PCAOB Adopts New Auditing Standard No. 18, Related Parties

by Blank Rome LLP
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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 Auditing Standard No. 18 superseded the PCAOB’s auditing standard AU sec. 334, Related Parties, which was issued in 1983.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.

 

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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