  • Minutes of shareholders’ and board of directors’ meetings.

However the standard requires the exercise of the auditor’s professional judgement to consider which other records or documents should be inspected, by taking into account the specific circumstances of the entity.

There is a vast array of records and documents potentially capable of providing information about related parties that the auditor may consider inspecting. Some of them include:

  • Other third party confirmations obtained by the auditor;
  • Returns made by the entity to regulatory authorities;
  • Shareholder registers to identify significant shareholders;
  • Records of the entity’s investments;
  • Contracts and agreements with key management and directors;
  • Contracts and agreements with other entities that have directors in common;
  • Significant contracts and agreements outside the entity’s normal course of business;
  • Specific invoices and correspondence from the entity’s professional advisers (perhaps in respect of the sale of the entity’s assets).

The auditor may encounter certain arrangements that, by virtue of their peculiarity, may indicate the existence of unidentified or undisclosed related party relationships or transactions. That could be the case for instance for:

  • Agreements for the provision of services to certain parties under terms and conditions that are outside the entity’s normal course of business;
  • Relationships of guarantees and guarantor.

It is important for the auditor to remain alert throughout the performance of the engagement for information that may indicate the existence of unidentified or undisclosed related parties.

SIGNIFICANT TRANSACTIONS OUTSIDE NORMAL BUSINESS

Consideration of significant transactions outside the entity’s normal course of business is very important in the audit of related parties as it is a means to help identifying undisclosed related party relationship and transactions and fraud risk factors.

ISA 550 does not specifically require the auditor to search for these transactions but rather to understand which controls are in place to authorise and approve them.

If the auditor identifies significant transactions outside the entity’s normal business, when inspecting records or documents or when performing other audit procedures, it will be necessary to make specific inquiries of management about:

  • The nature of these transactions, ie understand their business rationale and the terms and conditions involved;
  • Whether related parties may be involved.

Examples of significant transactions outside normal business that may require inquiry of management may include:

  • Complex equity transactions like corporate restructuring or acquisitions;
  • Transactions with offshore entities in jurisdictions with weak corporate law;
  • Sales transactions with large discounts or returns;
  • Transactions with circular arrangements, like sale and repurchase agreements.

By obtaining further information on significant transactions outside normal business, the auditor would be able to evaluate whether fraud risk factors are present. For instance a related party may be involved in such a transaction not only directly, by being party to it, but also indirectly, by influencing the transaction via the use of an intermediary. Such influence may be an indication of the existence of a fraud risk factor.

SIGNIFICANT RELATED PARTY TRANSACTIONS OUTSIDE NORMAL BUSINESS

Apart from gaining an understanding of related parties, the auditor is required, by ISA 315, to identify and assess the risks of material misstatement associated with related party relationships and transactions and to determine which of those risks are significant.

The auditor is also required, by ISA 330, to design and perform further audit procedures in response to the assessed risks of material misstatement involving related parties.

When significant related party transactions outside the normal course of the entity’s business are identified, they should be treated as significant risks. That implies that the auditor will need to perform substantive procedures that are specifically responsive to those risks.

The substantive procedures that have to be performed to obtain sufficient appropriate evidence about related party transactions outside normal business include:

  • Inspecting underlying contracts or agreements, if any;
  • Evaluating the business rationale, or rather lack of it, of the transactions to see whether they may have been initiated to engage in fraudulent financial reporting or to conceal misappropriation of assets;
  • Considering whether the terms of the transactions are consistent with management’s explanations;
  • Verifying if the transactions have been appropriately accounted for and disclosed in accordance with the applicable financial reporting requirements; and
  • Obtaining evidence that the transactions have been appropriately authorised and approved.

When evaluating if the business rationale of a related party transaction outside the entity’s normal business suggests the possibility of fraud, the auditor may consider a number of aspects such as:

  • Whether the transaction is excessively complex;
  • If it lacks an apparent logical business reason;
  • If it carries unusual terms of trade, like unusual prices, interest rates, repayment terms or guarantees;
  • Whether it involves related parties that were not previously identified by management.
  • Whether management is placing more emphasis on a particular accounting treatment rather than giving regard to the underlying economics of the transaction.

If the management’s explanations of the transaction is inconsistent with the its actual terms, the auditor should consider the reliability of other management’s explanations and representations on other significant matters.

When it is possible to establish that significant related party transactions outside the entity’s normal business have been authorised and approved by management, directors, or shareholders in certain circumstances, the auditor may infer that these have been properly considered at the appropriate level within the entity and the approval may also provide audit evidence that they have been properly disclosed in the financial statements.

On the other hand when such transactions are not subject to authorisation and approval and in the absence of rational explanations, they may represent a risk of material misstatement due to error or fraud. In any case, if the entity is subject to dominant influence by a related party or in view of the possibility of collusion between related parties, authorisation and approval may not be effective and may not provide sufficient evidence to exclude the risk of misstatement due to fraud.

When auditing a smaller entity the auditor may rely less on authorisation and approval to obtain audit evidence in respect of significant related party transactions outside the entity’s normal business. In fact a smaller entity is unlikely to have the type of controls available in a larger entity with different levels of authority and approval. In such circumstances the auditor may perform other procedures like inspecting relevant documentation, confirming aspects of the transactions with relevant parties or observing the involvement of the owner-manager with the transactions.

FRAUD RISK FACTORS

One of the objectives of the audit is that of identifying fraud risk factors arising from related parties and assessing the probability that they can lead to fraudulent financial reporting.

For such purpose the auditor should remain alert to fraud risk factors throughout the audit and, as already mentioned, especially when:

  • Considering the fraud potential of related parties at the engagement team discussion;
  • Considering whether the features of the entity’s control environment may deter or facilitate fraud, especially in terms of potential management override of controls;
  • Considering the fraud implications of the intentional non-disclosure by management of related party relationships or transactions; and
  • The business rationale of significant related party transactions outside the normal business of the entity is evaluated.

RELATED PARTY WITH DOMINANT INFLUENCE

Related parties may be in a position to exert dominant influence over an entity or its management and, when a single person or small group of persons is capable of exerting such influence, that represents a fraud risk factor.

The auditor may recognise the existence of dominant influence by a related party when some indicators, suggested by ISA 550, are present. That could be the case when, for instance:

  • The related party has vetoed some significant business decisions taken by management or directors;
  • Significant transactions require final approval by the related party;
  • When business proposals are initiated by the related party they are not questioned by management or directors;
  • Transactions involving the related party are not independently authorised or approved.

Dominant influence may also exist when the related party has been a founder of the entity and continues to be significantly involved in its management. That could often be the case for the owner-manager of a smaller entity and the auditor should consider that dominant influence is more likely than not to exist in owner-managed entities.

When other risk factors are present alongside the fraud risk factor of a related party with dominant influence, that may indicate significant risks of material misstatement due to fraud.

Such significant risk may exist if there is a high turnover of management or professional advisers, as in certain cases that may suggest that the related party is imposing unethical or fraudulent business practices to serve its own purposes.

Similarly, if business intermediaries are used for significant transactions that do not have a clear business rationale, that may indicate that the dominant related party may have an interest in such transactions and may control the intermediaries for fraudulent purposes.

If the auditor has assessed a significant risk of misstatement due to fraud as a result of the existence of a related party with dominant influence, the auditor should apply the requirements of ISA 240, which deals specifically with fraud. The procedures required by ISA 240 may include, among others, testing of the appropriateness of journal entries and other adjustments in the preparation of the financial statements and reviewing accounting estimates for bias.

In addition to applying the requirements of ISA 240, the auditor may perform some other procedures to understand what business relationships the dominant related party may have established, directly or indirectly, with the entity and to determine whether further substantive procedures are needed.

The procedures that can be performed to obtain such understanding may include:

  • Direct enquiry of the related party
  • Background research of certain transactions, for instance control of intermediaries may be researched using company registrar’s information or business information databases
  • Review of significant contracts with related parties or intermediaries
  • Review of employee whistle-blowing reports if available.

Discovery of unidentified or undisclosed related parties or transactions

The auditor may discover information or arrangements indicating the existence of related party relationships or significant transactions that have not been previously identified or disclosed by management.

In such a case, the auditor should probe the underlying circumstances and, if previously undisclosed related parties or significant transactions are identified, it will be necessary to take action and perform various procedures to respond to the risks that the discovery involves.

In particular the auditor will have to:

  • Communicate promptly the newly identified related parties to the engagement team as this may affect the results of risk assessment already performed and the further audit procedures needed;
  • Ask management to identify all transactions with the newly identified related parties and inquire why the entity’s controls failed to detect the party or transactions;
  • Perform substantive audit procedures in respect of the identified parties or transactions;
  • Reconsider the risk that other unidentified related parties or transactions may exist and perform further procedures to identify them if necessary; and
  • If the non-disclosure by management appears intentional, therefore indicating a risk of material misstatement due to fraud, evaluate the implications for the audit.

Substantive audit procedures that can be performed in respect of the newly identified related parties or transactions can include:

  • Enquiries about the nature of the relationships with the newly identified related parties, including inquiring parties outside the entity who may have significant knowledge of the entity and its business; these could be legal advisers, agents, consultants or other close business partners;
  • Analysing accounting records to identify further transactions with the newly identified related parties;
  • Checking the terms and conditions of transactions with the newly identified related parties and verifying if they have been accounted for and disclosed in line with the applicable financial reporting requirements.

If management has intentionally not disclosed to the auditor-related party relationships or significant transactions, the omission would represent a considerable risk of material misstatement due to fraud. In such a case the requirements and guidance in ISA 240 in respect of the auditor’s responsibilities relating to fraud in an audit of financial statements will apply.

In particular the possible involvement of management in a misstatement due to fraud requires reconsidering the reliability of the audit evidence previously obtained, as this may raise doubts about the completeness and truthfulness of the representations made by management and the genuineness of accounting records and documentation. In turn, this will require the auditor to re-evaluate the assessment of the risks of material misstatement due to fraud and the nature, timing and extent of the audit procedures to respond to the assessed risks. In other words the intentional non-disclosure by management of related parties and its potential involvement in fraud requires a substantial re-planning of the audit.

Additionally, in accordance with ISA 240, the fact that the auditor has significant concern about the integrity of management or the directors of the entity, as it could the case if management intentionally omitted to disclose related party information to the auditor for fraudulent purposes, is one of the exceptional circumstances that brings into question the auditor’s ability to continue performing the audit. In such circumstances the auditor should consider whether it is appropriate to withdraw from the engagement.

ARM’S-LENGTH ASSERTIONS FOR RELATED PARTY TRANSACTIONS

An entity could make a statement in the financial statements that a related party transaction was conducted on terms equivalent to those that prevail in an arm’s-length transaction. When these types of statements are included in the financial statements, the auditor should obtain sufficient appropriate audit evidence to verify the assertion.

The auditor may face some practical difficulties when trying to obtain audit evidence in respect of all the various aspects of a related party transaction. In fact, while the auditor may be able to confirm that such a transaction has been conducted at market price, like a similar arm’s-length transaction, as audit evidence in that respect may be readily available, it may be difficult to confirm whether other terms and conditions are equivalent to those that would apply with an independent party. For instance the transaction may feature different credit terms or provisions for contingencies or charges.

However financial reporting frameworks normally require management to make an arm’s-length statement in respect of related party transactions only if such assertion can be substantiated, as it is the case for FRS 102 and IAS 24, Related Party Disclosures. The auditor should therefore be able to obtain sufficient appropriate audit evidence by testing the management’s support for the arm’s-length assertion.

If, for instance, management has based its assertion on comparing the terms of the related party transaction with those of an identical or similar one with unrelated parties or with the known market terms for broadly similar transactions, the auditor may consider whether the approach taken by management is appropriate to support the assertion and may verify the source of the internal or external data and check whether the data is accurate, complete and relevant.

EVALUATION OF THE ACCOUNTING FOR AND DISCLOSURE OF RELATED PARTIES

In forming an opinion on the overall financial statements the auditor will need to evaluate whether:

  1. Accounting and disclosure of related party relationships and transactions comply with the requirements of the applicable financial reporting framework, and
  2. The effects of the related party relationships and transactions prevent the financial statements to achieve fair presentation.

The evaluation of related party disclosures in respect of the applicable financial reporting requirements may need special attention by the auditor as they may be complex and are often a source of material misstatement. The same complexity and excessive detail of the disclosures may actually obscure the substance of the related party transactions.

Related party disclosures should be evaluated considering whether the facts and circumstances of the entity have been appropriately summarised and presented so that disclosures are understandable. Disclosures may not be understandable if the business rationale and the effects of the transactions on the financial statements are unclear or if the key terms, conditions or other important elements necessary for understanding the transactions are not appropriately disclosed.

OTHER REQUIREMENTS IN ISA 550

The auditor is required to obtain written representations from the entity’s management, and in certain circumstances from directors when these are not involved in managing the entity, that:

  1. They have disclosed to the auditor the identity of related parties and all the related party relationships and transactions they are aware of; and
  2. They have accounted for and disclosed such relationships and transactions as required by the reporting framework.

The auditor may request written representations from directors to confirm oral representations on details of certain related party transactions or when they have interests in related party transactions.

Additionally, unless all the directors are involved in managing the entity, the auditor is required to communicate with directors (those charged with governance) significant related party matters arising during the audit.

Discussing with directors significant related party issues, as they arise during the audit, helps in reaching a common understanding of facts and circumstances and in finding a resolution to these issues on a timely basis.

Significant related party matters that can be discussed with directors include non-disclosure (intentional or not) by the management of related parties or significant transactions, which may alert directors of the existence of relationships or transactions of which they were not aware.

Similarly the auditor may point out to directors significant related party transactions not appropriately authorised and approved, which may indicate suspected fraud.

The auditor should also discuss with directors any disagreement with management about the disclosure of related party transactions under the applicable financial reporting requirements.

In respect of related parties documentation, ISA 550 requires the auditor to document the names of the identified related parties and the nature of the related party relationships.

The schedule below illustrates the documentation requirements in respect of related parties included in ISA 550 and relates to a family-owned/managed business consisting of a hotel and leisure centre.

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