In brief: PCAOB adopts final standard on related parties and related amendments

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In brief 06/13/2014 by Assurance services
In brief: PCAOB adopts final standard on related parties and related amendments

At a glance

The new standard and amendments are intended to strengthen auditor performance requirements in three critical areas.

What happened?

On June 10, 2014 the Public Company Accounting Oversight Board (“PCAOB” or “the Board”) adopted Auditing Standard No. 18, Related Parties (“the standard”), which is intended to strengthen auditor performance requirements for identifying, assessing, and responding to the risks of material misstatement associated with a company’s relationships and transactions with its related parties. The PCAOB also adopted amendments to certain PCAOB auditing standards that address the auditor’s responsibilities with respect to a company’s significant unusual transactions and a company’s financial relationships and transactions with its executive officers (“the amendments”). The PCAOB adopted the standard and amendments substantially as they were re-proposed in May 2013 (the standard and amendments were originally proposed in February 2012).

The Board determined the existing standards in these areas do not contain sufficient required procedures and are not sufficiently risk-based, which can lead to inadequate auditor effort. Additionally, the Board’s inspection and enforcement activities indicate that there are continuing weaknesses in auditors’ scrutiny in these areas.

The Board believes that the standard and amendments, which are aligned with the risk assessment standards, represent a cohesive audit approach that will contribute to audit effectiveness and provide opportunities for an efficient implementation.

Relationships and transactions with related parties

The standard, which supersedes PCAOB interim standard AU 334, Related Parties, is designed to strengthen auditor performance requirements by setting forth specific procedures for the auditor’s evaluation of a company’s identification of, accounting for and disclosure of relationships and transactions between the company and its related parties.  Among other things, the standard requires the auditor to:

  • Perform specific procedures to obtain an understanding of the company's relationships and transactions with its related parties, including obtaining an understanding of the terms and business purposes (or the lack thereof);
  • Evaluate whether the company has properly identified its related parties and relationships and transactions with related parties by performing procedures to test the accuracy and completeness of management’s identification, taking into account information gathered during the audit;  
  • Perform specific procedures if the auditor determines that a related party or relationship or transaction with a related party previously undisclosed to the auditor exists;
  • Perform specific procedures regarding each related party transaction that is either required to be disclosed in the financial statements or determined to be a significant risk; and
  • Communicate to the audit committee the auditor’s evaluation of the company’s identification of, accounting for and disclosure of its relationships and transactions with related parties, and other significant matters arising from the audit regarding the company’s relationships and transactions with related parties.

Significant unusual transactions

The amendments regarding significant unusual transactions revise PCAOB AU 316, Consideration of Fraud in a Financial Statement Audit, and other PCAOB auditing standards with the intent of strengthening the auditor’s performance requirements for the identification and evaluation of these transactions. Among other things, the amendments require the auditor to:

  • Perform specific procedures to identify significant unusual transactions and to obtain an understanding of, and evaluate, their business purpose (or lack thereof); and
  • Consider additional factors in evaluating whether significant unusual transactions may have been entered into to engage in fraudulent financial reporting or conceal misappropriation of assets.

Financial relationships and transactions with executive officers

Other amendments modify Auditing Standard No. 12, Identifying and Assessing Risks of Material Misstatement, to require the auditor to perform specific procedures to obtain an understanding of the company’s financial relationships and transactions with its executive officers, including compensation. The amendments do not require the auditor to make any determination regarding the reasonableness of compensation arrangements or recommendations regarding compensation arrangements.

Why is this important?

The standard and amendments, if approved by the SEC, will be applicable to all audits performed pursuant to PCAOB standards, including audits of brokers and dealers. Pursuant to the JOBS Act, the standard and amendments will be subject to a separate determination by the SEC regarding their applicability to audits of emerging growth companies (“EGCs”). The PCAOB is recommending that the standard and amendments apply to audits of EGCs, and is providing information including a discussion of economic considerations for audits of EGCs to assist the SEC in its consideration. The standard and amendments build upon the existing standards; therefore, we are in process of evaluating the impact of the changes against our current methodology.

What's next?

The standard and amendments will be effective, subject to SEC approval, for audits of financial statements for fiscal years beginning on or after December 15, 2014, including reviews of interim financial information within these fiscal years.

Questions?

PwC clients who have questions about this In brief should contact their engagement partner. Engagement teams who have questions should contact James Anderson (1-973-236-5738) or Julie Anne Dilley (1-646-471-3205) in the National Professional Services Group.

Authored by:

James D. Anderson
Partner
Phone: 1-973-236-5738
Email: james.d.anderson@us.pwc.com

Julie Anne Dilley
Director
Phone: 1-646-471-3205
Email: julie.anne.dilley@us.pwc.com