Finance executives gave their stamp of approval to the PCAOB’s revised proposed changes to the auditing standard on related party transactions.
Issues with related parties played a prominent role in the scandals that surfaced more than a decade ago at Enron Corp., Tyco International Ltd., and Refco Inc. The subject was one of the six areas investors wanted the PCAOB to fix when the board formed the Standing Advisory Group in 2004.
In February 2012, the audit regulator proposed in Release No. 2012-001,Related Parties, to strengthen the evaluation of the business dealings involving executives, directors, and family members auditors are required to carry out. The deals often fall outside a company’s normal operations and have long been suspected as a source of fraud.
In May 2013, the board revised the proposal in Release No. 2013-004, in part to solicit comments that will help the staff do a more detailed economic analysis for emerging growth companies as they’re defined in the April 2012 JOBS Act. Sec. 1 of PL112-106
The revised proposal also includes minor modifications made in response to comments on Release No. 2012-001, including a tighter alignment with the PCAOB’s risk assessment procedures.
In July, the committee on corporate reporting of Financial Executive International wrote to the PCAOB, saying the updated proposal is an improvement over the original draft.
“Because related party transactions and significant transactions outside the normal course of business are critical areas of potentially significant audit risk, we believe that this proposed standard should apply to all companies, including emerging growth companies,” wrote Stephen Cosgrove, Johnson & Johnson’s chief accounting officer and the committee’s chair. “Overall, we believe the frequency and relative magnitude of related party transactions is greater at smaller companies and start-up companies. Therefore, the audit risk of material misstatement from such activity is higher and audit focus in these areas is even more important at such companies.”
State accountant societies also supported the proposal but asked for some minor clarification in the final standard.
While acknowledging that an auditor should get reasonable assurance to support assertions within the financial statements, including those relating to the accuracy and completeness of related parties and transactions, the New York State Society of Certified Public Accountants said it is concerned that the proposed requirements “might imply that an auditor is responsible for identifying all related parties and transactions without limitation.”
The society asked the board to include additional context such as found in International Standard on Auditing, explaining that the nature of related party relationships and related party transactions may in some instances result in higher risks of material misstatements.
“The ISA further explains that related party relationships might present a greater opportunity for collusion, concealment or manipulation by management and, therefore, an auditor’s ability to detect material misstatements may be impacted even though the audit is properly planned and performed,” the NYSSCPA said.
The audit and assurance services committee of the Illinois CPA Society said it agreed with the requirement for auditor to perform five procedures for transactions required to be disclosed or determined to be a significant risk, but did not “agree that the same response is sufficient for both situations.”
The committee also asked the PCAOB to make clear whether the auditor should perform additional procedures beyond those listed in the release if a significant risk with related parties is identified.