Related Party Transactions (RPTs) are no longer an exception in modern business—they are a reality. Group structures, promoter-driven entities, family-run enterprises, and closely held companies frequently transact with related parties. While such transactions may be perfectly legitimate, they carry an inherent risk of bias, undue influence, and misstatement. In fact, some of the most significant corporate failures—both in India and globally—have had their roots in undisclosed or improperly structured related party transactions, making SA-550 a standard of heightened relevance rather than routine compliance.
Recognising this risk, SA-550 (Related Parties) places specific responsibilities on the auditor—not to question commercial wisdom, but to ensure proper identification, accounting, and disclosure. It deals with the auditor’s responsibilities relating to related party relationships and related party transactions. The scope of SA-550 is not confined merely to identifying related parties. It extends to the auditor’s responsibility to identify and assess risks of material misstatement arising from related party relationships and transactions, including risks arising from fraud, management bias, or override of controls.
(Ref: SA-550, Paras 1–3)
Meaning of Related Parties
Related parties are persons or entities that have the ability to control, jointly control, or significantly influence the management or operating policies of the reporting entity, or are themselves subject to such influence by the entity. This includes management, owners, and any other person or entity capable of exercising significant influence over decision-making.
Typically, related parties include holding and subsidiary companies, associate companies, joint ventures, key managerial personnel and their relatives, as well as individuals or entities exercising direct or indirect control over the reporting enterprise. From an audit perspective, the emphasis is not merely on legal form but on substance of influence and control, which often requires judgment beyond shareholding patterns.
(Ref: SA-550, Para 6; Ind AS 24; Section 2(76), Companies Act, 2013)
Need and Objectives of SA-550
SA-550 clearly articulates the objectives of the auditor in dealing with related parties. Irrespective of the existence of disclosure requirements under the applicable financial reporting framework, the auditor is required to obtain a sufficient understanding of related party relationships and transactions to enable identification of fraud risk factors, if any, arising from such relationships. These objectives directly influence audit planning, nature and extent of procedures, and the level of professional skepticism to be applied throughout the engagement.
Further, the auditor must conclude whether the financial statements, insofar as they are affected by related party relationships and transactions, achieve a true and fair view under fair presentation frameworks or are not misleading under compliance frameworks. Where the reporting framework prescribes specific related party disclosures, the auditor must obtain sufficient and appropriate audit evidence to ensure that such relationships and transactions have been properly identified, accounted for, and disclosed.
(Ref: SA-550, Paras 9–10)
Identification and Verification of Related Parties
In modern business structures, related party transactions are common and often arise in the ordinary course of business. However, SA-550 cautions that such transactions may pose a higher risk of material misstatement in certain circumstances, particularly where they are not conducted at arm’s length or where there is undue influence.
To identify related parties, the auditor may review prior years’ audit working papers, obtain a management-declared list of related parties, evaluate internal controls relating to identification of related party transactions, examine shareholder records, review minutes of meetings of those charged with governance, inspect statutory registers, analyse regulatory filings, scrutinize significant contracts and agreements, and review accounting records for unusual or non-recurring transactions. These procedures are particularly critical where transactions appear commercially rational on the surface but may conceal preferential terms or non-arm’s-length arrangements.
(Ref: SA-550, Paras 13–17)
Large and Small Entities – A Distinct Audit Approach
SA-550 recognises that identification of related parties differs significantly between large entities and small or owner-managed entities. In large entities, governance structures typically include independent directors and formal control systems. In contrast, in small entities, ownership and management are often concentrated in the same individuals.
As a result, the auditor’s responsibility becomes more extensive in small entities due to the increased risk of management override of controls. Accordingly, greater professional scepticism is required when auditing related party relationships and transactions in such entities. In such cases, the absence of formal documentation does not dilute audit responsibility; rather, it heightens the need for corroborative evidence and inquiry.
(Ref: SA-550, Para 12)
Verification of Related Party Transactions
The mere existence of related party transactions does not automatically result in misstatement. However, SA-550 requires the auditor to verify material related party transactions to determine whether they have been appropriately authorised, properly recorded, and adequately disclosed.
The auditor may apply risk-based benchmarks for verification, guided by prior audit experience and the nature of the transactions. However, transactions that are unusual, significant, or outside the normal course of business require heightened scrutiny.
(Ref: SA-550, Paras 18–23)
Auditor’s Responsibilities in Relation to Related Parties
The auditor’s responsibilities begin with identification of related parties and extend through audit planning, execution, and reporting. These responsibilities include designing audit procedures responsive to assessed risks, obtaining sufficient and appropriate audit evidence, and evaluating the adequacy of disclosures in the financial statements.
SA-550 acknowledges the inherent limitations of audit and reiterates that the auditor provides reasonable not absolute assurance regarding the identification of related party relationships and clarifies that it is not expected that the auditor will detect all related party relationships, especially where management deliberately conceals such information. While SA-550 does not require the auditor to determine commercial fairness, transactions that deviate significantly from market norms demand enhanced scrutiny and documentation.
(Ref: SA-550, Paras 4–5 and 25)
Interplay with Income-tax Act and Companies Act
While auditing related party transactions, the auditor must also be mindful of relevant statutory provisions under other laws. Under the Income-tax Act, 1961, related party transactions may attract provisions relating to deemed dividend, excessive or unreasonable payments, or transfer pricing adjustments. Under the Companies Act 2013, specific approval and disclosure requirements apply to related party transactions. This overlap is particularly significant in small entities, where the auditor often performs a dual role as statutory auditor and tax auditor.
(Ref: Section 2(22)(e) & Section 40A(2)(b), Income-tax Act, 1961; Section 188, Companies Act, 2013)
Management’s Responsibility for Related Party Transactions
SA-550 clearly places the primary responsibility for identification, accounting, and disclosure of related party relationships and transactions on management. Management is required to design and implement adequate internal controls and accounting systems to ensure transparency and completeness of disclosures in the financial statements.
(Ref: SA-550, Paras 4–5)
Reporting Implications
If the auditor is unable to obtain sufficient appropriate audit evidence regarding related party relationships and transactions, or concludes that disclosures are materially misstated or inadequate, the auditor is required to modify the audit opinion. Depending on the circumstances, this may result in a qualified opinion or a disclaimer of opinion, in accordance with SA-705.
(Ref: SA-550, Para 27; SA-705)
Important Judicial Pronouncements (Case Law)
Judicial authorities have consistently underscored that related party arrangements, though not illegal per se, warrant closer scrutiny due to their potential misuse. The judiciary has repeatedly emphasised the risks associated with related party transactions and the need for transparency:
- McDowell & Co. Ltd. v. CTO (1985) 154 ITR 148 (SC)
The Supreme Court held that colourable devices and artificial arrangements, often routed through related parties, cannot be permitted to defeat the intent of law.
- Vodafone International Holdings B.V. v. UOI (2012) 341 ITR 1 (SC)
The Court recognised that corporate structures and inter-group transactions must be examined in substance, particularly where control and influence exist.
- CIT v. Glaxo SmithKline Asia (P) Ltd. (2010) 195 Taxman 35 (SC)
The Supreme Court highlighted the potential misuse of related party transactions and the need for regulatory vigilance in ensuring arm’s length dealings.
- Satyam Computer Services Ltd. Scam Case (SEBI & SFIO findings)
The failure to properly disclose related party transactions was identified as a major governance lapse, reinforcing the critical role of auditors under SA-550.
In essence, SA-550 transforms related parties from a disclosure exercise into a core audit risk area where professional scepticism is not optional, but essential. Hence, SA-550 plays a crucial role in strengthening the credibility of financial reporting by addressing the inherent risks associated with related party relationships and transactions. It does not prohibit such transactions; rather, it mandates transparency, professional skepticism, and robust audit procedures. In an environment of heightened regulatory scrutiny and governance expectations, SA-550 remains one of the most critical standards from both an audit quality and public interest perspective.
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