Definition
AU-C 550 requires risk assessment inquiries of management and others about related parties and their transactions, a review of records for transactions outside the normal course, and procedures to identify previously unidentified or undisclosed relationships. For significant transactions outside the normal course, the auditor evaluates the business rationale and whether terms are supported. ASC 850 governs disclosure.
Why it matters in an audit or review
Related party transactions carry a higher risk of fraud and incomplete disclosure, because terms may not be arm's length and management may have an interest in hiding them. Auditors are also required to obtain written representations on completeness. A statement that transactions were at arm's length cannot be made unless it can be substantiated.
Example
During journal entry testing, the auditor notes a $250,000 (illustrative) loan to an entity that shares an address with the owner's spouse. The auditor asks about the relationship, inspects the note and board approvals, confirms the balance with the borrower, and adds a disclosure requirement under ASC 850.
Common mistakes
- Relying on the client's list alone.
- Treating a transaction as arm's length because management says so.
- Ignoring loans to officers and owners.
FAQ
Does the auditor look for related parties every year?
Yes. The inquiry, awareness and testing steps are required on every audit.
Sources
- AICPA, AU-C Section 550, Related Parties
- FASB ASC 850-10-50
Definitions paraphrase AICPA and FASB guidance; read the standard itself before relying on a requirement. Example figures are illustrative. This page is guidance, not professional advice. Report an error