Testing related-party sales starts with identifying which customers in the sales register are actually related parties, which the register itself almost never flags, then comparing the pricing and terms given to those customers against comparable third-party transactions to see whether they look arm's length, and finally checking that the resulting disclosures reflect what was actually found. The identification step is usually the harder one in practice, because the sales ledger has no field for it and management's own list of related parties is not always complete.
Why identification is the hard part
A related party for financial reporting purposes is defined by relationships of control, significant influence, or key management, not by anything that appears in a Tally customer master. A director's brother-in-law's firm, a company where a common director sits on the board, or an entity under common promoter control through a chain of shareholdings will sell and buy from the audited entity exactly like any ordinary customer, with no marker distinguishing the transaction in the accounting system. Relying solely on the list management provides is a common and risky shortcut, because the definition's scope is wider than most managements intuitively apply, and the parties most likely to be omitted are exactly the ones least convenient to disclose.
Building an independent identification list
- 01Start from statutory registers and filingsThe register of directors and their shareholdings, the register of contracts in which directors are interested, and the shareholding pattern give the formal relationships the Companies Act and the applicable accounting standard are concerned with.
- 02Cross-check director and KMP addresses and PANs against the customer and vendor mastersA match on address or PAN between a director's personal details and a counterparty entity is one of the more reliable indicators available directly from the client's own data.
- 03Review board minutes and related-party transaction approvals for the yearTransactions requiring board or audit committee approval under the entity's own governance framework will often name counterparties that do not appear on the formal related-party list maintained for disclosure.
- 04Ask about relationships directly, and ask more than onceA direct enquiry of management and, separately, of those charged with governance, repeated at different points in the audit rather than asked once at the start, surfaces relationships that a single upfront question misses.
- 05Look for customers or vendors with unusual commercial termsExtended credit periods, no security deposit where competitors require one, or pricing consistently better than other customers of similar size, are commercial patterns that sometimes indicate an undisclosed relationship even before any formal link is confirmed.
A newly incorporated entity, registered close to the audited company's own address, transacting at volumes that make it one of the larger customers or vendors within its first year of existence, is a pattern worth examining regardless of whether it appears on management's related-party list.
Assessing pricing against arm's-length comparables
Once related-party customers are identified, the audit question is whether the pricing and terms given to them are consistent with what the entity gives unrelated customers in comparable circumstances. A full transfer-pricing benchmarking study is a specialist exercise outside the scope of most statutory audits; the practical audit-level test is narrower and still useful.
- Compare the unit price or margin on sales to the related party against sales of the same or a similar product to unrelated customers in the same period, adjusting for obvious differences such as order volume
- Compare credit period and security terms given to the related party against the entity's standard terms for customers of similar size
- Check whether the related-party relationship corresponds to any separate statutory transfer-pricing documentation prepared for income-tax purposes, and note any material inconsistency between that documentation and what the statutory accounts show
- Look for related-party sales recorded at or near cost, or at a loss, with no commercial explanation, which raises questions about whether value is being shifted rather than genuinely traded
Common practice, not a requirement
Where the entity has separate transfer-pricing documentation prepared for income-tax compliance, requesting it as a starting point for the audit-level pricing comparison is common practice and saves rebuilding a comparable-pricing analysis from nothing, though the audit objective and the tax objective are not identical and the documentation should not be relied on uncritically.
Disclosure: a note on scope
Related-party disclosure requirements exist under both the Companies Act and the applicable accounting standard, and the two overlap but are not identical in scope or in the specific disclosures required. Given how frequently the detailed requirements are revised and how consequential getting the scope wrong can be, this is an area to check against the current text of the relevant section and standard for the period under audit rather than relying on a general description of what used to be required.
Regulatory requirement
Related-party disclosure obligations arise under company law and under the applicable accounting standard, and the definitions, approval requirements and disclosure content under each should be confirmed against the current statutory and standard text for the period under audit before concluding on completeness of disclosure.
The audit approach, summarised
| Step | Objective |
|---|---|
| Build an identification list independent of management's own list | Completeness of the related-party population |
| Extract all sales and balances to and from the identified parties | A full population to test, not a management-filtered subset |
| Compare pricing and terms to unrelated comparable transactions | Whether the transaction is at arm's length, or disclosed as not |
| Trace approvals through board or audit committee minutes | Whether governance requirements over the transaction were followed |
| Agree the disclosure note to the underlying analysis | Whether what is disclosed matches what was actually found |
How we think about this
Cross-matching director addresses and PANs against the customer master, and comparing a related party's pricing and terms against the rest of the book, are exactly the kind of exhaustive matching that should run across the whole ledger automatically rather than depend on an auditor remembering to check a specific name. Deciding whether a relationship exists in substance, and whether a pricing difference is commercially explained, stays a judgement for the auditor.
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
- Revenue, receivables & cut-offRevenue recognition testing in a statutory auditThe transfer-of-control test that governs when a sale is recognised, the misstatement patterns that recur in practice, and what evidence ties a recognised sale to an underlying document.
- Revenue, receivables & cut-offDebtors confirmation procedure: balance confirmation in practicePositive versus negative confirmation, selection criteria, handling non-responses and disputes, and the alternative procedures that cover the gap when confirmations fail.
- Revenue, receivables & cut-offCommon exceptions in revenue and receivables testingA reference catalogue of the exceptions that recur most often across revenue and receivables testing, why each happens, and what to do about it.
- 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.
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