[460] Related parties

Transcription

1 [460] Related parties (Issued November 1995) Contents Paragraphs Introduction 1 17 Identification of related parties and related party transactions Examining identified related party transactions and disclosures Disclosures relating to control of the entity Directors representations Audit conclusions and reporting Compliance with International Standards on Auditing 43 Effective date 44

2 Related parties Statements of Auditing Standards ( SASs ) are to be read in the light of The scope and authority of APB pronouncements. In particular, they contain basic principles and essential procedures ( Auditing Standards ), indicated by paragraphs in bold type, with which auditors are required to comply in the conduct of any audit. SASs also include explanatory and other material which is designed to assist auditors in interpreting and applying Auditing Standards. The definitions in the Glossary of terms are to be applied in the interpretation of SASs. Introduction The purpose of this SAS is to establish standards and provide guidance on auditing related party transactions, establishing the ultimate controlling party of the reporting entity and their respective disclosure in financial statements. Disclosure requirements with respect to related party transactions and control of an entity are found, for example, in companies legislation, accounting standards and stock exchange listing rules. The auditors should plan and perform the audit with the objective of obtaining sufficient audit evidence regarding the adequacy of the disclosure of related party transactions and control of the entity in the financial statements. (SAS 460.1) Definitions and scope Definitions of related parties, related party transaction, control and key management are given in Financial Reporting Standard 8 Related party disclosures (FRS 8) and are adopted for the purposes of this SAS. FRS 8 does not override the disclosure requirements of either companies legislation or stock exchange listing rules. Similarly, the requirements of FRS 8 do not override exemptions from disclosure given by law to, and utilised by, certain types of entity. For the purposes of this SAS companies legislation is defined as: (a) in Great Britain, the Companies Act 1985; (b) in Northern Ireland, The Companies (Northern Ireland) Order 1986; and (c) in the Republic of Ireland, the Companies Acts and the European Communities (Companies: Group Accounts) Regulations FRS 8 exempts the disclosure of certain related party transactions undertaken by an entity. In exceptional circumstances if an entity avails itself of an exemption contained in an accounting standard this may be inconsistent with the overriding requirement for the financial statements to give a true and fair view of the state of the entity s affairs. In the course of an audit the auditors may become aware of transactions that are exempt from disclosure under FRS 8. The auditors assess whether such related party transactions need to be disclosed in order for the financial statements to give a true and fair view. Inherent difficulties of detection The definition of a related party is complex and in part subjective and it may not always be self-evident to management whether a party is related. Furthermore,

3 many accounting systems are not designed to either distinguish or summarise related party transactions. Management may, therefore, have to carry out additional analysis of the accounting records to identify related party transactions. Accordingly related party transactions are often inherently difficult for auditors to detect. 7 These difficulties are heightened by the particular perspective to the concept of materiality introduced by FRS 8 which states: The materiality of related party transactions is to be judged, not only in terms of their significance to the reporting entity, but also in relation to the other related party when that party is: (a) a director, key manager or other individual in a position to influence, or accountable for stewardship of, the reporting entity; or (b) a member of the close family of any individual mentioned in (a) above; or (c) an entity controlled by any individual mentioned in (a) or (b) above. Although auditors design audit procedures so as to have a reasonable expectation of detecting undisclosed related party transactions that are material to the reporting entity, an audit cannot necessarily be expected to detect all such transactions; nor can it be expected to detect transactions that are not material to the entity, even though they may be material to the other related party. 8 The risk that undisclosed related party transactions will not be detected by the auditors is especially high when: (a) related party transactions have taken place without charge; (b) related party transactions are not self-evident to the auditor; (c) transactions are with a party that the auditor could not reasonably be expected to know is a related party; or (d) active steps have been taken by directors or management to conceal either the full terms of a transaction, or that a transaction is, in substance, with a related party. 9 Directors or management may wish to conceal the fact that a transaction is with a related party because: (a) its disclosure may be sensitive to the parties involved and the directors may be reticent about disclosing it; and (b) the transaction may be motivated by other than ordinary business considerations, for example to enhance the presentation of the financial statements (for example window dressing) or even fraud. Related party transactions may be concealed in whole or in part from the auditors for fraudulent or other purposes. The likelihood of detecting fraudulent related party transactions depends upon the nature of the fraud and, in particular, the degree of collusion, the seniority of those involved and the level of deception concerned. Statement of Auditing Standards 110 Fraud and error establishes the standards and provides the guidance on the auditors responsibility to consider fraud and error in an audit of financial statements, including related party transactions. Overseas activities 10 The requirements of this SAS apply to overseas activities irrespective of whether such overseas activities are carried on by a subsidiary of a United Kingdom or Irish

4 parent, or an associate, joint venture, division or employee of the entity based overseas. Accordingly, when an entity conducts activities overseas the auditors take steps to ensure that audit work relating to related parties is carried out in accordance with the requirements of this SAS. The auditors also take steps to ensure that the auditors of overseas components are familiar with the content of both this SAS, FRS 8, and other disclosure requirements affecting the entity. 11 Responsibilities of the directors The directors are responsible for the identification of related party transactions. The existence of related parties or related party transactions may affect the financial statements. For example: the entity s tax liability and expense may be affected by tax legislation which requires special attention when related parties exist; the entity may be engaged in transfers of goods and services with related parties in accordance with specified transfer pricing policies or under reciprocal trading arrangements, such as barter transactions, which may give rise to accounting recognition and measurement issues. As transactions between related parties may not be on an arm s length basis and there may be an actual, or perceived, conflict of interest the directors usually ensure that such transactions are subject to appropriate approval procedures. Material related party transactions are often formally approved by the board of directors. In owner managed entities although the risks associated with such transactions are the same there is less need for formalised procedures because the owner manager is often personally aware of, and implicitly or explicitly approves, all such transactions. The directors are also responsible for the disclosure of related party transactions in the financial statements. This responsibility arises because companies legislation, accounting standards and stock exchange listing rules require certain related party transactions and control of the entity to be disclosed in the financial statements Quality of evidence about related party transactions Evidence about related party transactions, given the nature of certain related party relationships may: (a) be limited, for example an instruction from a parent to a subsidiary undertaking to record a royalty expense; or (b) although not limited, be created by the related party, for example a confirmation of the existence of stocks held by a related party on consignment. The source of audit evidence affects the auditors assessment of its reliability. A greater degree of reliance may be placed on audit evidence that is obtained from or created by unrelated third parties. Unless the audit reveals evidence to the contrary, the auditors are entitled to accept representations, by directors and management, as truthful and records and documents as genuine. However, the auditors plan and perform the audit with an attitude

5 of professional scepticism, recognising that conditions or events may be found that indicate that undisclosed related party transactions exist. The degree of the auditors scepticism increases when they have concerns about the integrity of the directors or where the operating style of management does not place a high priority on financial statement disclosure. Identification of related parties and related party transactions 18 When planning the audit the auditors should assess the risk that material undisclosed related party transactions may exist. (SAS 460.2) 19 The directors responsibilities to identify, approve and disclose related party transactions require them to implement adequate accounting and internal control systems that identify related parties and ensure that related party transactions are appropriately identified in the accounting records and disclosed in the financial statements. When making their preliminary assessments of inherent and control risk the auditors obtain an understanding of such accounting and internal control systems. 20 The extent to which formal policies and codes of conduct dealing with relationships with related parties are maintained normally depends on the significance of related parties and on the philosophy and operating style of the directors and management of the entity. Such policies often cover the approval, recording and reporting of related party transactions entered into, on behalf of the entity, by directors and employees. When making their preliminary assessment of control risk the auditors may decide to obtain audit evidence with respect to related party transactions from testing the operation of such controls. Generally, the higher the auditors assessment of control risk, with respect to related parties, the more emphasis is placed on substantive procedures when developing the audit programme. 21 In respect of entities that do not have formal policies and codes of conduct concerning related party transactions, for example owner managed entities, the auditors may only be able to perform substantive procedures. If the auditors assess the risk of undisclosed related party transactions as low such planned substantive procedures may not need to be extensive. 22 The auditors should review for completeness information provided by the directors identifying material transactions with those parties that have been related parties for any part of the financial period. (SAS 460.3) 23 During the course of the audit, the auditors may carry out procedures which assist them in assessing the completeness of the information provided by the directors. Examples include: reviewing minutes of meetings of shareholders and directors and other relevant statutory records such as the register of directors interests; reviewing accounting records for large or unusual transactions or balances, in particular transactions recognised at or near the end of the financial period; reviewing confirmations of loans receivable and payable and confirmations from banks. Such a review may indicate the relationship, if any, of guarantors to the entity;

6 reviewing investment transactions, for example purchase or sale of an interest in a joint venture or other entity. After evaluating the results of: (a) any tests of control performed with respect to related party transactions; and (b) the procedures described in the preceding paragraph, 24 the auditors may determine that few additional substantive audit procedures are required to obtain reasonable assurance that no other material related party transactions have occurred. However, if the auditors assess the controls with respect to related party transactions as weak, they may determine that it is necessary to perform substantive procedures that were not initially in the audit programme to obtain reasonable assurance that no material undisclosed related party transactions have occurred. Such substantive procedures may include one or more of the following: enquiry of management and the directors as to whether transactions have taken place with related parties that are required to be disclosed by the disclosure requirements, such as FRS 8, that are applicable to the entity; review of prior year working papers for names of known related parties; enquiry as to the names of all pension and other trusts established for the benefit of employees and the names of their management and trustees; enquiry as to the affiliation of directors and officers with other entities; review of the register of interests in shares to determine the names of principal shareholders; enquiry of other auditors currently involved in the audit, or predecessor auditors, as to their knowledge of additional related parties; review of the entity s tax returns, listing documents supplied to Stock Exchanges, returns made under companies legislation and other information supplied to regulatory agencies for evidence of the existence of related parties; review of invoices and correspondence from lawyers for indications of the existence of related parties or related party transactions. The auditors should be alert for evidence of material related party transactions that are not included in the information provided by the directors. (SAS 460.4) Although related party transactions are a routine and necessary part of the operations of many entities the auditors are, nevertheless, alert for evidence of related party transactions that may not have been identified, or disclosed, by the directors. Auditors are therefore alert for evidence of transactions that appear unusual such as: transactions which have abnormal terms of trade, such as unusual prices, interest rates, guarantees and repayment terms; transactions which appear to lack a logical business reason for their occurrence; transactions in which substance differs from form; transactions processed or approved in a non-routine manner or by personnel who do not ordinarily deal with such transactions; unusual transactions which are entered into shortly before or after the end of the financial period

7 28 FRS 8 requires disclosure of any other elements of the [related party] transactions necessary for an understanding of the financial statements. An example falling within this requirement would be the need to give an indication that the transfer of a major asset had taken place at an amount materially different from that obtainable on normal commercial terms. The auditors, therefore, are alert for related party transactions that have occurred on other than normal commercial terms. In particular, the auditors are alert for unrecorded transactions such as the receipt or provision of management services at no charge. 29 The auditors consider the implications for other aspects of their audit if they identify material related party transactions not included in the information provided by the directors. In particular, the auditors consider the impact on their assessment of audit risk and the reliance placed on other representations made by directors during the course of the audit. Examining identified related party transactions and disclosures 30 The auditors should obtain sufficient appropriate audit evidence that material identified related party transactions are properly recorded and disclosed in the financial statements. (SAS 460.5) 31 Where evidence about a related party transaction is limited, the auditors consider performing procedures such as: discussing the purpose of the transaction with management or the directors; confirming the terms and amount of the transaction with the related party; corroborating with the related party the explanation of the purpose of the transaction and, if necessary, confirming that the transaction is bona-fide. 32 In circumstances where the audit evidence held by the entity is created by the related party the auditors consider performing procedures such as: obtaining evidence from an unrelated third party; confirming explanations received concerning the transaction (especially regarding its purpose) with persons associated with the transaction, such as bankers, lawyers, guarantors and agents. 33 In assessing whether an identified related party transaction that is not material to the reporting entity is nevertheless required to be disclosed because of its significance to the related party, as described in paragraph 7 above, the auditors discuss with the directors how the directors have formed their judgment on the relevant item. Disclosures relating to control of the entity 34 The auditors should obtain sufficient appropriate audit evidence that disclosures in the financial statements relating to control of the entity are properly stated. (SAS 460.6) 35 FRS 8 requires, when the reporting entity is controlled by another party, there should be disclosure of the related party relationship and the name of that party and, if different, that of the ultimate controlling party. If the controlling party or ultimate

8 controlling party of the entity is not known, that fact should be disclosed. Companies legislation contains additional detailed disclosure requirements relating to control of a company. The auditors may only be able to determine the name of the entity s ultimate controlling party through specific enquiry of management or the directors. When they consider it necessary, the auditors obtain corroboration from the ultimate controlling party confirming the directors representations in this regard. 36 Directors representations The auditors should obtain written representations from the directors concerning the completeness of information provided regarding the related party and control disclosures in the financial statements. (SAS 460.7) The written representations obtained by the auditors include confirmation from the board of directors that they (and any key managers or other individuals who are in a position to influence, or who are accountable for the stewardship of, the reporting entity) have disclosed all transactions relevant to the entity and that they are not aware of any other such matters required to be disclosed in the financial statements, whether under FRS 8 or other requirements. An entity may require its directors and managers to sign individual declarations on these disclosure matters. In view of the inherent difficulties of detecting undisclosed related party transactions (in particular, transactions that are not material to the entity), and having regard to the conclusions drawn from other audit evidence, the auditors may wish to inspect the individual declarations. For this purpose, it may be helpful if they are addressed jointly to the designated official of the entity and also to the auditors. In other cases, the auditors may wish to obtain representations directly from each director and from other members of management Audit conclusions and reporting The auditors should consider the implications for their report if: (a) they are unable to obtain sufficient appropriate audit evidence concerning related parties and transactions with such parties; or (b) the disclosure of related party transactions or the controlling party of the entity in the financial statements is not adequate. (SAS 460.8) If the auditors are unable to obtain sufficient appropriate audit evidence concerning related parties and transactions with such parties, this is a limitation on the scope of the audit. Accordingly, the auditors consider the need to issue either a qualified opinion or a disclaimer of opinion in accordance with the standards set out in SAS 600 Auditors reports on financial statements. If the auditors conclude that the disclosure of related party transactions is not adequate they consider the need to issue either a qualified or adverse opinion depending on the particular circumstances. Where the auditors are aware of material undisclosed related party transactions or an undisclosed control relationship, that in their opinion are required to be disclosed, the opinion section of their report,

9 whenever practicable, includes the information that would have been included in the financial statements had the relevant requirements been followed. Compliance with International Standards on Auditing 43 Compliance with the Auditing Standards contained in this SAS ensures compliance in all material respects with the requirements of the basic principles and essential procedures identified in International Standard on Auditing 550 Related parties (ISA 550) except that: (a) in the absence of any indication of a material misstatement of related party disclosures, ISA 550 permits auditors to limit their audit procedures to those identified in the ISA. Although the SAS sets out basic principles and essential procedures those procedures are not presumed necessarily to provide, of themselves, sufficient appropriate audit evidence; and (b) ISA 550 requires auditors to consider the adequacy of control procedures over the authorization and recording of related party transactions. This SAS although not requiring auditors to consider the adequacy of such controls does provide guidance to auditors for those circumstances where the testing of controls over related party transactions forms part of the audit approach. Effective date 44 Auditors are required to comply with the Auditing Standards contained in this SAS in respect of audits of financial statements for periods commencing on or after 23 December 1995.

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