Business transactions with related parties — such as friends, relatives, parent companies, subsidiaries and affiliated entities — may sometimes happen at above- or below-market rates. This can be misleading to people who rely on your company’s financial statements, because undisclosed related-party transactions may skew the company’s true financial results.
The hunt for related parties
Given the potential for double-dealing with related parties, auditors spend significant time hunting for undisclosed related-party transactions. Examples of documents and data sources that can help uncover these transactions are:
Specifically, auditors look for contracts for goods or services that are priced at less (or more) favorable terms than those in similar arm’s-length transactions between unrelated third parties.
For example, a spinoff business might lease office space from its parent company at below-market rates. A manufacturer might buy goods at artificially high prices from its subsidiary in a low-tax country to reduce its taxable income in the United States. Or an auto dealership might pay the owner’s daughter an above-market salary and various perks that aren’t available to unrelated employees.
Audit procedures designed to target related-party transactions include:
Accurate, complete reporting of these transactions requires robust internal controls. A company’s vendor approval process should provide guidelines to help accounting personnel determine whether a supplier qualifies as a related party and mark it accordingly in the ERP system. Without the right mechanisms in place, a company may inadvertently omit a disclosure about a related-party transaction.
Let’s talk about it
With related-party transactions, communication is key. Always tell your auditors about known related-party transactions and ask for help disclosing and reporting these transactions in a transparent manner that complies with U.S. Generally Accepted Accounting Principles.
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