Auditing Related-Party Transactions

September 17, 2026

Many companies transact with related parties. These can include the president, officers, subsidiaries, entities under common control, and even the owner's family members and friends. Audits require close attention to whether such transactions are legitimate and lawful, in order to ensure transparent financial reporting.

Risk assessment

Because related-party transactions heighten the risk of fraud and legal violations, they warrant attention regardless of company size. If material related-party transactions go undisclosed, or if they are not carried out at arm's length — that is, at market value — the company's financial results will not be fairly presented, potentially leading lenders, investors, and other stakeholders to draw the wrong conclusions. A company might, for example, boost its profits by paying a subsidiary below-market rent. Given these risks, auditors apply enhanced procedures for related-party risk beginning at the planning stage of the audit.

Management's role

Ultimate responsibility for preparing the financial statements rests with management, not the auditors. That responsibility includes identifying related parties. Outside business interests held by individual officers, or transactions involving their relatives, cannot be identified by the company unless the individuals disclose them. Establishing a conflict-of-interest policy — under which officers and key employees periodically report their outside relationships — allows these connections to surface at an early stage.

Companies must disclose related-party relationships and transactions in the notes to the financial statements. The disclosure should state the nature of the relationship, the amounts involved, and any outstanding balances.

Tailored audit procedures

During fieldwork, external auditors must obtain sufficient audit evidence to determine whether related-party transactions have been properly identified, accounted for, and disclosed. They begin by asking questions designed to build a thorough understanding of the related-party relationships and transactions — their nature, their terms, and their business purpose. From there, rather than relying solely on information provided by the company, auditors corroborate what they are told against public sources and outside records. This is where relationships that management itself was unaware of sometimes come to light.

Information gathered during an audit that can point to undisclosed related parties includes:

• Information published on the company's website

• Responses to confirmations and invoices from the company's attorneys

• Tax filings

• Life insurance policies held by the company

• Contracts and other agreements

• The company's organizational chart

Auditors also scrutinize significant transactions falling outside the ordinary course of business, as well as those that appear unusual in timing, size, or nature.

In closing

To support transparent financial statements, please share all information about your related-party relationships and transactions with your auditors. In particular, discuss any new arrangements entered into during the year, so that they can be properly disclosed in your year-end financial statements.