The document outlines the identification and disclosure requirements for related party transactions, emphasizing the importance of recognizing such transactions to avoid misleading financial statements. It highlights the auditor's role in assessing related party relationships, ensuring adequate disclosures, and obtaining relevant information during audits. Recent legislative changes in the Companies Act and Income Tax Act are discussed, including revisions to transaction approvals and classifications of related parties.

2. Refer to parties
which
Include individuals that are members of key
management personnel and close members of
their family
Are under common control and entities that
have shared control over or that are subject to
shared control
Either control or are controlled by another
entity
 The reporting entity would disclose the nature of the relationship with related
parties and the types of related party transactions that have occurred
including those for which no amount has been recognized and the amounts
involved related to the transaction.
 Related party transactions that occur in the normal course of operations and
at arm‟s length are excluded from the disclosure requirements.
 An entity would provide information about significant unrecognized related
party transactions in sufficient detail to enable users of the entity‟s financial
statements to understand the impact they have had on its financial position
and performance.
Related Parties
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3. Identification of Related Parties Transactions
Preliminary evaluation
concerning the likelihood
of related-party
transactions - usually
made during the planning
of audit
Preparation of Risk
Assessment
Questionnaire
Obtaining an
understanding
of the structure
of the entity and
management
responsibilities
Considering the
business
purpose of the
various
components of
the entity
Considering the
control consciousness
within the entity and
controls over
management
activities
We may classify related-
party transactions and
similar transactions that
require disclosure -
• Ones which are
recognized in the
accounting records
• No-charge
transactions
• Ones which
create economic
dependence
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4. Adequate
Disclosure
Fraud
Detection
• Transactions may be entered into
without substance.
• Inadequate disclosure or outright
concealment of related-party
transactions is likely to result in
misleading financial statements.
• Undisclosed relationship with a party
to a material transaction may be used
to fabricate transactions, leading to
fraud.
Two distinct but
mutually exclusive
aspects-
From Auditor‟s
Perspective
“An auditor cannot be expected to provide assurance that all related-party transactions will be
discovered”
• Possibility that material
related-party
transactions exist that
could affect the financial
statements.
Nevertheless, the auditor should be aware of -
• Common ownership or
management control
relationships, management
responsibilities and the
relationship of each of the
entity‟s component to the total
entity.
• Controls over management
activities and the business
purpose served by the
various components.
Examples of
transactions that
may indicate
related parties-
Transactions to borrow or
lend at no interest or at rates
significantly different from
market rates Sale of real estate at
a price significantly
different from its
appraised value
Non-monetary
exchange of
property for similar
property
Loans made with no
scheduled terms for
the time or method of
repayment
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5. Basic Approach
towards
Identification of
Material Related-
Party Transactions
Identify material
transactions (consider
whether there are
indications of previously
undisclosed relationships
for material transactions)
Identify related parties (through
inquiry and review of relevant
information to determine the
identity of related parties so that
material transactions with these
parties known to be related can
be examined). [Note: According
to SAS 45, the auditor should
place emphasis on testing
identified material related-party
transactions].
Examine identified
material related-party
transactions.
Ideal
procedures
to be
performed
solely for
the purpose
of
identifying
related
parties or
related-
party
transactions:
 Enquiry about management through Management Representation Letter
• Names of all related parties.
• Whether there were any transactions with these parties during the period.
• Whether the entity has procedures for identifying and properly accounting for
related-party transactions. If so, evaluation of these procedures must be done.
 Obtaining the names of all pension and other trusts established for the benefit of
employees and the names of officers and trustees of the trusts.
 Review of stockholder listings of closely held entities and identification of principal
stockholders.
 For indications of undisclosed relationships, review of the nature and extent of
business transacted with major:
• Customers
• Suppliers
• Borrowers and
• Lenders
 Considering whether transactions are occurring but not being given accounting
recognition, such as the client receiving or providing accounting, management, or
other services at no charge, or a major stockholder absorbing corporate expenses.
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6. GENERAL AUDIT PROCEDURES THEIR RELEVANCE TO RELATED PARTIES
 Review prior years‟ audit documentation Identify names of known related parties
 Review minutes of meetings of board of
directors and executive or operating
committees
Obtain information on material transactions
authorized or discussed
 Review confirmations of compensating
balance arrangements
Identify whether balances are or were
maintained for or by related parties
 Review invoices from law firms for regular or
special services
Identify indications of related parties or related
party transactions
 Review confirmations of loans receivable and
payable
Identify whether there are guarantees and the
nature of relationship to guarantor
 Review material investment transactions Determine whether investment created related
party
 Review accounting records for large, unusual,
or nonrecurring transactions or balances,
particularly at or near end of reporting period
Consider whether transactions are with related
parties
 Enquire about predecessor, principal, or
other auditors of related entities
Obtain their knowledge of related parties or
related-party transactions
The auditor should also consider obtaining written representations from
the client‟s senior management and its board of directors about whether
they or other related parties engaged in any transactions with the entity.
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7. Some of key changes envisaged in the 2013 Act include
the following:
• Need for central government approval has been done
away with.
• Widened ambit of transactions such as leasing of
property of any kind, appointment of any agent for
purchase and sale of goods, material, services or
property.
• Cash at prevailing market price has now been
substituted with „arm‟s length transaction‟ which has
been defined in the section.
• Transactions entered into with related parties now to
be included in the board‟s report along with
justification for entering into such contracts and
arrangements.
• Penalty for contravention of the provisions of section
297 was covered in general provisions in the 1956 Act.
However, this is now covered specifically in the section
itself which now extends to imprisonment.
• Central government may prescribe additional
conditions.
RELAXATION NORMS UNDER COMPANIES ACT, 2013 -
Contained under Section
188
 Though most of the
provisions under this
Section are quite similar
to the requirements
under Sections 297 and
314 of the Companies
Act, 1956.
 Revised Clause 49 pertaining to
corporate governance requires
shareholders‟ approval for all material
related party transaction with no
exception for transactions in ordinary
course of business or at arms-length.
 Applicable w.e.f. 1st October, 2014.
SEBI‟s CORPORATE
GOVERNANCE NORMS -
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8. TREATMENT UNDER INCOME TAX ACT, 1961 -
 Section 40A (2) of the Income Tax Act, 1961 disallows the expenditure incurred in respect of
„specified persons‟ (related parties) provided the Assessing Officer is of the opinion that the
expenditure is excessive and unreasonable.
• Fair market value of goods, services or
facilities for which the payment is made
to persons (related parties)
Disallowed Expenditures
include-
• Legitimate needs of business or
profession of the assessee
• The benefit derived by or accruing to
the assessee from the payment
Scope of word „related party„ under The Income Tax Act includes the following -
• Where the assessee is an any relative of the assessee
• Where the assessee is a any director of the company, company, firm, association partner of the firm,
or member of persons or Hindu undivided the association or family, or any family relative of such
director, partner or member
• Any individual who has a substantial interest in the business or profession of the assessee, or any
relative of such individual
• A company, firm, association of persons or Hindu undivided family having substantial interest in the
business or profession of the assessee or any director, partner or member of such company, firm,
association or family, or any relative of such director, partner or member
• A company, firm, association of persons or Hindu undivided family of which a director, partner or
member, as the case may be, has a substantial interest in the business or profession of the assessee;
or any director, partner or member of such company, firm, association or family or any relative of
such director, partner or member
• Any person who carries on a business or profession, where the assessee being an individual, or any
relative of such assessee, has a substantial interest in the business or profession of that person.
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