PCAOB proposed auditing standard – related parties

Proposed amendments to certain PCAOB auditing standards regarding significant unusual transactions and other proposed amendments to PCAOB auditing standards.

On May 7, 2013 the Public Company Accounting Oversight Board (PCAOB) reproposed the Proposed Auditing Standard – Related Parties; Proposed Amendments to Certain PCAOB Auditing Standards Regarding Significant Unusual Transactions; and Other Proposed Amendments to PCAOB Auditing Standards. This reproposal was in a response to public comments received from the initial proposal issued February 28, 2012.

The introduction in PCAOB Release No. 2013-004 provides the following summary:

Related party transactions have been contributing factors in numerous prominent financial reporting frauds over the last few decades. Financial reporting frauds also have involved significant transactions that are outside the normal course of business for the company or that otherwise appear to be unusual due to their timing, size, or nature (“significant unusual transactions”) and a company’s financial relationships and transactions with its executive officers. Corporate scandals involving these areas, such as financial reporting frauds at Enron Corporation, Tyco International, Ltd., Refco, Inc., and WorldCom, Inc., undermined investor confidence, resulted in significant losses for investors, as well as the loss of many jobs for employees. These critical areas have continued to be a contributing factor in more recent cases. The reproposed standard and amendments would update and strengthen auditor performance requirements in these critical areas, which could pose significant risks of material misstatement in company financial statements.

The reproposed standard was intended to clarify the alignment of the standard with the PCAOB’s risk assessment standards. This would require the auditor to evaluate whether the company has properly identified its related parties and relationships, and transactions with related parties, and tailor the audit plan to address such risk, if any. The reproposed standard would therefore heighten the audit focus on the evaluation of a company’s identification of, accounting for and disclosure of its relationships and transactions with related parties by setting forth specific audit procedures that would include, among others:

  • Obtaining an understanding of the company’s relationships and transactions with its related parties;
  • Performing specific procedures for related party transactions that require disclosure in the financial statements or that are determined to be a significant risk;
  • Evaluating whether the company has properly identified its related parties and relationships, and transactions with related parties;
  • Communicating with the audit committee, in a timely manner and prior to the issuance of the auditor’s report, the auditor’s evaluation of the company’s identification of, accounting for, and disclosure of its relationships and transactions with related parties.

The amendments related to significant unusual transactions are designed to enhance the auditor’s identification and evaluation of a company’s significant unusual transactions, and enhance the auditor’s evaluation of whether such transactions have been appropriately accounted for and adequately disclosed in the company’s financial statements and whether the lack of a business purpose indicates they may have been entered into to engage in fraudulent financial reporting or conceal misappropriation of assets.

Other reproposed amendments would require the auditor to perform specific procedures to obtain an understanding of the potential risks of material misstatement posed by incentives and pressures arising from a company’s financial relationships and transactions with its executive officers.

If adopted, the reproposed auditing standard would supersede PCAOB AU 334, Related Parties. The reproposed amendments would amend other auditing standards, including PCAOB AU 316, Consideration of Fraud in a Financial Statement Audit, and Auditing Standard 12, Identifying and Assessing Risks of Material Misstatement.

Public comments on the reproposal were due July 8. Two specific areas the PCAOB sought comment on were the economic impact the proposal would have and the potential effect on emerging growth companies as defined by the Jumpstart Our Business Startups Act, P.L. 112-106.

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