A CFO sells a warehouse to a company her brother controls for $2 million ($800,000 below appraised value) and discloses it as an "ordinary course" sale. The cash moved, the entry posted cleanly. AU-C 550 exists because that is exactly what an auditor must catch.
Why Related Parties Get Their Own Standard
HIGH-FREQUENCY: AU-C 550 treats related party transactions as carrying inherent fraud risk: they may not be at arm's length, may lack a business purpose, and management has motive and opportunity to use them to manipulate earnings, hide debt, or extract value. You can rebut the presumption for routine transactions, but the rebuttal must be documented.
KEY: Related party transactions are presumed a significant risk. Rebuttals are documented, never assumed.
- Management and directors: anyone able to influence financial or operating policies
- Immediate family: spouses, children (incl. adult), siblings, parents, in-laws. Household status does not matter.
- Controlled entities: subsidiaries, parents, sister companies under common control
- Equity-method investees (typically 20-50% with significant influence) and joint ventures
Common mistakes
- Treating the related party listing as complete. The questionnaire is the starting point. AU-C 550 requires independent procedures (minutes review, GL inspection, inquiry of others) to find parties management did not list.
- Accepting "arm's length" without corroboration. A management representation is not evidence. ASC 850 requires substantiation.
- Confusing disclosure with audit. A fully disclosed transaction may still lack economic substance or indicate fraud.
Bottom line
- AU-C 550 governs related parties; ASC 850 governs disclosure. Related party transactions are presumed a significant risk unless rebutted in writing.
- Identification covers management, directors, immediate family (incl. adult children, in-laws), controlled entities, equity-method investees, JVs, 10% owners.
- Identification requires inquiry plus inspection of minutes, records, and prior working papers.
- Substance over form: evaluate economic purpose, not just recording; arm's-length claims require corroboration.
Exam shortcut
If a question describes a transaction with a family member, controlled entity, or equity investee, AU-C 550 governs and "significant risk" is the default. When management claims arm's length, the right answer always involves obtaining independent corroboration. When an undisclosed related party surfaces, the trio is: expand procedures, reassess fraud risk, communicate to TCWG. ASC 850 disclosure requires nature, amount, balance, and terms.
The full lesson (about 1,535 words, 10 min read) adds 2 worked examples, all 6 common mistakes, a self-check, free in the app.
Learning objectives
- II.G3
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