Related Party Transactions, or RPTs, are among the most scrutinised areas in financial reporting and statutory audits. While such transactions are not inherently improper and may arise in the ordinary course of business, they present elevated risks of conflicts of interest, financial manipulation, and governance failures.
In a detailed article published in its newsletter, the National Financial Reporting Authority sets out how auditors should approach RPTs, highlighting regulatory requirements, audit responsibilities, and recurring deficiencies observed in practice.
Understanding What Constitutes a Related Party
The Companies Act, 2013 adopts a broad definition of related parties. It includes directors, key managerial personnel, and their relatives, along with entities in which such persons exercise control or significant influence. Holding companies, subsidiaries, associate companies, and fellow subsidiaries also fall within this scope.
Accounting standards further expand the definition. Ind AS 24 includes individuals with joint control, close family members, and post-employment benefit plans. The intent is clear. Any relationship capable of influencing decision-making or financial reporting must be identified and disclosed.
Regulatory Framework Governing RPTs
Related Party Transactions are regulated through a combination of company law, accounting standards, and securities regulations.
Under the Companies Act, 2013, the Audit Committee is required to approve or modify RPTs, while certain transactions must also receive board or shareholder approval based on prescribed thresholds. Companies are required to maintain proper registers and supporting documentation.
Ind AS 24 mandates detailed disclosures, including the nature of relationships, transaction volumes, outstanding balances, guarantees, commitments, and key managerial personnel compensation.
SEBI LODR Regulations add further safeguards by requiring audit committee pre-approval of RPTs, shareholder approval for material transactions, and periodic disclosures to stock exchanges.
Why Related Party Transactions Are a High-Risk Audit Area
NFRA highlights that RPTs are particularly vulnerable to abuse. They may be used to siphon funds, inflate revenues, manipulate profits, or transfer assets on non-market terms.
Governance concerns are amplified where promoter influence dominates decision-making. In complex group structures, indirect ownership and layered entities can conceal relationships, making identification more difficult. Valuation is another challenge, as many RPTs lack reliable market benchmarks to establish arm’s length pricing.
These factors collectively make RPTs a significant risk area requiring deeper audit scrutiny.
Auditor Responsibilities Under SA-550
Auditing standards require auditors to adopt a rigorous and sceptical approach to RPTs. Auditors must independently identify related parties and cannot rely solely on management representations.
This involves reviewing declarations by directors and key managerial personnel, analysing corporate and ownership structures, examining beneficial ownership, and applying analytical procedures to identify unusual transactions or linkages.
Auditors are also required to understand and test internal controls governing RPT approvals, including compliance with Sections 177 and 188 of the Companies Act and the quality of audit committee oversight.
Substantive Audit Procedures and Compliance Checks
Beyond control testing, auditors must perform substantive procedures. These include examining contracts, invoices, board and committee minutes, and correspondence, as well as independently confirming balances with related parties.
Auditors are expected to assess whether transactions are conducted at arm’s length, using appropriate benchmarks where available. They must also verify compliance with disclosure requirements under Ind AS 24 and SEBI LODR Regulations.
NFRA notes that audit documentation often reflects the existence of controls but lacks evidence of effective testing. Over-reliance on management assertions regarding pricing and commercial rationale remains a recurring weakness.
Key Regulatory Concerns Highlighted by NFRA
The NFRA article identifies several common deficiencies in audits of RPTs. These include failure to identify indirect or concealed related parties, insufficient testing of arm’s length nature, weak audit documentation, and limited challenge to management explanations.
Incomplete or inconsistent disclosures under Ind AS 24 and poor linkage between identified risks and audit procedures are also highlighted as significant concerns.
NFRA’s Expectations Going Forward
NFRA emphasises that auditors must adopt a heightened, investigative, and sceptical mindset, especially where commercial rationale is unclear or promoter influence is significant.
Robust documentation, independent corroboration of evidence, and clear alignment between risk assessment and audit procedures are essential. As corporate structures grow more complex, the responsibility on auditors to ensure transparent and faithful reporting of RPTs becomes even more critical.
Key Takeaway
Related Party Transactions sit at the intersection of governance, transparency, and financial reporting integrity. Auditing RPTs is not a routine compliance exercise but a core safeguard against governance abuse.
NFRA’s analysis reinforces that effective audits of RPTs play a vital role in protecting investor confidence, strengthening accountability, and preserving trust in the financial reporting ecosystem.
Concluding Comment
The NFRA article is an important diagnostic document, but it also inadvertently highlights the limits of a compliance-driven audit oversight model. Going forward, greater emphasis on risk-based supervision, early intervention, and shared accountability between auditors, audit committees, and regulators may be necessary to meaningfully reduce RPT-related governance failures.
Source: Adapted from NFRA Newsletter dated 29/01/2026 (DECODING CORPORATE RELATIONSHIPS: THE AUDITOR’S LENS ON RELATED PARTY TRANSACTIONS)