HKSA 550 - Related Parties (Condensed)

Introduction & Scope

Scope of HKSA 550

Deals with auditor’s responsibilities for related party relationships and transactions in an audit of financial statements. Expands on HKSA 315 (Revised 2019), HKSA 330, and HKSA 240.

Nature of Related Party Relationships

Many transactions are in the normal course of business and may carry no higher risk. However, higher risks can arise due to:

• Complex relationships and structures
• Ineffective information systems
• Transactions not conducted under normal market terms (e.g., no exchange of consideration)

Auditor’s Responsibilities

Fraud may be more easily committed through related parties (HKSA 240). Inherent limitations are greater due to management unawareness and collusion opportunities.

Effective Date

Periods beginning on or after 15 December 2009.

Objectives & Definitions

Objectives of the Auditor

• Obtain understanding of related party relationships and transactions to recognize fraud risk factors and conclude on fair presentation or misleading nature.
• Where framework establishes requirements, obtain sufficient appropriate audit evidence about identification, accounting, and disclosure.

Definitions

Risk Assessment Procedures and Related Activities

Engagement Team Discussion (Paragraph 12)

Specific consideration of susceptibility to material misstatement due to fraud or error from related party relationships. Matters to address include:

• Nature and extent of relationships and transactions
• Importance of professional skepticism
• Circumstances indicating undisclosed related parties (e.g., complex structure, special-purpose entities)
• Risk of management override of controls

Inquiries of Management (Paragraph 13)

Auditor shall inquire about:

• Identity of related parties, including changes from prior period
• Nature of relationships
• Whether transactions occurred, and their type and purpose

Understanding Controls (Paragraph 14)

Inquire of management and others to understand controls for:

• Identifying, accounting for, and disclosing related parties
• Authorizing and approving significant related party transactions
• Authorizing and approving significant transactions outside normal course of business

Maintaining Alertness (Paragraphs 15-16)

Remain alert when inspecting records/documents for indications of undisclosed related parties. Inspect bank/legal confirmations, minutes of meetings, and other records (e.g., tax returns, shareholder registers, contracts).

Sharing Information (Paragraph 17)

Share relevant information about related parties with other engagement team members.

Identification and Assessment of Risks

Risk Assessment (Paragraph 18)

Identify and assess risks of material misstatement associated with related party relationships and transactions. Treat identified significant related party transactions outside the entity’s normal course of business as giving rise to significant risks.

Fraud Risk Factors (Paragraph 19)

If fraud risk factors are identified (including dominant influence), consider them when assessing risks of material misstatement due to fraud.

In presence of other risk factors, dominant influence may indicate significant risks of material misstatement due to fraud (e.g., high turnover of senior management, use of intermediaries without clear business justification, excessive participation in accounting policy selection).

Responses to Risks of Material Misstatement

Further Audit Procedures (Paragraph 20)

Design and perform further audit procedures to obtain sufficient appropriate audit evidence about assessed risks. Examples include:

• Confirming or discussing transactions with intermediaries (banks, law firms)
• Confirming purposes/terms with related parties
• Reading financial statements of related parties
• Inquiries of management and governance, inspection of contracts, background research, review of whistle-blowing reports

Identification of Previously Undisclosed Related Parties (Paragraphs 21-22)

If arrangements suggest undisclosed related parties, determine whether circumstances confirm existence. If identified:

• Promptly communicate to engagement team
• Request management to identify all transactions with newly identified parties
• Inquire why controls failed
• Perform substantive audit procedures
• Reconsider risk of other undisclosed parties
• If non-disclosure appears intentional, evaluate implications for fraud risk

Significant Transactions Outside Normal Course (Paragraph 23)

For identified significant related party transactions outside normal course:

• Inspect underlying contracts/agreements
• Evaluate business rationale (e.g., overly complex, unusual terms, lack of logical business reason)
• Verify terms consistent with management’s explanations
• Obtain evidence of appropriate authorization and approval

Arm’s Length Assertions (Paragraph 24)

If management asserts a transaction was conducted on arm’s length terms, obtain sufficient appropriate audit evidence. Evaluate management’s support (e.g., comparison to similar transactions, external expert, market terms).

Evaluation, Written Representations & Communication

Evaluation of Accounting and Disclosure (Paragraph 25)

In forming an opinion, evaluate whether:

• Related party relationships and transactions have been appropriately accounted for and disclosed per the applicable financial reporting framework
• Effects prevent fair presentation (fair presentation frameworks) or cause misleading statements (compliance frameworks)

Disclosures are understandable if business rationale, effects, and key terms are clearly presented.

Written Representations (Paragraph 26)

Where the framework establishes related party requirements, obtain written representations from management (and where appropriate, those charged with governance) that:

• They have disclosed identity of all related parties and all related party relationships and transactions
• They have appropriately accounted for and disclosed such relationships and transactions

Communication with Those Charged with Governance (Paragraph 27)

Unless all are involved in management, communicate significant matters arising during the audit, such as:

• Non-disclosure of related parties or significant transactions
• Unauthorized transactions that may give rise to suspected fraud
• Disagreement with management on accounting/disclosure
• Non-compliance with laws prohibiting specific transactions
• Difficulties in identifying the ultimate controlling party

Documentation & Conformity

Documentation (Paragraph 28)

The auditor shall include in audit documentation:

• Names of identified related parties
• Nature of the related party relationships

Conformity with International Standards (Paragraph 29)

As of January 2024, HKSA 550 conforms with ISA 550, Related Parties. Compliance with HKSA 550 ensures compliance with ISA 550.