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Definitions
Related party
A party is related to an entity if it fulfils the following criteria in terms of the substance of the relationship, and not merely the legal form:
Directly, or indirectly through one or more intermediaries
The party:
- has the ability to control, or is controlled by, or is under common control with the entity, control being the power to govern the financial and operating policies so as to benefit from its activities, e.g. institutions controlled by the EU; or
- exercises significant influence over the entity in making financial and operating decisions, i.e. the power to participate in the financial and operating policy decisions of an entity, but not to control those policies;
The party is an associate of the entity
The entity has significant influence and the party is neither controlled by nor a joint venture of the entity.
Related-party transactions
Related party transactions comprise a transfer of resources or obligations between related parties, regardless of whether a price is charged. Related-party transactions exclude transactions with another entity that is a related party solely because of its economic dependence on the reporting entity or the government of which it forms part. Many related-party transactions are in the normal course of business and carry no higher risk than transactions with unrelated parties.
Instructions
Management responsibilities
Management is responsible for the identification and disclosure of related parties and transactions with such parties, including implementing internal control to ensure that such transactions are appropriately identified in the information system and disclosed.
Related-party disclosure in the EU accounts
To promote accountability and transparency, the European Union (EU), as the controlling and reporting entity, requires the disclosure of
- the existence of related parties in all cases where control exists, irrespective of whether there have been transactions between the related parties
- information about transactions between the EU and its related parties in certain circumstances.
Such disclosure includes, other than for normal arm’s-length transactions:
- the nature of the related-party relationships;
- the types of transactions that have occurred; and
- a description of the transactions, e.g. class of transactions, volume, terms and conditions, and amounts.
Examples of situations where related-party transactions may lead to disclosures include:
- purchases or transfers/sales of property and other assets;
- leasing arrangements;
- transfer of research and development;
- license agreements;
- finance (including loans, capital contributions, grants); and
- guarantees and collateral.
In its [link new-window title="consolidated%20annual%20accounts" link="https%3A%2F%2Fec.europa.eu%2Finfo%2Fpublications%2Fannual-accounts_en" icon="external-link" /]
, the European Union includes a Note to the accounts on related parties, which concerns the remuneration and financial entitlements of key management staff of the EU consolidated entities.
Auditor's responsibilities
The auditor has a responsibility to perform procedures to identify, assess and respond to the risks of material misstatement arising from the entity’s failure appropriately to account for or disclose related-party relationships, transactions or balances.
The auditor needs to be aware of related parties and transactions between such parties because:
- they may require disclosure in the financial statements;
- greater reliance may generally be placed on evidence from unrelated third parties;
- such relationships may expose an entity to risks not existing otherwise;
- such transactions may be motivated by reasons such as potential fraud.
Considerations when performing the audit
In responding to the [link title="assessed%20risk" link="%2Faware%2FGAP%2FPages%2FCA-FA%2FPlanning%2FAudit-risk-and-risk-assessment-procedures.aspx" /]
, the auditor undertakes appropriate audit procedures to address the risk of third-party relationships and transactions. If significant transactions outside the normal course of business are uncovered during the audit, the auditor should obtain an understanding of whether they involve third parties, and obtain evidence that such transactions have been approved.
Examples include transactions:
- having abnormal terms of trade or lacking an apparent logical business reason;
- where substance differs from form;
- which are processed in an unusual manner or unrecorded;
- which are of high volume or value with certain customers or suppliers.
Furthermore, the auditor should be alert for information indicating the existence of potential related parties and transactions not identified by management, including reviewing bank and legal confirmations and minutes of meetings of those charged with governance. In such instances, the auditor asks management to identify transactions with the newly-identified related parties, enquire as to why the controls did not identify or disclose these, and perform further audit procedures.
Disclosure of related-party relationships and transactions
The auditor should obtain sufficient, relevant and reliable audit evidence as to whether the identified related-party transactions have been properly recorded and disclosed. (S)he should also consider whether the related-party relationships and transactions could lead to the accounts failing to achieve fair presentation or transactions to be misleading.
Written representation on related parties
The auditor should obtain a [link new-window title="written%20representation" link="%2Faware%2FFA%2FPages%2FExamination%2FWritten-representations.aspx" /]
from management that:
- they have disclosed to the auditor the identity of related parties, relationships, and transactions of which they are aware;
- they have properly accounted for and disclosed such relationships and transactions.
If the auditor is unable to obtain sufficient, relevant and reliable [link new-window title="audit%20evidence" link="%2Faware%2FGAP%2FPages%2FAudit-evidence.aspx" /]
with regard to related parties and transactions with such parties or concludes that their disclosure in the financial statements is not adequate, the auditor should modify the auditor's [link new-window link %3D%2Faware%2FFA%2FPages%2FReporting%2FForming-an-opinion-in-financial-audit.aspx%22 title="opinion" /]
appropriately.
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