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Related Party Transactions- A Closer Perspective

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The shared slide provides an insight into the auditing & accounting aspects of the related party transactions. A brief description of certain relaxation norms under Companies Act 2013, SEBI's corporate governance norms and treatment under Income Tax Act, 1961 has been envisaged herein.

Veröffentlicht in: Business, Wirtschaft & Finanzen
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Related Party Transactions- A Closer Perspective

  1. 1. 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 2
  2. 2. 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 3
  3. 3. 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 4
  4. 4. 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. 5
  5. 5. 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. 6
  6. 6. 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 - 7
  7. 7. 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. 8