PCAOB Adopts New Auditing Standard No. 18, Related Parties

On June 10, 2014, the Public Company Accounting Oversight Board (PCAOB) adopted Auditing Standard No. 18, Related Parties, as well as amendments to certain PCAOB auditing standards regarding significant unusual transactions and other related amendments to PCAOB auditing standards. Auditing Standard No. 18 superseded the PCAOB’s auditing standard AU sec. 334, Related Parties, which was issued in 1983. The new auditing standard and amendments will be effective, subject to approval by the SEC, for audits of financial statements for fiscal years beginning on or after December 15, 2014.

Generally, under the new standard, auditors will be required to engage in a detailed analysis of transactions with related parties and inquire of management regarding:

a.         the names of the company’s related parties during the period under audit, including changes from the prior period;

b.         background information concerning the related parties (for example, physical location, industry, size, and extent of operations);

c.         the nature of any relationships, including ownership structure, between the company and its related parties;

d.         the transactions entered into, modified or terminated, with its related parties during the period under audit and the terms and business purposes (or the lack thereof) of such transactions;

e.         the business purpose for entering into a transaction with a related party versus an unrelated party;

 f.         any related party transactions that have not been authorized and approved in accordance with the company’s established policies or procedures regarding the authorization and approval of transactions with related parties; and

 g.        any related party transactions for which exceptions to the company’s established policies or procedures were granted and the reasons for granting those exceptions.

In addition to obtaining information regarding related party transactions from management, auditors will be required to inquire of others within the company regarding their knowledge of the foregoing matters. The auditor is expected to identify others within the company to whom inquiries should be directed, and determine the extent of such inquires, by considering whether such individuals are likely to have knowledge regarding such matters as:

a.         the company’s related parties or relationships or transactions with related parties;

b.         the company’s controls over relationships or transactions with related parties; and

c.         the existence of related parties or relationships or transactions with related parties previously undisclosed to the auditor.

The audit committee, or its chair, will also be questioned by the auditor regarding:

a.         the audit committee’s understanding of the company’s relationships and transactions with related parties that are significant to the company; and

b.         whether any member of the audit committee has concerns regarding relationships or transactions with related parties and, if so, the substance of those concerns.

The auditor will be required to communicate to the audit committee the results of the auditor’s evaluation of the company’s identification of, accounting for, and disclosure of its relationships and transactions with related parties, as well as other significant matters arising from the audit regarding the company’s relationships and transactions with related parties including, but not limited to:

a.         the identification of related parties or relationships or transactions with related parties that were previously undisclosed to the auditor;

b.         the identification of significant related party transactions that have not been authorized or approved in accordance with the company’s established policies or procedures;

c.         the identification of significant related party transactions for which exceptions to the company’s established policies or procedures were granted;

d.         the inclusion of a statement in the financial statements that a transaction with a related party was conducted on terms equivalent to those prevailing in an arm’s-length transaction and the evidence obtained by the auditor to support or contradict such an assertion; and

e.         the identification of significant related party transactions that appear to the auditor to lack a business purpose.

The SEC Approved PCAOB Rules on Communications with Audit Committees

On December 17, 2012, the SEC approved PCAOB proposed rules on Auditing Standard No. 16, Communications with Audit Committees.  Auditing Standard No. 16 supersedes PCAOB’s interim standards AU section 380, Communication with Audit Committees, and AU section 310, Appointment of the Independent Auditor.  Auditing Standard No. 16 is effective for audits of financial statements for fiscal years beginning on or after December 15, 2012 and applies to the audits of all issuers, including emerging growth companies established under the JOBS Act and foreign private issuers.

It is interesting to note that, among other matters, Auditing Standard No. 16 expands the inquiries of the audit committee required by Auditing Standard No. 12, Identifying and Assessing Risks of Material Misstatement, which requires the auditor to inquire of the audit committee regarding its knowledge of the risks of material misstatements, including fraud risks.  The inquiry required by Auditing Standard No. 16 goes beyond material misstatements and fraud risks and provides that the auditor “should inquire of the audit committee about whether it is aware of matters relevant to the audit, including, but not limited to, violations or possible violations of laws or regulations.” 

 In light of this inquiry, audit committees will need to discuss procedures for evaluating violations, including possible violations, of laws and regulations, especially considering the fact that this requirement does not include any materiality threshold.

PCAOB Issues Release About its Inspection Process to Assist Audit Committees

On August 1, 2012, the Public Company Accounting Oversight Board (PCAOB) issued Release No. 2012-003, Information for Audit Committees about the PCAOB Inspection Process.  This release was issued to assist audit committees in understanding the PCAOB’s inspection process of audit firms and gathering useful information about those inspections.  The release also includes certain questions an audit committee may want to ask their audit firm about the PCAOB inspection.  These questions include the following:

  • Was the company’s audit selected for PCAOB inspection?
  • Did the PCAOB identify deficiencies in other audits that involved auditing or accounting issues similar to issues presented in the company’s audit?
  • What were the audit firm’s responses to the PCAOB findings?
  • What is the audit firm changing to address any quality control issues?
  • What is the progress of the quality control remediation process?
  • What are the inspected years about which the PCAOB has made a final determination about the audit firm’s remediation efforts and what is the nature of that determination?
  • Has the PCAOB provided initial indications that the audit firm may not have sufficiently remediated any items?

The release can be obtained from the following link:

http://pcaobus.org/Inspections/Documents/Inspection_Information_for_Audit_Committees.pdf