HKSA 550 - Related Parties

HKSA 550 - Related Parties

Introduction

Scope of this HKSA

This Hong Kong Standard on Auditing (HKSA) 550 deals with the auditor's responsibilities relating to related party relationships and transactions in an audit of financial statements. Specifically, it expands on how HKSA 315 (Revised 2019), HKSA 330, and HKSA 240 are to be applied in relation to risks of material misstatement associated with related party relationships and transactions.

Nature of Related Party Relationships and Transactions

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 summarizing 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.

Responsibilities of the Auditor

Paragraph 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.

Paragraph 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:

(a) Achieve fair presentation (for fair presentation frameworks); or

(b) Are not misleading (for compliance frameworks).

Paragraph 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 HKSA 240, because fraud may be more easily committed through related parties.

Paragraph 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 HKSAs. 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.

Paragraph 7: Planning and performing the audit with professional skepticism as required by HKSA 200 is therefore particularly important in this context, given the potential for undisclosed related party relationships and transactions. The requirements in this HKSA 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.

Effective Date

This HKSA is effective for audits of financial statements for periods beginning on or after 15 December 2009.

Objectives

The objectives of the auditor are:

(a) 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:

(i) To recognize 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

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

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

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

(b) 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.

Definitions

For purposes of the HKSAs, the following terms have the meanings attributed below:

(a) 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.

(b) Related party – A party that is either:

(i) A related party as defined in the applicable financial reporting framework; or

(ii) Where the applicable financial reporting framework establishes minimal or no related party requirements:

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

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

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

i. Common controlling ownership;

ii. Owners who are close family members; or

iii. 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.

Requirements

Risk Assessment Procedures and Related Activities

Paragraph 11: As part of the risk assessment procedures and related activities that HKSA 315 (Revised 2019) and HKSA 240 require the auditor to perform during the audit, 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.

Understanding the Entity's Related Party Relationships and Transactions

Paragraph 12 - Engagement Team Discussion: The engagement team discussion that HKSA 315 (Revised 2019) and HKSA 240 require 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.

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

The nature and extent of the entity's relationships and transactions with related parties (using, for example, the auditor's record of identified related parties updated after each audit).

An emphasis on the importance of maintaining professional skepticism throughout the audit regarding the potential for material misstatement associated with related party relationships and transactions.

The circumstances or conditions of the entity that may indicate the existence of related party relationships or transactions that management has not identified or disclosed to the auditor (for example, a complex organizational structure, use of special-purpose entities for off-balance sheet transactions, or an inadequate information system).

The records or documents that may indicate the existence of related party relationships or transactions.

The importance that management and those charged with governance attach to the identification, appropriate accounting for, and disclosure of related party relationships and transactions (if the applicable financial reporting framework establishes related party requirements), and the related risk of management override of controls.

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

How special-purpose entities controlled by management might be used to facilitate earnings management.

How transactions between the entity and a known business partner of a key member of management could be arranged to facilitate misappropriation of the entity's assets.

Paragraph 13 - Inquiries of Management: The auditor shall inquire of management regarding:

(a) The identity of the entity's related parties, including changes from the prior period;

(b) The nature of the relationships between the entity and these related parties; and

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

Paragraph 14 - Understanding Controls: The auditor shall inquire 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:

(a) Identify, account for, and disclose related party relationships and transactions in accordance with the applicable financial reporting framework;

(b) Authorize and approve significant transactions and arrangements with related parties; and

(c) Authorize and approve significant transactions and arrangements outside the normal course of business.

Others within the entity who may have knowledge of related party relationships and transactions include:

Those charged with governance

Personnel in a position to initiate, process, or record transactions that are both significant and outside the entity's normal course of business

The internal audit function

In-house legal counsel

The chief ethics officer or equivalent person

Maintaining Alertness for Related Party Information When Reviewing Records or Documents

Paragraph 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.

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:

(a) Bank and legal confirmations obtained as part of the auditor's procedures;

(b) Minutes of meetings of shareholders and of those charged with governance; and

(c) Such other records or documents as the auditor considers necessary in the circumstances of the entity.

Records or documents that the auditor may inspect include:

Third-party confirmations obtained by the auditor

Entity income tax returns

Information supplied by the entity to regulatory authorities

Shareholder registers to identify the entity's principal shareholders

Statements of conflicts of interest from management and those charged with governance

Records of the entity's investments and those of its pension plans

Contracts and agreements with key management or those charged with governance

Significant contracts and agreements not in the entity's ordinary course of business

Specific invoices and correspondence from the entity's professional advisors

Life insurance policies acquired by the entity

Significant contracts re-negotiated by the entity during the period

Reports of the internal audit function

Documents associated with the entity's filings with a securities regulator

Paragraph 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 inquire of management about:

(a) The nature of these transactions; and

(b) Whether related parties could be involved.

Examples of transactions outside the entity's normal course of business may include:

Complex equity transactions, such as corporate restructurings or acquisitions

Transactions with offshore entities in jurisdictions with weak corporate laws

The leasing of premises or the rendering of management services by the entity to another party if no consideration is exchanged

Sales transactions with unusually large discounts or returns

Transactions with circular arrangements, for example, sales with a commitment to repurchase

Transactions under contracts whose terms are changed before expiry

Paragraph 17 - Sharing Information with Engagement Team: The auditor shall share relevant information obtained about the entity's related parties with the other members of the engagement team.

Relevant related party information that may be shared includes:

The identity of the entity's related parties

The nature of the related party relationships and transactions

Significant or complex related party relationships or transactions that may be determined to be significant risks, in particular transactions in which management or those charged with governance are financially involved

Identification and Assessment of the Risks of Material Misstatement Associated with Related Party Relationships and Transactions

Paragraph 18: In meeting the HKSA 315 (Revised 2019) requirement to identify and assess the risks of material misstatement, 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.

Paragraph 19 - Fraud Risk Factors: 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 HKSA 240.

Indicators of dominant influence exerted by a related party include:

The related party has vetoed significant business decisions taken by management or those charged with governance.

Significant transactions are referred to the related party for final approval.

There is little or no debate among management and those charged with governance regarding business proposals initiated by the related party.

Transactions involving the related party (or a close family member of the related party) are rarely independently reviewed and approved.

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:

An unusually high turnover of senior management or professional advisors may suggest unethical or fraudulent business practices that serve the related party's purposes.

The use of business intermediaries for significant transactions for which there appears to be no clear business justification may suggest that the related party could have an interest in such transactions through control of such intermediaries for fraudulent purposes.

Evidence of the related party's excessive participation in or preoccupation with the selection of accounting policies or the determination of significant estimates may suggest the possibility of fraudulent financial reporting.

Responses to the Risks of Material Misstatement Associated with Related Party Relationships and Transactions

Paragraph 20: As part of the HKSA 330 requirement that the auditor respond to assessed risks, 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.

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:

Confirming or discussing specific aspects of the transactions with intermediaries such as banks, law firms, guarantors, or agents, where practicable and not prohibited by law, regulation or ethical rules.

Confirming the purposes, specific terms or amounts of the transactions with the related parties (this audit procedure may be less effective where the auditor judges that the entity is likely to influence the related parties in their responses to the auditor).

Where applicable, reading the financial statements or other relevant financial information, if available, of the related parties for evidence of the accounting of the transactions in the related parties' accounting records.

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 perform audit procedures such as:

Inquiries of, and discussion with, management and those charged with governance.

Inquiries of the related party.

Inspection of significant contracts with the related party.

Appropriate background research, such as through the Internet or specific external business information databases.

Review of employee whistle-blowing reports where these are retained.

Identification of Previously Unidentified or Undisclosed Related Parties or Significant Related Party Transactions

Paragraph 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.

Paragraph 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:

(a) Promptly communicate the relevant information to the other members of the engagement team;

(b) Where the applicable financial reporting framework establishes related party requirements:

(i) Request management to identify all transactions with the newly identified related parties for the auditor's further evaluation; and

(ii) Inquire 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;

(c) Perform appropriate substantive audit procedures relating to such newly identified related parties or significant related party transactions;

(d) 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

(e) 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.

Examples of substantive audit procedures relating to newly identified related parties or significant related party transactions include:

Making inquiries regarding the nature of the entity's relationships with the newly identified related parties, including (where appropriate and not prohibited by law, regulation or ethical rules) inquiring of parties outside the entity who are presumed to have significant knowledge of the entity and its business.

Conducting an analysis of accounting records for transactions with the newly identified related parties. Such an analysis may be facilitated using computer-assisted audit techniques.

Verifying the terms and conditions of the newly identified related party transactions, and evaluating whether the transactions have been appropriately accounted for and disclosed in accordance with the applicable financial reporting framework.

Identified Significant Related Party Transactions outside the Entity's Normal Course of Business

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

(a) Inspect the underlying contracts or agreements, if any, and evaluate whether:

(i) 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;

(ii) The terms of the transactions are consistent with management's explanations; and

(iii) The transactions have been appropriately accounted for and disclosed in accordance with the applicable financial reporting framework; and

(b) Obtain audit evidence that the transactions have been appropriately authorized and approved.

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 consolidated 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.

Assertions That Related Party Transactions Were Conducted on Terms Equivalent to Those Prevailing in an Arm's Length Transaction

Paragraph 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.

Management's support for the assertion may include:

Comparing the terms of the related party transaction to those of an identical or similar transaction with one or more unrelated parties.

Engaging an external expert to determine a market value and to confirm market terms and conditions for the transaction.

Comparing the terms of the transaction to known market terms for broadly similar transactions on an open market.

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

Considering the appropriateness of management's process for supporting the assertion.

Verifying the source of the internal or external data supporting the assertion, and testing the data to determine their accuracy, completeness and relevance.

Evaluating the reasonableness of any significant assumptions on which the assertion is based.

Evaluation of the Accounting for and Disclosure of Identified Related Party Relationships and Transactions

Paragraph 25: In forming an opinion on the financial statements in accordance with HKSA 700 (Revised), the auditor shall evaluate:

(a) Whether the identified related party relationships and transactions have been appropriately accounted for and disclosed in accordance with the applicable financial reporting framework; and

(b) Whether the effects of the related party relationships and transactions:

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

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

Evaluating related party disclosures means considering whether the facts and circumstances of the entity's related party relationships and transactions have been appropriately summarized and presented so that the disclosures are understandable. Disclosures of related party transactions may not be understandable if:

(a) The business rationale and the effects of the transactions on the financial statements are unclear or misstated; or

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

Written Representations

Paragraph 26: Where the applicable financial reporting framework establishes related party requirements, the auditor shall obtain written representations from management and, where appropriate, those charged with governance that:

(a) 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

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

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

When they have approved specific related party transactions that (a) materially affect the financial statements, or (b) involve management.

When they have made specific oral representations to the auditor on details of certain related party transactions.

When they have financial or other interests in the related parties or the related party transactions.

Communication with Those Charged with Governance

Paragraph 27: Unless all of those charged with governance are involved in managing the entity, the auditor shall communicate with those charged with governance significant matters arising during the audit in connection with the entity's related parties.

Examples of significant related party matters include:

Non-disclosure (whether intentional or not) by management to the auditor of related parties or significant related party transactions, which may alert those charged with governance to significant related party relationships and transactions of which they may not have been previously aware.

The identification of significant related party transactions that have not been appropriately authorized and approved, which may give rise to suspected fraud.

Disagreement with management regarding the accounting for and disclosure of significant related party transactions in accordance with the applicable financial reporting framework.

Non-compliance with applicable law or regulations prohibiting or restricting specific types of related party transactions.

Difficulties in identifying the party that ultimately controls the entity.

Documentation

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

Conformity and Compliance with International Standards on Auditing

As of January 2024, this HKSA conforms with International Standard on Auditing (ISA) 550, Related Parties. Compliance with the requirements of this HKSA ensures compliance with ISA 550.

Key Takeaways Summary Table

Area	Key Requirements
Scope	Expands on HKSA 315, 330, and 240 for related party risks
Objectives	Understand related party relationships; identify fraud risk factors; obtain audit evidence on identification, accounting, and disclosure
Risk Assessment	Engagement team discussion; inquiries of management; understanding controls; maintaining alertness for related party information
Identification & Assessment	Treat significant related party transactions outside normal course as significant risks; consider fraud risk factors including dominant influence
Responses	Design further audit procedures; identify previously undisclosed related parties; inspect contracts for significant transactions; obtain evidence on arm's length assertions
Evaluation	Evaluate accounting and disclosure; assess fair presentation or misleading nature
Written Representations	Obtain representations on completeness of related party identification and proper accounting/disclosure
Communication	Communicate significant related party matters to those charged with governance
Documentation	Document names of identified related parties and nature of relationships