PCAOB: Auditing Standards - Related Parties

Question 1

Objective

Answer 1

The auditor’s objective is “to obtain sufficient appropriate audit evidence to determine whether related parties and relationships and transactions with related parties have been properly identified, accounted for, and disclosed in the financial statements.”

Question 2

Risk Assessment

Answer 2

The auditor should identify and assess the risks of material misstatement at the financial statement and assertion levels, including the risks of material misstatement associated with related parties and transactions with related parties.

Question 3

Response to risk assessment

Answer 3

The auditor should design and implement audit responses addressing the assessed risks of material misstatement, including the risks of material misstatement associated with related parties and transactions with related parties.

Question 4

Perform Risk Assessment Procedures

Answer 4

A. The auditor should obtain an understanding of the company’s process for

1. Identifying related parties and transactions with related parties;
2. Authorizing and approving transactions with related parties; and
3. Accounting for and disclosing relationships and transactions with related parties in the financial statements.

B. The auditor should make appropriate inquiries of management, others who may be knowledgeable about related-party issues, and the audit committee (or chair).

1. Inquire of management about the following:
   a. The names of the company’s related parties, the nature of the relationships, and any changes from the prior period;
   b. Background information about the related parties, including location, industry, size, etc.;
   c. The transactions involving related parties during the period, including the terms and business purposes of those transactions; and
   d. Any related-party transactions that were not authorized according to the company’s established policies (including any exceptions that were granted and the reasons).
2. Inquire of others who may have knowledge of the matters identified above. These may include internal auditors, in-house legal counsel, the chief compliance/ethics officer, and the human resources director.
3. Inquire of the audit committee (or its chair) about the audit committee’s understanding of the company’s relationships, significant related-party transactions, and whether any member of the audit committee has any concerns about related-party issues.

Question 5

Respond to Risk Assessment

Answer 5

A. For any related-party transactions that are required to be disclosed or that are determined to be a significant risk, the auditor should do the following:

1. Read the underlying documents for consistency with explanations from inquiries and other audit evidence about the business purpose;
2. Determine whether the transaction has been authorized and approved in accordance with the company’s established policies and whether any exceptions to the company’s established policies were granted;
3. Evaluate the financial capability of the related parties with respect to significant responsibilities (relevant information might include the audited financial statements of the related parties, reports of regulatory agencies, financial publications, and income tax returns if available); and
4. Perform other procedures as necessary regarding the assessed risks of material misstatement.

B.
Intercompany accounts – The auditor should address the risks of material misstatement regarding the company’s intercompany accounts.

Question 6

Evaluation of FS Treatment

Answer 6

The auditor should evaluate whether the company has properly identified its related parties and transactions with related parties.
A. The auditor should read the minutes of board meetings and evaluate any significant unusual transactions, including transactions with executives.
B. If the auditor believes that previously undisclosed related-party relationships or transactions may exist, the auditor should perform procedures (beyond inquiry of management) to determine whether those relationships or transactions do exist.
C. If the auditor determines that previously undisclosed related-party relationships or transactions exist, the auditor should do the following:
1. Inquire of management about the possible existence of other transactions with the related party previously undisclosed;
2. Evaluate why the matter was previously undisclosed to the auditor;
3. Communicate relevant information to other members of the audit team;
4. Consider the need to perform additional procedures to identify other relationships or transactions previously undisclosed;
5. Perform the procedures identified above for transactions with related parties required to be disclosed or determined to be a significant risk; and
6. Reconsider the auditor’s risk assessment: (1) evaluate the implications to the auditor’s assessment of internal control; (2) reassess the risk of material misstatement and perform additional procedures as necessary; and (3) evaluate the implications for the audit if the auditor believes the undisclosed matter indicates that fraud or an illegal act may be involved.

Question 7

Communication with Audit Committee

Answer 7

A. In general, the auditor should communicate the auditor’s evaluation of the company’s identification and financial reporting of related-party relationships and transactions.
B. The auditor should also communicate other significant matters associated with related-party relationships and transactions, such as the following:
1. Related-party relationships or transactions with parties that were previously undisclosed to the auditor;
2. Significant related-party transactions that have not been authorized in accordance with the company’s established policies or for which exceptions to the company’s established policies were made;
3. Related-party transactions identified by the auditor that appear to lack an appropriate business purpose; and
4. Management’s assertion included in the financial statements that the terms of a related-party transaction was equivalent to that of an arm’s-length transaction (and the evidence obtained by the auditor that is consistent or inconsistent with that assertion).

Question 8

Examples of information that may indicate that related parties or transactions with related parties previously undisclosed to the auditor might exist:

Answer 8

1. Purchasing or selling at significantly different than market prices;
2. Sales transactions that have unusual terms (e.g., “bill and hold” transactions) or engaging in transactions that lack economic substance;
3. Borrowing or lending at significantly different than normal terms;
4. Advancing funds that are used to pay for an otherwise uncollectible receivable; or
5. Guarantees outside the normal course of business.

Question 9

Examples of sources of information that may indicate that related parties or transactions with related parties previously undisclosed to the auditor might exist:

Answer 9

1. Filings with the SEC and other regulatory agencies;
2. Confirmation responses and lawyer letters;
3. Internal reports (e.g., reports prepared by the entity’s internal auditors and records from the company’s whistleblower program);
4. Shareholder registers identifying major shareholders; or
5. Contracts and other agreements with management or others involving significant unusual transactions.