Related parties: ISA 550

Many corporate scandals have had a related party at the centre. A director sells an asset to his own company at a high price, or a company lends money to a business its chairman controls, and nobody tells the auditor.

This topic covers what related parties are, why they raise audit risk, the risk assessment procedures International Standard on Auditing (ISA) 550 requires, how the auditor responds to undisclosed relationships and unusual transactions, and what must be obtained from the directors.

Examiners give a short scenario with a related party hint, such as a balance owed by a company the chairman controls, and ask what the auditor should do. The first step is always to see that a small amount can still be material. In the November 2025 expectation gap case, hidden related party purchases were part of the story, which shows how often examiners use the theme.

Related parties and related party transactions

Related parties are individuals or organisations that might have, or might be expected to have, an undue influence on the company being audited. They include:

• the directors and key management;
• their families;
• other companies controlled by directors, key managers and their close family; and
• other companies in the same group.

Related party transactions are material transactions between the client and a related party. Management must record and disclose all material ones, because they may be carried out on more favourable terms than similar transactions with an independent third party.

IAS 24 Related party disclosures takes the approach of disclosing the amounts of related party transactions and the nature of the relationships. Users can then decide for themselves whether the transactions have distorted the financial statements.

ISA 550 was redrafted in July 2008, for two reasons: the public attention given to related party accounting after scandals such as Enron, and the fact that the older version was mostly procedural and did not deal with the risks of material misstatement from related parties.

Why related parties affect the audit

Many related party transactions are normal and carry no higher risk than ordinary ones. But in some circumstances they raise risk:

• related parties may work through complex structures, so the transactions may be complex;
• accounting systems may be poor at identifying and summarising related party transactions and balances; and
• the transactions may not be on normal market terms. Some may be for nil consideration.

There is also a higher risk of fraud, because related parties give more opportunity for collusion, concealment or manipulation by management. The auditor approaches the area with particular professional scepticism.

The objectives of the auditor

The auditor aims to obtain:

1. an understanding of the entity’s related party relationships and transactions; and
2. sufficient appropriate audit evidence about whether they have been properly identified, accounted for and disclosed in the financial statements.

The understanding must be enough to recognise fraud risk factors that arise from related parties and to conclude whether the statements achieve fair presentation in respect of them.

The requirements of ISA 550

Most material misstatements linked to related parties arise because management fails to disclose relationships and transactions to the auditor. So ISA 550 sets a minimum set of risk assessment procedures aimed at finding those that management has not identified or disclosed.

Risk assessment procedures

As part of the procedures required by ISAs 240 and 315, the auditor must:

1. consider the risk of material misstatement, from fraud or error, arising from related party relationships and transactions;
2. make inquiries of management about the identity of related parties, the nature of the relationships and the nature of any transactions during the period; and
3. understand the internal controls over the identification, accounting and disclosure of related party relationships and transactions, over the authorisation and approval of significant related party transactions, and over the authorisation and approval of significant transactions outside the normal course of business.

Identifying related parties

The auditor obtains a list of related parties from the directors and decides whether it is complete. Tests of completeness may include:

• reviewing the previous years’ working papers for known related parties;
• reviewing the company’s procedures for identifying them;
• asking about the directors’ other interests, such as whether a director owns another company and whether it has traded with the client;
• reviewing the shareholder records for major shareholders;
• reviewing the minutes of general meetings; and
• asking other audit firms involved in a group audit, or the previous auditors, what they know.

A complete list can be hard to get, because the main source of information is management, who may want to keep relationships hidden. Problem areas are close family relationships and a business owned or influenced by a director. Two companies are not related parties just because the same person is a director or shareholder in both. The question is whether that person has influence in both.

The auditor may also find it hard to identify the transactions unless the client records them separately. Related party transactions may be hidden among all the other transactions.

Staying alert during the audit

While inspecting records or documents, the auditor must watch for signs of related parties or transactions that were not identified or disclosed. The auditor must specifically inspect:

• bank and legal confirmations obtained in the audit;
• minutes of shareholder and management meetings; and
• any other records or documents the circumstances call for.

If the auditor finds significant transactions outside the normal course of business, the auditor must ask about their nature and whether related parties could be involved. ISA 550 says that significant related party transactions outside the normal course of business must be treated as giving rise to significant risks of material misstatement. The whole team is told what has been learned about related parties.

Dominant parties

Any fraud risk factors must be considered when assessing the risk of fraud under ISA 240. A key fraud risk factor in ISA 550 is a party with dominant influence over the entity. Such a party can override management and force the entity into a transaction in which it has an interest. Signs of a dominant party include:

• the party vetoing significant business decisions;
• significant transactions being referred to the party for final approval;
• little or no debate among management on the party’s proposals; and
• transactions involving the party or its close family rarely being independently reviewed or approved.

Responding to the risks

Undisclosed related parties or transactions

If the auditor finds related parties or significant related party transactions that management did not identify or disclose, the auditor must:

1. decide whether the circumstances confirm that the relationship or transaction exists;
2. tell the audit team;
3. ask management to identify all transactions with the newly identified related parties;
4. ask why the entity’s system failed to identify or disclose them;
5. carry out suitable substantive procedures on them;
6. reconsider the risk of other undisclosed related parties or transactions, and do more work if needed; and
7. if non-disclosure appears intentional, evaluate the implications for the audit.

Significant transactions outside the normal course of business

The auditor must inspect the underlying contracts to judge whether:

• they were made to commit fraudulent financial reporting or to hide misappropriation of assets, which a lack of business reason may suggest;
• the terms agree with management’s explanations; and
• they are properly accounted for and disclosed.

The auditor must also get evidence that they were properly authorised. If management states in the notes that a related party transaction was on arm’s length terms, the auditor must get evidence to support it.

Materiality of related party transactions

ISA 450 requires the auditor to consider the size and nature of a misstatement and the circumstances in which it occurs. For related party transactions, much smaller amounts can be material, because their significance to users depends on the nature of the relationship and not only on the amount.

A transaction can be material even at ₦0, for example the sale of the company’s assets to a related party at a very low price.

Other requirements

• Written representations. The auditor must always get written representations from the directors on related parties. They must cover the completeness of the information about the identity of related parties and about related party relationships and transactions, and the adequacy of accounting and disclosure in the financial statements.
• Those charged with governance. Unless all of them are involved in managing the entity, the auditor communicates significant matters about related parties to them.
• Documentation. The names of all identified related parties and the nature of the relationships are documented.

The rules in more depth

Why the audit starts from management’s list but does not stop there

Management knows who the related parties are, so the list is the natural start. But management is also the party with a reason to leave names out. The auditor therefore checks the list against independent sources, such as share registers, minutes, confirmations and prior-year papers.

Why unusual transactions are significant risks

A transaction outside the normal course of business has no routine controls and no history. It is more likely to be driven by something other than commercial need. Treating it as a significant risk makes the auditor inspect the contract, the reason and the authorisation.

Why a nil amount can be material

IAS 24 asks for disclosure so that users can judge for themselves. A gift of an asset to a director costs the company something real, but may appear as a nil transaction. Users would want to know. Materiality for related parties is judged by what the information tells them, and not by the size of the amount.

Why representations are required but not enough

Directors are best placed to confirm the list. But a written statement from the party with the incentive to conceal is weak evidence on its own. It supports, and does not replace, the auditor’s own work.

Worked example: a small balance with a related party

1. Relationship. Tolu is a related party, because a director controls it. This is a related party balance and not just a trade debtor.
2. Materiality. Judged by nature, not size. The amount is tiny against ₦25 million, but the relationship and the unexplained balance may matter to users. The auditor should not accept management’s “immaterial” argument.
3. Find out the nature. Ask management and the chairman what the amount is for. Inspect the underlying documents and the ledger entries. Find out why it has not moved for a year.
4. Test recoverability. A balance unpaid for a year from a related party raises doubt about recovery and may be a loan in disguise. Ask for confirmation from Tolu and review its ability to pay.
5. Disclosure. If it is a related party balance, IAS 24 disclosure of the nature of the relationship and the amount is needed. Ask management to correct the statements.
6. Completeness and system. Ask why the system did not flag it. Request a full list of transactions with Tolu, and widen the search for other undisclosed related parties. Tell the team.
7. Representations and governance. Obtain written representations on related parties, and tell those charged with governance. If non-disclosure appears deliberate, consider the effect on the opinion and on reliance on management.

Conclusion. Treat the balance as a related party item and investigate the nature, recovery and disclosure, whatever its size.

How to score full marks

• Define the related party first and say why the transaction is a risk.
• Say that materiality is judged by nature, and that a small or even nil amount can be material.
• For identification, give the sources: prior papers, shareholder records, minutes, directors’ other interests, other auditors.
• For unusual transactions, say “significant risk”, and inspect contracts for business rationale, consistency with explanation, accounting and disclosure, and authorisation.
• For an undisclosed party that you find, follow the seven steps and ask why the system failed.
• Add representations, governance and documentation at the end.
• Time. Spend time in proportion to marks.

Common mistakes in the exam

• Accepting management’s statement that a small balance is immaterial.
• Treating two companies as related because they share a director, without asking about influence.
• Relying on the directors’ list alone.
• Forgetting that the transactions outside the normal course of business are significant risks.
• Forgetting to ask why the system failed to identify the transaction.
• Not mentioning IAS 24 disclosure.
• Treating a written representation as sufficient evidence by itself.

Quick revision

• Related parties: directors, key management, families, controlled companies, group companies. Disclose under IAS 24.
• Risk: complex structures, weak systems, non-market terms, collusion and fraud.
• Procedures: consider risk, inquire of management, understand controls, test the completeness of the list, stay alert, inspect confirmations and minutes.
• Unusual transactions outside the normal course: significant risk. Dominant party: fraud risk factor.
• If undisclosed party found: confirm it, tell the team, list transactions, ask why, test, reconsider risk, assess intent.
• Materiality by nature: even ₦0 can be material.
• Always get directors’ written representations. Tell those charged with governance. Document the names.

Practice questions

These are original questions written in the style of the Institute of Chartered Accountants of Nigeria (ICAN) exam. Try each one before you open the answer. Full model answers follow the written questions.

Recall check: multiple choice

The real ICAN paper has no multiple-choice section. These questions are for quick recall. The written questions that follow are closer to the exam.

Written questions

Model answers

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