You have been contracted to audit the financial statements of Ben Webster \& Associates, a privately held real estate investing firm. Ben has been in the business for several years and has built up a sizable portfolio of properties, mostly commercial office buildings, but has never issued audited, GAAP-based financial statements. He now seeks to do so since his bank told him they would consider better terms on his line of credit if he provided audited financial statements.

Ben has a sister, Martha, who is in the construction business. Many, but not all, of Ben's projects are constructed by Martha's firm. The arrangement on a typical project is for Martha's firm to build a commercial office building "on spec" so that Ben's firm can attempt to lease it. Although the normal arrangement in this industry calls for the construction company to be paid off as the construction is completed with the proceeds from the investment company's construction loan, the informal terms between Martha and Ben allow for Martha to share some of the market risk (i.e., that the building doesn't quickly lease up) by her accepting payments from Ben's firm on an as-leased basis. Ben's firm has taken advantage of this several times within the past several years, to the point that Ben considers the arrangement an alternative, but reliable, source of financing. As for her part, Martha knows that by extending the payment terms on occasion she will gain preferential status on Ben's construction business even when her bid is not the lowest.

Discuss the ramifications of this arrangement for your audit of Ben's firm. Specifically:

a. What risk is inherently associated with this related party transaction?

b. How would you identify the related party transactions (e.g., what documentation would you study)?

c. What accounts and compliance with what accounting methods would require more careful study for those transactions identified as related party transactions?

d. What disclosures in the financial statements would be necessary as a result of the material related party transactions?