Specific Independent Auditing Standard No.16 - Related Parties and Transactions with Such Parties

Specific Independent Auditing Standard No.16 - Related Parties and Transactions with Such Parties Chapter 1 General provisions Article 1 This standard is prepared in accordance with the General Independent Auditing Standard to establish standards and to define the working requirements for Certified Public Accountants ("CPAs") for the audit of related parties and transactions with such parties and to ensure a high standard of professional work. Article 2 The terms "related party" and "related party transaction" in this standard are consistent with the relevant concepts in the Accounting Standards for Business Enterprises. Article 3 Unless otherwise specified, CPAs should refer to this standard in performing audit work other than the audit of financial statements. Chapter 2 General principles Article 4 It is the responsibility of the entity’s management to identify and disclose related parties and transactions with such parties in accordance with the requirements of the Accounting Standards for business Enterprises. It is the responsibility of the CPAs to perform the necessary audit procedures and obtain sufficient appropriate audit evidence to determine whether the entity identifies and discloses related parties and transactions with such parties in accordance with the requirements of the Accounting Standards for Business Enterprises. Article 5 Due to the complexity of related parties and transactions with such parties and the inherent limitations of internal controls and audit tests, the CPA cannot ensure that all misstatements and omissions in reporting related parties and transactions with such parties are detected even if the CPA acts in accordance with the Independent Auditing Standards in performing the audit work. Article 6 During the audit, the CPA should obtain an adequate understanding of the division of responsibility of the entity’s management and the components of the entity and their inter-relationship etc. The CPA should also consider whether there are incidents of misstatements and omissions in reporting related parties and transactions with such parties. Chapter 3 Identification of related parties and transactions with such parties Article 7 The CPA should review the list of related parties provided by the entity and should perform the following audit procedures to detect whether other related parties exist: (1) review prior year audit working papers; (2) understand and evaluate the entity’s procedures in identifying and accounting for related parties and transactions with such parties; (3) review the list of major investors and key management personnel; (4) understand the affiliations of individual major investors and key management personnel with other relevant entities; (5) understand the affiliations of the close family members of individual major investors and those of key management personnel with other relevant entities; (6) review minutes of the shareholders’ meetings, of the board of directors’ meetings and of other important meetings; (7) make enquiries with other CPAs and the preceding CPA; (8) examine material investment transactions incurred and asset restructuring plans made during the accounting period being audited; and (9) examine income tax returns and other relevant information submitted to government authorities and stock exchanges etc. Article 8 When the CPA has detected the following transactions during the audit process, he should pay attention to identifying whether parties involved in the transactions are related parties: (1) significant transactions with entities or individuals with whom the entity has no normal business relations; (2) transactions which have abnormal terms of trade, such as unusual prices, interest rates, rent and payment terms etc; (3) high value transactions with certain customers or suppliers; (4) transactions in which substance differs from form; (5) barter transactions; (6) transactions which apparently lack a business reason for their occurrence; (7) significant transactions occurred near the balance sheet date; and (8) transactions processed in an unusual manner. Article 9 The CPA should provide a list of identified related parties to other CPAs to enable them to pay attention to identifying transactions between the entity and these related parties during the audit. Article 10 The CPA should perform the following specific audit procedures to identify whether the relevant transactions are related party transactions: (1) review minutes of the shareholders’ meetings, of the board of directors’ meetings and of other important meetings; (2) make enquiries with the management regarding the authorisation of relevant significant transactions; (3) review representations made by the entity’s management; (4) understand the nature and scope of transactions between the entity and its principal customers, suppliers, creditors and debtors; (5) understand whether there are transactions which have occurred but have not been accounted for; (6) review accounting records for large, unusual and not-recurring transactions or balances, especially those transactions recognised near the balance sheet date; and (7) review the relevant confirmations of deposits and loans, and check whether there exists a guarantor relationship. Article 11 The CPA should pay adequate attention if the entity is under the following circumstances, which may lead to related party transactions: (1) lack of the necessary working capital to continue the business; (2) a desire for a continuing favourable profit record for the purpose of sustaining the share price and obtaining finance etc; (3) an overly optimistic profit forecast; (4) over-reliance on a single or relatively few products, customers or transactions; (5) occurrence of an industrial crisis; (6) excess of production capacity; (7) significant litigation, especially litigation between the shareholders and the management; and (8) relatively high risk of technology obsolescence of the industry within which the entity operates. Article 12 The CPA should pay adequate attention if the entity is under the following circumstances, as they indicate the possibility of the existence of undisclosed related party transactions: (1) occurrence of gratuitous related party transactions; (2) occurrence of related party transactions that are difficult to discover; and (3) occurrence of transactions with related parties who are difficult to identify. Article 13 The CPA should pay adequate attention if he discovers that the entity’s management has intentionally concealed related parties or related party transactions, as this indicates the possibility of the existence of other undisclosed related parties or related party transactions. The entity’s management may conceal related party transactions for the following reasons: (1) the related parties may be sensitive to the disclosure of the transactions; or (2) the transactions may have been concluded for the purpose of window dressing, instead of any commercial reason. Chapter 4 Examining related party transactions Article 14 After identifying related parties and transactions with such parties, the CPA should perform the necessary audit procedures and obtain sufficient appropriate audit evidence to determine whether related party transactions have been properly recorded and disclosed. The audit procedures that should normally be performed for such purpose by the CPA include: (1) making enquiries with the management to understand the purpose and pricing policies of the related party transactions; (2) examining the relevant invoices, agreements, contracts and other relevant documents; (3) ascertaining whether the relevant transactions have been approved in the shareholders’ meetings, by the board of directors or by the relevant authorities and management personnel; (4) examining the disclosure of related party transactions in the financial statements; (5) verifying the account balances between the related parties at a particular time and, if necessary, communicating with the CPAs, who perform audits for the related parties to verify certain special, important and typical transactions between the related parties; and (6) examining the value and transferability of any pledge of collateral. Article 15 When examining a significant related party transaction, the CPA should consider performing the following additional audit procedures: (1) confirming the terms and amount of the related party transaction; (2) inspecting relevant evidence possessed by the related party; (3) confirming or discussing the relevant important information of the related party transactions with the relevant intermediaries; and (4) obtaining information regarding the repayment ability of the related parties in respect of any significant receivables from or guarantees provided to them. Article 16 The CPA should obtain a written representation from the entity’s management concerning the following matters: (1) the truthfulness and completeness of information provided regarding the identification of related parties; and (2) the adequacy of disclosures of related parties and transactions with such parties in the financial statements. Chapter 5 Considerations in the preparation of the audit report Article 17 The CPA should form an audit conclusion on related parties and transactions with such parties based on the audit evidence obtained, and should determine its impact on the audit opinion. Article 18 If there are limitations on the scope of the audit, which preclude the CPA from obtaining sufficient appropriate audit evidence about related parties and transactions with such parties which have a material impact on the financial statements, the CPA should consider expressing a qualified opinion or a disclaimer of opinion. Article 19 If the disclosure of related parties and transactions with such parties which have a material impact on the financial statements does not comply with the requirements of the relevant accounting standards, the CPA should express a qualified opinion or an adverse opinion. Chapter 6 Supplementary provisions Article 20 The Chinese Institute of Certified Public Accountants is responsible for the interpretation of this standard. Article 21 This standard takes effect from 1 July 1999.