Related Party Transactions – Audit Procedures under Section 188 of the Companies Act, 2013

Introduction

A Related Party Transaction (RPT) means any deal or arrangement between a company and a person or entity that is related to the company. These transactions include sale, purchase, loan, lease, services, transfer of property, appointment to an office of profit, etc. Since such transactions can be misused, the Companies Act, 2013 has laid down strict rules and audit procedures under Section 188.

Who is a Related Party? Section 2(76)

A related party includes the following:

• Directors of the company

• Key Managerial Personnel (KMP)

• Relatives of directors or KMP, such as son, daughter, wife, siblings, and adopted children

• Companies in which directors or KMPs have significant influence or are directors

• Holding company, subsidiary company, and associate company

  
  

Who is NOT a Related Party?

The following persons are not treated as related parties:

• Ordinary employees (Who are not KMP)

• Shareholders only because they hold shares

• Relatives of shareholders (unless the shareholder is a director or KMP)

• Friends, consultants, or advisors without a control or management role

• Former directors or former KMPs

• Cousins, grandparents, father-in-law, son-in-law

• Professionals like CA, CS, Cost Accountant, Advocate

  
  

Examples of Related Party Transactions

Some common examples of RPTs are:

• The company sells goods to a director’s brother at a lower price

• The company gives an interest-free loan to a director’s relative

• The company takes an office building on rent from a director’s company

• The company pays to director’s wife a salary

• The company purchases machinery from its subsidiary

  
  

Audit Procedures for Related Party Transactions (Section 188)

1. Identification of Related Parties

The auditor should identify all related parties as defined under Section 2(76) by checking:

• List of directors

• Key Managerial Personnel

• Relatives

• Related companies

  
  

2. Check the Nature of Transaction

The auditor should verify the type of transaction, such as:

• Sale or purchase of goods

• Rendering or availing of services

• Leasing of property

• Transfer of assets

• Appointment to the office of profit

  
  

3. Verification of Approvals

3.1 Board Approval (Mandatory)

• Every related party transaction covered under Section 188 must be approved by the Board of Directors.

• Approval must be taken through a resolution passed in a Board meeting.

• The interested director is not allowed to participate in the meeting.

  
  

3.2 Shareholders’ Approval (When Required)

If the transaction exceeds prescribed limits, shareholders’ approval by special resolution is required as per Rule 15.

Limits Prescribed for Shareholders’ Approval

Type of Transaction	Limit requiring Special Resolution
Sale/purchase of goods	10% of turnover or ₹100 crore (whichever is lower)
Buying/selling property	10% of net worth or ₹100 crore (whichever is lower)
Leasing of property	10% of turnover or net worth or ₹100 crore (whichever is lower)
Rendering/availing services	10% of turnover or ₹50 crore (whichever is lower)
Appointment to the office of profit	Monthly remuneration exceeding ₹2.5 lakh
Underwriting securities	1% of net worth

(Turnover and net worth are taken from the last audited financial statements.)

4. Check Arm’s Length and Ordinary Course of Business

The auditor should ensure that:

• Transactions are carried out at market price

• Terms are fair and reasonable

• Transactions are in the ordinary course of business

  
  

5. Verification of Documents

The auditor should examine:

• Agreements and contracts

• Invoices and bills

• Payment proofs

• Delivery or service records

  
  

6. Check Disclosures

The auditor must verify proper disclosure of RPTs in:

• Financial statements as per AS 18 or Ind AS 24

• Register of contracts maintained in Form MBP-4

  
  

7. Perform Audit Tests

• Match invoices with ledger accounts

• Confirm balances with related parties

• Check consistency and completeness of records

  
  

8. Reporting of Non-Compliance

If approvals or disclosures are missing:

• Auditor must report under CARO 2020 – Clause 3(xiii)

• Non-compliance should also be mentioned in the audit report under Section 143

  
  

Penalties for Non-Compliance with Section 188

For the Company

• Listed Company: Fine up to ₹25 lakh

• Other Companies: Fine up to ₹5 lakh

  
  

For Directors or Officers in Default

• Imprisonment up to 1 year, or

• Fine between ₹25,000 and ₹5 lakh, or

• Both imprisonment and fine

Additionally, directors involved must compensate the company for any losses caused.

Conclusion

Related Party Transactions require careful monitoring because they involve parties connected to the company. Section 188 of the Companies Act, 2013 ensures transparency, fairness, and protection of shareholders’ interests. Auditors play a key role in identifying, verifying, and reporting such transactions to ensure legal compliance.