PCAOB FLASH REPORT
PCAOB Adopts New Requirements for Related Party and
Significant Unusual Transactions, and Executive Off...
Protiviti | 2
• Basic requirements for every engagement – Existing standards provide the auditor
latitude in determining w...
Protiviti | 3
(3) Perform certain procedures for each related party transaction that is either required to be
disclosed in...
© 2014 Protiviti Inc. An Equal Opportunity Employer M/F/D/V.
Protiviti is not licensed or registered as a public accountin...
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PCAOB Adopts New Requirements for Related Party and Significant Unusual Transactions, and Executive Officer Financial Relationships/Transactions

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Earlier this month, the PCAOB adopted a new auditing standard and various amendments to other auditing standards to strengthen auditor performance requirements in three challenging areas:
• Related party transactions;
• Significant unusual transactions; and
• A company's financial relationships and transactions with its executive officers.
The board’s intent in addressing these transactions and relationships is to improve existing standards by requiring additional procedures in each of these areas and provide direction to ensure the auditor’s approach to these areas is sufficiently risk-based and appropriately coordinated.
This Flash Report summarizes the PCAOB’s new auditing standard and the board’s various amendments, along with the implications for auditors and companies. The requirements will be effective for calendar year 2015 audits, including interim periods (e.g., required for fiscal years beginning on or after December 15, 2014). They will apply to audits of companies listed on exchanges in the United States.

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PCAOB Adopts New Requirements for Related Party and Significant Unusual Transactions, and Executive Officer Financial Relationships/Transactions

  1. 1. PCAOB FLASH REPORT PCAOB Adopts New Requirements for Related Party and Significant Unusual Transactions, and Executive Officer Financial Relationships/Transactions June 27, 2014 Earlier this month, the Public Company Accounting Oversight Board (PCAOB) adopted a new auditing standard and various amendments to other auditing standards to strengthen auditor performance requirements in three challenging areas: • Related party transactions; • Significant unusual transactions; and • A company's financial relationships and transactions with its executive officers. The board’s intent in addressing these transactions and relationships is to improve existing standards by requiring additional procedures in each of these areas and provide direction to ensure the auditor’s approach to these areas is sufficiently risk-based and appropriately coordinated. The PCAOB believes these areas pose increased risk of material misstatement in company financial statements and, therefore, they require closer attention. The new standard responds to continuing weaknesses in auditors' scrutiny of these areas noted by the PCAOB’s inspection and enforcement process. Most importantly, these areas have been contributing factors in a number of reported fraudulent financial statements. According to James R. Doty, PCAOB Chairman, as quoted in the board’s press release dated June 10, 2014, "Subjecting these areas to enhanced auditor scrutiny may help avert corporate failures and avoid harm to investors." For the press release, see http://pcaobus.org/News/Releases/Pages/06102014_AS18.aspx. What’s New? – Related Parties In some instances, related party transactions have been used to engage in fraudulent financial reporting and to conceal misappropriation of assets – misstatements that are certainly relevant to the auditor's consideration of fraud. These transactions warrant attention as they involve parties who are under common control or influence and, thus, are not operating at arms’ length with each other, meaning the parties to a transaction are not independent. The new standard sets 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. Specifically, it includes some auditing concepts and procedures from existing standards that relate to identifying and evaluating related parties and related party transactions. However, the standard differs from existing standards in several ways:
  2. 2. Protiviti | 2 • Basic requirements for every engagement – Existing standards provide the auditor latitude in determining whether suggested procedures apply in specific circumstances. With respect to certain basic requirements, the new standard does not. For example, with regard to the auditor's response to the risks of material misstatement associated with a company's relationships and transactions with its related parties, the new standard requires basic procedures that focus on those transactions that require disclosure in the financial statements or that are determined to be a significant risk. These procedures are designed to assist the auditor in identifying red flags that indicate potential risks of material misstatement. Additionally, the standard requires more in- depth procedures that are designed to be scalable and commensurate with the company's specific facts and circumstances. • Enhanced procedures for obtaining an understanding of a company’s relationships and transactions with related parties – Existing standards provide limited direction for obtaining this understanding. The new standard requires the performance of specific procedures in this area, including obtaining an understanding of the terms and business motivation (or lack thereof) of related party transactions. • Alignment with risk assessment standards – The new standard builds upon the risk assessment standards the PCAOB adopted in 2010. The new procedures are intended to be performed in conjunction with the procedures performed during the auditor's risk assessment process. • Sharper focus on proper accounting – Existing standards provide that the auditor should place primary emphasis on the adequacy of disclosure of related party transactions. The new standard requires that the auditor evaluate both the accounting for, and disclosure of, related party transactions. • Required audit committee communications – Existing standards do not refer to communications with audit committees regarding related party transactions. The new standard requires the auditor to communicate with the audit committee (or its chair) to obtain information during the risk assessment, as well as to communicate relevant matters regarding the auditor's evaluation of the company's identification of, accounting for, and disclosure of its relationships and transactions with related parties. • Emphasis on a complementary audit approach – The new standard requires the auditor to take into account information gathered during the audit process when evaluating a company's identification of its related parties. For example, the auditor should consider the linkage between a company's relationships and transactions with its related parties, its significant unusual transactions, and its financial relationships and transactions with its executive officers. This complementary audit approach should help the auditor "connect the dots" between different aspects of the audit. The new standard requires the auditor to understand the company’s processes for identifying related parties and relationships and transactions with related parties, authorizing and approving transactions with related parties, and accounting for and disclosing relationships and transactions with related parties in the financial statements. It outlines inquiries auditors must make of management and others in this regard. Once the auditor understands the company’s processes, the new standard provides that the auditor: (1) Identify and assess the risks of material misstatement at both the financial statement level and the assertion level; (2) Design and implement audit procedures that address the identified risks of material misstatement;
  3. 3. Protiviti | 3 (3) Perform certain procedures for each related party transaction that is either required to be disclosed in the financial statements or determined to be a significant risk; (4) Evaluate whether the company has properly identified its related parties and relationships and transactions with related parties; and (5) Evaluate whether related party transactions have been properly accounted for and disclosed in the financial statements. Regarding point (5), the auditor must evaluate whether the financial statements contain the information regarding relationships and transactions with related parties essential for a fair presentation in conformity with the applicable financial reporting requirements. What’s New? – Significant Unusual Transactions The various amendments announced by the PCAOB recognize that a company's significant unusual transactions can create complex accounting and financial statement disclosure issues that could pose increased risks of material misstatement. In some instances, significant unusual transactions have been used to engage in fraudulent financial reporting. For example, significant unusual transactions, especially those close to period end that pose difficult "substance-over-form" questions, may be conducted to obscure a company's financial position or operating results. In such cases, management may place more emphasis on the need for a particular accounting treatment than on the transaction’s underlying economic substance. Experience has taught that this behavior lays the groundwork for misstated financial statements, misappropriation of assets or even fraud. The PCAOB’s amendments include specific audit procedures that are designed to improve the auditor's identification and evaluation of unusual transactions. Among other things, the auditor must: • Perform procedures to identify significant unusual transactions; • Perform procedures to obtain an understanding of, and evaluate, the business purpose (or lack thereof) of identified significant unusual transactions; and • Evaluate whether significant unusual transactions may have been conducted to engage in fraudulent financial reporting or conceal misappropriation of assets. What’s New? – Financial Relationships and Transactions with Executive Officers A company's executive officers are in a unique position to influence a company's accounting and financial statement disclosures. A company's financial relationships and transactions with its executive officers (as one example, executive officer compensation) can create incentives and pressures for executive officers to meet financial targets, which can result in risks of material misstatement to a company's financial statements. Existing standards require the auditor to consider obtaining an understanding of compensation arrangements with senior management (including incentive compensation arrangements, changes or adjustments to those arrangements, and special bonuses) as part of obtaining an understanding of the company and its business. The new amendments strengthen the existing standards by requiring the auditor, as part of the audit risk assessment process, to perform procedures to obtain an understanding of the company's financial relationships and transactions with its executive officers.
  4. 4. © 2014 Protiviti Inc. An Equal Opportunity Employer M/F/D/V. Protiviti is not licensed or registered as a public accounting firm and does not issue opinions on financial statements or offer attestation services. For example, the auditor could consider whether the company's internal control over financial reporting is designed and operating to address the risk that management might seek accounting results solely to boost certain executive officers' compensation. This understanding could also assist the auditor in determining areas where management bias might occur, e.g., certain accounting estimates, including fair value measurements. Note that these amendments do not require the auditor to make any determination regarding the reasonableness of compensation arrangements or submit recommendations regarding compensation arrangements. Effective Date If approved by the Securities and Exchange Commission (SEC), the new standard and various amendments will be effective 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. In addition, pursuant to the Jumpstart Our Business Startups Act (JOBS Act) in the United States, the SEC has the prerogative to determine whether the new audit requirements would apply to audits of emerging growth companies. Summary These new performance requirements for auditors will likely drive additional auditor effort and focus. They are intended to provide a more cohesive approach to auditing the three areas they address. Companies engaged in related party dealings, significant unusual transactions and/or financial relationships and transactions with key executives should expect increased audit emphasis in these areas. See http://pcaobus.org/Rules/Rulemaking/Docket038/Release_2014_002_Related_Parties.pdf for the final rule. About Protiviti Protiviti (www.protiviti.com) is a global consulting firm that helps companies solve problems in finance, technology, operations, governance, risk and internal audit, and has served more than 40 percent of FORTUNE 1000® and FORTUNE Global 500® companies. Protiviti and its independently owned Member Firms serve clients through a network of more than 75 locations in 25 countries. The firm also works with smaller, growing companies, including those looking to go public, as well as with government agencies. Protiviti is a wholly owned subsidiary of Robert Half (NYSE: RHI). Founded in 1948, Robert Half is a member of the S&P 500 index.

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