Related-party transactions can occur when a company conducts business with individuals or entities that have a close relationship with the company, its directors, management, or shareholders. These transactions may involve sales, purchases, loans, management fees, or other financial arrangements.
For companies engaging Audit Services Singapore, related-party transactions can receive particular attention because their nature and terms may affect financial reporting and disclosures. Auditors generally need to understand the relationships involved and obtain appropriate evidence about significant transactions.
What Is a Related-Party Transaction?
A related-party transaction is generally a transaction between an entity and a party that has a relationship with the entity that can affect how the parties interact.
Examples can include transactions involving:
- Directors or key management personnel
- Companies under common control
- Parent or subsidiary companies
- Entities controlled by significant shareholders
- Close family members of relevant individuals
- Businesses with significant influence over the reporting entity
The exact definition depends on the applicable accounting framework.
Why Auditors Examine These Transactions
Related-party transactions may have accounting and disclosure implications that differ from ordinary business transactions.
Auditors therefore need to determine whether relevant transactions have been properly identified, recorded, and disclosed in the financial statements.
The audit may also consider whether the transaction has been conducted on terms that require further examination or explanation.
Identifying Related Parties
One of the first steps is understanding who may qualify as a related party.
Auditors may review corporate records, organizational structures, shareholder information, director details, and management-provided information.
They may also ask management about relationships that are not immediately apparent from the accounting records.
Reviewing Management’s Declarations
Management may provide information about known related parties and transactions.
Auditors can compare this information with other evidence obtained during the engagement.
This can help identify inconsistencies or transactions that require additional investigation.
Examining Corporate Records
Corporate documents can provide useful evidence about relationships between parties.
Auditors may review items such as:
- Shareholder records
- Director information
- Group structures
- Board minutes
- Ownership documents
- Corporate registers
- Agreements involving connected entities
These records can help establish the nature of relationships relevant to the audit.
Reviewing the General Ledger
The accounting records may contain transactions with related parties that need further examination.
Auditors can use the general ledger and other accounting data to identify unusual transactions, balances, descriptions, or counterparties.
Transactions involving directors, shareholders, affiliated companies, or unusual accounts may receive additional attention depending on the circumstances.
Examining Significant Transactions
Large or unusual related-party transactions may require detailed review.
Auditors may examine the underlying contracts, invoices, payment records, approvals, and accounting entries.
The objective is to understand what occurred and assess whether the transaction has been appropriately reflected in the financial statements.
Reviewing Agreements and Contracts
Contracts can explain the commercial terms of related-party arrangements.
For example, an agreement may establish the amount of a management fee, loan interest, rental payment, or service charge.
Auditors may compare the accounting records with the contractual terms and investigate significant differences.
Examining Loans and Advances
Loans, advances, and other financial arrangements between related parties can be particularly relevant.
Auditors may examine:
- Loan agreements
- Interest terms
- Repayment schedules
- Outstanding balances
- Payment records
- Security arrangements
- Relevant approvals
These records can help auditors understand the substance and accounting treatment of the arrangement.
Reviewing Transactions With Directors
Transactions involving directors can require careful examination because directors may have authority or influence over company decisions.
Depending on the circumstances, auditors may review director-related payments, loans, reimbursements, contracts, or other transactions.
Relevant corporate approvals and financial statement disclosures may also be considered.
Checking Transactions Near Year-End
Transactions occurring close to the reporting date may receive attention as part of audit procedures.
Auditors may examine whether related-party transactions have been recorded in the correct accounting period and whether outstanding balances are appropriately reflected.
This can involve reviewing invoices, contracts, payment records, and subsequent transactions.
Assessing the Business Purpose
Auditors may seek to understand why a related-party transaction occurred.
A clear commercial purpose can help explain the nature of the transaction and its accounting treatment.
Where a transaction appears unusual or lacks clear supporting information, auditors may perform additional procedures to obtain sufficient evidence.
Considering Transaction Terms
The terms of a related-party transaction can be relevant to the audit.
Auditors may consider pricing, payment conditions, interest rates, guarantees, repayment arrangements, or other contractual terms.
Comparisons with similar transactions may sometimes provide useful context, although the appropriate audit procedures depend on the specific circumstances.
Checking Financial Statement Disclosures
Related-party transactions may require disclosure under the applicable financial reporting framework.
Auditors examine whether relevant relationships, transactions, outstanding balances, and other required information have been appropriately presented or disclosed.
They may compare the proposed disclosures with supporting records and information obtained during the audit.
Looking for Unrecorded Transactions
Not every related-party transaction is necessarily obvious from the accounting records.
Auditors may perform procedures designed to identify transactions that have not been initially disclosed or recorded as related-party transactions.
These procedures can include reviewing minutes, confirmations, contracts, unusual journal entries, and other available evidence.
Evaluating Management Representations
Management representations can form part of the audit evidence concerning related-party relationships and transactions.
However, representations are considered alongside other audit evidence rather than necessarily being the sole basis for an audit conclusion.
Auditors may seek corroborating evidence when appropriate.
Reviewing Journal Entries
Journal entries involving related parties may receive additional attention when they are unusual, significant, or made near the end of the reporting period.
Auditors may examine the purpose of the entry, supporting documentation, authorization, and resulting financial statement impact.
This can help identify entries that require further clarification.
Common Documentation Auditors May Request
Businesses should be prepared to provide documentation relevant to identified related-party transactions.
This may include:
- Contracts and agreements.
- Invoices and receipts.
- Bank statements.
- Board or shareholder approvals.
- Loan documentation.
- Ownership records.
- Management fee calculations.
- Correspondence concerning significant arrangements.
- Reconciliation schedules.
- Supporting accounting entries.
The precise documents requested will depend on the transaction and audit engagement.
Challenges in Auditing Related-Party Transactions
Related-party auditing can become more complex when ownership structures are complicated or relationships are not clearly documented.
Other challenges may include transactions involving overseas entities, informal arrangements, incomplete records, or changes in ownership during the reporting period.
Maintaining an updated record of relevant relationships can make the process easier.
How Businesses Can Prepare
Companies can improve their audit readiness by maintaining a current related-party register and documenting significant transactions throughout the year.
It is also useful to communicate changes in ownership, management, corporate structure, or connected relationships to the accounting and audit teams.
Good documentation helps establish a clear connection between the relationship, transaction, accounting treatment, and financial statement disclosure.
Conclusion
Related-party transactions can require careful audit attention because they involve relationships that may have implications for accounting, transparency, and financial statement disclosure. Auditors may examine corporate records, accounting entries, contracts, approvals, payment records, and other evidence to understand these transactions.
Businesses can support an efficient audit by identifying related parties early, maintaining complete documentation, and keeping clear records of significant arrangements. A structured approach throughout the financial year can make related-party transactions easier to explain and evaluate during the audit.
