CAF-8 · Chapter 11
Related Party Transactions MCQs with Answers
10 multiple-choice questions on Related Party Transactions for CAF-8 Audit and Assurance Essentials. Try each one before revealing the answer and explanation.
Practise this chapter interactivelyQuestion 1
According to ISA 550, why do Related Party (RP) transactions pose a higher risk of material misstatement?
- A) Because related parties always want to pay more tax than necessary.
- B) Because RP transactions may not be conducted under normal market terms (arm's length) and can be used to manipulate financial results.
- C) Because the auditor is personally related to the client's CEO.
- D) Because related parties are legally prohibited from trading with each other.
Show answer & explanation
Answer: B) Because RP transactions may not be conducted under normal market terms (arm's length) and can be used to manipulate financial results.
Related parties (like family members or parent companies) can influence each other to set prices that wouldn't exist between independent parties, which can be used to hide losses or shift profits.
Question 2
Management claims that all transactions with its parent company were conducted on 'Arm’s Length' terms. What is the auditor's responsibility regarding this specific claim?
- A) Accept the claim as true without further testing.
- B) Obtain sufficient appropriate audit evidence to support management's assertion that the terms were equivalent to those in an arm's length transaction.
- C) Disclaim an opinion because it's impossible to verify arm's length terms.
- D) Insist that all parent-subsidiary trades be stopped immediately.
Show answer & explanation
Answer: B) Obtain sufficient appropriate audit evidence to support management's assertion that the terms were equivalent to those in an arm's length transaction.
If management makes an explicit claim of arm’s length terms in the financial statements, the auditor must specifically test that claim by comparing the prices to those of independent third parties.
Question 3
Which of the following is an example of a Related Party for a corporate audit client?
- A) A random individual who bought 1 share of the company on the stock exchange.
- B) A company controlled by the spouse of the client's Managing Director.
- C) The local utility company that provides electricity to the factory.
- D) The tax authorities.
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Answer: B) A company controlled by the spouse of the client's Managing Director.
Related parties include entities that can exercise significant influence or control. Close family members of key management personnel are considered related parties under IAS 24.
Question 4
During the audit, the auditor discovers a significant transaction with a company that was not disclosed as a related party by management. What is the auditor's first action?
- A) Resign from the audit immediately.
- B) Communicate the discovery to the other members of the engagement team and inquire why management failed to identify/disclose it.
- C) Post a public warning about the company on social media.
- D) Assume it was just a minor clerical error and ignore it.
Show answer & explanation
Answer: B) Communicate the discovery to the other members of the engagement team and inquire why management failed to identify/disclose it.
Communication within the team and inquiry of management are the first steps to determine if the failure to disclose was an oversight or an intentional attempt to conceal fraud.
Question 5
Which of the following audit procedures would most likely help an auditor identify undisclosed related party transactions?
- A) Reviewing the board of directors’ minutes and shareholder records.
- B) Counting the physical inventory in the retail stores.
- C) Checking the employee's uniform cleanliness.
- D) Recalculating the previous year's depreciation.
Show answer & explanation
Answer: A) Reviewing the board of directors’ minutes and shareholder records.
Minutes and share registers often reveal the identities of major shareholders and directors' outside business interests, which are primary sources of related parties.
Question 6
What is the primary disclosure requirement for Related Party transactions under IAS 24?
- A) To list every single pencil purchased from a related party.
- B) To disclose the nature of the relationship, the amount of transactions, and outstanding balances at the year-end.
- C) To disclose the home addresses of all related party owners.
- D) No disclosure is required if the transactions are conducted in cash.
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Answer: B) To disclose the nature of the relationship, the amount of transactions, and outstanding balances at the year-end.
To make the financial statements understandable, IAS 24 requires disclosure of the relationship, transaction volumes, and any unpaid amounts at the balance sheet date.
Question 7
An auditor notices that a client sold a building to its majority shareholder for 10% of its market value. What is the most significant risk associated with this transaction?
- A) The risk that the building was painted poorly.
- B) The risk of lack of 'Occurrence' and 'Valuation' resulting in hidden distributions to shareholders.
- C) The risk that the buyer will forget to pay for the building.
- D) The risk that the shareholder used the building for a different purpose.
Show answer & explanation
Answer: B) The risk of lack of 'Occurrence' and 'Valuation' resulting in hidden distributions to shareholders.
Selling an asset significantly below market value to a related party is often a way to illegally extract value (a 'de facto' dividend) while manipulating profit/loss.
Question 8
ISA 550 requires the auditor to obtain a 'Written Representation' from management. What should this representation cover regarding related parties?
- A) That management is personally related to the auditor.
- B) That management has disclosed to the auditor the identity of the entity's related parties and all related party relationships and transactions.
- C) That management will never use related parties again.
- D) That related parties are more important than the auditor.
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Answer: B) That management has disclosed to the auditor the identity of the entity's related parties and all related party relationships and transactions.
Management representations are a core requirement to ensure management formally acknowledges it has given the auditor all relevant information about its related parties.
Question 9
If an auditor is unable to obtain sufficient appropriate evidence regarding a significant undisclosed related party transaction, how might this impact the audit report?
- A) They must issue an unmodified opinion.
- B) They may need to qualify the opinion or issue a disclaimer if the matter is material and pervasive.
- C) They should skip the disclosure section in the report.
- D) They should increase the audit fee to cover the risk.
Show answer & explanation
Answer: B) They may need to qualify the opinion or issue a disclaimer if the matter is material and pervasive.
A limitation on scope regarding material and potentially pervasive undisclosed transactions leads to a modified audit opinion.
Question 10
Which of the following documents is least likely to help in identifying related parties?
- A) Conflicts of interest register.
- B) Confirmation from banks and lawyers.
- C) The office floor cleaning schedule.
- D) Investments in other entities recorded in the ledger.
Show answer & explanation
Answer: C) The office floor cleaning schedule.
Administrative schedules for cleaning are irrelevant to identifying parties with financial influence or control. Investment records and conflict registers are highly relevant.