What the PCAOB’s new related-party standard means for auditors


A new PCAOB related-party auditing standard may cause audit firms to revise their audit plans and methodologies to ensure that newly required procedures are fully incorporated into all phases of the audit.

The PCAOB issued Auditing Standard (AS) No. 18, Related Parties, on June 10 along with amendments to auditing standards in the areas of significant unusual transactions and financial relationships, and transactions with executive officers. The standard and amendments will require auditors to perform specific procedures that are intended to strengthen auditor performance in these high-risk areas. The PCAOB has indicated that previous guidance in these areas did not contain sufficient required procedures and was not sufficiently risk-based.  

The new standard on related parties requires the auditor to perform specific procedures to understand a company’s relationships and transactions with related parties. The company’s process for identifying these relationships and transactions, including authorization and approval, is an important aspect of its internal control that must be understood and documented by the auditor in the same way that other key controls are.

In addition to identification, companies must properly account for these transactions and provide adequate disclosure in the financial statements. Auditors must perform procedures to test that the company’s related parties and transactions with those parties have been completely and accurately identified, accounted for, and disclosed. Further, additional procedures are required if the auditor identifies related-party relationships or transactions that were not previously disclosed to the auditor. The standard also requires specific audit committee communications about the results of the auditor’s evaluation.

The previous auditing standard in this area, AU Section 334, Related Parties, was less specific as to required procedures and included procedures for the auditor to consider. Appendix 4 of the PCAOB release compares portions of the new standard to existing standards. The intent of the new standard is to make audit procedures more effective. For many auditors, the new requirements are logical and familiar as part of a risk-based audit approach. Related-party transactions, as a risk area, have always been an area for inquiry and review of related documentation, accounting, and disclosure. 

Chris Smith, CPA, BDO USA LLP’s accounting and auditing professional practice leader, supports the related-party standard because it “makes sense” and provides guidance on how to look for these transactions and what to do with them once identified. He indicated that he was not concerned about the burden of this standard on auditors.

“What may be new is the need to change audit plans to ensure an understanding of the company’s process and incorporate audit procedures from the outset of the engagement,” Smith said. “... The standard provides good guidance on the nature of inquiries that might be made and the people within a company to whom they might be directed.”

Marc Panucci, CPA, a PwC audit partner agreed that many firms are most likely performing certain of the new required related-party procedures already as part of a risk-based audit. He also suggested that firms may need to think through how to incorporate identification of related-party relationships and transactions into other audit areas.

“There’s an appendix to the actual standard that walks through what might be things that would be indicators of undisclosed related-party transactions—a list of items,” Panucci said. “We need to include these in our thought process and make sure we emphasize these indicators that may come up in many different areas of the audit.”

Significant unusual transactions

The PCAOB also amended AU Section 316, Consideration of Fraud in a Financial Statement Audit, to require specific procedures to identify and evaluate “significant unusual transactions.” Auditors must understand the business purpose of these transactions, or lack thereof; evaluate accounting and disclosure of these transactions; and consider whether these transactions were entered into for fraudulent financial reporting or misappropriation of assets.

Smith said the guidance on significant unusual transactions clarifies what auditors should already be doing in this area.

“It is a natural extension of existing procedures,” Smith said. “The focus is more on identifying procedures to make it more of an active part of the audit process, rather than what to do if you find them.”

Panucci said the significant unusual transactions amendments include additional factors related to fraud and misappropriation to consider. He specifically referred to the list of things to consider in the amended paragraph 67 of AU Section 316 that provides new areas to evaluate, some of which are more explicit than under prior guidance.

In the area of audit committee communications, Smith and Panucci agree that auditors should already be including discussion of related-party and significant unusual transactions in their discussions of risk areas with audit committees.  The new standards make the required communications more explicit and more focused on the underlying internal controls. The incremental time added should not be substantial, but there should be a benefit to both the audit committee and the auditor as audit committees become more focused on these types of transactions and related internal controls, Smith said.

The PCAOB also modified AS No. 12, Identifying and Assessing Risks of Material Misstatement, to require auditors to perform procedures (as part of a risk assessment) to understand the financial relationships and transactions with executive officers. The focus is on incentives and pressures for executives to meet financial targets or other relationships that could result in the risk of material misstatement, including executive pay and other arrangements.

Here again, both Smith and Panucci were in agreement that performing procedures to gain a sufficient understanding in this area should already have been part of the auditors’ risk-assessment process and will not represent significant new audit procedures to be performed. What is somewhat different are certain specific procedures, such as inquiries of different individuals from in the past (such as compensation committee members or consultants), that have been added.

The standard and amendments will be effective, subject to SEC approval, for audits of financial statements for fiscal years beginning on or after Dec. 15, 2014, including reviews of interim financial information within these fiscal years. As auditors implement the new standard and amendments into their audit plans and procedures, it will become clearer as to whether there will be incremental efforts (and cost), or whether these will just become part of an overall risk-based audit approach without additional significant procedures required.

Maria L. Murphy ( emailmariamurphy@gmail.com ) is a freelance writer. She has worked in public accounting as an audit and technical review partner and as a national office director, in private industry in accounting and financial reporting roles, and most recently as the editor-in-chief of The CPA Journal.

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