ISA (NZ) 550

1. This International Standard on Auditing (New Zealand) (ISA (NZ)) deals with the auditor’s responsibilities relating to related party relationships and transactions in an audit of financial statements. Specifically, it expands on how ISA (NZ) 315 (Revised 2019),¹ ISA (NZ) 330,² and ISA (NZ) 240³ are to be applied in relation to risks of material misstatement associated with related party relationships and transactions.

NZ1.1 For the purposes of this ISA (NZ), a reference to “management” is taken to mean “management, and where appropriate, those charged with governance”.

NZ1.2 In New Zealand, those charged with governance generally have responsibility for ensuring an entity meets its legal obligations in relation to the preparation of the financial statements. In these cases the process of financial reporting is usually delegated to management, but the responsibility for such matters remains with those charged with governance. In applying this standard the auditor shall apply professional judgement, using knowledge of the legal requirements and corporate governance practices of New Zealand as well as the particular engagement circumstances, to determine whether the requirements of this standard apply to management or those charged with governance or both.

2. Many related party transactions are in the normal course of business. In such circumstances, 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, in some circumstances, give rise to higher risks of material misstatement of the financial statements than transactions with unrelated parties. For example:.

• Related parties may operate through an extensive and complex range of relationships and structures, with a corresponding increase in the complexity of related party transactions.

• Information systems may be ineffective at identifying or summarising transactions and outstanding balances between an entity and its related parties.

• Related party transactions may not be conducted under normal market terms and conditions; for example, some related party transactions may be conducted with no exchange of consideration.

3. Because related parties are not independent of each other, many 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. Where the applicable financial reporting framework establishes such requirements, 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 in accordance with the requirements of the framework.

4. Even if the applicable financial reporting framework establishes minimal or no related party requirements, the auditor nevertheless needs to obtain an understanding of the entity’s related party relationships and transactions sufficient to be able to conclude whether the financial statements, insofar as they are affected by those relationships and transactions: (Ref: Para. A1)

1. Achieve fair presentation (for fair presentation frameworks); or (Ref: Para. A2)

2. Are not misleading (for compliance frameworks). (Ref: Para. A3)

5. In addition, 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 ISA (NZ) 240,⁴ because fraud may be more easily committed through related parties.

6. Owing to the inherent limitations of an audit, there is an unavoidable risk that some material misstatements of the financial statements may not be detected, even though the audit is properly planned and performed in accordance with the ISAs (NZ).⁵ In the context of related parties, the potential effects of inherent limitations on the auditor’s ability to detect material misstatements are greater for such reasons as the following:

• Management may be unaware of the existence of all related party relationships and transactions, particularly if the applicable financial reporting framework does not establish related party requirements.

• Related party relationships may present a greater opportunity for collusion, concealment or manipulation by management.

7. Planning and performing the audit with professional scepticism as required by ISA (NZ) 200⁶ is therefore particularly important in this context, given the potential for undisclosed related party relationships and transactions. The requirements in this ISA (NZ) are designed to assist the auditor in identifying and assessing the risks of material misstatement associated with related party relationships and transactions, and in designing audit procedures to respond to the assessed risks.

8. This ISA (NZ) is effective for audits of financial statements for periods beginning on or after 1 September, 2011.

9. The objectives of the auditor are:

1. Irrespective of whether the applicable financial reporting framework establishes related party requirements, to obtain an understanding of related party relationships and transactions sufficient to be able:

   1. To recognise fraud risk factors, if any, arising from related party relationships and transactions that are relevant to the identification and assessment of the risks of material misstatement due to fraud; and

   2. To conclude, based on the audit evidence obtained, whether the financial statements, insofar as they are affected by those relationships and transactions:

      1. Achieve fair presentation (for fair presentation frameworks); or

      2. Are not misleading (for compliance frameworks); and

2. In addition, where the applicable financial reporting framework establishes related party requirements, to obtain sufficient appropriate audit evidence about whether related party relationships and transactions have been appropriately identified, accounted for and disclosed in the financial statements in accordance with the framework.

10. For purposes of the ISAs (NZ), the following terms have the meanings attributed below:

1. Arm’s length transaction – A transaction conducted on such terms and conditions as between a willing buyer and a willing seller who are unrelated and are acting independently of each other and pursuing their own best interests.

2. Related party – A party that is either: (Ref: Para. A4-A7)

   1. A related party as defined in the applicable financial reporting framework; or

   2. Where the applicable financial reporting framework establishes minimal or no related party requirements:

      1. A person or other entity that has control or significant influence, directly or indirectly through one or more intermediaries, over the reporting entity;

      2. Another entity over which the reporting entity has control or significant influence, directly or indirectly through one or more intermediaries; or

      3. Another entity that is under common control with the reporting entity through having:

         1. Common controlling ownership;

         2. Owners who are close family members; or

         3. Common key management.

However, entities that are under common control by a state (that is, a national, regional or local government) are not considered related unless they engage in significant transactions or share resources to a significant extent with one another.

11. As part of the risk assessment procedures and related activities that ISA (NZ) 315 (Revised 2019) and ISA (NZ) 240 require the auditor to perform during the audit,⁷ the auditor shall perform the audit procedures and related activities set out in paragraphs 12- 17 to obtain information relevant to identifying the risks of material misstatement associated with related party relationships and transactions. (Ref: Para. A8)

12. The engagement team discussion that ISA (NZ) 315 (Revised 2019) and ISA (NZ) 240 require⁸ shall include specific consideration of the susceptibility of the financial statements to material misstatement due to fraud or error that could result from the entity’s related party relationships and transactions. (Ref: Para. A9-A10)

13. The auditor shall enquire of management regarding:

1. The identity of the entity’s related parties, including changes from the prior period; (Ref: Para. A11-A14)

2. The nature of the relationships between the entity and these related parties; and

3. Whether the entity entered into any transactions with these related parties during the period and, if so, the type and purpose of the transactions.

14. The auditor shall enquire of management and others within the entity, and perform other risk assessment procedures considered appropriate, to obtain an understanding of the controls, if any, that management has established to: (Ref: Para. A15-A20)

1. Identify, account for, and disclose related party relationships and transactions in accordance with the applicable financial reporting framework;

2. Authorise and approve significant transactions and arrangements with related parties; and (Ref: Para. A21)

3. Authorise and approve significant transactions and arrangements outside the normal course of business.

15. During the audit, the auditor shall remain alert, when inspecting records or documents, for arrangements or other information that may indicate the existence of related party relationships or transactions that management has not previously identified or disclosed to the auditor. (Ref: Para. A22-A23). In particular, the auditor shall inspect the following for indications of the existence of related party relationships or transactions that management has not previously identified or disclosed to the auditor:

1. Bank and legal confirmations obtained as part of the auditor’s procedures;

2. Minutes of meetings of shareholders and of those charged with governance; and

3. Such other records or documents as the auditor considers necessary in the circumstances of the entity.

16. If the auditor identifies significant transactions outside the entity’s normal course of business when performing the audit procedures required by paragraph 15 or through other audit procedures, the auditor shall enquire of management about: (Ref: Para. A24-A25)

1. The nature of these transactions; and (Ref: Para. A26)

2. Whether related parties could be involved. (Ref: Para. A27)

17. The auditor shall share relevant information obtained about the entity’s related parties with the other members of the engagement team. (Ref: Para. A28)

18. In meeting the ISA (NZ) 315 (Revised 2019) requirement to identify and assess the risks of material misstatement,⁹ the auditor shall identify and assess the risks of material misstatement associated with related party relationships and transactions and determine whether any of those risks are significant risks. In making this determination, the auditor shall treat identified significant related party transactions outside the entity’s normal course of business as giving rise to significant risks.

19. If the auditor identifies fraud risk factors (including circumstances relating to the existence of a related party with dominant influence) when performing the risk assessment procedures and related activities in connection with related parties, the auditor shall consider such information when identifying and assessing the risks of material misstatement due to fraud in accordance with ISA (NZ) 240. (Ref: Para. A6 and A29-A30)

20. As part of the ISA (NZ) 330 requirement that the auditor respond to assessed risks,¹⁰ the auditor designs and performs further audit procedures to obtain sufficient appropriate audit evidence about the assessed risks of material misstatement associated with related party relationships and transactions. These audit procedures shall include those required by paragraphs 21-24. (Ref: Para. A31-A34)

21. If the auditor identifies arrangements or information that suggests the existence of related party relationships or transactions that management has not previously identified or disclosed to the auditor, the auditor shall determine whether the underlying circumstances confirm the existence of those relationships or transactions.

22. If the auditor identifies related parties or significant related party transactions that management has not previously identified or disclosed to the auditor, the auditor shall:

1. Promptly communicate the relevant information to the other members of the engagement team; (Ref: Para. A35)

2. Where the applicable financial reporting framework establishes related party requirements:

   1. Request management to identify all transactions with the newly identified related parties for the auditor’s further evaluation; and

   2. Enquire as to why the entity’s controls over related party relationships and transactions failed to enable the identification or disclosure of the related party relationships or transactions;

3. Perform appropriate substantive audit procedures relating to such newly identified related parties or significant related party transactions; (Ref: Para. A36)

4. Reconsider the risk that other related parties or significant related party transactions may exist that management has not previously identified or disclosed to the auditor, and perform additional audit procedures as necessary; and

5. If the non-disclosure by management appears intentional (and therefore indicative of a risk of material misstatement due to fraud), evaluate the implications for the audit. (Ref: Para. A37)

23. For identified significant related party transactions outside the entity’s normal course of business, the auditor shall:

1. Inspect the underlying contracts or agreements, if any, and evaluate whether:

   1. The business rationale (or lack thereof) of the transactions suggests that they may have been entered into to engage in fraudulent financial reporting or to conceal misappropriation of assets;¹¹ (Ref: Para. A38-A39)

   2. The terms of the transactions are consistent with management’s explanations; and

   3. The transactions have been appropriately accounted for and disclosed in accordance with the applicable financial reporting framework; and

2. Obtain audit evidence that the transactions have been appropriately authorised and approved. (Ref: Para. A40-A41)

24. If management has made an assertion in the financial statements to the effect that a related party transaction was conducted on terms equivalent to those prevailing in an arm’s length transaction, the auditor shall obtain sufficient appropriate audit evidence about the assertion. (Ref: Para. A42-A45)

25. In forming an opinion on the financial statements in accordance with ISA (NZ) 700 (Revised),¹² the auditor shall evaluate: (Ref: Para. A46)

1. Whether the identified related party relationships and transactions have been appropriately accounted for and disclosed in accordance with the applicable financial reporting framework; and (Ref: Para. A47)

2. Whether the effects of the related party relationships and transactions:

   1. Prevent the financial statements from achieving fair presentation (for fair presentation frameworks); or

   2. Cause the financial statements to be misleading (for compliance frameworks).

26. [Amended by the NZAuASB.]

NZ26.1 Where the applicable financial reporting framework establishes related party requirements, the auditor shall obtain written representations from those charged with governance that: (Ref: Para. A48-A49)

1. They have disclosed to the auditor the identity of the entity’s related parties and all the related party relationships and transactions of which they are aware; and

2. They have appropriately accounted for and disclosed such relationships and transactions in accordance with the requirements of the framework.

27. Unless all of those charged with governance are involved in managing the entity,¹³ the auditor shall communicate with those charged with governance significant matters arising during the audit in connection with the entity’s related parties. (Ref: Para. A50)

28. The auditor shall include in the audit documentation the names of the identified related parties and the nature of the related party relationships.¹⁴

A1. An applicable financial reporting framework that establishes minimal related party requirements is one that defines the meaning of a related party but that definition has a substantially narrower scope than the definition set out in paragraph 10(b)(ii) of this ISA (NZ), so that a requirement in the framework to disclose related party relationships and transactions would apply to substantially fewer related party relationships and transactions.

A2. In the context of a fair presentation framework,¹⁵ related party relationships and transactions may cause the financial statements to fail to achieve fair presentation if, for example, the economic reality of such relationships and transactions is not appropriately reflected in the financial statements. For instance, fair presentation may not be achieved if the sale of a property by the entity to a controlling shareholder at a price above or below fair market value has been accounted for as a transaction involving a profit or loss for the entity when it may constitute a contribution or return of capital or the payment of a dividend.

A3. In the context of a compliance framework, whether related party relationships and transactions cause the financial statements to be misleading as discussed in ISA (NZ) 700 (Revised) depends upon the particular circumstances of the engagement. For example, even if non-disclosure of related party transactions in the financial statements is in compliance with the framework and applicable law or regulation, the financial statements could be misleading if the entity derives a very substantial portion of its revenue from transactions with related parties, and that fact is not disclosed. However, it will be extremely rare for the auditor to consider financial statements that are prepared and presented in accordance with a compliance framework to be misleading if in accordance with ISA (NZ) 210¹⁶ the auditor has determined that the framework is acceptable.¹⁷

A4. Many financial reporting frameworks discuss the concepts of control and significant influence. Although they may discuss these concepts using different terms, they generally explain that:

1. Control is the power to govern the financial and operating policies of an entity so as to obtain benefits from its activities; and

2. Significant influence (which may be gained by share ownership, statute or agreement) is the power to participate in the financial and operating policy decisions of an entity, but is not control over those policies.

A5. The existence of the following relationships may indicate the presence of control or significant influence:

1. Direct or indirect equity holdings or other financial interests in the entity.

2. The entity’s holdings of direct or indirect equity or other financial interests in other entities.

3. Being part of those charged with governance or key management (that is, those members of management who have the authority and responsibility for planning, directing and controlling the activities of the entity).

4. Being a close family member of any person referred to in subparagraph (c).

5. Having a significant business relationship with any person referred to in subparagraph (c).

A6. Related parties, by virtue of their ability to exert control or significant influence, may be in a position to exert dominant influence over the entity or its management. Consideration of such behaviour is relevant when identifying and assessing the risks of material misstatement due to fraud, as further explained in paragraphs A29-A30.

A7. In some circumstances, a special-purpose entity may be a related party of the entity because the entity may in substance control it, even if the entity owns little or none of the special-purpose entity’s equity.

A8. The public sector auditor’s responsibilities regarding related party relationships and transactions may be affected by the audit mandate, or by obligations on public sector entities arising from law, regulation or other authority. Consequently, the public sector auditor’s responsibilities may not be limited to addressing the risks of material misstatement associated with related party relationships and transactions, but may also include a broader responsibility to address the risks of non-compliance with law, regulation and other authority governing public sector bodies that lay down specific requirements in the conduct of business with related parties. Further, the public sector auditor may need to have regard to public sector financial reporting requirements for related party relationships and transactions that may differ from those in the private sector.

A9. Matters that may be addressed in the discussion among the engagement team include:

A10. In addition, the discussion in the context of fraud may include specific consideration of how related parties may be involved in fraud. For example:

A11. Where the applicable financial reporting framework establishes related party requirements, information regarding the identity of the entity’s related parties is likely to be readily available to management because the entity’s information systems will need to record, process and summarise related party relationships and transactions to enable the entity to meet the accounting and disclosure requirements of the framework. Management is therefore likely to have a comprehensive list of related parties and changes from the prior period. For recurring engagements, making the enquiries provides a basis for comparing the information supplied by management with the auditor’s record of related parties noted in previous audits.

A12. However, where the framework does not establish related party requirements, the entity may not have such information systems in place. Under such circumstances, it is possible that management may not be aware of the existence of all related parties. Nevertheless, the requirement to make the enquiries specified by paragraph 13 still applies because management may be aware of parties that meet the related party definition set out in this ISA (NZ). In such a case, however, the auditor’s enquiries regarding the identity of the entity’s related parties are likely to form part of the auditor’s risk assessment procedures and related activities performed in accordance with ISA (NZ) 315 (Revised 2019) to obtain information regarding the entity’s organisational structure, ownership, governance and business model.

In the particular case of common control relationships, as management is more likely to be aware of such relationships if they have economic significance to the entity, the auditor’s enquiries are likely to be more effective if they are focused on whether parties with which the entity engages in significant transactions, or shares resources to a significant degree, are related parties.

A13. In the context of a group audit, ISA (NZ) 600 (Revised) requires the group auditor to request component auditors to communicate on a timely basis related party relationships not previously identified by group management or the group auditor.¹⁸ Such information provides a useful basis for the group auditor’s enquiries of management regarding the identity of related parties.

A14. The auditor may also obtain some information regarding the identity of the entity’s related parties through enquiries of management during the engagement acceptance or continuance process.

A15. Others within the entity are those considered likely to have knowledge of the entity’s related party relationships and transactions, and the entity’s controls over such relationships and transactions. These may include, to the extent that they do not form part of management:

A16. The audit is conducted on the premise that management and, where appropriate, those charged with governance have acknowledged and understand that they have responsibility for the preparation of the financial statements in accordance with the applicable financial reporting framework, including where relevant their fair presentation, and for such internal control as management and, where appropriate, those charged with governance determine is necessary to enable the preparation of financial statements that are free from material misstatement, whether due to fraud or error.¹⁹ Accordingly, where the framework establishes related party requirements, the preparation of the financial statements requires management, with oversight from those charged with governance, to design, implement and maintain adequate controls over related party relationships and transactions so that these are identified and appropriately accounted for and disclosed in accordance with the framework. In their oversight role, those charged with governance monitor how management is discharging its responsibility for such controls. Regardless of any related party requirements the framework may establish, those charged with governance may, in their oversight role, obtain information from management to enable them to understand the nature and business rationale of the entity’s related party relationships and transactions.

A17. In meeting the ISA (NZ) 315 (Revised 2019) requirement to obtain an understanding of the control environment,²⁰ the auditor may consider features of the control environment relevant to mitigating the risks of material misstatement associated with related party relationships and transactions, such as:

A18. Controls over related party relationships and transactions within some entities may be deficient or non-existent for a number of reasons, such as:

• The low importance attached by management to identifying and disclosing related party relationships and transactions.

• The lack of appropriate oversight by those charged with governance.

• An intentional disregard for such controls because related party disclosures may reveal information that management considers sensitive, for example, the existence of transactions involving family members of management.

• An insufficient understanding by management of the related party requirements of the applicable financial reporting framework.

• The absence of disclosure requirements under the applicable financial reporting framework.

Where such controls are ineffective or non-existent, the auditor may be unable to obtain sufficient appropriate audit evidence about related party relationships and transactions. If this were the case, the auditor would, in accordance with ISA (NZ) 705²¹ consider the implications for the audit, including the opinion in the auditor’s report.

A19. Fraudulent financial reporting often involves management override of controls that otherwise may appear to be operating effectively.²² The risk of management override of controls is higher if management has relationships that involve control or significant influence with parties with which the entity does business because these relationships may present management with greater incentives and opportunities to perpetrate fraud. For example, management’s financial interests in certain related parties may provide incentives for management to override controls by (a) directing the entity, against its interests, to conclude transactions for the benefit of these parties, or (b) colluding with such parties or controlling their actions. Examples of possible fraud include:

A20. Controls in smaller entities are likely to be less formal and smaller entities may have no documented processes for dealing with related party relationships and transactions. An owner-manager may mitigate some of the risks arising from related party transactions, or potentially increase those risks, through active involvement in all the main aspects of the transactions. For such entities, the auditor may obtain an understanding of the related party relationships and transactions, and any controls that may exist over these, through enquiry of management combined with other procedures, such as observation of management’s oversight and review activities, and inspection of available relevant documentation.

A21. Authorisation involves the granting of permission by a party or parties with the appropriate authority (whether management, those charged with governance or the entity’s shareholders) for the entity to enter into specific transactions in accordance with pre-determined criteria, whether judgemental or not. Approval involves those parties’ acceptance of the transactions the entity has entered into as having satisfied the criteria on which authorisation was granted. Examples of controls the entity may have established to authorise and approve significant transactions and arrangements with related parties or significant transactions and arrangements outside the normal course of business include:

A22. During the audit, the auditor may inspect records or documents that may provide information about related party relationships and transactions, for example:

A23. An arrangement involves a formal or informal agreement between the entity and one or more other parties for such purposes as:

A24. Obtaining further information on significant transactions outside the entity’s normal course of business enables the auditor to evaluate whether fraud risk factors, if any, are present and, where the applicable financial reporting framework establishes related party requirements, to identify the risks of material misstatement.

A25. Examples of transactions outside the entity’s normal course of business may include:

A26. Enquiring into the nature of the significant transactions outside the entity’s normal course of business involves obtaining an understanding of the business rationale of the transactions, and the terms and conditions under which these have been entered into.

A27. A related party could be involved in a significant transaction outside the entity’s normal course of business not only by directly influencing the transaction through being a party to the transaction, but also by indirectly influencing it through an intermediary. Such influence may indicate the presence of a fraud risk factor.

A28. Relevant related party information that may be shared among the engagement team members includes, for example:

A29. Domination of management by a single person or small group of persons without compensating controls is a fraud risk factor.²³ Indicators of dominant influence exerted by a related party include:

A30. In the presence of other risk factors, the existence of a related party with dominant influence may indicate significant risks of material misstatement due to fraud. For example:

A31. The nature, timing and extent of the further audit procedures that the auditor may select to respond to the assessed risks of material misstatement associated with related party relationships and transactions depend upon the nature of those risks and the circumstances of the entity.²⁴

A32. Examples of substantive audit procedures that the auditor may perform when the auditor has assessed a significant risk that management has not appropriately accounted for or disclosed specific related party transactions in accordance with the applicable financial reporting framework (whether due to fraud or error) include:

A33. If the auditor has assessed a significant risk of material misstatement due to fraud as a result of the presence of a related party with dominant influence, the auditor may, in addition to the general requirements of ISA (NZ) 240, perform audit procedures such as the following to obtain an understanding of the business relationships that such a related party may have established directly or indirectly with the entity and to determine the need for further appropriate substantive audit procedures:

A34. Depending upon the results of the auditor’s risk assessment procedures, the auditor may consider it appropriate to obtain audit evidence without testing the entity’s controls over related party relationships and transactions. In some circumstances, however, it may not be possible to obtain sufficient appropriate audit evidence from substantive audit procedures alone in relation to the risks of material misstatement associated with related party relationships and transactions. For example, where intra-group transactions between the entity and its components are numerous and a significant amount of information regarding these transactions is initiated, recorded, processed or reported electronically in an integrated system, the auditor may determine that it is not possible to design effective substantive audit procedures that by themselves would reduce the risks of material misstatement associated with these transactions to an acceptably low level. In such a case, in meeting the ISA (NZ) 330 requirement to obtain sufficient appropriate audit evidence as to the operating effectiveness of controls,²⁵ the auditor is required to test the entity’s controls over the completeness and accuracy of the recording of the related party relationships and transactions.

A35. Communicating promptly any newly identified related parties to the other members of the engagement team assists them in determining whether this information affects the results of, and conclusions drawn from, risk assessment procedures already performed, including whether the risks of material misstatement need to be reassessed.

A36. Examples of substantive audit procedures that the auditor may perform relating to newly identified related parties or significant related party transactions include:

A37. The requirements and guidance in ISA (NZ) 240 regarding the auditor’s responsibilities relating to fraud in an audit of financial statements are relevant where management appears to have intentionally failed to disclose related parties or significant related party transactions to the auditor. The auditor may also consider whether it is necessary to re- evaluate the reliability of management’s responses to the auditor’s enquiries and management’s representations to the auditor.

A38. In evaluating the business rationale of a significant related party transaction outside the entity’s normal course of business, the auditor may consider the following:

• Whether the transaction:

• Is overly complex (for example, it may involve multiple related parties within a group).

• Has unusual terms of trade, such as unusual prices, interest rates, guarantees and repayment terms.

• Lacks an apparent logical business reason for its occurrence.

• Involves previously unidentified related parties.

• Is processed in an unusual manner.

• Whether management has discussed the nature of, and accounting for, such a transaction with those charged with governance.

• Whether management is placing more emphasis on a particular accounting treatment rather than giving due regard to the underlying economics of the transaction.

If management’s explanations are materially inconsistent with the terms of the related party transaction, the auditor is required, in accordance with ISA (NZ) 500,²⁶ to consider the reliability of management’s explanations and representations on other significant matters.

A39. The auditor may also seek to understand the business rationale of such a transaction from the related party’s perspective, as this may help the auditor to better understand the economic reality of the transaction and why it was carried out. A business rationale from the related party’s perspective that appears inconsistent with the nature of its business may represent a fraud risk factor.

A40. Authorisation and approval by management, those charged with governance, or, where applicable, the shareholders of significant related party transactions outside the entity’s normal course of business may provide audit evidence that these have been duly considered at the appropriate levels within the entity and that their terms and conditions have been appropriately reflected in the financial statements. The existence of transactions of this nature that were not subject to such authorisation and approval, in the absence of rational explanations based on discussion with management or those charged with governance, may indicate risks of material misstatement due to error or fraud. In these circumstances, the auditor may need to be alert for other transactions of a similar nature. Authorisation and approval alone, however, may not be sufficient in concluding whether risks of material misstatement due to fraud are absent because authorisation and approval may be ineffective if there has been collusion between the related parties or if the entity is subject to the dominant influence of a related party.

A41. A smaller entity may not have the same controls provided by different levels of authority and approval that may exist in a larger entity. Accordingly, when auditing a smaller entity, the auditor may rely to a lesser degree on authorisation and approval for audit evidence regarding the validity of significant related party transactions outside the entity’s normal course of business. Instead, the auditor may consider performing other audit procedures such as inspecting relevant documents, confirming specific aspects of the transactions with relevant parties, or observing the owner-manager’s involvement with the transactions.

A42. Although audit evidence may be readily available regarding how the price of a related party transaction compares to that of a similar arm’s length transaction, there are ordinarily practical difficulties that limit the auditor’s ability to obtain audit evidence that all other aspects of the transaction are equivalent to those of the arm’s length transaction. For example, although the auditor may be able to confirm that a related party transaction has been conducted at a market price, it may be impracticable to confirm whether other terms and conditions of the transaction (such as credit terms, contingencies and specific charges) are equivalent to those that would ordinarily be agreed between independent parties. Accordingly, there may be a risk that management’s assertion that a related party transaction was conducted on terms equivalent to those prevailing in an arm’s length transaction may be materially misstated.

A43. The preparation of the financial statements requires management to substantiate an assertion that a related party transaction was conducted on terms equivalent to those prevailing in an arm’s length transaction. Management’s support for the assertion may include:

A44. Evaluating management’s support for this assertion may involve one or more of the following:

A45. Some financial reporting frameworks require the disclosure of related party transactions not conducted on terms equivalent to those prevailing in arm’s length transactions. In these circumstances, if management has not disclosed a related party transaction in the financial statements, there may be an implicit assertion that the transaction was conducted on terms equivalent to those prevailing in an arm’s length transaction.

A46. ISA (NZ) 450 requires the auditor to consider both the size and the nature of a misstatement, and the particular circumstances of its occurrence, when evaluating whether the misstatement is material.²⁷ The significance of the transaction to the financial statement users may not depend solely on the recorded amount of the transaction but also on other specific relevant factors, such as the nature of the related party relationship.

A47. Evaluating the related party disclosures in the context of the disclosure requirements of the applicable financial reporting framework means considering whether the facts and circumstances of the entity’s related party relationships and transactions have been appropriately summarised and presented so that the disclosures are understandable. Disclosures of related party transactions may not be understandable if:

1. The business rationale and the effects of the transactions on the financial statements are unclear or misstated; or

2. Key terms, conditions, or other important elements of the transactions necessary for understanding them are not appropriately disclosed.

A48. Circumstances in which it may be appropriate to obtain written representations from those charged with governance include:

A49. The auditor may also decide to obtain written representations regarding specific assertions that management may have made, such as a representation that specific related party transactions do not involve undisclosed side agreements.

A50. Communicating significant matters arising during the audit²⁸ in connection with the entity’s related parties helps the auditor to establish a common understanding with those charged with governance of the nature and resolution of these matters. Examples of significant related party matters include: