PCAOB on Related Parties

Question 1

PCAOB auditing standards dealing with related-party issues specifically require an auditor of an issuer to obtain an understanding of the company’s process for each of the following except for
Identifying related parties and transactions with related parties.
Authorizing and approving transactions with related parties.
Determining that the terms of related-party transactions are substantially equivalent to those prevailing in arm’s-length transactions with unrelated parties.
Accounting for and disclosing relationships and transactions with related parties in the financial statements.

Answer 1

Determining that the terms of related-party transactions are substantially equivalent to those prevailing in arm’s-length transactions with unrelated parties.

The PCAOB requires the auditor to obtain an understanding of the company’s process for the following: (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. There is no reason to expect that related-party transactions will have terms substantially equivalent to those associated with transactions with unrelated parties.

Question 2

PCAOB auditing standards require an auditor of a public company to communicate with the audit committee about a variety of related-party matters. Each of the following is required to be communicated with the audit committee except
The auditor’s evaluation of the company’s identification and financial reporting treatment of related-party relationships and transactions.
Management’s justification for engaging in transactions with a related party instead of arm’s-length transactions with unrelated parties.
Related-party relationships or transactions with parties discovered by the auditor that were previously undisclosed to the auditor.
Related-party transactions identified by the auditor that appear to lack an appropriate business purpose.

Answer 2

Management’s justification for engaging in transactions with a related party instead of arm’s-length transactions with unrelated parties.

The PCAOB does not require the auditor to communicate with the audit committee about management’s justification for engaging in transactions with a related party instead of with an unrelated party. Indeed, the company should have an appropriate process established to authorize and approve transactions with related parties, which presumably informs the audit committee as necessary.

Question 3

Suppose that management of an issuer makes an assertion in a footnote to the company’s financial statements that material transactions with related parties were conducted on terms equivalent to those prevailing in arm’s-length transactions. If evidence cannot be obtained to support this assertion and management declines to alter that footnote, what type of audit opinion would be appropriate?
Unqualified with an explanatory paragraph.
Qualified for a scope limitation.
Qualified or adverse for a material misstatement.
Disclaimer of opinion.

Answer 3

Qualified or adverse for a material misstatement.

PCAOB auditing standards (specifically, AS Section 2410) state that the auditor should consider a qualified or adverse opinion under such circumstances.