Scenario: An auditor is auditing the financial statements of a nonissuer. The auditor identifies a material related party transaction that was not authorized in accordance with the entity's policies. <br/><br/>What is the auditor's primary concern?

Answer options:

The transaction is automatically void.

The transaction may be fraudulent or may indicate a risk of fraud (misappropriation or override).

The transaction must be reclassified as equity.

The auditor must withdraw.

How to approach this question

Related Party + Unauthorized = Fraud Risk. Why did they bypass the rules for their friend?

Full Answer

B.The transaction may be fraudulent or may indicate a risk of fraud (misappropriation or override).✓ Correct

Significant related party transactions that are not authorized or are outside the normal course of business are significant risks and may indicate fraud (e.g., looting the company). The auditor must evaluate the business rationale.

Common mistakes

Focusing on accounting classification rather than the fraud risk.

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