This is a composite, illustrative scenario built from how a related-party loan compliance gap typically surfaces, not an account of a named client. A balance recorded as a “current account with subsidiary” had, over two years, only ever moved in one direction — funds flowing from the parent to the subsidiary, with no repayment, no interest charged, and no running settlement pattern a genuine trading current account would show. In substance, this was a loan, which meant the parent's Section 186 requirements on inter-corporate loans and investments applied, and the board approvals and disclosures that provision requires had never been obtained because nobody had classified the balance as a loan in the first place.
Why the label on the ledger didn't settle the question
Regulatory requirement
Substance over form is not an audit nicety here — Section 186 of the Companies Act applies to the loan or investment as a matter of fact, regardless of what the parties called the arrangement on their books. A current account that functions as a one-way, unrepaid, non-interest-bearing flow of funds is a loan in substance, and the statutory requirements follow the substance.
What was checked
- 01Pulled two years of transaction history on the accountEvery entry was a transfer from parent to subsidiary. Not one entry in either year represented a repayment, a trade settlement, or a reversal — a pattern inconsistent with a genuine trading current account.
- 02Checked whether any interest had been chargedNone. A related-party loan carrying no interest is itself worth separately evaluating against arm's-length pricing norms, independent of the approval question.
- 03Checked board minutes for any approval referencing this balanceNo resolution existed approving a loan or investment to the subsidiary at any point in either year, and no reference to Section 186 limits or the special resolution threshold the amount would have required.
- 04Checked whether the amount exceeded the limits that trigger shareholder approvalIt did, once compared to the parent's own net worth and free reserves — which meant not just board approval but a shareholder special resolution should have been obtained and was not.
What the gap actually meant
| Missing | Consequence |
|---|---|
| Board resolution approving the loan | A compliance breach under Section 186, regardless of the audit opinion on the financial statements |
| Shareholder special resolution (amount exceeded the threshold) | A separate, more serious compliance breach — this required the highest level of approval under the section, not just board sign-off |
| Interest at arm's length, or a documented rationale for an interest-free loan to a subsidiary | A related-party pricing question, assessed separately from the approval compliance gap |
| Disclosure as a related-party loan in the notes to accounts | The balance had been disclosed only as a generic inter-company balance, not specifically identified as a loan to a related party |
What went into the file
- The two-year transaction history, establishing the one-directional pattern that supported treating this as a loan in substance.
- The Section 186 threshold calculation, showing the amount exceeded the level requiring shareholder approval.
- Confirmation that no board resolution and no shareholder special resolution existed for this balance.
- The matter referred to the client's legal/secretarial function for regularisation — the audit does not cure a compliance breach, it identifies and reports it.
- The disclosure in the financial statements corrected to identify the balance specifically as a related-party loan, not a generic current account.
How we think about this
Testing related-party balances by their ledger label, rather than by the actual transaction pattern behind them, is how a loan-in-substance stays classified as an ordinary current account for years. Pulling the full transaction history — not just the closing balance — is what actually reveals whether a balance behaves like a loan.
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 & disclosuresSection 188 compliance: what an auditor checksSection 188 approval is a governance fact to verify against minutes, not an assumption to carry forward from last year's file.
- 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 & disclosuresAuditing loans to directors and connected personsThe riskiest loans to directors are rarely booked as loans. They show up as unsettled expense advances and drifting current-account balances.
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