Testing arm's-length pricing in a related-party transaction means comparing the price and terms against what an unrelated party would have agreed, which is straightforward for transaction types with a visible external market — standard rent, commoditised goods, bank-benchmarked interest — and genuinely not possible for types with no clean comparable, such as a bespoke management fee or a brand royalty. The right response to the second category is to say plainly that no comparable exists and limit the conclusion accordingly, rather than constructing a benchmark that only looks rigorous.
Start by sorting transactions into the two categories
Before testing anything, decide which category a transaction falls into. This sounds obvious and is routinely skipped under time pressure, which is how a management fee ends up tested the same way as a rent payment and signed off with a pricing conclusion nobody can actually support.
| Category | Examples | Testing approach |
|---|---|---|
| Has a reasonably clean external comparable | Standard commercial rent, commoditised goods and services, bank-referenced interest rates | Benchmark directly against the external comparable; a pricing conclusion is supportable |
| Has a comparable with caveats | Goods sold to related and unrelated customers at different volumes or credit terms | Benchmark against the client's own unrelated-party pricing, adjusted for the known differences, and state the adjustment |
| Has no clean comparable | Management or technical fees, brand royalties, bespoke intra-group services, guarantees given without a fee | No pricing conclusion; confirm approval and disclosure instead, and state the scope limitation explicitly |
Where a comparable genuinely exists
- 01Use the client's own unrelated-party transactions firstIf the client sells the same goods to unrelated customers, or rents similar premises from an unrelated landlord elsewhere, that is a more directly relevant comparable than an external market survey, because it controls for the client's own specific circumstances.
- 02Use a market rate proxy for standard premises and routine servicesLocal commercial rent for similar property, or a published or bank-quoted lending rate adjusted for tenor and the borrower's standing, are reasonable proxies for rent and interest respectively, and are widely accepted as sufficient evidence for these specific transaction types.
- 03Adjust explicitly for known differences, and record the adjustmentIf the related-party price differs from the comparable, check whether a stated, verifiable reason explains the gap — volume discount, longer credit period, different specification — before concluding the pricing is or is not at arm's length.
- 04Conclude in proportion to the strength of the comparableA direct comparable supports a clear conclusion. A comparable with meaningful caveats supports a qualified conclusion, stated with the caveats attached rather than smoothed over.
Where no clean comparable exists
Management fees, royalties, brand licensing, and bespoke shared-service arrangements are the recurring examples. These typically depend on a valuation methodology — discounted cash flow, comparable company multiples, royalty rate benchmarking from databases that are themselves imperfect — that sits outside the scope of an ordinary audit procedure and arguably outside the auditor's competence to perform unaided.
Constructing an informal benchmark for one of these transaction types — a royalty rate found on a general web search, or a management fee percentage taken from an unrelated industry survey of uncertain comparability — and then presenting a pricing conclusion built on it, creates a false impression of rigour. It is worse than stating plainly that no reliable comparable was available, because it invites reliance on a number that was never actually load-bearing.
- State explicitly in the working paper that no reliable external comparable exists for the transaction type.
- Shift the procedure to what can be evidenced: board and, where applicable, shareholder approval under section 188, consistency of the fee basis with any underlying agreement, and complete and accurate disclosure of the actual terms.
- Where the amount is material enough that pricing genuinely matters to the financial statements — not just to disclosure — consider whether the engagement needs a valuation specialist, and document that consideration even if the conclusion is that it is not required this year.
- Never present the absence of a benchmark as if the transaction were therefore acceptable by default. The correct record is a stated scope limitation, not a clean opinion by omission.
A worked contrast
A client pays rent to a promoter-owned entity for its registered office, and a management fee to a group holding company for "strategic services". The rent is testable: local commercial rates for similar office space in the same micro-market are available from more than one source, and a conclusion that the rent is or is not broadly in line with market is supportable. The management fee is not testable the same way: there is no market quote for "strategic services" from this specific holding company, and any number assembled to produce one would be manufactured for the purpose of the audit file rather than derived from an actual market. The right file documents a clear pricing conclusion for the rent and a stated scope limitation for the fee, rather than treating both the same way because both are related-party payments.
Common practice, not a requirement
Where a management or similar fee recurs year after year at a flat percentage of revenue or a flat amount with no apparent revision, checking that the basis is at least internally consistent with the governing agreement, and that it has been approved and disclosed, is commonly treated as sufficient audit response given the absence of an external benchmark. This is an accepted practical limit, not a standard requirement, and it should be stated as a limitation rather than implied as a conclusion on fairness of price.
How we think about this
Comparing a related-party rent or interest rate against an external, checkable figure is a comparison a system can run consistently and flag deviations from automatically. Deciding that no comparable exists for a bespoke fee, and that the honest response is a stated scope limitation rather than a manufactured number, is a judgement about the limits of audit evidence that has to be made by the auditor, not quietly resolved by software.
This is practical guidance written for audit teams, not an authoritative statement of any standard or statute. Standards, forms and timelines change. Check the current text issued by the ICAI and the relevant authority before relying on anything here in an audit file.
Related resources
- Related parties & disclosuresRelated-party transaction testing under AS 18 / Ind AS 24Testing related-party transactions means proving the population is complete before checking what management already disclosed.
- Related parties & disclosuresRelated-party disclosure checklist for financial statementsA related-party note that lists transactions but not relationships, or balances but not terms, is an incomplete disclosure even if every number in it is correct.
- Related parties & disclosuresCommon-control entities: why they raise audit riskA promoter running several unlisted entities under common control creates a structure where money, not just transactions, can move without much friction. That is the risk to test for.
Free tools, no signup
Each one reads a file entirely in your browser — or, for two of them, just answers a few questions — and nothing is ever uploaded.
- Purchase register checkDuplicate payments, round-sum amounts, weekend-dated invoices, incomplete records.
- GSTR-2B reconcilerMatches your purchase register against GSTR-2B — missing invoices either side, amount mismatches.
- Bank reconciliation checkerMatches your cash book against a bank statement — what's outstanding on each side.
- Fixed asset register checkDuplicate asset codes, missing location or useful life, negative net book value.
- Payroll red-flag scannerBank accounts shared across employees, and records missing an ID, PAN or salary.
- CARO applicability checkerAnswer a few questions about the company and see which CARO 2020 clauses likely apply.
- MSME payment delay checkerMSME-flagged invoices paid — or still unpaid — beyond the 45-day Section 22 limit.
- Depreciation useful life checkerCompares a useful life in use against the Schedule II, Part C indicative figure.
- Materiality calculatorOverall and performance materiality against PBT, revenue, assets or equity, with reasoning shown.
- Sample size calculatorStatistical sample size for a test of controls or a substantive test of detail.