Is a person having significant influence (to an entities) considered a related parties

We received a very good question from our Accounting & Auditing blog's royal readers with regard to related parties, as follows:

"I would like to inquire that related company or related party does not necessary to own shares in the other company but also have great influence in the decision making. Am I right? What if they do not own shares but has great influence in the decision making, does it still consider as related?"

According to International Accounting Standard 24, the definition of a related party does not only include shareholders, but also many other parties. A person who may exercise significant influence over the entity's decision making is also considered a related party.

Why is it important to identify an individual having significant influence as a related party? This is because we need to consider whether the transaction entred into between the Company and the invidiual ( having significant influence) are conducted on an arms-length basis. There are instances / cases where the said transactions were not entered into on an arms-length basis but not detected by audit committee or auditors.

Hence, the responsiblity of auditors include obtaining the list of related parties from audit client, identify potential related parties not identified by management, pay reasonably sufficient attention to related parties transactions, and ensure that related party transactions are disclosed appropriately in accordance with IAS 24.

Recommendation of new accounting procedures: Investment-equity reconciliation

A good exercise can be undertaken by the holding company is to prepare appropriate documentation to reconcile investor's cost of investment to investee's share capital for any investment-equtiy relationships within the Group.

The procdure appears to be straight forward, simple and non-complex on first thought. However, the reconciliation can turn into a complex procedure, due to:

- impairment been recorded for cost of investment
- difference exchange rate was used to translate the funding (i.e. investor used exchange rate A, while investee used exchange rate B)
- funding remitted / received is not recorded in appropriate account, etc

This recommended procedure is particularly useful for entities with significant number of subsidiaries. Discrepancies (between cost of investment and share capital) are usually expected for large group of entities.

This reconciliation excercise help to ensure that appropriate figures are recorded in respective source ledger, and ensure that appropriate elimination are done at group level.

Accounting treatment for fraud- losses

We received question from our Accounting & Auditing readers on what would be the accounting entries for losses arising from fraud incidence.

In most of the circumstances, the losses arising from fraud wil be recorded in profit & loss statement. For instance, if a Company sufferred misappropriation of cash, the following accounting entries should be recorded:

Dr. Loss (Profit & Loss)
Cr. Cash

If the losses arising from fraud incident is material, this fact (i.e. fraud incident) need to be disclosed in the financial statement of the Company. Management of the Company need to consider the local laws & regulations on the disclosure requirement of fraud.

What is financial auditing?

We received a lot of question asking us what is financial audit? What does a financial audit involved? We will try to explain in a layman term.

Background:

Company ABC is a publicly listed company. They have hired their own accountants to preare the financial statements, including: income statement, balance sheet, cash flow statement on a monthly basis.

Question:

How does the public know if the financial statement prepared by Company ABC is appropriate and in accordance with accounting standard.

Financial audit:

This is when the financial auditor come in and play a major role, where they review the financial statemetn close process of the Company's, review the accouting treatments and policies, and give you their own opinion on the financial statement. The opinion of the auditor is whether " the financial statement is fairly stated". "Fairly stated", in substance, implies that certain tolerable errors are expected.

Life without auditor:

The financial statement prepared by Company ABC may be prepared on a inappropriate manner/ not in accordance with accounting standard. However, since no professional personnel is conducting a review on the financial statement, the inappropriate financial statement will be accepted by the public.

Consequence of life without auditor:

The incorrect financial statement led to wrong decision being made by financial statement user.