PCAOB Adopts Auditing Standard No. 18: Crony Disclosures

Let us welcome into the world a new auditing standard:

The Public Company Accounting Oversight Board today adopted a new auditing standard and amendments to other auditing standards to strengthen auditor performance requirements in three critical areas of the audit: related party transactions, significant unusual transactions, and a company's financial relationships and transactions with its executive officers.

The Board took this action today because these transactions and relationships could pose increased risk of material misstatement in company financial statements. The Board determined that its existing requirements in these critical areas do not contain sufficient required procedures and are not sufficiently risk-based. Further, the Board's inspection and enforcement activities indicate that there are continuing weaknesses in auditors' scrutiny in these areas.

"The new auditing standard and amendments we adopted today address transactions and relationships that have been contributing factors in a number of financial reporting frauds," said James R. Doty, PCAOB Chairman. "Subjecting these areas to enhanced auditor scrutiny may help avert corporate failures and avoid harm to investors."

Auditing Standard No. 18 directs auditors, as part of the risk assessment process, to obtain an understanding of the following:

  • the company's relationships and transactions with its related parties, including obtaining an understanding of the nature of the relationships and of the terms and business purposes (or the lack thereof) of transactions involving related parties
  • the business purpose (or the lack thereof) of identified significant unusual transactions
  • the company's financial relationships and transactions with its executive officers

The PCAOB figured that current requirements before AS 18 did not stress enough audit scrutiny in relationships and related transactions. As these areas come with increased risk of material misstatement, it was high time to make sure auditors are doing enough checking there.

Auditing Standard No. 18, Related Parties, requires specific audit procedures for the auditor's evaluation of a company's identification of, accounting for, and disclosure of transactions and relationships between a company and its related parties. The new standard supersedes the Board's interim auditing standard, AU sec. 334, Related Parties.

The amendments regarding significant unusual transactions include specific audit procedures that are designed to improve the auditor's identification and evaluation of such transactions, and to enhance the auditor's understanding of their business purposes.

While you're testing these crony relationships and transactions, you're also supposed to look for undisclosed relationships and transactions that might exist because of course you are.

Here is a handy fact sheet from the PCAOB should you need it.

Before you CPA exam candidates freak out (as you always tend to do when a new rule comes out), remember any changes within the realm of exam content are eligible to be tested no earlier than 6 months after the rule's effective date. Meaning AS 18 won't show up in AUD until Q3 of 2015, if approved by the SEC.

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