Renewed Audit Focus - Related Parties and Unusual Transactions
3
our roots run deep TM MAYER HOFFMAN MCCANN P.C. – AN INDEPENDENT CPA FIRM A publication of the Professional Standards Group MHMMessenger © 2014 MAYER HOFFMAN MCCANN P.C. 877-887-1090 • www.mhmcpa.com • All rights reserved. TM AS 18 takes the guidance a few steps further by requiring certain procedures to be performed, while also aligning with the risk assessment standards in place under AS 12, Identifying and Assessing Risks of Material Misstatement. In addition, AS 18 places additional emphasis on accounting, rather than only a focus on disclosure, and adds required communication with audit committees. Related party transactions, significant unusual transactions and transactions with a company’s executive officers are three critical areas of risk that have been contributing factors in a number of financial reporting frauds over the last several decades. The PCAOB has previously concluded that its existing requirements to audit these areas are not sufficient and are not sufficiently risk-based. In response, the PCAOB issued, and the SEC has approved Auditing Standard (“AS”) No. 18, Related Parties, as well as amendments to existing standards on auditing significant unusual transactions and transactions with a company’s executives. These changes may result in additional documentation and scrutiny of these types of transactions by audit firms as they comply with the standard for audits performed under PCAOB standards, including those for publicly traded companies and broker-dealers. Related Parties Existing guidance for auditing related party transactions is primarily contained in AU sec. 334, Related Parties. AU sec. 334 provides guidance and examples of procedures for the auditor’s consideration in identifying and evaluating related party transactions; however, it does not require the auditor to perform any specific procedures. November 2014 Renewed Audit Focus: Related Parties and Unusual Transactions Things for Management to Consider • Perform a deep dive on internal controls and processes in place to identify, account for, and disclose related party transactions, as well as other significant unusual transactions. The auditor is now required to assess your ability to perform these tasks. • Begin conversations with your audit committee about any concerns they may have about related party transactions, significant unusual transactions, or relationships and transactions with executives prior to the auditors engaging in these conversations. This will avoid surprises and give management time to respond to the audit committee’s concerns. • Be prepared to provide management representation that all related party transactions and relationships have been disclosed to the auditors. • Ensure that sufficient documentation is in place regarding executive compensation arrangements and gain an understanding of such arrangements in order to assess the controls in place to prevent manipulation of earnings, specifically for the benefit of compensation targets.
Transcript of Renewed Audit Focus - Related Parties and Unusual Transactions
our roots run deepTM
Mayer HoffMan Mccann P.c. – an IndePendenT cPa fIrM
a publication of the Professional Standards Group
MHMMessenger
© 2 0 1 4 M ay e r H o f f M a n M c c a n n P. c . 877-887-1090 • www.mhmcpa.com • All rights reserved.
TM
AS 18 takes the guidance a few steps further by requiring certain procedures to be performed, while also aligning with the risk assessment standards in place under AS 12, Identifying and Assessing Risks of Material Misstatement. In addition, AS 18 places additional emphasis on accounting, rather than only a focus on disclosure, and adds required communication with audit committees.
Related party transactions, significant unusual transactions and transactions with a company’s executive officers are three critical areas of risk that have been contributing factors in a number of financial reporting frauds over the last several decades. The PCAOB has previously concluded that its existing requirements to audit these areas are not sufficient and are not sufficiently risk-based.
In response, the PCAOB issued, and the SEC has approved Auditing Standard (“AS”) No. 18, Related Parties, as well as amendments to existing standards on auditing significant unusual transactions and transactions with a company’s executives. These changes may result in additional documentation and scrutiny of these types of transactions by audit firms as they comply with the standard for audits performed under PCAOB standards, including those for publicly traded companies and broker-dealers.
Related Parties
Existing guidance for auditing related party transactions is primarily contained in AU sec. 334, Related Parties. AU sec. 334 provides guidance and examples of procedures for the auditor’s consideration in identifying and evaluating related party transactions; however, it does not require the auditor to perform any specific procedures.
November 2014
Renewed Audit Focus: Related Parties and Unusual Transactions
Things for Management to Consider• Perform a deep dive on internal controls and
processes in place to identify, account for, and disclose related party transactions, as well as other significant unusual transactions. The auditor is now required to assess your ability to perform these tasks.
• Begin conversations with your audit committee about any concerns they may have about related party transactions, significant unusual transactions, or relationships and transactions with executives prior to the auditors engaging in these conversations. This will avoid surprises and give management time to respond to the audit committee’s concerns.
• Be prepared to provide management representation that all related party transactions and relationships have been disclosed to the auditors.
• Ensure that sufficient documentation is in place regarding executive compensation arrangements and gain an understanding of such arrangements in order to assess the controls in place to prevent manipulation of earnings, specifically for the benefit of compensation targets.
© 2 0 1 4 M ay e r H o f f M a n M c c a n n P. c . 877-887-1090 • www.mhmcpa.com • All rights reserved.
MHMMessenger
2
Among other things, AS 18 requires the auditor to:
• Perform specific procedures to obtain an understanding of the company’s relationships and transactions with related parties in conjunction with required risk assessment procedures. This includes getting an understanding of the business purposes (or lack thereof) of transactions involving related parties. Such procedures include understanding the company’s process for identifying related parties, performing inquiries and communicating with the engagement team so that they can be on alert while performing substantive testing.
• Evaluate whether the company has properly identified its related parties and transactions and relationships with related parties. This requires testing of the accuracy and completeness of management’s list of related parties, taking into account information gathered during the audit. The reading of meeting minutes of stockholders, directors, etc. is one procedure to assist in testing the relationships identified by the company.
• Perform procedures in the event that a related party is identified that was previously undisclosed to the auditor. Such procedures include, but are not limited to, obtaining an understanding of why the relationship was not disclosed, assessing whether additional procedures to identify other relationships are needed and evaluating the control implications.
• Design testing procedures for each related party transaction that is either required to be disclosed or determined to be a significant risk. Examples such as reading relevant contracts to confirm management’s description of the relationship, and determining whether the arrangement was approved in accordance with the company’s policies are provided as a guide to testing.
• Communicate to the audit committee the auditor’s evaluation of the company’s identification of, accounting for, and disclosure of its relationships and transactions with related parties.
• Obtain representation from management that there are no related party transactions or relationships that have not been disclosed to the auditors.
Where judgment was utilized in the past to determine the extent of audit procedures to be performed around related party transactions, AS 18 introduces requirements that will likely expand the scope of most PCAOB compliant audits.
The standard not only increases the burden on auditors, but as a result of procedures that the auditor is required to perform over internal controls and the treatment of related parties by management, it will require management to assess its processes and internal controls over identifying related party transactions and how such transactions are accounted for and disclosed.
Significant Unusual Transactions
The PCAOB’s approach to amending its guidance pertaining to auditing significant unusual transactions emphasizes a complementary audit approach, especially with respect to the requirements of AS 18 discussed above. The amendments introduce similar, required procedures by which to identify and test significant unusual transactions.
A re-emphasis is placed on understanding the business rationale (or lack thereof) for significant unusual transactions with an eye toward whether transactions have been entered into as a means to engage in fraudulent financial reporting of misappropriation of assets.
Finally, the amendments broaden the definition of significant unusual transactions to those that “appear”
© 2 0 1 4 M ay e r H o f f M a n M c c a n n P. c . 877-887-1090 • www.mhmcpa.com • All rights reserved.
MHMMessenger
3
The information in this MHM Messenger is a brief summary and may not include all the details relevant to your situation. Please contact your MHM auditor to further discuss the impact on your audit or audit report.
to be unusual due to their timing, size, or nature, and not just those that are unusual. As a result, management may need to reassess its control process to ensure that it has appropriate controls in place to identify and account for transactions that may meet the expanded definition of significant unusual transactions.
Ultimately, significant unusual transactions are not substantively different than a transaction with a related party. Thus, amendments were required in conjunction with the issuance of AS 18 to ensure that the procedures around each type of transaction are consistently applied.
Relationships and Transactions with Executives
The PCAOB amended AS 12 regarding the company’s relationships and transactions with its executive officers with the intent of heightening the auditor’s attention to incentives and pressures on these individuals to achieve particular financial and operating results. Audit procedures will now include the review of compensation arrangements with executive officers, proxy statements, and potential interviews of the compensation committee chair or relevant consultants that can describe the company’s overall compensation structure and philosophy.
It is important to note that the amendments explicitly provide that the auditor is not required to assess the appropriateness or reasonableness of executive compensation.
Final Thoughts
Through the issuance of AS 18 and the amendments to auditing standards regarding significant unusual transactions and transactions and relationships with executives, the PCAOB has introduced complementary procedures with the overall goal of improving the detection of material misstatement and fraud. The requirements are effective for audits for fiscal years beginning on or after December 15, 2014, including reviews of interim financial information in those years.
In order to avoid surprises during the audit, management should consider the need to evaluate its internal controls, procedures and accounting for related party transactions, significant unusual transactions, and relationships and transactions with executives prior to the auditor’s performance of additional procedures.
For More Information
If you have any specific questions, comments or concerns, please share them with Brad Hale of MHM’s Professional Standards Group or your MHM service professional. You can reach Brad at [email protected] or 813.215.6669.
