Why is there a higher risk of material misstatement on the financial statements when related parties are involved in a lot of transactions?

Risk of material misstatement is higher in related party transactions due to reasons such as

• selling to related party at terms outside normal course of business,
• higher credit days allowed which increases the risk of bad debts
• selling at cost price and not recognizing inter company profits in books of accounts
• long outstanding under-provisioned receivables, 
• not having written contract/agreement in place with related parties.

 

The audit of related party relationships and transactions is a crucial aspect in the performance of an audit of financial statements under the International Standards on Auditing

In many cases related party transactions are undertaken in the course of the normal business of an entity, for instance a company may perform the acquisition of certain items for all the entities in a group or, rather, members of the management of an entity may occasionally buy the same goods or services offered to the entity’s clients with the same ‘staff discount’ applicable to other employees.In such a case, related party transactions may not pose a higher risk of material misstatement of the financial statements than similar transactions with unrelated parties.However, in other circumstances, in view of the nature of related party relationships and transactions, they may carry a higher risk of material misstatement in respect of:    Risks from inappropriate accounting;    Risks from non-identification or non-disclosure;    Risks of fraud;    Risks about the ability of the company to continue in business as a going concern – if the entity’s interest is constantly subordinated to that of related parties.

The nature of related oart relationship,and transportations may in some circumstances, give rise to higher risks of material misstatement of the financial statements than transactions with unrelated parties for example: *Information systems may be ineffective at identifying or summarizing transactions and outstanding balances between sny entity and its related parties *Related party transactions may not be conducted under normal market terms and conditions *Related parties may operate through an extensive​ and complex range of relationships and structures,eith a corresponding increase in the complexity​of relsted party transactions

because there are conflict of interest may be occurred and also there are probability that the dealing price with the related party may be lower than the market price.    

Many transactions s with the related parties are concluded in the normal course of business activities. In these circumstances, they may not give rise to a the risk higher of significant anomalies in the financial statements they may include not be higher ed than the that of transactions with parties not related. However, the nature of the relationships and transactions with related parties may, in certain situations, lead to higher risks of anomalies significant in financial statements as transactions with unrelated parties. For example :  The related parties may exercise their business by making use of a broad range of complex links and structures, with the consequent

IAS-24: Related Parties Disclosure:

The objective of this Standard is to ensure that an entity’s financial statements contain the disclosures necessary to draw attention to the possibility that its financial position and profit or loss may have been affected by the existence of related parties and by transactions and outstanding balances, including commitments, with such parties.

A related party is a person or entity that is related to the entity that is preparing its financial statements (in this Standard referred to as the ‘reporting entity’).

(a) A person or a close member of that person’s family is related to a reporting entity if that person:

(i) has control or joint control over the reporting entity;

(ii) has significant influence over the reporting entity; or

(iii) is a member of the key management personnel of the reporting entity or of a parent of the reporting entity.

(b) An entity is related to a reporting entity if any of the following conditions applies:

(i) The entity and the reporting entity are members of the same group (which means that each parent, subsidiary and fellow subsidiary is related to the others).

(ii) One entity is an associate or joint venture of the other entity (or an associate or joint venture of a member of a group of which the other entity is a member).

(iii) Both entities are joint ventures of the same third party.

(iv) One entity is a joint venture of a third entity and the other entity is an associate of the third entity.

(v) The entity is a post-employment benefit plan for the benefit of employees of either the reporting entity or an entity related to the reporting entity. If the reporting entity is itself such a plan, the sponsoring employers are also related to the reporting entity.

(vi) The entity is controlled or jointly controlled by a person identified in (a).

(vii) A person identified in