Document ID: SEC-2014-1251-0001
Agency: sec
Document Type: Notice
Title: Self-Regulatory Organizations; Proposed Rule Changes: Public Company Accounting Oversight Board
Posted Date: 2014-07-24T04:00Z

[Federal Register Volume 79, Number 142 (Thursday, July 24, 2014)]
[Notices]
[Pages 43163-43229]
From the Federal Register Online via the Government Printing Office [www.gpo.gov]
[FR Doc No: 2014-17400]

[[Page 43163]]

Vol. 79

Thursday,

No. 142

July 24, 2014

Part III

Securities and Exchange Commission

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Public Company Accounting Oversight Board; Notice of Filing of Proposed 
Rules Relating to Auditing Standard No. 18, Related Parties, Amendments 
to Certain PCAOB Auditing Standards Regarding Significant Unusual 
Transactions, and Other Amendments to PCAOB Auditing Standards; Notice

  Federal Register / Vol. 79 , No. 142 / Thursday, July 24, 2014 / 
Notices  

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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-72643; File No. PCAOB-2014-01]

Public Company Accounting Oversight Board; Notice of Filing of 
Proposed Rules Relating to Auditing Standard No. 18, Related Parties, 
Amendments to Certain PCAOB Auditing Standards Regarding Significant 
Unusual Transactions, and Other Amendments to PCAOB Auditing Standards

July 18, 2014.
    Pursuant to Section 107(b) of the Sarbanes-Oxley Act of 2002 (the 
``Act''), notice is hereby given that on July 10, 2014, the Public 
Company Accounting Oversight Board (the ``Board'' or the ``PCAOB'') 
filed with the Securities and Exchange Commission (the ``SEC'' or the 
``Commission'') the proposed rules described in items I and II below, 
which items have been prepared by the Board. The Commission is 
publishing this notice to solicit comments on the proposed rules from 
interested persons.

I. Board's Statement of the Terms of Substance of the Proposed Rules

    On June 10, 2014, the Board adopted Auditing Standard No. 18, 
Related Parties (``Auditing Standard No. 18'' or the ``standard''), 
amendments to certain PCAOB auditing standards regarding significant 
unusual transactions, and other amendments to PCAOB auditing standards 
(collectively referred to as, the ``standard and amendments'' or the 
``proposed rules''). The amendments to certain PCAOB auditing standards 
regarding significant unusual transactions (the ``amendments regarding 
significant unusual transactions'') and other amendments to PCAOB 
auditing standards (the ``other amendments'') are collectively referred 
to herein as the ``amendments.'' The text of the proposed rules is set 
out below.

Auditing Standard No. 18

Related Parties

Introduction
    1. This standard establishes requirements regarding the auditor's 
evaluation of a company's identification of, accounting for, and 
disclosure of relationships and transactions between the company and 
its related parties.\1\
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    \1\ The auditor should look to the requirements of the U.S. 
Securities and Exchange Commission for the company under audit with 
respect to the accounting principles applicable to that company, 
including the definition of the term ``related parties'' and the 
financial statement disclosure requirements with respect to related 
parties.
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Objective
    2. The objective of the auditor 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.\2\
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    \2\ See, e.g., paragraphs 30-31 of Auditing Standard No. 14, 
Evaluating Audit Results. See also paragraph .04 of AU sec. 411, The 
Meaning of Present Fairly in Conformity With Generally Accepted 
Accounting Principles.
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Performing Risk Assessment Procedures to Obtain an Understanding of the 
Company's Relationships and Transactions With Its Related Parties
    3. The auditor should perform procedures to obtain an understanding 
of the company's relationships and transactions with its related 
parties that might reasonably be expected to affect the risks of 
material misstatement of the financial statements in conjunction with 
performing risk assessment procedures in accordance with Auditing 
Standard No. 12, Identifying and Assessing Risks of Material 
Misstatement. The procedures performed to obtain an understanding of 
the company's relationships and transactions with its related parties 
include:
    a. Obtaining an understanding of the company's process (paragraph 
4);
    b. Performing inquiries (paragraphs 5-7); and
    c. Communicating with the audit engagement team and other auditors 
(paragraphs 8-9).

    Note: Obtaining an understanding of the company's relationships 
and transactions with its related parties includes obtaining an 
understanding of the nature of the relationships between the company 
and its related parties and of the terms and business purposes (or 
the lack thereof) of the transactions involving related parties.

    Note: Performing the risk assessment procedures described in 
paragraphs 4-9 of this standard in conjunction with the risk 
assessment procedures required by Auditing Standard No. 12 is 
intended to provide the auditor with a reasonable basis for 
identifying and assessing risks of material misstatement associated 
with related parties and relationships and transactions with related 
parties.

Obtaining an Understanding of the Company's Process
    4. In conjunction with obtaining an understanding of internal 
control over financial reporting, the auditor should obtain an 
understanding of the company's process for: \3\
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    \3\ See, e.g., paragraph 18 of Auditing Standard No. 12, which 
requires the auditor to obtain a sufficient understanding of each 
component of internal control over financial reporting to (a) 
identify the types of potential misstatements, (b) assess the 
factors that affect the risks of material misstatement, and (c) 
design further audit procedures. See also paragraph 20 of Auditing 
Standard No. 12, which states that obtaining an understanding of 
internal control includes evaluating the design of controls that are 
relevant to the audit and determining whether the controls have been 
implemented.
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    a. Identifying related parties and relationships and transactions 
with related parties;
    b. Authorizing and approving transactions with related parties; and
    c. Accounting for and disclosing relationships and transactions 
with related parties in the financial statements.

Performing Inquiries

    5. The auditor should inquire of management regarding: \4\
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    \4\ See also AU sec. 333, Management Representations. Obtaining 
such representations from management complements the performance of 
procedures in paragraph 5 and is not a substitution for those 
inquiries.
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    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.
    6. The auditor should inquire of others within the company 
regarding their knowledge of the matters in paragraph 5 of this 
standard. The auditor should identify others within the company \5\ to 
whom inquiries

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should be directed, and determine the extent of such inquires, by 
considering whether such individuals are likely to have knowledge 
regarding:
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    \5\ Examples of ``others'' within the company who may have such 
knowledge include: personnel in a position to initiate, process, or 
record transactions with related parties and those who supervise or 
monitor such personnel; internal auditors; in-house legal counsel; 
the chief compliance/ethics officer or person in equivalent 
position; and the human resources director or person in equivalent 
position.
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    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.\6\
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    \6\ For purposes of this standard, the phrase ``related parties 
or relationships or transactions with related parties previously 
undisclosed to the auditor'' includes, to the extent not disclosed 
to the auditor by management: (1) related parties; (2) relationships 
or transactions with known related parties; and (3) relationships or 
transactions with previously unknown related parties.
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    7. The auditor should inquire of the audit committee,\7\ or its 
chair, regarding:
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    \7\ The term ``audit committee'' has the same meaning as the 
term used in Auditing Standard No. 16, Communications with Audit 
Committees.
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    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.

Communicating With the Audit Engagement Team and Other Auditors

    8. The auditor should communicate to engagement team members 
relevant information about related parties, including the names of the 
related parties and the nature of the company's relationships and 
transactions with those related parties.\8\
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    \8\ This communication, which can be more effective when it 
occurs at an early stage of the audit, complements the discussion 
among engagement team members regarding risks of material 
misstatement in accordance with paragraph 49 of Auditing Standard 
No. 12. See also paragraph 5 of Auditing Standard No. 10, 
Supervision of the Audit Engagement, which establishes requirements 
regarding supervision of the engagement team members, including 
directing engagement team members to bring significant accounting 
and auditing issues arising during the audit to the attention of the 
engagement partner or other engagement team members performing 
supervisory activities.
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    9. If the auditor is using the work of another auditor, the auditor 
should communicate to the other auditor relevant information about 
related parties, including the names of the company's related parties 
and the nature of the company's relationships and transactions with 
those related parties.\9\ The auditor also should inquire of the other 
auditor regarding the other auditor's knowledge of any related parties 
or relationships or transactions with related parties that were not 
included in the auditor's communications.
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    \9\ See AU sec. 543, Part of Audit Performed by Other 
Independent Auditors, which describes the auditor's responsibilities 
regarding using the work and reports of other independent auditors 
who audit the financial statements of one or more subsidiaries, 
divisions, branches, components, or investments included in the 
financial statements.
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Identifying and Assessing Risks of Material Misstatement

    10. The auditor should identify and assess the risks of material 
misstatement at the financial statement level and the assertion 
level.\10\ This includes identifying and assessing the risks of 
material misstatement associated with related parties and relationships 
and transactions with related parties, including whether the company 
has properly identified, accounted for, and disclosed its related 
parties and relationships and transactions with related parties.
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    \10\ See paragraph 59 of Auditing Standard No. 12.

    Note:  In identifying and assessing the risks of material 
misstatement associated with related parties and relationships and 
transactions with related parties, the auditor should take into 
account the information obtained from performing the procedures in 
paragraphs 4-9 of this standard and from performing the risk 
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assessment procedures required by Auditing Standard No. 12.

Responding to the Risks of Material Misstatement

    11. The auditor must design and implement audit responses that 
address the identified and assessed risks of material misstatement.\11\ 
This includes designing and performing audit procedures in a manner 
that addresses the risks of material misstatement associated with 
related parties and relationships and transactions with related 
parties.\12\
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    \11\ See paragraph 3 of Auditing Standard No. 13, The Auditor's 
Responses to the Risks of Material Misstatement.
    \12\ See generally, Auditing Standard No. 13 and paragraph 17 of 
Auditing Standard No. 15, Audit Evidence, which provides that 
inquiry of company personnel, by itself, does not provide sufficient 
audit evidence to reduce audit risk to an appropriately low level 
for a relevant assertion or to support a conclusion about the 
effectiveness of a control.

    Note:  The auditor also should look to the requirements in 
paragraphs .66-.67A of AU sec. 316, Consideration of Fraud in a 
Financial Statement Audit, for related party transactions that are 
also significant unusual transactions (for example, significant 
related party transactions outside the normal course of business). 
For such related party transactions, AU sec. 316.67 requires that 
the auditor evaluate whether the business purpose (or the lack 
thereof) of the transactions indicates that the transactions may 
have been entered into to engage in fraudulent financial reporting 
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or conceal misappropriation of assets.

Transactions With Related Parties Required To Be Disclosed in the 
Financial Statements or Determined To Be a Significant Risk

    12. For each related party transaction that is either required to 
be disclosed in the financial statements or determined to be a 
significant risk, the auditor should:
    a. Read the underlying documentation and evaluate whether the terms 
and other information about the transaction are consistent with 
explanations from inquiries and other audit evidence about the business 
purpose (or the lack thereof) of the transaction;
    b. Determine whether the transaction has been authorized and 
approved in accordance with the company's established policies and 
procedures regarding the authorization and approval of transactions 
with related parties;
    c. Determine whether any exceptions to the company's established 
policies or procedures were granted; \13\
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    \13\ Information gathered while obtaining an understanding of 
the company also might assist the auditor in identifying agreements 
prohibiting or restricting related party transactions (for example, 
loans or advances to related parties).
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    d. Evaluate the financial capability of the related parties with 
respect to significant uncollected balances, loan commitments, supply 
arrangements, guarantees, and other obligations, if any; \14\ and
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    \14\ Examples of information that might be relevant to the 
auditor's evaluation of a related party's financial capability 
include, among other things, the audited financial statements of the 
related party, reports issued by regulatory agencies, financial 
publications, and income tax returns of the related party, to the 
extent available.
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    e. Perform other procedures as necessary to address the identified 
and assessed risks of material misstatement.

    Note: The applicable financial reporting framework may allow the 
aggregation of similar related party transactions for disclosure 
purposes. If the company has aggregated related party transactions 
for disclosure purposes in accordance with the applicable financial 
reporting framework, the auditor may perform the procedures in 
paragraph 12 for only a selection of transactions from each 
aggregation of related party transactions (versus all transactions 
in the aggregation), commensurate with the risks of material 
misstatement.

Intercompany Accounts

    13. The auditor should perform procedures on intercompany account 
balances as of concurrent dates, even if

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fiscal years of the respective companies differ.

    Note:  The procedures performed should address the risks of 
material misstatement associated with the company's intercompany 
accounts.

Evaluating Whether the Company Has Properly Identified Its Related 
Parties and Relationships and Transactions With Related Parties

    14. The auditor should evaluate whether the company has properly 
identified its related parties and relationships and transactions with 
related parties. Evaluating whether a company has properly identified 
its related parties and relationships and transactions with related 
parties involves more than assessing the process used by the company. 
This evaluation requires the auditor to perform procedures to test the 
accuracy and completeness of the related parties and relationships and 
transactions with related parties identified by the company, taking 
into account the information gathered during the audit.\15\ As part of 
this evaluation, the auditor should read minutes of the meetings of 
stockholders, directors, and committees of directors, or summaries of 
actions of recent meetings for which minutes have not yet been 
prepared.
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    \15\ Information obtained from identifying and evaluating a 
company's significant unusual transactions and obtaining an 
understanding of a company's financial relationships and 
transactions with its executive officers could indicate that related 
parties or relationships or transactions with related parties 
previously undisclosed to the auditor might exist.

    Note:  Appendix A contains examples of information and sources 
of information that may be gathered during the audit that could 
indicate that related parties or relationships or transactions with 
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related parties previously undisclosed to the auditor might exist.

    15. If the auditor identifies information that indicates that 
related parties or relationships or transactions with related parties 
previously undisclosed to the auditor might exist, the auditor should 
perform the procedures necessary to determine whether previously 
undisclosed relationships or transactions with related parties, in 
fact, exist.\16\ These procedures should extend beyond inquiry of 
management.
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    \16\ See paragraph 29 of Auditing Standard No. 15, which states 
that if audit evidence obtained from one source is inconsistent with 
that obtained from another, or if the auditor has doubts about the 
reliability of information to be used as audit evidence, the auditor 
should perform the audit procedures necessary to resolve the matter 
and should determine the effect, if any, on other aspects of the 
audit.
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    16. If the auditor determines that a related party or relationship 
or transaction with a related party previously undisclosed to the 
auditor exists, the auditor should:
    a. Inquire of management regarding the existence of the related 
party or relationship or transaction with a related party previously 
undisclosed to the auditor and the possible existence of other 
transactions with the related party previously undisclosed to the 
auditor;
    b. Evaluate why the related party or relationship or transaction 
with a related party was previously undisclosed to the auditor; \17\
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    \17\ See AU sec. 333.04, which states that if a representation 
made by management is contradicted by other audit evidence, the 
auditor should investigate the circumstances and consider the 
reliability of the representation made. Based on the circumstances, 
the auditor should consider whether his or her reliance on 
management's representations relating to other aspects of the 
financial statements is appropriate and justified.
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    c. Promptly communicate to appropriate members of the engagement 
team and other auditors participating in the audit engagement relevant 
information about the related party or relationship or transaction with 
the related party;
    d. Assess the need to perform additional procedures to identify 
other relationships or transactions with the related party previously 
undisclosed to the auditor;
    e. Perform the procedures required by paragraph 12 of this standard 
for each related party transaction previously undisclosed to the 
auditor that is required to be disclosed in the financial statements or 
determined to be a significant risk; and
    f. Perform the following procedures, taking into account the 
information gathered from performing the procedures in a. through e. 
above:
    i. Evaluate the implications on the auditor's assessment of 
internal control over financial reporting, if applicable;
    ii. Reassess the risk of material misstatement and perform 
additional procedures as necessary if such reassessment results in a 
higher risk; \18\ and
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    \18\ See paragraph 74 of Auditing Standard No. 12, which states 
that when the auditor obtains audit evidence during the course of 
the audit that contradicts the audit evidence on which the auditor 
originally based his or her risk assessment, the auditor should 
revise the risk assessment and modify planned audit procedures or 
perform additional procedures in response to the revised risk 
assessments.
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    iii. Evaluate the implications for the audit if management's 
nondisclosure to the auditor of a related party or relationship or 
transaction with a related party indicates that fraud or an illegal act 
may have occurred. If the auditor becomes aware of information 
indicating that fraud or another illegal act has occurred or might have 
occurred, the auditor must determine his or her responsibilities under 
AU secs. 316.79-.82, AU sec. 317, Illegal Acts by Clients, and Section 
10A of the Securities Exchange Act of 1934, 15 U.S.C. 78j-1.

Evaluating Financial Statement Accounting and Disclosures

    17. The auditor must evaluate whether related party transactions 
have been properly accounted for and disclosed in the financial 
statements. This includes evaluating whether the financial statements 
contain the information regarding relationships and transactions with 
related parties essential for a fair presentation in conformity with 
the applicable financial reporting framework.\19\
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    \19\ See paragraphs 30-31 of Auditing Standard No. 14.
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Assertions That Transactions With Related Parties Were Conducted on 
Terms Equivalent to Those Prevailing in Arm's-Length Transactions

    18. If the financial statements include a statement by management 
that transactions with related parties were conducted on terms 
equivalent to those prevailing in an arm's-length transaction, the 
auditor should determine whether the evidence obtained supports or 
contradicts management's assertion. If the auditor is unable to obtain 
sufficient appropriate audit evidence to substantiate management's 
assertion, and if management does not agree to modify the disclosure, 
the auditor should express a qualified or adverse opinion.\20\
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    \20\ See paragraph .06.l. of AU sec. 333, which requires the 
auditor to obtain written representations from management if the 
financial statements include such an assertion. Representations from 
management alone are not sufficient appropriate audit evidence. See 
also paragraphs .35-.36 of AU sec. 508, Reports on Audited Financial 
Statements.

    Note:  Transactions with related parties might not be conducted 
on terms equivalent to those prevailing in arm's-length transactions 
(e.g., a company may receive services from a related party without 
cost). Except for routine transactions, it may not be possible for 
management to determine whether a particular transaction would have 
taken place, or what the terms and manner of settlement would have 
been, if the parties had not been related. Accordingly, it may be 
difficult for the auditor to obtain sufficient appropriate audit 
evidence to substantiate management's assertion that a transaction 
was consummated on terms equivalent to those that prevail in arm's-
length transactions. A preface to a statement such as ``management 
believes that'' or ``it is the

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company's belief that'' does not change the auditor's 
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responsibilities.

Communications With the Audit Committee

    19. The auditor should 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.\21\ The auditor also should communicate other significant 
matters arising from the audit regarding the company's relationships 
and transactions with related parties including, but not limited to:
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    \21\ See Auditing Standard No. 16 regarding the timing of the 
communications to the audit committee.
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    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.

APPENDIX A--Examples of Information and Sources of Information That May 
Be Gathered During the Audit That Could Indicate That Related Parties 
or Relationships or Transactions With Related Parties Previously 
Undisclosed to the Auditor Might Exist

    A1. This Appendix contains examples of information and sources 
of information that may be gathered during the audit that could 
indicate that related parties or relationships or transactions with 
related parties previously undisclosed to the auditor might exist. 
Specifically, paragraph A2. of this Appendix contains examples of 
information that could indicate that related parties or 
relationships or transactions with related parties previously 
undisclosed to the auditor might exist. Similarly, paragraph A3. 
contains examples of sources that could contain such information. 
The examples contained in this Appendix are not intended to 
represent a comprehensive listing.
    A2. The following are examples of information that may be 
gathered during the audit that could indicate that related parties 
or relationships or transactions with related parties previously 
undisclosed to the auditor might exist:
     Buying or selling goods or services at prices that 
differ significantly from prevailing market prices;
     Sales transactions with unusual terms, including 
unusual rights of return or extended payment terms generally not 
offered;
     ``Bill and hold'' type transactions;
     Borrowing or lending on an interest-free basis or with 
no fixed repayment terms;
     Occupying premises or receiving other assets or 
rendering or receiving management services when no consideration is 
exchanged;
     Engaging in a nonmonetary transaction that lacks 
commercial substance;
     Sales without economic substance (e.g., funding the 
other party to the transaction to facilitate collection of the sales 
price, or entering into a transaction shortly prior to period end 
and unwinding that transaction shortly after period end);
     Loans to parties that, at the time of the loan 
transaction, do not have the ability to repay and possess 
insufficient or no collateral;
     Loans made without prior consideration of the ability 
of the party to repay;
     A subsequent repurchase of goods that indicates that at 
the time of sale an implicit obligation to repurchase may have 
existed that would have precluded revenue recognition or sales 
treatment;
     Advancing company funds that are used directly or 
indirectly to pay what would otherwise be an uncollectible loan or 
receivable;
     Sales at below market rates to an intermediary whose 
involvement serves no apparent business purpose and who, in turn, 
sells to the ultimate customer at a higher price, with the 
intermediary (and ultimately its principals) retaining the 
difference;
     Guarantees and guarantor relationships outside the 
normal course of business; or
     Transactions between two or more entities in which each 
party provides and receives the same or similar amounts of 
consideration (e.g., round-trip transactions).
    A3. The following are examples of sources of information that 
may be gathered during the audit that could indicate that related 
parties or relationships or transactions with related parties 
previously undisclosed to the auditor might exist:
     Periodic and current reports, proxy statements, and 
other relevant company filings with the SEC and other regulatory 
agencies;
     Disclosures contained on the company's Web site;
     Confirmation responses and responses to inquiries of 
the company's lawyers;
     Tax filings and related correspondence;
     Invoices and correspondence received from the company's 
professional advisors, for example, attorneys and consulting firms;
     Relevant internal auditors' reports;
     Conflicts-of-interest statements from management and 
others;
     Shareholder registers that identify the company's 
principal shareholders;
     Life insurance policies purchased by the company;
     Records of the company's investments, pension plans, 
and other trusts established for the benefit of employees, including 
the names of the officers and trustees of such investments, pension 
plans, and other trusts;
     Contracts or other agreements (including, for example, 
partnership agreements and side agreements or other arrangements) 
with management;
     Contracts and other agreements representing significant 
unusual transactions;
     Significant contracts renegotiated by the company 
during the period under audit;
     Records from a management, audit committee, or board of 
directors' whistleblower program;
     Expense reimbursement documentation for executive 
officers; or
     The company's organizational charts.

Amendments to Certain PCAOB Auditing Standards Regarding 
Significant Unusual Transactions

A. Identifying Significant Unusual Transactions

Auditing Standard No. 5, An Audit of Internal Control Over Financial 
Reporting That Is Integrated With An Audit of Financial Statements

    Auditing Standard No. 5, An Audit of Internal Control Over 
Financial Reporting That Is Integrated with an Audit of Financial 
Statements, as amended, is amended as follows:
    In paragraph 14:
     The first bullet point is replaced with:
    Controls over significant transactions that are outside the 
normal course of business for the company or that otherwise appear 
to be unusual due to their timing, size, or nature (``significant 
unusual transactions''), particularly those that result in late or 
unusual journal entries; 10A/ and
     Footnote 10A is added at the end of the first bullet:
10A/ See paragraphs .66-.67A of AU sec. 316, 
Consideration of Fraud in a Financial Statement Audit.

Auditing Standard No. 9, Audit Planning

    Auditing Standard No. 9, Audit Planning, as amended, is amended 
as follows:
    In paragraph 12, subparagraph a. is replaced with:
    The nature and amount of assets, liabilities, and transactions 
executed at the location or business unit, including, e.g., 
significant transactions that are outside the normal course of 
business for the company or that otherwise appear to be unusual due 
to their timing, size, or nature (``significant unusual 
transactions'') executed at the location or business 
unit.14/

Auditing Standard No. 12, Identifying and Assessing Risks of 
Material Misstatement

    Auditing Standard No. 12, Identifying and Assessing Risks of 
Material Misstatement, is Amended as follows:
    a. In paragraph 13:
     The fifth bullet point is replaced with: The methods 
the company uses to account for significant transactions that are 
outside the normal course of business for the company or that 
otherwise appear to be

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unusual due to their timing, size, or nature (``significant unusual 
transactions''); 7A/ and
     Footnote 7A is added at the end of the fifth bullet:

    7A/ See AU secs. 316.66-.67A.
    b. In paragraph 56.a.:
     In item (6), delete the word ``and'' at the end of the 
item.
     In item (7), change the period (.) at the end of the 
phrase to a semicolon (;) and add the word ``and'' after the 
semicolon.
     Add Item (8):
    (8) Whether the company has entered into any significant unusual 
transactions and, if so, the nature, terms, and business purpose (or 
the lack thereof) of those transactions and whether such 
transactions involved related parties.\31A\
     Add footnote 31A at the end of item (8):

    \31A\ See AU secs. 316.66-.67A.

    c. In paragraph 56.b.:
     In item (3), delete the word ``and'' at the end of the 
item.
     In item (4), change the period (.) at the end of the 
phrase to a semicolon (;) and add the word ``and'' after the 
semicolon.
     Add item (5):
    (5) Whether the company has entered into any significant unusual 
transactions.
    d. In paragraph 56.c.:
     In item (3), delete the word ``and'' at the end of the 
item.
     In item (4), change the period (.) at the end of the 
phrase to a semicolon (;) and add the word ``and'' after the 
semicolon.
     Add item (5):
    (5) Whether the company has entered into any significant unusual 
transactions.
    e. In paragraph 57, the third bullet point is replaced with:
    Employees involved in initiating, recording, or processing 
complex or unusual transactions, e.g., a sales transaction with 
multiple elements, a significant unusual transaction, or a 
significant related party transaction; and
    f. Paragraph 71.g., is replaced with:
    Whether the risk involves significant unusual transactions.
    g. Paragraph 73A is added after paragraph 73:
    73A. The auditor should obtain an understanding of the controls 
that management has established to identify, authorize and approve, 
and account for and disclose significant unusual transactions in the 
financial statements, if the auditor has not already done so when 
obtaining an understanding of internal control, as described in 
paragraphs 18-40 and 72-73 of this standard.

Auditing Standard No. 13, The Auditor's Responses to the Risks of 
Material Misstatement

    Auditing Standard No. 13, The Auditor's Responses to the Risks 
of Material Misstatement, as amended, is amended as follows:
    a. The second sentence of footnote 3 to paragraph 5.d. is 
replaced with:
    See also paragraphs .66-.67A of AU sec. 316, Consideration of 
Fraud in a Financial Statement Audit, and paragraphs .04 and .06 of 
AU sec. 411, The Meaning of Present Fairly in Conformity With 
Generally Accepted Accounting Principles.
    b. Paragraph 15.c. is replaced with:
    Evaluating whether the business purpose for significant 
transactions that are outside the normal course of business for the 
company or that otherwise appear to be unusual due to their timing, 
size, or nature (``significant unusual transactions'') indicates 
that the transactions may have been entered into to engage in 
fraudulent financial reporting or conceal misappropriation of assets 
(AU secs. 316.66-.67A).

AU sec. 316, ``Consideration of Fraud in a Financial Statement Audit''

    SAS No. 99, ``Consideration of Fraud in a Financial Statement 
Audit'' (AU sec. 316, ``Consideration of Fraud in a Financial 
Statement Audit''), as amended, is amended as follows:
    a. The first item in paragraph .85A.2, section a., under 
``Opportunities'' is replaced with the following two items:

 Related party transactions that are also significant 
unusual transactions (e.g., a significant related party transaction 
outside the normal course of business)
 Significant transactions with related parties whose 
financial statements are not audited or are audited by another firm

    b. The fourth item in paragraph .85A.2, section a., under 
``Opportunities'' is replaced with:

 Significant or highly complex transactions or significant 
unusual transactions, especially those close to period end, that 
pose difficult ``substance-over-form'' questions

    c. The following item is added as the last item to paragraph 
.85A.2, section a., under ``Opportunities'':

 Contractual arrangements lacking a business purpose

AU sec. 722, ``Interim Financial Information''

    SAS No. 100, ``Interim Financial Information'' (AU sec. 722, 
``Interim Financial Information''), as amended, is amended as 
follows:
    a. In paragraph .55, Appendix B, paragraph B1., the tenth bullet 
is replaced with the following two bullets:

 The occurrence of infrequent transactions
 The occurrence of significant unusual transactions

B. Evaluating Significant Unusual Transactions

Auditing Standard No. 13, The Auditor's Responses to the Risks of 
Material Misstatement

    Auditing Standard No. 13, The Auditor's Responses to the Risks 
of Material Misstatement, as amended, is amended as follows:
    a. Paragraph 11A is added after paragraph 11:
    11A. Responding to Risks Associated with Significant Unusual 
Transactions. Paragraph 71.g. of Auditing Standard No. 12 indicates 
that one of the factors to be evaluated in determining significant 
risks is whether the risk involves significant unusual transactions. 
Also, AU secs. 316.66-.67A establish requirements for performing 
procedures to respond to fraud risks regarding significant unusual 
transactions. Because significant unusual transactions can affect 
the risks of material misstatement due to error or fraud, the 
auditor should take into account the types of potential 
misstatements that could result from significant unusual 
transactions in designing and performing further audit procedures, 
including procedures performed pursuant to AU secs. 316.66-.67A.

Auditing Standard No. 16, Communications with Audit Committees

    Auditing Standard No. 16, Communications with Audit Committees, 
is amended as follows:
    a. In paragraph 13.d., the phrase ``rationale for'' is replaced 
with the phrase ``purpose (or the lack thereof) of.''

AU sec. 316, ``Consideration of Fraud in a Financial Statement Audit''

    SAS No. 99, ``Consideration of Fraud in a Financial Statement 
Audit'' (AU sec. 316, ``Consideration of Fraud in a Financial 
Statement Audit''), as amended, is amended as follows:
    a. Paragraph .66 is replaced with:
    .66 Evaluating whether the business purpose for significant 
unusual transactions indicates that the transactions may have been 
entered into to engage in fraud. Significant transactions that are 
outside the normal course of business for the company or that 
otherwise appear to be unusual due to their timing, size, or nature 
(``significant unusual transactions'') may be used to engage in 
fraudulent financial reporting or conceal misappropriation of 
assets.

    Note: The auditor's identification of significant unusual 
transactions should take into account information obtained from: (a) 
The risk assessment procedures required by Auditing Standard No. 12, 
Identifying and Assessing Risks of Material Misstatement (e.g., 
inquiring of management and others, obtaining an understanding of 
the methods used to account for significant unusual transactions, 
and obtaining an understanding of internal control over financial 
reporting) and (b) other procedures performed during the audit 
(e.g., reading minutes of the board of directors meetings and 
performing journal entry testing).

    Note: The auditor should take into account information that 
indicates that related parties or relationships or transactions with 
related parties previously undisclosed to the auditor might exist 
when identifying significant unusual transactions. See paragraphs 
14-16 of Auditing Standard No. 18, Related Parties. Appendix A of 
Auditing Standard No. 18, Related Parties, includes examples of such 
information and examples of sources of such information.

    b. Paragraph .66A is added after paragraph .66:
    .66A The auditor should design and perform procedures to obtain 
an understanding of the business purpose (or the lack thereof) of 
each significant unusual transaction that the auditor has 
identified. The procedures should include:
    a. Reading the underlying documentation and evaluating whether 
the terms and other

[[Page 43169]]

information about the transaction are consistent with explanations 
from inquiries and other audit evidence about the business purpose 
(or the lack thereof) of the transaction;
    b. Determining whether the transaction has been authorized and 
approved in accordance with the company's established policies and 
procedures;
    c. Evaluating the financial capability of the other parties with 
respect to significant uncollected balances, loan commitments, 
supply arrangements, guarantees, and other obligations, if any; \fn 
24A\ and
    d. Performing other procedures as necessary depending on the 
identified and assessed risks of material misstatement.

    Note:  Paragraph 11A of Auditing Standard No. 13 requires the 
auditor to take into account the types of potential misstatements 
that could result from significant unusual transactions in designing 
and performing further audit procedures.

    c. Footnote 24A is added after subparagraph c. of paragraph .66A

\fn 24A\ Examples of information that might be relevant to the 
auditor's evaluation of the other party's financial capability 
include, among other things, the audited financial statements of the 
other party, reports issued by regulatory agencies, financial 
publications, and income tax returns of the other party, to the 
extent available.

    d. Paragraph .67 is replaced with:
    .67 The auditor should evaluate whether the business purpose (or 
the lack thereof) indicates that the significant unusual transaction 
may have been entered into to engage in fraudulent financial 
reporting or conceal misappropriation of assets. In making that 
evaluation, the auditor should evaluate whether:
     The form of the transaction is overly complex (e.g., 
the transaction involves multiple entities within a consolidated 
group or unrelated third parties);
     The transaction involves unconsolidated related 
parties, including variable interest entities;
     The transaction involves related parties or 
relationships or transactions with related parties previously 
undisclosed to the auditor; \fn 25A\
     The transaction involves other parties that do not 
appear to have the financial capability to support the transaction 
without assistance from the company, or any related party of the 
company;
     The transaction lacks commercial or economic substance, 
or is part of a larger series of connected, linked, or otherwise 
interdependent arrangements that lack commercial or economic 
substance individually or in the aggregate (e.g., the transaction is 
entered into shortly prior to period end and is unwound shortly 
after period end);
     The transaction occurs with a party that falls outside 
the definition of a related party (as defined by the accounting 
principles applicable to that company), with either party able to 
negotiate terms that may not be available for other, more clearly 
independent, parties on an arm's-length basis;
     The transaction enables the company to achieve certain 
financial targets;
     Management is placing more emphasis on the need for a 
particular accounting treatment than on the underlying economic 
substance of the transaction (e.g., accounting-motivated structured 
transaction); and
     Management has discussed the nature of and accounting 
for the transaction with the audit committee or another committee of 
the board of directors or the entire board.

    Note:  Paragraphs 20-23 of Auditing Standard No. 14, Evaluating 
Audit Results, provide requirements regarding the auditor's 
evaluation of whether identified misstatements might be indicative 
of fraud.

    e. Footnote 25 is deleted and footnote 25A is added at the end 
of the third bullet in paragraph .67:

\fn 25A\ Related parties or relationships or transactions with 
related parties previously undisclosed to the auditor includes, to 
the extent not disclosed to the auditor by management: (1) Related 
parties; (2) relationships or transactions with known related 
parties; and (3) relationships or transactions with previously 
unknown related parties. Auditing Standard No. 18, Related Parties, 
requires the auditor to perform certain procedures in circumstances 
in which the auditor determines that related parties or 
relationships or transactions with related parties previously 
undisclosed to the auditor exist.

    f. Paragraph .67A is added after paragraph 67:
    .67A The auditor must evaluate whether significant unusual 
transactions that the auditor has identified have been properly 
accounted for and disclosed in the financial statements. This 
includes evaluating whether the financial statements contain the 
information regarding significant unusual transactions essential for 
a fair presentation of the financial statements in conformity with 
the applicable financial reporting framework.\fn 25B\

    Note: The auditor considers management's disclosure regarding 
significant unusual transactions in other parts of the company's 
Securities and Exchange Commission filing containing the audited 
financial statements in accordance with AU sec. 550, Other 
Information in Documents Containing Audited Financial Statements.

    g. Footnote 25B is added at the end of paragraph.67A:

\fn 25B\ See paragraphs 30-31 of Auditing Standard No. 14.

Other Amendments to PCAOB Auditing Standards

Auditing Standard No. 12, Identifying and Assessing Risks of Material 
Misstatement

    Auditing Standard No. 12, Identifying and Assessing Risks of 
Material Misstatement, is amended as follows:
    a. The following sentence is added to the end of footnote 3 of 
paragraph 4:
    Also, Auditing Standard No. 18, Related Parties, requires the 
auditor to perform procedures to obtain an understanding of the 
company's relationships and transactions with its related parties 
that might reasonably be expected to affect the risks of material 
misstatement of the financial statements.
    b. In paragraph 10, the note following the final bullet is 
deleted.
    c. Paragraph 10A is added after paragraph 10:
    10A. To assist in obtaining information for identifying and 
assessing risks of material misstatement of the financial statements 
associated with a company's financial relationships and transactions 
with its executive officers (e.g., executive compensation, including 
perquisites, and any other arrangements), the auditor should perform 
procedures to obtain an understanding of the company's financial 
relationships and transactions with its executive officers. The 
procedures should be designed to identify risks of material 
misstatement and should include, but not be limited to (1) reading 
the employment and compensation contracts between the company and 
its executive officers and (2) reading the proxy statements and 
other relevant company filings with the Securities and Exchange 
Commission and other regulatory agencies that relate to the 
company's financial relationships and transactions with its 
executive officers.
    d. In paragraph 11:
     The third bullet is replaced with:
    Obtaining an understanding of compensation arrangements with 
senior management other than executive officers referred to in 
paragraph 10A, including incentive compensation arrangements, 
changes or adjustments to those arrangements, and special bonuses;
     In the fourth bullet, delete the period (.) and add a 
semicolon (;) at the end of the bullet.
     Add a fifth bullet:
    Inquiring of the chair of the compensation committee, or the 
compensation committee's equivalent, and any compensation 
consultants engaged by either the compensation committee or the 
company regarding the structuring of the company's compensation for 
executive officers; and
     Add a sixth bullet:
    Obtaining an understanding of established policies and 
procedures regarding the authorization and approval of executive 
officer expense reimbursements.
    e. In Appendix A, paragraph A3A is added after paragraph A3:
    A3A. Executive officer--For issuers, the president; any vice 
president of a company in charge of a principal business unit, 
division, or function (such as sales, administration or finance); 
any other officer who performs a policy-making function; or any 
other person who performs similar policy-making functions for a 
company. Executive officers of subsidiaries may be deemed executive 
officers of a company if they perform such policy-making functions 
for the company. (See Rule 3b-7 under the Exchange Act.) For brokers 
and dealers, the term ``executive officer'' includes a broker's or 
dealer's chief executive officer, chief financial officer, chief 
operations officer, chief legal officer, chief compliance officer, 
director, and individuals with similar status or functions. (See 
Schedule A of Form BD.)

[[Page 43170]]

Auditing Standard No. 16, Communications with Audit Committees

    Auditing Standard No. 16, Communications with Audit Committees, 
is amended as follows:
    a. The phrase ``AU sec. 334, Related Parties'' in footnote 25 is 
replaced with the phrase ``Auditing Standard No. 18, Related 
Parties.''
    b. The following bullet is inserted after the third bullet in 
Appendix B:
     Auditing Standard No. 18, Related Parties, paragraphs 7 
and 19.

AU sec. 315, ``Communications Between Predecessor and Successor 
Auditors''

    SAS No. 84, ``Communications Between Predecessor and Successor 
Auditors'' (AU sec. 315, ``Communications Between Predecessor and 
Successor Auditors''), as amended, is amended as follows:
    a. The following bullet is added to the end of paragraph .09:
     The predecessor auditor's understanding of the nature 
of the company's relationships and transactions with related parties 
and significant unusual transactions.\fn 5A\
    b. Add the following footnote to the end of paragraph .09:

\fn 5A\ Paragraph .66 of AU sec. 316, Consideration of Fraud in a 
Financial Statement Audit, describes significant unusual 
transactions.

    c. In paragraph .11, replace the fifth sentence with:
    The predecessor auditor should ordinarily permit the successor 
auditor to review working papers, including documentation of 
planning, internal control, audit results, and other matters of 
continuing accounting and auditing significance, such as the working 
papers containing an analysis of balance sheet accounts, those 
relating to contingencies, related parties, and significant unusual 
transactions.

AU sec. 316, ``Consideration of Fraud in a Financial Statement Audit''

    SAS No. 99, ``Consideration of Fraud in a Financial Statement 
Audit'' (AU sec. 316, ``Consideration of Fraud in a Financial 
Statement Audit''), as amended, is amended as follows:
    a. The heading before paragraph .79 is replaced with:
    Communication about Possible Fraud to Management, the Audit 
Committee, the Securities and Exchange Commission, and Others \fn 
37\
    b. Paragraph .81A is added after paragraph .81:
    .81A The auditor has a responsibility, under certain conditions, 
to disclose possible fraud to the Securities and Exchange Commission 
to comply with certain legal and regulatory requirements. These 
requirements include reports in connection with the termination of 
the engagement, such as when the entity reports an auditor change 
and the fraud or related risk factors constitute a reportable event 
or are the source of a disagreement, as these terms are defined in 
Item 304 of Regulation S-K and Item 16F of Form 20-F. These 
requirements also include reports that may be required pursuant to 
Section 10A(b) of the Securities Exchange Act of 1934 relating to an 
illegal act that the auditor concludes has a material effect on the 
financial statements.
    c. For paragraph .82:
     Footnotes 39 and 41 are deleted.
     The paragraph is replaced with:
    .82 The auditor also may have a duty to disclose the existence 
of possible fraud to parties outside the entity in the following 
circumstances:
    a. To a successor auditor when the successor makes inquiries in 
accordance with AU sec. 315, Communications Between Predecessor and 
Successor Auditors.\fn 40\
    b. In response to a subpoena.
    c. To a funding agency or other specified agency in accordance 
with requirements for the audits of companies that receive 
governmental financial assistance.
    d. The following item is added to paragraph .85A.2, section b., 
under ``Opportunities'':
     The exertion of dominant influence by or over a related 
party

AU sec. 330, ``The Confirmation Process''

    SAS No. 67, ``The Confirmation Process'' (AU sec. 330, ``The 
Confirmation Process''), as amended, is amended as follows:
    a. Footnote 2 to paragraph .27 is replaced with:
    Auditing Standard No. 18, Related Parties, establishes 
requirements regarding the auditor's evaluation of relationships and 
transactions between the company and its related parties.

AU sec. 333, ``Management Representations''

    SAS No. 85, ``Management Representations'' (AU sec. 333, 
``Management Representations''), as amended, is amended as follows:
    a. The third sentence of paragraph .03 is replaced with:
    For example, after the auditor performs the procedures described 
in Auditing Standard No. 18, Related Parties, the auditor should 
obtain a written representation that management has no knowledge of 
any relationships or transactions with related parties that have not 
been properly accounted for and adequately disclosed. The auditor 
should obtain this written representation even if the results of 
those procedures indicate that relationships and transactions with 
related parties have been properly accounted for and adequately 
disclosed.
    b. In paragraph .06:
     Subparagraph c. is replaced with:
    Availability of all financial records and related data, 
including the names of all related parties and all relationships and 
transactions with related parties.
     Subparagraph f. is replaced with:
    Absence of (1) unrecorded transactions and (2) side agreements 
or other arrangements (either written or oral) undisclosed to the 
auditor.
     Subparagraph l. is replaced with:
    Information concerning related party transactions and amounts 
receivable from or payable to related parties, including support for 
any assertion that a transaction with a related party was conducted 
on terms equivalent to those prevailing in an arm's-length 
transaction.\fn 9\
    c. Footnote 9 to paragraph .06 is replaced with:
    See paragraph 18 of Auditing Standard No. 18, Related Parties.
    d. The second sentence in paragraph 4 of Appendix A is replaced 
with:
    Examples are fraud, in section 316, Consideration of Fraud in a 
Financial Statement Audit, and related parties, in Auditing Standard 
No. 18, Related Parties.
    e. In paragraph 6 of Appendix A:
     Item 2.a. is replaced with:
    Financial records and related data, including the names of all 
related parties and all relationships and transactions with related 
parties.
     Item 11.d. is added:
    Side agreements or other arrangements (either written or oral) 
that have not been disclosed to you.

AU sec. 334, ``Related Parties''

    SAS No. 45, Omnibus Statement on Auditing Standards --1983 (AU 
sec. 334, ``Related Parties''), as amended, is superseded.

AU sec. 9334, ``Related Parties: Auditing Interpretations of Section 
334''

    AU sec. 9334, ``Related Parties: Auditing Interpretations of 
Section 334,'' as amended, is superseded.

AU sec. 336, ``Using the Work of a Specialist''

    SAS No. 73, ``Using the Work of a Specialist'' (AU sec. 336, 
``Using the Work of a Specialist''), as amended, is amended as 
follows:
    a. Footnote 6 of paragraph .10 is replaced with:
    The term relationship includes, but is not limited to, those 
situations meeting the definition of ``related parties'' contained 
in the financial reporting framework applicable to the company under 
audit.

AU sec. 560, ``Subsequent Events''

    SAS No. 1, ``Codification of Auditing Standards and 
Procedures,'' section 560, ``Subsequent Events'' (AU sec. 560, 
``Subsequent Events''), as amended, is amended as follows:
    a. In paragraph .12b.:
     Item (v) is added:
    Whether there have been any changes in the company's related 
parties.
     Item (vi) is added:
    Whether there have been any significant new related party 
transactions.
     Item (vii) is added:
    Whether the company has entered into any significant unusual 
transactions.

AU sec. 722, ``Interim Financial Information''

    SAS No. 100, ``Interim Financial Information'' (AU sec. 722, 
``Interim Financial Information''), as amended, is amended as 
follows:
    a. In paragraph .24:
     Subparagraph g. is replaced with:
    Availability of all financial records and related data, 
including the names of all related parties and all relationships and 
transactions with related parties.
     Subparagraph j. is replaced with:
    Absence of (1) unrecorded transactions and (2) side agreements 
or other arrangements

[[Page 43171]]

(either written or oral) undisclosed to the auditor.
     Subparagraph m. is replaced with:
    Information concerning related party transactions and amounts 
receivable from or payable to related parties, including support for 
any assertion that a transaction with a related party was conducted 
on terms equivalent to those prevailing in an arm's-length 
transaction.
    b. The second sentence of paragraph C5 of paragraph .56 is 
replaced with:
    Examples are fraud, in section 316, Consideration of Fraud in a 
Financial Statement Audit, and related parties, in Auditing Standard 
No. 18, Related Parties.
    c. Within paragraph C6 of paragraph .56, within the first 
illustrative representation letter (1.) for a review of interim 
financial information (statements):
     Item 2.a. is replaced with:
    All financial records and related data, including the names of 
all related parties and all relationships and transactions with 
related parties.
    d. Within paragraph C6 of paragraph .56, within the second 
illustrative representation letter (2.) for a review of interim 
financial information (statements):
     Item 2.a. is replaced with:
    All financial records and related data, including the names of 
all related parties and all relationships and transactions with 
related parties.
     Item 12.d. is added:
    Side agreements or other arrangements (either written or oral) 
that have not been disclosed to you.

II. Board's Statement of the Purpose of, and Statutory Basis for, the 
Proposed Rules

    In its filing with the Commission, the Board included statements 
concerning the purpose of, and basis for, the proposed rules and 
discussed any comments it received on the proposed rules. The text of 
these statements may be examined at the places specified in Item IV 
below. The Board has prepared summaries, set forth in Sections A, B, 
and C below, of the most significant aspects of such statements. In 
addition, the Board is requesting that the Commission approve the 
proposed rules, pursuant to Section 103(a)(3)(C) of the Sarbanes-Oxley 
Act, for application to audits of emerging growth companies (``EGCs''), 
as that term is defined in Section 3(a)(80) of the Securities Exchange 
Act of 1934 (the ``Exchange Act''). The Board's request is set forth in 
Section D below.

A. Board's Statement of the Purpose of, and Statutory Basis for, the 
Proposed Rules

(a) Purpose
Introduction
    The Board is adopting a new auditing standard and amendments to its 
auditing standards to strengthen auditor performance requirements in 
three critical areas that historically have represented increased risks 
of material misstatement in company financial statements. Related party 
transactions; significant transactions that are outside the normal 
course of business for the company or that otherwise appear to be 
unusual due to their timing, size, or nature (``significant unusual 
transactions''); and a company's financial relationships and 
transactions with its executive officers,\22\ have been contributing 
factors in numerous financial reporting frauds over the last several 
decades.\23\ Prominent corporate scandals involving these critical 
areas served to undermine investor confidence and resulted in 
significant losses for investors, as well as the loss of many jobs.\24\ 
These critical areas have continued to be contributing factors in more 
recent cases.\25\ As discussed below, the Board's oversight activities 
indicate that there are continuing weaknesses in auditors' scrutiny of 
these areas.
---------------------------------------------------------------------------

    \22\ A company's related party transactions, significant unusual 
transactions, and financial relationships and transactions with its 
executive officers, are collectively referred to herein as ``the 
critical areas'' or ``these critical areas.''
    \23\ Such prominent corporate scandals include Enron 
Corporation, Tyco International, Ltd., Refco, Inc., and WorldCom, 
Inc. For a more detailed discussion of such financial reporting 
frauds, see: (i) Proposed Auditing Standard--Related Parties, 
Proposed Amendments to Certain PCAOB Auditing Standards Regarding 
Significant Unusual Transactions and Other Proposed Amendments to 
PCAOB Auditing Standards (the ``proposing release'' or the 
``proposal''), PCAOB Release No. 2012-001 (February 28, 2012) at 9-
11, http://pcaobus.org/Rules/Rulemaking/Docket038/Release_2012-001_Related_Parties.pdf and (ii) Proposed Auditing Standard--
Related Parties, Proposed Amendments to Certain PCAOB Auditing 
Standards Regarding Significant Unusual Transactions and Other 
Proposed Amendments to PCAOB Auditing Standards (the ``reproposing 
release'' or the ``reproposal''), PCAOB Release No. 2013-004 (May 7, 
2013) at 2, http://pcaobus.org/Rules/Rulemaking/Docket038/Release%202013-004_Related%20Parties.pdf.
    \24\ In one such example, Enron Corporation was the nation's 
largest natural gas and electric marketer, with reported annual 
revenue of more than $150 billion. When it filed for bankruptcy on 
December 2, 2001, its stock price had dropped, in less than a year, 
from more than $80 per share to less than $1. See SEC Settles Civil 
Fraud Charges Filed Against Richard A. Causey, Former Enron Chief 
Accounting Officer; Causey Barred From Acting as an Officer or 
Director of a Public Company (U.S. Securities and Exchange 
Commission (``SEC'' or ``Commission'') Litigation Release No. 19996, 
February 9, 2007).
    \25\ See, e.g., SEC Accounting and Auditing Enforcement Release 
(``AAER'') No. 3447, SEC v. Keyuan Petrochemicals, Inc. and Aichun 
Li (February 28, 2013), and SEC AAER No. 3385, SEC v. China Natural 
Gas, Inc. and Qinan Ji (May 14, 2012).
---------------------------------------------------------------------------

    The Board developed the standard and amendments because, as 
described more fully below, the Board believes its existing 
requirements need to be strengthened to heighten the auditor's 
attention to areas that have been associated with risks of fraudulent 
financial reporting and that also may pose increased risks of error. 
The Board has concluded that its existing requirements in these 
critical areas do not contain sufficient required procedures and are 
not sufficiently risk-based, which can lead to inadequate auditor 
effort in the critical areas. The auditor, serving in the role as a 
gatekeeper \26\ in the financial reporting system, should be alert to 
the possibility that transactions in these critical areas pose 
increased risks and, thus, require heightened scrutiny during the 
audit.\27\ Increased auditor attention to these critical areas should, 
in the Board's view, increase the likelihood of the auditor identifying 
material misstatements.
---------------------------------------------------------------------------

    \26\ According to the SEC, ``The federal securities laws, to a 
significant extent, make independent auditors ``gatekeepers'' to the 
public securities markets. These laws require, or permit us to 
require, financial information filed with us to be certified (or 
audited) by independent public accountants. Without an opinion from 
an independent auditor, the company cannot satisfy the statutory and 
regulatory requirements for audited financial statements and cannot 
sell its securities to the public. The auditor is the only 
professional that a company must engage before making a public 
offering of securities and the only professional charged with the 
duty to act and report independently from management.'' See SEC 
Securities Act Release No. 33-7870, Proposed Rule: Revision of the 
Commission's Auditor Independence Requirements (June 30, 2000) at 
Section II.A. See also, SEC Securities Act Release No. 33-7919, 
Final Rule: Revision of the Commission's Auditor Independence 
Requirements (November 21, 2000) at Section III.A.
    \27\ See, e.g., SEC AAER No. 3427, In the Matter of the 
Application of Wendy McNeeley, CPA, at 10-12 (December 13, 2012), 
http://www.sec.gov/litigation/opinions/2012/34-68431.pdf. That 
opinion states, in part, that the SEC and courts have repeatedly 
held that related party transactions require heightened scrutiny by 
auditors. See also McCurdy v. SEC, 396 F3d 1258, 1261 (D.C. Cir. 
2005) (citing Howard v. SEC, 376 F3d 1136, 1149 (D.C. Cir. 2004) 
noting that related-party transactions ``are viewed with extreme 
skepticism in all areas of finance,'' aff'g James Thomas McCurdy, 
CPA, 57 SE.C. 277 (2004)).
---------------------------------------------------------------------------

    The standard and amendments being adopted by the Board include: the 
standard; amendments regarding significant unusual transactions; and 
other amendments. As described below, the standard and amendments 
address:
     Relationships and Transactions with Related Parties;
     Significant Unusual Transactions; and
     Financial Relationships and Transactions with Executive 
Officers.
    Relationships and Transactions with Related Parties: The standard 
addresses the auditing of relationships and transactions between a 
company and its

[[Page 43172]]

related parties. A company's related party transactions could pose 
increased risks of material misstatement, as their substance might 
differ materially from their form.\28\ Related party transactions also 
may involve difficult measurement and recognition issues that can lead 
to errors in financial statements. Such transactions potentially 
provide more of an opportunity for management to act in its own 
interests, rather than in the interests of the company and its 
investors. Moreover, in some instances, related party transactions have 
been used to engage in fraudulent financial reporting and to conceal 
misappropriation of assets--types of misstatements that are relevant to 
the auditor's consideration of fraud.\29\ The importance to investors 
of auditing related party transactions is reflected in Section 10A of 
the Securities Exchange Act of 1934 (the ``Exchange Act''), which 
requires each audit of financial statements of an issuer to include 
``procedures designed to identify related party transactions that are 
material to the financial statements or otherwise require disclosure 
therein.'' \30\ The standard is designed to strengthen auditor 
performance requirements by setting forth specific procedures for the 
auditor's evaluation of a company's identification of, accounting for, 
and disclosure of relationships and transactions between the company 
and its related parties. The standard supersedes the Board's existing 
standard, AU sec. 334, Related Parties, (the ``existing standard''), 
which has not been substantively updated since it was issued in 
1983.\31\
---------------------------------------------------------------------------

    \28\ See also Section D for additional discussion of such risks.
    \29\ See paragraph .06 of AU sec. 316, Consideration of Fraud in 
a Financial Statement Audit.
    \30\ See Section 10A(a)(2) of the Exchange Act, 15 U.S.C. 78j-
1(a)(2), which was added to the Exchange Act by the Private 
Securities Litigation Reform Act, enacted by Congress in 1995.
    \31\ AU sec. 334 is one of the Board's interim auditing 
standards. Shortly after the Board's inception, the Board adopted 
the existing standards of the American Institute of Certified Public 
Accountants (``AICPA''), as in existence on April 16, 2003, on an 
initial, transitional basis. See Establishment of Interim 
Professional Auditing Standards, PCAOB Release No. 2003-006 (April 
18, 2003).
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    Significant Unusual Transactions: The amendments regarding 
significant unusual transactions recognize that a company's significant 
unusual transactions can create complex accounting and financial 
statement disclosure issues that could pose increased risks of material 
misstatement. In some instances, significant unusual transactions have 
been used to engage in fraudulent financial reporting. For example, 
significant unusual transactions, especially those close to period end 
that pose difficult ``substance-over-form'' questions, may be entered 
into to obscure a company's financial position or operating 
results.\32\ In such cases, management may place more emphasis on the 
need for a particular accounting treatment than on the underlying 
economic substance of the transaction. Existing audit requirements 
regarding significant unusual transactions are principally contained in 
AU sec. 316. The amendments regarding significant unusual transactions 
include specific procedures that are designed to improve the auditor's 
identification and evaluation of a company's significant unusual 
transactions and, in particular, to enhance the auditor's understanding 
of the business purpose (or the lack thereof) of such transactions.
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    \32\ See, e.g., SEC AAER No. 1631, In the Matter of Dynegy Inc., 
Respondent (September 24, 2002), http://www.sec.gov/litigation/admin/33-8134.htm; and SEC AAER No. 2775, In the Matter of Michael 
Lowther, CPA, Respondent (January 28, 2008), http://www.sec.gov/litigation/admin/2008/34-57210.pdf.
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    Financial Relationships and Transactions with Executive Officers: 
The other amendments include, among other things, improved audit 
procedures addressing a company's financial relationships and 
transactions with its executive officers. A company's executive 
officers are in a unique position to influence a company's accounting 
and disclosures. A company's financial relationships and transactions 
with its executive officers (as one example, executive officer 
compensation) can create incentives and pressures for executive 
officers to meet financial targets, which can result in risks of 
material misstatement to a company's financial statements. The other 
amendments modify Auditing Standard No. 12, Identifying and Assessing 
Risks of Material Misstatement, to require the auditor to perform 
specific procedures, as part of the auditor's risk assessment 
process,\33\ to obtain an understanding of the company's financial 
relationships and transactions with its executive officers. However, 
these amendments do not require the auditor to make any determination 
regarding the reasonableness of compensation arrangements or 
recommendations regarding compensation arrangements.
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    \33\ In 2010, the Board adopted eight standards on assessing and 
responding to risk in an audit (the ``risk assessment standards''), 
which cover the entire audit process, from initial planning 
activities to evaluating audit evidence to forming the opinion to be 
expressed in the auditor's report. See Auditing Standards Related to 
the Auditor's Assessment of and Response to Risk and Related 
Amendments to PCAOB Standards, PCAOB Release 2010-004 (August 5, 
2010).
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    The auditor's efforts regarding these critical areas are, in many 
ways, complementary. For example, the auditor's efforts to identify and 
evaluate a company's significant unusual transactions could identify 
information that indicates that a related party or relationship or 
transaction with a related party previously undisclosed to the auditor 
might exist. Likewise, obtaining an understanding of a company's 
financial relationships and transactions with its executive officers 
also could identify such information. The standard and amendments 
direct the auditor to consider the linkage between a company's 
relationships and transactions with its related parties, its 
significant unusual transactions, and its financial relationships and 
transactions with its executive officers. This complementary audit 
approach should help the auditor ``connect the dots'' between different 
aspects of the audit. Both the auditor and the investor benefit from a 
comprehensive and consistent examination of the critical areas, not 
only because of the risk of material misstatement due to fraud, but 
also because these transactions, due to their nature, could pose a risk 
of material misstatement due to error.
    In addition, the standard imposes new requirements relating to the 
auditor's communications with the company's audit committee. These 
changes recognize that the new auditor performance requirements 
contained in the standard relate to areas of the audit that warrant 
discussion with the audit committee. The new communication requirements 
in the standard work in concert with the communication requirements in 
Auditing Standard No. 16, Communications with Audit Committees,\34\ and 
require the auditor to include, as one of the auditor's required 
communications with the audit committee, the auditor's evaluation of 
the company's identification of, accounting for, and disclosure of its 
relationships with related parties. Additionally, the amendments 
regarding significant unusual transactions are intended to enhance the 
discussion between the auditor and the audit committee regarding the 
business purpose (or the lack thereof) of a company's significant 
unusual transactions required by Auditing Standard No. 16.\35\ 
Similarly, requiring

[[Page 43173]]

the auditor to perform procedures to obtain an understanding of the 
company's financial relationships and transactions with its executive 
officers is intended to improve the auditor's identification of fraud 
risks or other significant risks, which are also already required to be 
discussed with the audit committee pursuant to Auditing Standard No. 
16.\36\
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    \34\ See Communications with Audit Committees; Related 
Amendments to PCAOB Standards; and Transitional Amendments to AU 
Sec. 380, PCAOB Release No. 2012-004 (August 15, 2012).
    \35\ See paragraph 13.d. of Auditing Standard No. 16, as revised 
by certain amendments regarding significant unusual transactions. As 
revised, the auditor is required to communicate to the audit 
committee the auditor's understanding of the business purpose (or 
the lack thereof) of significant unusual transactions.
    \36\ See paragraph 9 of Auditing Standard No. 16, which requires 
the auditor to discuss with the audit committee the significant 
risks identified during the auditor's risk assessment procedures.
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    As discussed below, recommendations to improve the requirements in 
the critical areas have been longstanding. The standard and amendments 
reflect public input, including discussions with the Board's Standing 
Advisory Group (``SAG'') \37\ and comments received on a proposal in 
2012 \38\ and a reproposal in 2013.\39\ A wide range of commenters, 
including audit firms serving companies of all sizes, were supportive 
overall of the need to improve existing standards in these critical 
areas. During the standard-setting process, the Board considered 
various alternatives, including some proposed by commenters, in order 
to develop new requirements that would promote investor protection, but 
that also would provide opportunities for efficient implementation. 
After considering the comments received on the reproposal, the Board is 
adopting the standard and amendments substantially as reproposed.
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    \37\ The SAG discussed the topic of related parties at a number 
of its meetings prior to the issuance of the Board's proposal, 
including at meetings occurring on: September 8-9, 2004; June 21, 
2007; and October 14-15, 2009. The SAG also discussed the proposal 
and reproposal on May 17, 2012 and May 15, 2013, respectively. See 
the SAG Meeting Archive at http://pcaobus.org/Standards/SAG/Pages/SAGMeetingArchive.aspx.
    \38\ See the proposing release, which included: (i) an auditing 
standard, Related Parties (``proposed standard''); (ii) amendments 
to certain PCAOB auditing standards regarding significant unusual 
transactions; and (iii) other amendments to PCAOB auditing standards 
(collectively, these are referred to as the ``proposed standard and 
amendments'').
    \39\ See the reproposing release, which included: (i) an 
auditing standard, Related Parties (``reproposed standard''); (ii) 
amendments to certain PCAOB auditing standards regarding significant 
unusual transactions; and (iii) other proposed amendments to PCAOB 
auditing standards (collectively, these are referred to as the 
``reproposed standard and amendments'').
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    In general, the Board's new performance requirements for auditors 
are designed to promote heightened scrutiny in the critical areas, with 
the goal of promoting the auditor's ability to identify, evaluate, and 
respond to risks of material misstatement. The new requirements 
represent a targeted approach, focusing on areas that have historically 
reflected increased risks of fraudulent financial reporting and that 
also may pose increased risks of error. The Board believes that the 
standard and amendments, which are aligned with the risk assessment 
standards, represent a cohesive audit approach that will contribute to 
audit effectiveness and provide opportunities for an efficient 
implementation. In the Board's view, the new requirements further the 
Board's overall mission of improving audit quality, protecting the 
interests of investors, and furthering the public interest in the 
preparation of informative, accurate, and independent audit 
reports.\40\
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    \40\ See Section 101 of the Sarbanes-Oxley Act of 2002 
(``Sarbanes-Oxley'' or the ``Act''), Public Law 107-204, 116 Stat. 
745. Under Section 101 of the Act, the mission of the PCAOB is ``to 
oversee the audit of companies that are subject to the securities 
laws, and related matters, in order to protect the interests of 
investors and further the public interest in the preparation of 
informative, accurate, and independent audit reports . . . .''
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Background and Need for Improvement
    As described more fully in the Board's proposing and reproposing 
releases, the Board developed the standard and amendments against the 
backdrop of several decades of financial reporting frauds involving 
companies' relationships and transactions with related parties, 
significant unusual transactions, and financial relationships and 
transactions with executive officers.\41\
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    \41\ See also Section D, which further elaborates on the Board's 
consideration of the need, the alternatives considered, and the 
Board's existing requirements and current audit practices, in 
connection with the Board's consideration of the economic impacts of 
the standard and amendments.
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    In considering the need for improvement, the Board noted that some 
of its existing requirements in these critical areas had not been 
updated to address significant developments since their issuance. For 
example, the existing standard addressing the auditing of related 
parties, AU sec. 334, had remained largely unchanged for many years, 
despite prominent corporate scandals.\42\ The Board observed that the 
existing standard provided guidance and examples of procedures the 
auditor could perform, in lieu of specific required procedures. This 
could result in inadequate audit effort in an area that could pose 
increased risks of material misstatement. Additionally, the nature and 
extent of audit procedures addressing a company's related party 
transactions could vary widely. AU sec. 334 also does not reflect the 
risk-based approach taken in the Board's risk assessment standards, 
adopted in 2010, which provide an overall framework for the audit, 
based on the auditor's assessment of, and response to, risks of 
material misstatement.\43\
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    \42\ Audit procedures regarding a company's related parties have 
remained largely unchanged since the issuance of AU sec. 335, 
Related Party Transactions, in July 1975. In 1983, AU sec. 335 was 
replaced with AU sec. 334, but the nature and extent of the 
auditor's responsibilities and procedures pertaining to related 
parties in AU sec. 335 were carried over into AU sec. 334. AU sec. 
334 removed guidance relating to accounting considerations and 
disclosure standards for related parties (in response to the 
issuance of Financial Accounting Standards Board (``FASB'') 
Statement of Financial Accounting Standards No. 57, Related Party 
Disclosures, which is now contained in FASB Accounting Standards 
Codification Topic 850, Related Party Disclosures), along with other 
related technical changes.
    \43\ See PCAOB Release 2010-004 (August 5, 2010).
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    The Board's view was also informed by a number of prominent reports 
and studies that supported the need to improve its existing 
requirements in the critical areas to better address issues pertinent 
to fraudulent financial reporting. These included studies by the audit 
profession that predated the establishment of the Board, and that 
suggested improvements to certain auditing standards adopted by the 
Board on an interim basis in 2003. For example, the Report of the 
Quality Control Inquiry Committee (the ``QCIC Report'') of the AICPA's 
SEC Practice Section recommended, after studying more than 200 cases 
involving audit failures, that ``required audit procedures be broadened 
to help ensure the auditor gains a more complete understanding of 
related-party transactions, including the business aspects of the 
transactions.'' \44\
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    \44\ See AICPA SEC Practice Section, Memo To Managing Partners 
of SECPS Member Firms, ``Recommendations for the Profession Based on 
Lessons Learned from Litigation'' (October 2002), which includes the 
QCIC Report as an attachment.
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    The Board also considered the results of its oversight activities. 
For example, the Board has observed that the facts underlying a 
significant percentage of the Board's settled disciplinary actions to 
date have involved auditors' failures to perform sufficient procedures 
regarding related party transactions.\45\

[[Page 43174]]

Many of these cases involve smaller audit firms. Likewise, the Board's 
inspection program has identified a range of deficiencies in auditing 
related party transactions, particularly with respect to audits of 
smaller public companies that were conducted by smaller domestic audit 
firms.\46\ The audit deficiencies cited included failures to test for 
undisclosed related parties and failures to address risks posed by 
known related party transactions, including failures to obtain an 
understanding of the business purpose of such transactions. The types 
of audit deficiencies observed by the Board indicate that audit 
practice is inconsistent under the existing framework, which suggests 
that this is a challenging area warranting additional auditor effort 
and focus.
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    \45\ See, e.g., Order Instituting Disciplinary Proceedings, 
Making Findings, and Imposing Sanctions: In the Matter of P. Parikh 
& Associates, Ashok B. Rajagiri, CA, Sandeep P. Parikh, CA, and 
Sundeep P S G Nair, CA, Respondents, PCAOB Release No. 105-2013-002 
(April 24, 2013); Order Instituting Disciplinary Proceedings, Making 
Findings, and Imposing Sanctions: In the Matter of Jaspers + Hall, 
PC, Thomas M. Jaspers, CPA, and Patrick A. Hall, CPA, Respondents, 
PCAOB Release No. 105-2008-002 (October 21, 2008); Order Instituting 
Disciplinary Proceedings, Making Findings, and Imposing Sanctions: 
In the Matter of Williams & Webster, P.S., Kevin J. Williams, CPA, 
and John G. Webster, CPA, Respondents, PCAOB Release No. 105-2007-1 
(June 12, 2007); and Order Instituting Disciplinary Proceedings, 
Making Findings, and Imposing Sanctions: In the Matter of Kenny H. 
Lee CPA Group, Inc., and Kwang Ho Lee, CPA, Respondents, PCAOB 
Release No. 105-2005-022 (November 22, 2005).
    \46\ See Report on 2007-2010 Inspections of Domestic Firms that 
Audit 100 or Fewer Public Companies, PCAOB Release No. 2013-001 
(February 25, 2013) at 29, http://pcaobus.org/Inspections/Documents/02252013_Release_2013_001.pdf, which states, in part, 
``Inspections staff have observed deficiencies related to firms' 
failures to test for undisclosed related parties or transactions 
with undisclosed related parties. Some of those firms failed to 
identify and address the lack of disclosure of related party 
transactions in the financial statements. Inspections staff have 
also identified deficiencies relating to the firms' failure to 
obtain an understanding of the nature and business purpose of 
transactions with related parties and to evaluate whether the 
accounting for those transactions reflects their economic 
substance.'' See also Report on the PCAOB's 2004, 2005, and 2006 
Inspections of Domestic Triennially Inspected Firms, PCAOB Release 
No. 2007-010, at 7 (October 22, 2007), http://pcaobus.org/Inspections/Documents/2007_10-22_4010_Report.pdf.
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    Significantly, the need for heightened scrutiny of related party 
transactions has been highlighted by SEC enforcement actions. For 
example, in a 2012 opinion issued by the SEC involving a company's 
transactions with its executive officers, the SEC stated ``although in 
an ordinary arms-length transaction, one may assume that parties will 
act in their own economic interest, this assumption breaks down when 
the parties are related.'' \47\ Additionally, a study performed by the 
SEC of five years of enforcement actions that was required by Section 
704 of the Act examined 227 enforcement matters and found that 23 of 
those cases included the failure to disclose related party 
transactions.\48\
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    \47\ See SEC, In the Matter of the Application of Wendy 
McNeeley, CPA, AAER No. 3427, at 15 (December 13, 2012), http://www.sec.gov/litigation/opinions/2012/34-68431.pdf. As previously 
noted, that opinion states, in part, that the SEC and courts have 
repeatedly held that related party transactions require heightened 
scrutiny by auditors and notes the importance of the auditor 
understanding the business purpose of material related party 
transactions.
    \48\ Section 704 of the Act directed the SEC to study 
enforcement actions over the five years preceding its enactment ``to 
identify areas of issuer financial reporting that are most 
susceptible to fraud, inappropriate manipulation, or inappropriate 
earnings management.'' See Report Pursuant to Section 704 of the 
Sarbanes-Oxley Act of 2002 (January 24, 2003) at 6.
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    SEC enforcement cases also have highlighted the role played by 
executive officers in fraudulent financial reporting by public 
companies. For example, a study examining SEC AAERs from 1998 to 2007 
noted that the most commonly cited motivations for fraud included the 
need to: (i) Meet external earnings expectations of analysts and 
others; (ii) meet internally set financial targets or make the company 
look better; (iii) conceal the company's deteriorating financial 
condition; (iv) increase the stock price; (v) bolster financial 
position for pending equity or debt financing; (vi) increase management 
compensation through achievement of bonus targets and through enhanced 
stock appreciation; and (vii) cover up assets misappropriated for 
personal gain.\49\ That study indicated that the chief executive 
officer and/or chief financial officer were named in 89 percent of the 
cases involving fraudulent financial reporting brought by the SEC 
during that period.
---------------------------------------------------------------------------

    \49\ See Mark S. Beasley, Joseph V. Carcello, Dana R. Hermanson, 
and Terry L. Neal, Fraudulent Financial Reporting 1998-2007: An 
Analysis of U.S. Public Companies, Committee of Sponsoring 
Organizations of the Treadway Commission (May 2010) at 3, http://www.coso.org/documents/COSOFRAUDSTUDY2010_001.pdf.
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    The Board further considered that other standard-setters already 
have taken action to update their standards in related areas. For 
example, in July 2008, the International Auditing and Assurance 
Standards Board (``IAASB'') took action to update and revise its 
auditing standard on related parties with the issuance of International 
Standard on Auditing No. 550, Related Parties. The IAASB emphasized 
that its new standard was warranted given the public focus on the 
accounting and auditing of related party relationships and transactions 
after recent major corporate scandals.\50\ The Auditing Standards Board 
(``ASB'') of the AICPA also revised its auditing standard on related 
parties with the issuance of AU-C Section 550, Related Parties, 
contained in Statement on Auditing Standards No. 122, Statement on 
Auditing Standards: Clarification and Recodification, in October 2011.
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    \50\ See IAASB Exposure Draft, Related Parties (December 2005). 
In addition, the IAASB staff issued guidance in August 2010 
addressing the auditing of significant unusual or highly complex 
transactions. See IAASB Staff Questions and Answers, Auditor 
Considerations Regarding Significant Unusual or Highly Complex 
Transactions (August 2010).
---------------------------------------------------------------------------

    These considerations, particularly the magnitude and number of 
financial fraud cases over the last several decades involving 
companies' relationships and transactions with related parties, 
significant unusual transactions, and financial relationships and 
transactions with executive officers, strongly indicate the need to 
strengthen existing auditing standards addressing these critical areas 
to promote audit quality and investor protection.
The Board's Proposals and Development of the Board's Approach
    The following discussion highlights a number of key decisions made 
by the Board as it developed the standard and amendments, beginning 
with its proposal in 2012.\51\
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    \51\ Prior to proposing the standard and amendments, the Board 
considered a number of alternatives. Section D contains a more 
detailed discussion of alternatives considered by the Board, 
including alternatives considered before the Board determined to 
issue the proposed standard and amendments in 2012.
---------------------------------------------------------------------------

    The Board's Proposals: The Board issued its proposal on February 
28, 2012.\52\ The Board received 37 comment letters on the proposed 
standard and amendments and discussed the proposed standard and 
amendments with the SAG on May 17, 2012.\53\
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    \52\ See the proposing release.
    \53\ The comment period was extended from May 15, 2012 until May 
31, 2012 to accommodate the discussion and comments received in 
connection with the SAG meeting. The transcript of the SAG's 
discussion of the proposed standard and amendments is available at 
http://pcaobus.org/Rules/Rulemaking/Docket038/2012-05-17_Transcript-Related_Parties.pdf.
---------------------------------------------------------------------------

    In general, commenters were supportive of the Board's standard-
setting efforts to enhance the auditor's efforts in the critical areas 
addressed by the proposal. However, commenters suggested several areas 
in which the proposed standard and amendments could be clarified or 
improved, including with respect to the other proposed amendments 
regarding a company's financial relationships and transactions with its 
executive officers.
    In response to comments received, the Board made a number of 
revisions to its proposal and issued a reproposal for comment on May 7, 
2013.\54\ The Board's reproposing release discussed the Board's 
consideration of comments received and the reasons for making the 
changes in the reproposed standard and amendments. Additionally, the 
Board

[[Page 43175]]

sought comment, and empirical data, on the potential economic 
implications of the reproposed standard and amendments, as well as on 
issues pertinent to the application of the reproposed standard and 
amendments to audits of brokers and dealers. Further, as a result of 
the enactment of the Jumpstart Our Business Startups Act (the ``JOBS 
Act''), the Board also sought comment in its reproposal on issues 
pertinent to the applicability of the reproposed standard and 
amendments to audits of emerging growth companies (``EGCs'').\55\
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    \54\ See the reproposing release.
    \55\ Public Law 112-106 (April 5, 2012). See Section 
103(a)(3)(C) of the Act (15 U.S.C. 7213(a)(3)(C)), as added by 
Section 104 of the JOBS Act.
---------------------------------------------------------------------------

    The Board received 24 comment letters on the reproposed standard 
and amendments and discussed the reproposed standard and amendments 
with the SAG on May 15, 2013.\56\ In general, commenters were 
supportive overall of the Board's efforts to improve existing standards 
in these critical areas. Notably, virtually all of those who commented 
on the reproposed amendments regarding a company's financial 
relationships and transactions with its executive officers indicated 
that the reproposed amendments sufficiently clarified an issue raised 
during the initial proposal, i.e., that the requirement for the auditor 
to obtain an understanding of the company's financial relationships and 
transactions with its executive officers does not require the auditor 
to assess the appropriateness of the compensation of the company's 
executive officers. Those who commented on the applicability of the 
standard were generally supportive of applying the standard and 
amendments to companies of all sizes, as well as to audits of brokers 
and dealers and audits of EGCs.
---------------------------------------------------------------------------

    \56\ The transcript of the SAG's discussion of the reproposed 
standard and amendments is available at http://pcaobus.org/Rules/Rulemaking/Docket038/2013-05-15_SAG%20Transcript-Related_Parties.pdf.
---------------------------------------------------------------------------

    In response to the Board's request for input and empirical data 
regarding economic considerations, commenters provided their views 
regarding whether the standard and amendments would improve audit 
quality, as well as their views regarding potential costs and 
implementation issues. However, commenters did not provide empirical 
data.\57\
---------------------------------------------------------------------------

    \57\ Section D discusses the Board's consideration of the 
economic impacts regarding the standard and amendments in greater 
detail.
---------------------------------------------------------------------------

    As noted above, after consideration of the comments received, the 
Board is adopting the standard and amendments substantially as 
reproposed, with some clarifications and revisions in response to 
certain comments received. Section C contains a detailed discussion of 
comments received by the Board during the reproposal process, including 
the Board's response to significant comments received on the reproposed 
standard and amendments. Additionally, to assist the auditor in 
implementing the standard and amendments, Section C includes discussion 
and examples from the Board's proposing and reproposing releases 
modified to address the standard and amendments being adopted by the 
Board.
    The Board's Overall Approach: The following discussion describes 
the Board's overall approach to developing the standard and amendments, 
and highlights some of the alternatives and policy choices made as the 
Board moved from its proposal to its reproposal and then to the 
adoption of the standard and amendments. In general, in developing the 
standard and amendments, the Board determined to develop an approach 
that would promote the auditor's heightened scrutiny of the critical 
areas but that would, at the same time, also provide opportunity for 
efficient implementation. Key considerations included:
     Aligning with the Risk Assessment Standards: The Board 
initially proposed to align the auditor's efforts with the risk 
assessment standards, which require the auditor to consider the risks 
of material misstatement, whether due to error or fraud, throughout the 
audit. In the Board's view, this overall risk assessment approach 
promotes a cohesive audit, with opportunities to integrate audit effort 
where appropriate, and, at the same time, positions the auditor to 
identify areas in which there may be increased risks of material 
misstatement in company financial statements. In response to comments 
on its proposal, the Board took steps in its reproposal to more closely 
align the reproposed standard and amendments with its risk assessment 
standards. Commenters who addressed this aspect of the reproposal 
generally agreed that the revisions improved the alignment with the 
risk assessment standards. This approach is retained in the standard 
and amendments being adopted by the Board.
     Addressing Complementary Audit Areas: The proposed 
standard and amendments were intended to highlight: (i) linkages 
between the standard and amendments and (ii) the opportunity for 
complementary audit work, which could improve audit effectiveness and 
offer opportunities for efficient implementation. For example, the 
auditor's work in identifying and evaluating significant unusual 
transactions could assist the auditor in identifying related parties or 
relationships or transactions with related parties previously 
undisclosed to the auditor by management. In its reproposal, the Board 
made revisions to improve the linkage between the reproposed standard 
and amendments. This approach is retained in the standard and 
amendments being adopted by the Board.
     Using Existing Concepts and Procedures: The Board included 
some existing auditing concepts and procedures in its proposed standard 
and amendments. This was intended to permit audit firms to build on 
existing methodologies and training. This approach could minimize the 
costs of implementing the standard and amendments. In its reproposal, 
the Board sought comment on such issues. Several auditing firms who 
commented indicated that they would be able to update their 
methodologies and train staff to apply the standard and amendments in a 
short period, suggesting that the implementation of the standard would 
not be unduly burdensome. This approach is retained in the standard and 
amendments being adopted by the Board.
     Providing Opportunity for a Scaled Approach: The proposed 
standard was intended to provide for a scaled approach, establishing 
basic required procedures intended to assist the auditor in identifying 
red flags that indicate potential risks of material misstatement. The 
basic procedures were supplemented by more in-depth procedures that are 
commensurate with the facts and circumstances of the company under 
audit. Such facts and circumstances may include the size or complexity 
of the transaction, the nature of the company's relationships or 
transactions with its related parties, and the related risk of material 
misstatements in the financial statements. In response to a request for 
comments arising out of the Board's reproposal, many commenters agreed 
that the reproposed standard and amendments provide for a scaled 
approach. This approach is retained in the standard and amendments 
being adopted by the Board.
    Additionally, commenters raised a variety of issues for 
consideration by the Board during the standard-setting process. A 
number of such comments resulted in revisions and clarifications

[[Page 43176]]

to the standard and amendments.\58\ Some of the more significant of 
these include:
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    \58\ Section C contains a more detailed discussion of comments 
received by the Board during the reproposal process, including the 
Board's response to significant comments received on the reproposed 
standard and amendments.
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     Expanding Auditor Judgment: In response to comments, the 
Board made changes to the proposed standard to allow for more auditor 
judgment, in appropriate circumstances. For example, in its proposal, 
all related party relationships or transactions that were not 
previously disclosed to the auditor, as well as those that would 
require disclosure in the company's financial statements, would have 
been considered to be a significant risk, requiring additional audit 
attention in all cases. In response to comments, the Board removed from 
the reproposal the requirement that the auditor always treat each 
related party relationship or transaction previously undisclosed by 
management as a significant risk. In making this change, the Board 
observed that not all undisclosed related party relationships or 
transactions might represent a significant risk. Instead, the 
additional procedures would only be required in circumstances where 
previously undisclosed transactions were determined by the auditor to 
require disclosure in the financial statements or consideration as a 
significant risk. This change, which is retained in the standard being 
adopted by the Board, could eliminate potentially unnecessary audit 
work.
     Clarifying the Auditor's Responsibilities To Identify a 
Company's Related Parties: In response to comments received, the Board 
made clarifications to the proposed standard to emphasize that the 
auditor's efforts to identify a company's related parties and 
relationships and transactions with its related parties begins with 
management's work. The approach taken in the Board's reproposal in this 
area recognizes that the company is responsible for the preparation of 
its financial statements, including the identification of the company's 
related parties, and that the auditor begins the audit with information 
obtained from the company. This approach is retained in the standard 
being adopted by the Board. Additionally, in response to comments 
received on the reproposed standard, several clarifying changes have 
been made. Those changes emphasize more prominently the auditor's 
responsibility to perform procedures to test the accuracy and 
completeness of the company's identification of its related parties, 
taking into account the information gathered during the audit. Those 
changes also clarify that Appendix A of the standard contains examples 
of information and sources of information that may be gathered by the 
auditor during the audit.
     Clarifying the Focus Regarding Executive Officers: As 
proposed, the other amendments provided direction to the auditor to 
consider the potential risks of material misstatement relating to a 
company's executive compensation arrangements as part of the auditor's 
risk assessment procedures. While some commenters were fully supportive 
of this approach, other commenters on the proposal raised concerns 
regarding whether the Board intended that the auditor make an 
assessment of the reasonableness of executive compensation 
arrangements. As reproposed, the other amendments relating to this area 
were clarified to explicitly provide that the procedures required for 
the auditor to obtain an understanding of a company's financial 
relationships and transactions with its executive officers do not 
require the auditor to make any determinations regarding the 
appropriateness or reasonableness of the company's compensation 
arrangements with its executive officers. This approach is retained in 
the amendments being adopted by the Board.
Overview of the Standard and Amendments and Key Improvements From 
Existing Standards
    The following discussion provides a summary of the standard and 
amendments being adopted by the Board, key improvements from existing 
standards, and changes being made to the reproposed standard and 
amendments.
Auditing Standard No. 18, Related Parties
    Overview of the Standard: The standard is intended to strengthen 
auditor performance requirements for identifying, assessing, and 
responding to the risks of material misstatement associated with a 
company's relationships and transactions with its related parties. 
Among other things, the standard requires the auditor to:
     Perform specific procedures to obtain an understanding of 
the company's relationships and transactions with its related parties, 
including obtaining an understanding of the nature of the relationships 
between the company and its related parties and of the terms and 
business purposes (or the lack thereof) of transactions involving 
related parties. The new procedures are performed in conjunction with 
the auditor's risk assessment procedures pursuant to Auditing Standard 
No. 12.
     Evaluate whether the company has properly identified its 
related parties and relationships and transactions with its related 
parties.\59\ In making that evaluation, the auditor performs procedures 
to test the accuracy and completeness of management's identification, 
taking into account information gathered during the audit. If the 
auditor identifies information that indicates that undisclosed 
relationships and transactions with a related party might exist, the 
auditor performs procedures necessary to determine whether undisclosed 
relationships or transactions with related parties in fact exist.
---------------------------------------------------------------------------

    \59\ To further assist the auditor's efforts in this area, the 
other amendments include a complementary provision that expands 
existing management representations contained in AU sec. 333, 
Management Representations. However, the auditor may not rely solely 
on management's representations since they are not a substitute for 
the application of those audit procedures necessary to afford a 
reasonable basis for an opinion regarding the financial statements 
under audit.
---------------------------------------------------------------------------

     Perform specific procedures if the auditor determines that 
a related party or relationship or transaction with a related party 
previously undisclosed to the auditor exists.
     Perform specific procedures regarding each related party 
transaction that is either required to be disclosed in the financial 
statements or determined to be a significant risk.
     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, 
and other significant matters arising from the audit regarding the 
company's relationships and transactions with related parties.
    The Existing Standard: The existing requirements for auditing 
relationships and transactions with related parties are contained 
primarily in AU sec. 334. AU sec. 334 recognizes that the auditor 
performs procedures to identify and evaluate a company's relationships 
and transactions with its related parties as part of performing an 
audit of financial statements. In doing so, AU sec. 334 provides 
guidance and examples of procedures for the auditor's consideration in 
identifying and evaluating related party transactions. Examples of 
procedures in AU sec. 334 include procedures to obtain information from 
management (such as obtaining the names of all related parties and 
inquiring whether there were any transactions with these parties

[[Page 43177]]

during the period) as well as procedures intended to assist the auditor 
in identifying related parties that have not been disclosed to the 
auditor by management (such as reviewing filings with the SEC, 
reviewing company accounting records and certain invoices, and making 
inquiries of other auditors). Notably, AU sec. 334 states that not all 
of the procedures may be required in every audit. It further states 
that, in the absence of evidence to the contrary, related party 
transactions should not be assumed to be outside the ordinary course of 
business.\60\ Finally, AU sec. 334 states that the auditor should place 
primary emphasis on the adequacy of disclosure of related party 
transactions.
---------------------------------------------------------------------------

    \60\ Thus, AU sec. 334 could be misunderstood to create a 
``presumption of validity'' for the business purpose of related 
party transactions in situations where experience suggests a need 
for heightened scrutiny.
---------------------------------------------------------------------------

    Key Improvements from the Existing Standard: The standard includes 
some auditing concepts and procedures from AU sec. 334 that relate to 
identifying and evaluating related parties and related party 
transactions. However, the standard differs from AU sec. 334 in a 
number of key respects. These include:
     Adding Basic Requirements: AU sec. 334 suggests procedures 
for the auditor's consideration, noting that not all of them may be 
required in every audit. The standard requires basic procedures for the 
auditor's response to the risks of material misstatement associated 
with a company's relationships and transactions with its related 
parties that focus on those related party transactions that require 
disclosure in the financial statements or that are determined to be a 
significant risk. These procedures are designed to assist the auditor 
in identifying red flags that indicate potential risks of material 
misstatement. Additionally, the standard requires more in-depth 
procedures that are designed to be scalable and commensurate with the 
company's facts and circumstances.
     Enhancing Procedures To Obtain an Understanding of the 
Company's Relationships and Transactions With Its Related Parties: 
Unlike AU sec. 334, which includes limited direction for obtaining an 
understanding of the company's relationships and transactions with its 
related parties, the standard requires the performance of specific 
procedures in this area, including obtaining an understanding of the 
terms and business purposes (or the lack thereof) of related party 
transactions.
     Aligning With the Risk Assessment Standards: Since the 
adoption of AU sec. 334, the Board adopted and amended a number of 
auditing standards, including its risk assessment standards. The 
standard is designed to align with and build upon the risk assessment 
standards that were adopted in 2010. The new procedures are intended to 
be performed in conjunction with the procedures performed during the 
auditor's risk assessment.
     Improving the Auditor's Focus on Accounting: As noted 
above, AU sec. 334 states that the auditor should place primary 
emphasis on the adequacy of disclosure of related party transactions. 
The standard requires that the auditor evaluate both the accounting 
for, and disclosure of, related party transactions.
     Adding Audit Committee Communications: AU sec. 334 does 
not mention communications with audit committees regarding related 
party transactions. The standard requires the auditor to communicate 
with the audit committee (or its chair) to obtain information during 
the auditor's risk assessment, as well as to communicate to the audit 
committee regarding the auditor's evaluation of the company's 
identification of, accounting for, and disclosure of its relationships 
and transactions with related parties.
     Emphasizing a Complementary Audit Approach: The standard 
requires the auditor to take into account information gathered during 
the audit when evaluating a company's identification of its related 
parties, for example, information with respect to significant unusual 
transactions.
    Changes From the Reproposed Standard: The Board is adopting the 
standard substantially as reproposed, except for certain clarifications 
and changes that are being made largely in response to comments. One 
change more prominently emphasizes that the auditor's evaluation of 
whether a company has properly identified its related parties and 
relationships and transactions with related parties requires the 
auditor to perform procedures to test the accuracy and completeness of 
the company's identification of its related parties and relationships 
and transactions with its related parties. That change also provides 
that the auditor's evaluation takes into account the information 
gathered during the audit. Another change clarifies that Appendix A of 
the standard contains examples of information and sources of 
information that may be gathered by the auditor during the audit. More 
detail regarding the changes made to the standard is included in 
Section C.
Amendments Regarding Significant Unusual Transactions
    The amendments regarding significant unusual transactions revise AU 
sec. 316 and other PCAOB auditing standards with the intent of 
strengthening the auditor's performance requirements for the 
identification and evaluation of significant unusual transactions. 
Among other things, the amendments regarding significant unusual 
transactions:
     Require the auditor to perform procedures to identify 
significant unusual transactions;
     Require the auditor to perform procedures to obtain an 
understanding of, and evaluate, the business purpose (or the lack 
thereof) of identified significant unusual transactions; and
     Add factors for the auditor to consider in evaluating 
whether significant unusual transactions may have been entered into to 
engage in fraudulent financial reporting or conceal misappropriation of 
assets.
    The amendments regarding significant unusual transactions include 
targeted enhancements to AU sec. 316, as well as amendments to Auditing 
Standard No. 12 and Auditing Standard No. 13, The Auditor's Responses 
to the Risks of Material Misstatement. The amendments regarding 
significant unusual transactions also include conforming changes to 
other PCAOB auditing standards to provide for consistency in the use of 
the term ``significant unusual transactions'' throughout the Board's 
standards. During the reproposal process, the Board added a number of 
clarifying changes, including some intended to enhance the 
complementary linkages between the auditor's work relating to 
significant unusual transactions and related party transactions. This 
approach is maintained in the amendments being adopted by the Board.
    Existing Standards Regarding Significant Unusual Transactions: 
Existing auditing requirements regarding significant unusual 
transactions are principally contained in AU sec. 316.\61\ 
Specifically, AU sec. 316.66 recognizes that during a financial 
statement audit, the auditor may become aware of significant 
transactions that are outside the normal course of business for the 
company or that otherwise appear to be unusual given the auditor's 
understanding of the company and its environment. AU sec. 316.66 
requires that, if the auditor becomes aware of significant unusual 
transactions during the course of an

[[Page 43178]]

audit, the auditor should gain an understanding of the business 
rationale of such transactions and whether that rationale (or the lack 
thereof) suggests that such transactions may have been entered into to 
engage in fraudulent financial reporting or to conceal the 
misappropriation of assets. In addition, the existing risk assessment 
standards anticipate that the auditor will consider risks of material 
misstatement that are posed by significant transactions that are 
outside the normal course of business for the company or otherwise 
appear unusual due to their timing, size, or nature.\62\
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    \61\ See AU secs. 316.66-.67.
    \62\ See paragraph 71.g. of Auditing Standard No. 12.
---------------------------------------------------------------------------

    Key Improvements From the Existing Standards: The amendments 
regarding significant unusual transactions are designed to improve 
existing Board standards in the following key respects:
     Conforming Descriptions of Significant Unusual 
Transactions: The amendments regarding significant unusual transactions 
amend AU sec. 316.66 to describe significant unusual transactions as 
significant transactions that are outside the normal course of business 
for the company or that otherwise appear to be unusual due to their 
timing, size, or nature. The amendments regarding significant unusual 
transactions also include conforming changes to introduce a uniform 
description of ``significant unusual transactions'' throughout the 
Board's standards.
     Improving Requirements for Identifying Significant Unusual 
Transactions: The amendments regarding significant unusual transactions 
require the performance of specific procedures intended to improve the 
auditor's identification of significant unusual transactions, for 
example, by amending Auditing Standard No. 12 to require the auditor to 
make inquiries of management and others.
     Improving the Auditor's Evaluation of Significant Unusual 
Transactions: The amendments regarding significant unusual transactions 
to AU secs. 316.66-.67A include basic procedures for obtaining 
information for evaluating significant unusual transactions. The basic 
procedures include: (i) Reading the underlying documentation relating 
to significant unusual transactions and evaluating whether the terms 
and other information about the transaction are consistent with 
explanations from inquiries and other audit evidence about the business 
purpose (or the lack thereof) of the transaction; (ii) determining 
whether the transaction has been authorized and approved in accordance 
with the company's established policies and procedures; and (iii) 
evaluating the financial capability of the other parties to the 
transaction with respect to significant uncollected balances, 
guarantees, and other obligations. The basic procedures are designed to 
assist the auditor in identifying red flags that indicate potential 
risks of material misstatement. Additionally, the standard requires 
more in-depth procedures that are designed to be scalable and 
commensurate with the facts and circumstances of the audit.
     Enhancing Attention to the Business Purpose (or the Lack 
Thereof) of Significant Unusual Transactions: The amendments regarding 
significant unusual transactions to AU secs. 316.66-.67 are intended to 
enhance the auditor's evaluation of the business purpose of significant 
unusual transactions by, among other things, expanding the factors 
considered by the auditor in evaluating whether the business purpose 
(or the lack thereof) indicates that such transactions may have been 
entered into to engage in fraudulent financial reporting or conceal 
misappropriation of assets.
     Emphasizing a Complementary Audit Approach: The amendments 
to AU secs. 316.66-.67A emphasize a complementary audit approach by 
requiring the auditor to take into account other work performed during 
the audit, for example, information gathered with respect to related 
party transactions, when identifying a company's significant unusual 
transactions.
     Emphasizing Accounting and Disclosure: The amendments 
regarding significant unusual transactions to AU sec. 316.67A are 
intended to heighten the auditor's attention to accounting matters 
relative to significant unusual transactions. The new requirements 
emphasize that the auditor must evaluate whether the financial 
statements contain the information regarding significant unusual 
transactions essential for a fair presentation in conformity with the 
applicable financial reporting framework.\63\
---------------------------------------------------------------------------

    \63\ See paragraphs 30-31 of Auditing Standard No. 14, 
Evaluating Audit Results, which address the auditor's evaluation of 
the presentation of the financial statements, including the 
disclosures.
---------------------------------------------------------------------------

    Changes From the Reproposed Amendments: The Board is adopting the 
amendments substantially as reproposed, with some clarifying changes. 
More detail regarding those changes is included in Section C.
Financial Relationships and Transactions With Executive Officers
    The other amendments are intended to provide for improved audit 
procedures in complementary areas, including requiring that the auditor 
perform procedures, as part of the auditor's risk assessment, to obtain 
an understanding of the company's financial relationships and 
transactions with its executive officers.\64\ These new procedures are 
intended to heighten the auditor's attention to incentives or pressures 
for the company to achieve a particular financial position or operating 
result, recognizing the key role that a company's executive officers 
may play in the company's accounting decisions or in a company's 
financial reporting.
---------------------------------------------------------------------------

    \64\ See Section C--Other Amendments to PCAOB Auditing 
Standards, for a discussion of the applicable definition of the term 
``executive officer.''
---------------------------------------------------------------------------

    As discussed previously, clarifications were made to the other 
amendments to explicitly provide that the auditor's work relating to a 
company's financial relationships and transactions with its executive 
officers does not include an assessment of the appropriateness or 
reasonableness of executive compensation arrangements.
    The Existing Standards and Key Improvements: The existing risk 
assessment standards require the auditor to consider obtaining an 
understanding of compensation arrangements with senior management 
(including incentive compensation arrangements, changes or adjustments 
to those arrangements, and special bonuses) as part of obtaining an 
understanding of the company. The other amendments strengthen existing 
requirements by requiring the auditor, as part of the audit risk 
assessment process, to perform procedures to obtain an understanding of 
the company's financial relationships and transactions with its 
executive officers. This reflects that a company's executive officers 
are a group that, because of their position in the company, can exert 
influence over the company's accounting and financial statement 
presentation.
    No Changes From Reproposed Amendments: The Board is adopting the 
amendments regarding financial relationships and transactions with 
executive officers as reproposed. A discussion of the comments received 
is included in Section C.
Other Amendments to PCAOB Auditing Standards
    In addition to the other amendments relating to financial 
relationships and

[[Page 43179]]

transactions with executive officers, the other amendments being 
adopted by the Board revise other auditing standards to conform them to 
the standard and amendments and, where appropriate, include new 
requirements that complement the standard and amendments regarding 
significant unusual transactions.
    For example, the other amendments include changes to AU sec. 333, 
relating to management's written representations to the auditor, to 
include a representation that management has made available to the 
auditor the names of all related parties and relationships and 
transactions with related parties. Additionally, the other amendments 
to AU sec. 333 require the auditor to obtain relevant written 
representations from management: (i) That there are no side agreements 
or other arrangements (either written or oral) undisclosed to the 
auditor, and (ii) if the company's financial statements include an 
assertion that transactions with related parties were conducted on 
terms equivalent to those prevailing in an arm's-length transaction.
    Other new requirements in the other amendments complement the 
requirements in the standard and amendments through improvements to the 
auditor's: (i) communications with a predecessor auditor; (ii) 
procedures during the period subsequent to the balance sheet date 
through the date of the auditor's report; and (iii) procedures during 
reviews of interim financial information. These and the other 
amendments being adopted by the Board are discussed in greater detail 
in Section C.
    The Board is adopting the other amendments substantially as 
reproposed, with only minor clarifying changes. More detail regarding 
those changes is included in Section C.
(b) Statutory Basis
    The statutory basis for the proposed rules is Title I of the Act.

B. Board's Statement on Burden on Competition

    Not applicable. The Board's consideration of the economic impacts 
of the standard and amendments are discussed in Section D.

C. Board's Statement on Comments on the Proposed Rules Received From 
Members, Participants or Others

    The Board released the proposal for public comment on February 28, 
2012. The Board received 37 written comment letters relating to the 
proposal. The Board discussed the proposal with the SAG on May 17, 
2012.
    The Board released the reproposal for public comment on May 7, 
2013. The Board received 24 written comment letters relating to the 
reproposal. The Board discussed the reproposal with the SAG on May 15, 
2013.
    The Board has carefully considered all comments received. The 
Board's response to the comments it received on the reproposal and the 
changes made to the rules in response to the comments received are 
discussed below. Additionally, below is a comparison of the objective 
and key requirements of the proposed rules with the analogous standards 
of the International Auditing and Assurance Standards Board (``IAASB'') 
and the Auditing Standards Board (``ASB'') of the AICPA.
1. Discussion of the Proposed Rules and Comments Received
Introduction
    After considering the comments received, the Board is adopting the 
standard and amendments substantially as reproposed, except for certain 
clarifications and changes that are being made largely in response to 
comments.
    A recurring theme from comments received on both the proposal and 
reproposal dealt with including additional discussion and examples in 
the standard and amendments. Several commenters requested that the 
Board include additional discussion and examples contained in the 
proposing and reproposing releases in the text of the standard and 
amendments. Some commenters suggested that not including additional 
discussion and examples could affect the consistency of implementation 
and the initial and recurring implementation costs.
    The Board considered these comments and determined, as it has done 
in other projects, to include performance requirements in the standard 
and amendments and to provide additional discussion and examples 
primarily in an appendix to its adopting release. As noted in the 
reproposal, this approach promotes a clear separation between the 
required procedures and the Board's additional discussion regarding the 
application of the standard and amendments. To assist auditors in 
implementing the standard and amendments, the discussion below includes 
additional discussion and examples previously included in the proposing 
and reproposing releases, modified to address the standard and 
amendments being adopted by the Board.
    The discussion below relates to: Auditing Standard No. 18, Related 
Parties; Amendments to Certain PCAOB Auditing Standards Regarding 
Significant Unusual Transactions; Other Amendments to PCAOB Auditing 
Standards; Audits of Brokers and Dealers; and Effective Date.
Auditing Standard No. 18, Related Parties
    Commenters generally supported the Board's standard-setting efforts 
to strengthen the existing auditing standard, with many commenters 
noting that the reproposed standard could have a positive impact on 
audit quality. Many commenters also suggested changes for further 
improving the reproposed standard, including some clarifications and 
editorial suggestions.
    The Board is adopting the standard, substantially as reproposed, 
but is making certain revisions to clarify and refine various aspects 
of the standard. The most significant changes include:
     Clarifying the Scope of the Auditor's Inquiries Regarding 
Related Party Transactions (Paragraph 5): Paragraph 5 of the standard 
includes a revision to clarify the scope of the auditor's inquiries of 
management to include transactions with its related parties that were 
modified during the period under audit.
     Including Examples of Others Within the Company of Whom 
the Auditor Might Inquire (Paragraph 6): A footnote has been added to 
paragraph 6 of the standard to provide examples of others within the 
company that the auditor might inquire of regarding the company's 
relationships and transactions with related parties.
     Providing Direction Regarding Timing of Communications 
(Paragraph 8): Paragraph 8 of the standard includes a revision that 
notes that the communication to engagement team members pursuant to 
paragraph 8 can be more effective when it occurs at an early stage of 
the audit.
     Providing Direction Regarding Intercompany Accounts 
(Paragraph 13): A note has been added to paragraph 13 of the standard 
to clarify that the procedures performed by the auditor should address 
the risks of material misstatement associated with the company's 
intercompany accounts.
     Clarifying the Auditor's Responsibility for Evaluating the 
Company's Identification of its Related Parties (Paragraph 14): 
Paragraph 14 includes revisions to highlight that the auditor's 
evaluation of a company's identification of its related parties 
includes performing procedures to test the accuracy and completeness of 
the related parties and relationships and transactions with related 
parties identified by the company, and that

[[Page 43180]]

such evaluation takes into account the information gathered during the 
audit.
     Clarifying the Auditor's Responsibility Regarding Appendix 
A (Paragraph 14): Language has been added to paragraph 14 and Appendix 
A (referred to in paragraph 14) to clarify that Appendix A contains 
examples of information and sources of information that may be gathered 
during the audit.
     Expanding the Examples Contained in Appendix A (Appendix 
A): The examples of sources of information contained in Appendix A of 
the standard have been expanded to include the company's ``disclosures 
contained on the company's Web site'' (in addition to the company's 
disclosures in SEC filings, which is already included as an example in 
Appendix A).
     Clarifying the Procedures Performed If the Auditor 
Identifies a Related Party or Relationship or Transaction with a 
Related Party Previously Undisclosed to the Auditor (Paragraph 16): 
Paragraph 16 includes a number of clarifications, the most significant 
of which include revisions clarifying that paragraph 16 requires the 
auditor to perform initial procedures intended to help the auditor 
understand and evaluate the nature of the undisclosed related party or 
relationship or transaction with a related party identified by the 
auditor. Taking into account the information gathered from performing 
those procedures, the auditor then performs additional procedures to 
evaluate any broader implications for the audit.
    The following sections discuss the standard being adopted by the 
Board, the existing standard, significant comments received, and the 
Board's responses, including a description of the changes from the 
reproposed standard. The following sections also include additional 
discussion and examples that could be useful to auditors in 
implementing the standard. The sections are organized by the following 
topical areas:

 Introduction (Paragraph 1)
 Objective (Paragraph 2)
 Performing Risk Assessment Procedures to Obtain an 
Understanding of the Company's Relationships and Transactions with Its 
Related Parties (Paragraphs 3-9)
 Identifying and Assessing Risks of Material Misstatement 
(Paragraph 10)
 Responding to the Risks of Material Misstatement (Paragraphs 
11-13)
 Evaluating Whether the Company Has Properly Identified Its 
Related Parties and Relationships and Transactions with Related Parties 
(Paragraphs 14-16)
 Evaluating Financial Statement Accounting and Disclosures 
(Paragraphs 17-18)
 Communications with the Audit Committee (Paragraph 19)
Introduction (Paragraph 1 of the Standard)

Discussion of Paragraph 1 of Auditing Standard No. 18

    Paragraph 1 of the standard states that the standard establishes 
requirements regarding the auditor's evaluation of a company's 
identification of, accounting for, and disclosure of relationships and 
transactions between the company and its related parties.
    A footnote to paragraph 1 of the standard provides that the auditor 
should look to the requirements of the SEC for the company under audit 
with respect to the accounting principles applicable to that company, 
including the definition of the term ``related parties'' and the 
financial statement disclosure requirements with respect to related 
parties (which is referred to as a ``framework neutral'' approach).\65\
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    \65\ For SEC filings that include financial statements prepared 
in accordance with or reconciled to U.S. Generally Accepted 
Accounting Principles (``GAAP''), see, e.g., Financial Accounting 
Standards Board's (``FASB'') Accounting Standards Codification Topic 
850, Related Party Disclosures. For SEC filings that include 
financial statements prepared in accordance with International 
Financial Reporting Standards, as issued by the International 
Accounting Standards Board (``IFRS''), see, e.g., International 
Accounting Standard No. 24, Related Party Disclosures.
---------------------------------------------------------------------------

    In contrast to the specific required procedures contained in the 
standard, AU sec. 334 provides guidance on procedures that the auditor 
should consider to identify related party relationships and 
transactions, and to satisfy himself concerning the required financial 
statement accounting and disclosures.\66\ The standard also improves 
upon the existing standard by using a framework neutral approach. The 
existing standard, on the other hand, refers the auditor to the 
definition of a related party contained in GAAP.
---------------------------------------------------------------------------

    \66\ See AU secs. 334.01-.02.
---------------------------------------------------------------------------

    After considering all comments received, the Board is adopting 
paragraph 1 of the standard as reproposed.
Objective (Paragraph 2 of the Standard)

Discussion of Paragraph 2 of Auditing Standard No. 18

    Paragraph 2 of the standard states that the objective of the 
auditor 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. A footnote refers the auditor to other 
relevant standards, including paragraphs 30-31 of Auditing Standard No. 
14, Evaluating Audit Results, and paragraph .04 of AU sec. 411, The 
Meaning of Present Fairly in Conformity with Generally Accepted 
Accounting Principles.
    The intent of the objective is to focus the auditor on the end 
result--obtaining 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.
    In contrast, the existing standard does not specifically describe 
an objective for the auditor's work regarding a company's relationships 
and transactions with its related parties.

Discussion of Comments Received on Paragraph 2 of the Reproposed 
Standard

    The Board considered all comments received, including the following 
significant comments:
    Including the Consideration of ``Fraud'' as an Explicit Objective: 
A few commenters recommended that the objective of the standard refer 
to the risk of fraud as an explicit objective of the standard. The 
Board considered similar comments received on the proposal in 
developing its reproposal. As noted in the reproposal, related party 
transactions warrant special attention by the auditor, in part, because 
of their historic association with material misstatements that are 
associated with fraudulent financial reporting. The standard requires 
the auditor to perform specific procedures intended to provide for 
heightened scrutiny of the company's identification of, accounting for, 
and disclosure of its related parties and relationships and 
transactions with related parties. Since some related party 
transactions may be routine and occur in the ordinary course of 
business, the Board determined to take a risk-based approach that 
aligns with and builds upon its risk assessment standards.\67\ The risk 
assessment standards emphasize that the auditor's responsibilities for 
assessing and responding to fraud are an integral part of the audit 
process rather than a separate, parallel process. In the Board's view, 
this represents an effective and efficient audit approach. This is in

[[Page 43181]]

contrast to the approach taken in the existing standard, which states 
that in the absence of evidence to the contrary, related party 
transactions should not be assumed to be outside the ordinary course of 
business.\68\
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    \67\ See Auditing Standards Related to the Auditor's Assessment 
of and Response to Risk and Related Amendments to Other PCAOB 
Standards, PCAOB Release 2010-004 (August 5, 2010).
    \68\ AU sec. 334.06.
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    Incorporating Materiality into the Objective: A few commenters 
recommended including a reference to materiality in the objective of 
the standard. The Board considered these comments but noted that 
auditing standards require the auditor to design and perform audits to 
identify material misstatements. Also, direction regarding the 
auditor's considerations of materiality already is contained in 
Auditing Standard No. 11, Consideration of Materiality in Planning and 
Performing an Audit.
    The Board is adopting paragraph 2 of the standard as reproposed, 
except for an additional reference to paragraph 30 of Auditing Standard 
No. 14 that has been added to footnote 2.
Performing Risk Assessment Procedures To Obtain an Understanding of the 
Company's Relationships and Transactions With Its Related Parties 
(Paragraphs 3 Through 9 of the Standard)

Discussion of Paragraphs 3 Through 9 of Auditing Standard No. 18

    Paragraph 3 of the standard builds upon the foundational risk 
assessment requirements contained in Auditing Standard No. 12, 
Identifying and Assessing Risks of Material Misstatement. Chiefly, 
paragraph 3 of the standard requires the auditor to perform specific 
procedures to obtain an understanding of the company's relationships 
and transactions with its related parties that might reasonably be 
expected to affect the risks of material misstatement of the financial 
statements, in conjunction with performing risk assessment procedures 
in accordance with Auditing Standard No. 12.\69\
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    \69\ In addition, the other amendments make a conforming 
amendment to Auditing Standard No. 12.
---------------------------------------------------------------------------

    Understanding the nature and business purpose (or the lack thereof) 
of a company's relationships and transactions with its related parties 
is important for the auditor's evaluation of the company's accounting 
for and disclosure of related party transactions because a company's 
relationships and transactions with its related parties could pose 
increased risks of material misstatement. For example, to improve the 
appearance of its financial condition, a company and a related party 
could attempt to ``dress up'' the appearance of the company's balance 
sheet at period end by agreeing to have the company temporarily pay 
down its related party debt prior to the balance sheet date while 
having an undisclosed side agreement to subsequently borrow the same or 
a comparable amount shortly after period end.
    Paragraph 3 further provides that the procedures to be performed to 
obtain an understanding of the company's relationships and transactions 
include: (i) procedures to obtain an understanding of the company's 
process; (ii) performing inquiries; and (iii) communicating with the 
audit engagement team and other auditors.
    The existing standard suggests some similar procedures for the 
auditor's consideration. For example, the existing standard states in 
AU sec. 334.05 that, in determining the scope of work to be performed 
with respect to possible transactions with related parties, the auditor 
should obtain an understanding of management responsibilities and the 
relationship of each component of the entity to the total entity. AU 
sec. 334.05 further states that the auditor should consider controls 
over management activities and the business purpose served by the 
various components of the entity. AU sec. 334.09 states that, after 
identifying related party transactions, the auditor should apply the 
procedures that the auditor considers necessary to obtain satisfaction 
concerning the purpose, nature, and extent of these transactions and 
their effect on the financial statements. Additionally, paragraph 71 of 
Auditing Standard No. 12 states that one factor to be considered in 
determining whether a risk represents a significant risk is whether the 
risk involves significant transactions with related parties.

Obtaining an Understanding of the Company's Process (Paragraph 4 of the 
Standard)

    Paragraph 4 of the standard also aligns with and builds upon the 
requirements in Auditing Standard No. 12. Auditing Standard No. 12 
requires the auditor to obtain a sufficient understanding of each 
component of internal control over financial reporting to: (i) identify 
the types of potential misstatement; (ii) assess the factors that 
affect the risks of material misstatement; and (iii) design further 
audit procedures.\70\ Paragraph 4 of the standard requires that, in 
conjunction with obtaining an understanding of internal control over 
financial reporting, the auditor obtain an understanding of the 
controls that management has established to: (i) identify related 
parties and relationships and transactions with related parties; (ii) 
authorize and approve transactions with related parties; and (iii) 
account for and disclose relationships and transactions with related 
parties in the financial statements.
---------------------------------------------------------------------------

    \70\ See paragraph 18 of Auditing Standard No. 12.
---------------------------------------------------------------------------

    Obtaining an understanding of the company's controls, including its 
policies and procedures, is important to an auditor's consideration of 
the risks that a company's relationships and transactions with related 
parties may pose for material misstatement of the company's financial 
statements. The standard recognizes that material features of 
companies' policies and procedures for the review, approval, or 
ratification of related party transactions will vary depending on both 
the size and complexity of the company and the types of transactions 
covered by such policies and procedures. The standard should not be 
read to imply that such policies and procedures should be in writing or 
adhere to any particular framework.
    AU sec. 334, issued before the adoption of the risk assessment 
standards, is similar, but not as specific. Among other things, AU sec. 
334.05 states that, in determining the scope of work to be performed 
with respect to possible transactions with related parties, the auditor 
should obtain an understanding of management responsibilities. AU sec. 
334.05 further states that the auditor should consider controls over 
management activities.

Performing Inquiries (Paragraphs 5 Through 7 of the Standard)

    Briefly, paragraphs 5 through 7 of the standard require the auditor 
to make specific inquiries of: (i) company management; (ii) others 
within the company likely to have additional knowledge regarding the 
company's related parties or relationships or transactions with the 
company's related parties; and (iii) the company's audit committee.
    Appropriately focused inquiries can inform the auditor's 
understanding of the nature of the relationships between the company 
and its related parties, and the terms and business purposes (or the 
lack thereof) of transactions involving related parties. In addition, 
inquiries can assist the auditor in determining the extent of audit 
procedures that should be performed to determine whether the company 
has identified its related parties and relationships and transactions 
with its related parties.
    The inclusion of the phrase ``(or the lack thereof)'' throughout 
the standard

[[Page 43182]]

and amendments is intended to promote a questioning and skeptical 
approach by the auditor when obtaining an understanding of the business 
purpose of related party transactions. Sharpening the auditor's focus 
on evaluating the business purpose of related party transactions is 
particularly appropriate in view of the risk of material misstatement 
involving related party transactions.\71\ The importance of identifying 
transactions that appear to lack a business purpose also is reinforced 
in other parts of the standard. For example, the standard requires the 
auditor to communicate to the audit committee the identification of 
significant related party transactions that appear to the auditor to 
lack a business purpose.
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    \71\ See, e.g., paragraph 15 of FASB Statement No. 57, Related 
Parties, which states ``[w]ithout disclosure to the contrary, there 
is a general presumption that transactions reflected in financial 
statements have been consummated on an arm's-length basis between 
independent parties. However, that presumption is not justified when 
related party transactions exist because the requisite conditions of 
competitive, free-market dealings may not exist. Because it is 
possible for related party transactions to be arranged to obtain 
certain results desired by the related parties, the resulting 
accounting measures may not represent what they usually would be 
expected to represent.''
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    Paragraph 5 contains a list of inquiries of management that consist 
of basic information that the auditor should obtain as part of 
obtaining an understanding of the company's financial relationships and 
transactions with its related parties, such as the names of the 
company's related parties and the nature of the company's relationships 
and transactions with those related parties. A footnote to paragraph 5 
refers the auditor to AU sec. 333, Management Representations, and 
notes that obtaining such representations from management complements 
the performance of procedures in paragraph 5 and is not a substitution 
for those inquiries.
    Paragraph 6 provides that the auditor also inquire of others within 
the company regarding their knowledge of the same matters that are the 
subject of the auditor's inquiries of management pursuant to paragraph 
5 of the standard.
    A footnote to paragraph 6 states that examples of ``others'' within 
the company who may have such knowledge include: personnel in a 
position to initiate, process, or record transactions with related 
parties and those who supervise or monitor such personnel; internal 
auditors; in-house legal counsel; the chief compliance/ethics officer 
or person in equivalent position; and the human resource director or 
person in equivalent position. These examples of ``others'' included in 
the standard are not intended to imply that these individuals could not 
also be members of ``management'' for a particular company.
    The inquiries required in paragraph 6 provide an opportunity for 
the auditor to corroborate the information obtained from management. 
Paragraph 6 does not, however, require the auditor to inquire of others 
within the company regarding matters that the auditor does not believe 
are reasonably within their knowledge.
    Paragraph 7 of the standard provides that the auditor also should 
make inquiries of the company's audit committee, or its chair, 
regarding the audit committee's understanding of the company's 
relationships and transactions with related parties, focusing on those 
that are significant to the company.\72\ Additionally, the standard 
provides that the auditor should inquire as to whether any member of 
the audit committee has concerns regarding the company's relationships 
or transactions with related parties. The inquiries of the audit 
committee, or its chair, pursuant to paragraph 7 of the standard work 
in concert with the auditor's communications with the audit committee 
pursuant to paragraph 19 of the standard to provide an opportunity for 
the auditor to corroborate management's responses. The audit committee 
communication requirements in the standard are intended to provide the 
auditor with a forum to discuss sensitive areas that potentially may 
involve the financial interests of members of the company's management.
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    \72\ Paragraph 8 of Auditing Standard No. 16, Communications 
with Audit Committees, also requires the auditor to make certain 
inquiries of the audit committee.
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    The inquiries in paragraphs 5 through 7 of the standard could be 
performed at the same time as the inquiries about the risks of material 
misstatement, including fraud risks, that are performed as part of the 
auditor's risk assessment, as required by paragraphs 54 through 58 of 
Auditing Standard No. 12. These inquiries also would provide an 
opportunity for the auditor to discuss, as appropriate, the company's 
financial relationships and transactions with its executive officers 
with the audit committee, or its chair, as part of the auditor's 
procedures to obtain an understanding of the company's relationships 
and transactions with its related parties.
    In contrast to the new requirements contained in the standard, the 
existing standard describes a variety of specific audit procedures for 
the auditor's consideration in determining the existence of related 
parties.\73\ These specific procedures include requesting from 
appropriate management personnel the names of all related parties and 
inquiring whether there were any transactions with these parties during 
the period. The existing standard has no audit committee communication 
requirement. The procedures in paragraph 5 through 7 of the standard 
provide more specific procedures for the auditor regarding the use of 
inquiries of management and others.
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    \73\ See AU sec. 334.07.
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Communicating With the Audit Engagement Team and Other Auditors 
(Paragraphs 8 and 9 of the Standard)

    Paragraphs 8 and 9 of the standard require the auditor to 
communicate to engagement team members and, if applicable, other 
auditors, relevant information about related parties, including the 
names of the related parties and the nature of the company's 
relationships and transactions with those related parties. A footnote 
to paragraph 8 states that this communication, which can be more 
effective when it occurs at an early stage of the audit, complements 
the discussion among engagement team members regarding risks of 
material misstatement in accordance with paragraph 49 of Auditing 
Standard No. 12. That footnote also refers the auditor to paragraph 5 
of Auditing Standard No. 10, Supervision of the Audit Engagement. If 
the auditor is using the work of another auditor, paragraph 9 of the 
standard further requires the auditor to make certain inquiries of the 
other auditor regarding the other auditor's knowledge of any related 
parties or relationships or transactions with related parties that were 
not included in the auditor's communications.\74\
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    \74\ The standard does not include a specific requirement for 
the auditor to make similar inquires of engagement team members 
because existing standards already require engagement team members 
to bring relevant matters to the attention of the audit engagement 
partner. See, e.g., paragraph 5 of Auditing Standard No. 10.
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    Communicating information to engagement team members regarding a 
company's related parties and relationships and transactions with 
related parties might increase the likelihood that the engagement team 
will identify related parties or relationships or transactions with 
related parties previously undisclosed to the auditor by management. 
Effective communication to engagement team members might also highlight 
evidence

[[Page 43183]]

that corroborates or contradicts information provided by management 
about relationships and transactions with related parties. 
Additionally, effective communication to engagement team members could 
enhance the auditor's understanding of the company's relationships and 
transactions with its related parties.
    Examples of matters regarding related parties that the engagement 
team might discuss include: (i) Information that could indicate the 
existence of related parties or relationships or transactions with 
related parties previously undisclosed to the auditor; (ii) sources of 
information that could indicate the existence of related parties or 
relationships or transactions with related parties previously 
undisclosed to the auditor; (iii) how entities controlled by management 
(e.g., variable interest entities) might be used to facilitate earnings 
management; and (iv) how transactions between the company and a known 
business partner of a member of management could be arranged to 
facilitate fraudulent financial reporting or asset misappropriation.
    In addition, under PCAOB standards, a principal auditor may use the 
work and reports of other auditors who have audited the financial 
statements of one or more subsidiaries, divisions, branches, 
components, or investments included in the company's financial 
statements.\75\ Exchanging relevant information about related parties 
with the other auditor can assist the principal auditor in 
understanding the overall nature of the company's relationships and 
transactions with related parties and in identifying related parties or 
relationships or transactions with related parties previously 
undisclosed to the auditor.
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    \75\ See paragraph .01 of AU sec. 543, Part of Audit Performed 
by Other Independent Auditors.
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    AU sec. 334.08 contains audit procedures intended to provide 
guidance for identifying material transactions that may be indicative 
of the existence of previously unidentified related party 
relationships. One such procedure is to provide audit personnel 
performing segments of the audit, or auditing and reporting separately 
on the accounts of related components of the reporting entity, with the 
names of known related parties so that they may become aware of 
transactions with such parties during their audits. Further, AU sec. 
334.07.g., suggests a number of audit procedures for determining the 
existence of related party relationships, including making inquiries of 
other auditors of related entities concerning their knowledge of 
existing relationships and the extent of management involvement in 
material transactions. Finally, paragraph .13 of AU sec. 9334, Related 
Parties: Auditing Interpretations of Section 334, states that the 
principal auditor and the other auditor should obtain from each other 
the names of known related parties and that, ordinarily, the exchange 
should be made at an early stage of the audit. In contrast to the 
suggested procedures provided in the existing standard, the standard 
provides specific procedures for the auditor regarding this topic.

Discussion of Comments Received on Paragraphs 3 Through 9 of the 
Reproposed Standard

    The Board considered all comments received, including the following 
significant comments:
    Inquiring Regarding ``Modifications'' to Related Party 
Transactions: One commenter stated that modifications to transactions 
with related parties during the period may give rise to a risk of 
material misstatement. This commenter suggested clarifying the scope of 
paragraph 5.d. of the reproposed standard by adding the word 
``modified'' after the phrase ``the transactions entered into.'' This 
change would clarify that the auditor's inquiries regarding the 
company's related party transactions entered into during the audit 
period would include inquiries regarding any such transactions that 
were modified during that period. The Board considered this comment and 
agreed that this would be a useful change. The Board has made a change 
to paragraph 5.d. to reflect the commenter's suggestion.
    Providing Additional Direction Regarding the Auditor's Inquiries: 
Two commenters recommended including additional direction regarding the 
auditor's inquiries. One commenter suggested providing further 
direction on the nature and extent of the auditor's inquiries. Another 
commenter suggested that the Board provide examples of others within 
the company of whom the auditor might inquire to clarify the intent of 
the requirement in paragraph 6. The Board considered these comments and 
has added a new footnote to paragraph 6. That new footnote states that 
examples of ``others'' within the company who may have such knowledge 
include: Personnel in a position to initiate, process, or record 
transactions with related parties and those who supervise or monitor 
such personnel; internal auditors; in-house legal counsel; the chief 
compliance/ethics officer or person in equivalent position; and the 
human resources director or person in equivalent position.\76\ The 
Board declined to add more specific requirements because determining 
the nature and extent of the auditor's inquiries is an area that would 
benefit from the auditor's consideration of the facts and circumstances 
of the audit.
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    \76\ These examples of ``others'' had been included in the 
proposed standard but were removed from the reproposal because the 
Board did not wish to suggest that the auditor should make inquiries 
of each of these individuals in all instances. Additionally, one 
commenter on the proposal observed that some of the ``others'' might 
also be members of management in some companies. However, in view of 
comments indicating that additional examples in the standard would 
be helpful, the Board believes that these examples could be useful 
to auditors, and including them in a footnote to the standard should 
avoid the notion that these examples in and of themselves impose 
requirements.
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    Timing of the Auditor's Communications: At the SAG discussion, a 
suggestion was made to include direction regarding the timing of the 
auditor's communication to the engagement team. The Board considered 
this comment, noting that, similar to the approach under the existing 
standard, this communication would generally occur at an early stage of 
the audit as it would be performed in conjunction with the risk 
assessment procedures.\77\ Further, the proposing release had noted 
that communicating information about related parties at an early stage 
of the audit would benefit such discussions and should continue 
throughout the audit. The Board has revised the footnote to paragraph 8 
of the standard to indicate that this communication can be more 
effective when it occurs at an early stage of the audit.
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    \77\ See AU sec. 9334.13.
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    The Board is adopting paragraphs 3 through 9 of the standard 
substantially as reproposed, except for, as described above: (i) 
Revising item d. of paragraph 5 to clarify that auditors' inquiries 
include inquiries regarding any transactions that were modified during 
the period; (ii) adding a footnote to paragraph 6 that includes 
examples of others within the company to whom the auditor may address 
inquiries; and (iii) revising the footnote to paragraph 8 to indicate 
that the communication can be more effective when it occurs at an early 
stage of the audit. Identifying and Assessing Risks of Material 
Misstatement (Paragraph 10 of the Standard)

Discussion of Paragraph 10 of Auditing Standard No. 18

    Paragraph 10 of the standard aligns with the risk assessment 
requirements contained in Auditing Standard No. 12, which require the 
auditor to identify

[[Page 43184]]

and assess the risks of material misstatement at the financial 
statement level and the assertion level. Paragraph 10 of the standard 
states that this includes identifying and assessing the risks of 
material misstatement associated with related parties and relationships 
and transactions with related parties, including whether the company 
has properly identified, accounted for, and disclosed its related 
parties and relationships and transactions with related parties. A 
footnote to paragraph 10 refers the auditor to paragraph 59 of Auditing 
Standard No. 12.
    The clause ``including whether the company has properly identified, 
accounted for, and disclosed its related parties and relationships and 
transactions with related parties'' in paragraph 10 is intended to 
highlight, among other things, that the auditor's assessment of risk 
includes a focus on risks related to the company's less than complete 
identification of its related parties or relationships or transactions 
with related parties. Such a focus helps support the auditor's 
evaluation of whether the company has properly identified its related 
parties and relationships and transactions with related parties.
    Due to their nature, transactions with related parties might 
involve difficult measurement and recognition issues that can lead to 
errors in financial statements, for example, when terms are not 
properly considered in accounting determinations. Related parties might 
also buy or sell goods or services at prices that differ significantly 
from prevailing market prices or offer unusual rights of return or 
extended payment terms.
    Additionally, as previously discussed, under the risk assessment 
standards, the auditor is required to determine whether any of the 
identified and assessed risks of material misstatement are fraud risks 
or other significant risks.\78\ The standard does not mandate that all 
related party transactions be presumed to be or deemed to be 
significant risks or designated as a fraud risk. Under the risk 
assessment approach, the auditor's assessment is based on the facts and 
circumstances of the audit, including the facts and circumstances of a 
company's relationships and transactions with related parties. However, 
depending on the facts and circumstances, assessed risks of material 
misstatement associated with related parties and relationships and 
transactions with related parties might also represent fraud risks or 
other significant risks. AU sec. 316, Consideration of Fraud in a 
Financial Statement Audit, provides examples of fraud risk factors, 
including some concerning related parties.\79\
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    \78\ See paragraphs 59.f., 70, and 71 of Auditing Standard No. 
12.
    \79\ See AU sec. 316.85.A.2, Section a., under 
``Opportunities.''
---------------------------------------------------------------------------

    The complexity of a transaction is a factor considered by auditors 
when assessing risks of material misstatement associated with related 
party transactions. Further, when the substance of a related party 
transaction differs materially from its form, or when a company's 
related parties operate through an extensive and complex range of 
relationships and structures, heightened scrutiny is warranted. For 
example, depending upon the facts and circumstances, the creation of a 
variable interest entity in which the company's economic interest (its 
obligation to absorb losses or its right to receive benefits) is 
disproportionately greater than the company's stated power might 
represent a fraud risk or other significant risk, especially in the 
presence of other fraud risk factors.\80\ Examples of fraud risk 
factors regarding related parties that individually, or in combination 
with other fraud risk factors, might indicate the existence of a fraud 
risk, include significant related party transactions not in the 
ordinary course of business or with related entities not audited or 
audited by another firm.\81\
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    \80\ Paragraph 10 of Auditing Standard No. 12 states that 
obtaining an understanding of the nature of the company includes 
understanding the company's significant investments, including 
equity method investments, joint ventures and variable interest 
entities.
    \81\ The amendments regarding significant unusual transactions 
separate this example into two examples--(i) related party 
transactions that are also significant unusual transactions and (ii) 
significant transactions with related parties whose financial 
statements are not audited or are audited by another firm.
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    The existence of dominant influence is another factor considered by 
auditors when assessing the risks of material misstatement. Related 
parties, due to their ability to control or significantly influence, 
may be in a position to prevent a company from pursuing its own 
separate interests. Identifying the risks of material misstatement 
associated with dominant influence can assist the auditor's assessment 
of the risks of material misstatement. AU sec. 316.85 already describes 
the principle of dominant influence in the example of a fraud risk 
factor by stating that the ineffective monitoring of management as a 
result of domination of management by a single person or small group, 
without compensating controls, provides an opportunity for management 
to engage in fraudulent financial reporting.
    Examples of factors that may signal dominant influence exerted by a 
related party include:
     Significant transactions are referred to the related party 
for approval;
     There is little or no debate among management and the 
board of directors regarding business proposals initiated by the 
related party; or
     The related party played a leading role in starting the 
company and continues to play a leading role in managing the company, 
even if the related party is no longer formally part of management or 
the board of directors.
    The existence of dominant influence by itself, or in the presence 
of other fraud risk factors (e.g., use of an intermediary whose 
involvement serves no apparent business purpose), might indicate the 
existence of a fraud risk.
    The other amendments to PCAOB auditing standards complement the 
requirements of paragraph 10 by amending AU sec. 316.85.A.2 to include 
the exertion of dominant influence by or over a related party as an 
example of a fraud risk factor. The other amendment to AU sec. 
316.85.A.2 expands that concept to encompass all related parties 
outside of management of the company. The amendments do not define 
dominant influence, as doing so might result in some auditors being 
overly focused on the definition itself, instead of focusing on the red 
flags associated with dominant influence that might create risks of 
material misstatement at the financial statement level.
    AU sec. 334 does not provide specific guidance for the auditor 
regarding the identification and assessment of risks of material 
misstatement associated with related party transactions. In fact, AU 
sec. 334.06 provides that, in the absence of evidence to the contrary, 
transactions with related parties should not be assumed to be outside 
the ordinary course of business.\82\
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    \82\ Thus, AU sec. 334.06 could be misunderstood to create a 
``presumption of validity'' for the business purpose of related 
party transactions in situations where experience suggests a need 
for heightened scrutiny.
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Discussion of Comments Received on Paragraph 10 of the Reproposed 
Standard

    The Board considered all comments received, including the following 
significant comments:
    Referencing Information Obtained From Past Audits: One commenter 
recommended requiring the auditor to determine that there were no 
changed circumstances for material related party

[[Page 43185]]

transactions previously authorized and approved. Another commenter 
suggested including a reference to the requirements pertaining to 
information obtained from past audits contained in the risk assessment 
standards both to improve the effectiveness of the audit process and to 
remind auditors of their responsibility regarding the information 
previously obtained regarding ongoing matters.
    The Board considered these comments, noting that paragraph 10 
requires that, in identifying and assessing the risks associated with 
related parties and relationships and transactions with related 
parties, the auditor should take into account the information obtained 
from performing the procedures in paragraphs 4 through 9 and the risk 
assessment procedures required by Auditing Standard No. 12, which 
address information obtained from past audits.\83\ Thus, the auditor is 
already required to take such information obtained from past audits 
into account in identifying and assessing risks of material 
misstatement. Further, the revisions made to item d. of paragraph 5, 
which require the auditor to inquire of management regarding 
transactions with related parties modified during the period under 
audit, should assist the auditor in identifying transactions for which 
the auditor would not be able to rely on information obtained from past 
audits.
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    \83\ Paragraphs 41 through 45 of Auditing Standard No. 12 note 
that the auditor's risk assessment procedures require the auditor to 
consider information from the client acceptance and retention 
evaluation, audit planning activities, past audits, and other 
engagements.
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    The Board is adopting paragraph 10 of the standard as reproposed. 
Responding to the Risks of Material Misstatement (Paragraphs 11 through 
13 of the Standard).

Discussion of Paragraphs 11 Through 13 of Auditing Standard No. 18

    Paragraph 11 of the standard aligns with the requirement in 
Auditing Standard No. 13, The Auditor's Responses to the Risks of 
Material Misstatement, for the auditor to design and implement audit 
responses that address the identified and assessed risks of material 
misstatement. Paragraph 11 states that this includes designing and 
performing audit procedures that address the risks of material 
misstatement associated with related parties and relationships and 
transactions with related parties. Footnotes to paragraph 11 refer the 
auditor to relevant paragraphs of the risk assessment standards. A note 
to paragraph 11 refers the auditor to the new requirements in 
paragraphs .66-.67A of AU sec. 316 for related party transactions that 
are also significant unusual transactions.
    AU sec. 334 also provides guidance to the auditor regarding audit 
procedures to evaluate identified related party transactions. For 
example, AU sec. 334.09 provides that, after identifying related party 
transactions, the auditor should apply the procedures the auditor 
considers necessary to obtain satisfaction concerning the purpose, 
nature, and extent of these transactions and their effect on the 
financial statements. The procedures should be directed toward 
obtaining and evaluating sufficient appropriate evidential matter and 
should extend beyond inquiry of management. AU sec. 334.09 includes 
procedures that should be considered and footnote 6 of AU sec. 334.09 
provides that, until the auditor understands the business sense of 
material transactions, he cannot complete his audit.\84\ AU sec. 334.10 
includes other procedures that the auditor should consider when the 
auditor believes it necessary to fully understand a particular 
transaction, and notes that those procedures might not otherwise be 
deemed necessary to comply with generally accepted auditing standards.
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    \84\ AU sec. 411.06 requires the auditor to consider whether the 
substance of a transaction differs materially from its form when 
evaluating whether the financial statements have been presented 
fairly in accordance with the applicable financial reporting 
framework. Understanding the ``business sense'' of material 
transactions is encompassed by this consideration.
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Transactions With Related Parties Required To Be Disclosed in the 
Financial Statements or Determined To Be a Significant Risk (Paragraph 
12 of the Standard)

    Briefly, paragraph 12 of the standard requires the auditor to 
perform certain basic procedures (supplemented by more in-depth 
procedures commensurate with the auditor's evaluation of the company's 
facts and circumstances) regarding related party transactions that are 
either required to be disclosed in the financial statements or 
determined to be a significant risk.\85\
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    \85\ The SEC expects that auditors will provide ``heightened 
scrutiny'' of a company's related party transactions. See SEC 
Accounting and Auditing Enforcement Release (``AAER'') No. 3427, In 
the Matter of the Application of Wendy McNeeley, CPA, at 10-12 
(December 13, 2012), which states in part that the SEC and courts 
have repeatedly held that related party transactions require 
heightened scrutiny by auditors and notes the importance of the 
auditor understanding the business purpose of material related party 
transactions.
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    Focusing the auditor's attention on related party transactions that 
are required to be disclosed in the financial statements or determined 
to be a significant risk is intended to make the auditor's evaluation 
of whether the company's related party transactions are properly 
accounted for and disclosed most effective.
    One important focus of the procedures required by paragraph 12 is 
the auditor's evaluation of the business purpose (or the lack thereof) 
of the related party transactions that are required to be disclosed or 
determined to be a significant risk. The procedures in paragraph 12 are 
designed to work with the procedures in paragraphs 3 through 9 to 
provide the auditor with additional information to understand and 
assess the business purpose (or the lack thereof) of the targeted 
related party transactions that are subject to paragraph 12. 
Understanding the business purpose of related party transactions is an 
important consideration in assessing and responding to risks of 
material misstatement and requires the auditor to understand other 
factors underlying the transaction. For example, although a company may 
assert that it has utilized a related party transaction to achieve a 
particular goal, the company may, in fact, have used the transaction 
for some other purpose.\86\ Obtaining an understanding of the terms and 
business purpose of a related party transaction includes understanding 
why the company entered into the transaction with a related party 
versus an unrelated party. A business purpose that appears inconsistent 
with the nature of the company's business might represent a fraud risk 
factor.
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    \86\ For example, a broker or dealer might use related party 
transactions to make the size of their operations appear smaller to 
avoid regulatory requirements.
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    Performing Basic Procedures: Paragraphs 12.a.-d. contains the basic 
procedures to be applied to related party transactions that are either 
required to be disclosed in the financial statements or determined to 
be a significant risk. Paragraph 12.a. requires the auditor to read the 
underlying documentation relating to the company's related party 
transaction(s) and evaluate whether the terms and other information 
about the transaction are consistent with explanations from inquiries 
and other audit evidence about the business purpose (or the lack 
thereof) of the transaction. This requirement, together with the other 
requirements in paragraphs 12.b.-d., require the auditor to evaluate 
appropriate information regarding the transaction, including, for 
example, the executed contract, and to

[[Page 43186]]

consider whether the contract and other underlying documentation is 
appropriately authorized and approved, and is consistent with 
explanations from inquiries of management and others. The auditor also 
considers how that information compares to other available audit 
evidence. For example, when evaluating the responses to inquiries of 
management and others, the auditor takes into account information 
obtained from other sources. Such sources could include, for example, 
SEC filings that include a description of the registrant's policies and 
procedures for the review, approval, or ratification of ``related 
person'' transactions or that identify any ``related person'' 
transaction where such policies and procedures did not require review, 
approval or ratification or where such policies and procedures were not 
followed.\87\
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    \87\ See Instruction 1 to Item 404(a) of SEC Regulation S-K for 
the definition of ``related person.'' Disclosure requirements 
regarding ``related persons'' in Regulation S-K may differ from 
``related party'' disclosures. See also, Securities Act Release No. 
33-8732A, Executive Compensation and Related Person Disclosure 
(August 29, 2006), http://www.sec.gov/rules/final/2006/33-8732afr.pdf.
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    In particular, paragraph 12.d. of the standard requires the auditor 
to evaluate the financial capability of the related party with respect 
to significant uncollected balances, loan commitments, supply 
arrangements, guarantees, and other obligations. This requirement 
applies only to items that are individually or collectively 
significant. Obtaining evidence to evaluate the financial capability of 
a related party can inform the auditor's evaluation of the business 
purpose (or the lack thereof), including whether the substance of that 
transaction differs materially from its form.\88\
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    \88\ See, e.g., McCurdy v. SEC, 396 F.3d 1258, 1261 (D.C. Cir. 
2005), noting that ``among transactions calling for close inspection 
are related-party transactions, including transactions between a 
company and its officers or directors. Such dealings are viewed with 
extreme skepticism in all areas of finance . . . . The reason for 
this is apparent: Although in an ordinary arms-length transaction, 
one may assume that parties will act in their own economic self-
interest, this assumption breaks down when the parties are related. 
A company that would perform a thorough credit-risk assessment 
before extending a loan might not do so if the loan were to one of 
its officers or directors.''
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    Performing Other Procedures: Paragraph 12.e. requires the auditor 
to supplement the basic required procedures contained in paragraphs 
12.a.-d. with more in-depth procedures commensurate with the auditor's 
evaluation of the company's facts and circumstances. This approach 
provides the auditor with the opportunity to scale the audit based on 
the auditor's judgment regarding other procedures that are necessary to 
address the identified and assessed risks of material misstatement. 
This requires the auditor to make a determination about what procedures 
are needed to evaluate the accounting and disclosure of the related 
party transactions. For example, related party transactions might pose 
valuation and measurement issues that are not present in arm's-length 
transactions. Consequently, the auditor's tests regarding valuation of 
a receivable from an entity under common control might be more 
extensive than for a trade receivable of the same amount from an 
unrelated party because the common controlling parties may be motivated 
to obscure the substance of the transaction.
    The procedures contained in paragraph 12.e. are designed to work 
with other procedures that the auditor performs during the audit to 
address the relevant assertions associated with each related party 
transaction that requires disclosure.\89\ For example, if a company 
makes a material purchase of property, plant and equipment from an 
unconsolidated related party, the auditor could inspect the asset to 
obtain audit evidence that supports management's assertion regarding 
the existence of the asset. Further, the auditor might examine 
underlying documents supporting the transfer of title and ownership to 
obtain audit evidence that supports management's assertion regarding 
its rights and obligations.
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    \89\ See paragraph 8 of Auditing Standard No. 13, which requires 
the auditor to design and perform audit procedures in a manner that 
addresses the assessed risks of material misstatement for each 
relevant assertion of each significant account and disclosure. This 
includes designing and performing audit procedures in a manner that 
addresses the assessed risks of material misstatement associated 
with related parties and relationships and transactions with related 
parties. See also, paragraph 17 of Auditing Standard No. 13, which 
states that tests of controls must be performed in the audit of 
financial statements for each relevant assertion for which 
substantive procedures alone cannot provide sufficient appropriate 
audit evidence and when necessary to support the auditor's reliance 
on the accuracy and completeness of financial information used in 
performing other audit procedures.
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    The economic substance of a related party transaction may differ 
materially from its form. AU sec. 411.06 requires that the auditor 
consider whether the substance of a transaction differs materially from 
its form when evaluating whether the financial statements have been 
presented fairly in accordance with the applicable financial reporting 
framework. Thus, the procedures performed pursuant to paragraph 12.e. 
are intended to address the auditor's concerns about whether the 
substance of a related party transaction differs materially from its 
form. For example, evaluating the collectability of receivables due 
from companies owned or controlled by officers of the company under 
audit might include questions beyond evaluating the financial 
capability of the related party to pay.
    Examples of other procedures that might be appropriate for the 
auditor to perform pursuant to paragraph 12.e., depending on the nature 
of the transaction and the risks of material misstatement of the 
financial statements, include:
     Inquiring directly of the related party regarding the 
business purpose of the transaction;
     Inspecting information in the possession of the related 
party or other parties to the transaction, if available;
     Reading public information regarding the related party and 
the transaction, if any;
     Reading the financial statements or other relevant 
financial information obtained from the related party, if available, to 
understand how the related party accounted for the transaction;
     Confirming the terms of the transaction with other parties 
with knowledge of the transaction (e.g., banks, guarantors, agents, or 
attorneys), if any;
     Determining whether there are any side agreements or other 
arrangements (either written or oral) with the related party, including 
confirming that none exist, if appropriate;
     Evaluating the transferability and value of collateral 
provided by the related party, if any; and
     Performing procedures at the related party, if possible.
    In certain circumstances, an auditor may decide to perform audit 
procedures at the related party in order to obtain sufficient 
appropriate audit evidence to support the auditor's opinion. The 
auditor, however, may not be able to perform procedures at the related 
party's premises because the related party may not allow the auditor to 
perform such procedures. However, in all cases the auditing standards 
require the auditor to obtain sufficient appropriate audit evidence to 
support his or her audit opinion.\90\
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    \90\ Paragraph 2 of the standard states that the objective of 
the auditor 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. As provided by paragraph 
14 of the standard, the auditor's evaluation should be supported by 
auditing procedures and evidence obtained from procedures performed 
during the audit, including procedures designed to test the accuracy 
and completeness of the related parties and relationships and 
transactions with related parties disclosed by the company to the 
auditor.

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[[Page 43187]]

    Aggregating Transactions for Disclosure: Accounting principles 
applicable to the company may allow the aggregation of related party 
transactions that require disclosure (e.g., by type of related party 
transaction). A note to paragraph 12 of the standard addresses the 
auditor's responsibility for aggregated related party disclosures. That 
note states that, if the company has aggregated related party 
transactions for disclosure purposes in accordance with the applicable 
financial reporting framework, the auditor may perform the procedures 
in paragraph 12 of the standard for only a selection of transactions 
from each aggregation of related party transactions (versus all 
transactions in the aggregation), commensurate with the risks of 
material misstatement. The Board notes that a ``selection of 
transactions'' could be the selection of one transaction from the 
aggregation in the appropriate circumstances.
    Existing standards require the auditor to design and perform audit 
procedures in a manner that addresses the assessed risks of material 
misstatement for each relevant assertion of each significant account 
and disclosure.\91\ AU sec. 334.08-.09 contains procedures that the 
auditor should consider performing when responding to risks arising 
from related party relationships and transactions and directs the 
auditor to apply the procedures the auditor considers necessary to 
obtain satisfaction concerning the purpose, nature, and extent of 
identified related party transactions and their effect on the financial 
statements, noting that those procedures should extend beyond inquiry 
of management.
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    \91\ See paragraph 8 of Auditing Standard No. 13.
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Intercompany Accounts (Paragraph 13 of the Standard)

    Paragraph 13 of the standard requires the auditor to perform 
procedures on intercompany account balances as of concurrent dates, 
even if fiscal years of the respective companies differ. This 
requirement is based on the procedure in the existing standard, AU sec. 
334.09.e., which requires the auditor to consider arranging for the 
audits of intercompany account balances to be performed as of 
concurrent dates, even if the fiscal years differ, and for the 
examination of specified, important, and representative related party 
transactions by the auditors for each of the parties, with appropriate 
exchange of relevant information. Other existing standards also 
reference the importance of the auditor's review of consolidating 
accounts.\92\
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    \92\ See, e.g., paragraph .10 of AU sec. 543, Part of Audit 
Performed by Other Independent Auditors, and paragraphs .28-.34 of 
AU sec. 332, Auditing Derivative Instruments, Hedging Activities, 
and Investments in Securities.
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    A new note to paragraph 13 states that the procedures performed 
should address the risks of material misstatement associated with the 
company's intercompany accounts. Discussion of the Comments Received on 
Paragraphs 11 through 13 of Auditing Standard No. 18. The Board 
considered all comments received, including the following significant 
comments:
    Evaluating the Financial Capability of the Related Party: One 
commenter recommended that the standard should require the auditor to 
consider evaluating the financial capability of a related party and 
that the standard should include appropriate alternative procedures if 
information regarding the related party's financial capability is not 
readily available. Another commenter stated that the evaluation of the 
financial capability of the related party should not result in 
significant additional time by management or the auditor. The Board 
considered these comments noting that auditors are currently performing 
procedures to evaluate the financial capability of counterparties in a 
variety of audit areas today, regardless of whether the counterparty is 
a related party. For example, auditors might examine the company's 
support regarding the financial capability of another party as part of 
evaluating the company's decision to recognize revenue on a particular 
transaction.
    Performing Procedures on Intercompany Balances: Some commenters 
recommended providing additional direction, including specific 
procedures that the auditor should perform pursuant to paragraph 13. 
One commenter recommended requiring the auditor to determine the 
business purpose for intercompany transactions, and whether the 
transactions have ``economic substance.''
    The Board considered these comments, noting that the preparation of 
consolidated financial statements could involve complex matters 
regarding intercompany transactions. For example, a company could 
consolidate a subsidiary that has a different year-end. The risks of 
material misstatement with intercompany transactions could include not 
only the risks associated with intercompany account balances, but also 
the resulting effect on the consolidated financial statements, after 
elimination of such balances. The procedures performed pursuant to 
paragraph 13 should address the risks of material misstatement. Those 
procedures could include examining account reconciliations and material 
transactions, regardless of their timing. The procedures performed 
pursuant to paragraphs 3 through 9 apply to intercompany transactions 
and include inquiring of management regarding the business purpose of 
the transaction and the business purpose for entering into the 
transaction. Some intercompany transactions might give rise to 
significant risks of material misstatement that are subject to the 
procedures in paragraph 12.
    The Board considered including additional direction regarding 
intercompany transactions, but noted that such direction could be 
viewed as making the requirement unnecessarily prescriptive, which 
could result in unnecessary costs. However, to remind auditors of the 
need to address the potential risks of material misstatement, the Board 
added a note to paragraph 13, which states that the procedures 
performed should address the risks of material misstatement associated 
with the company's intercompany accounts. Further, based on comments 
received, the header preceding paragraph 13 has been revised to refer 
to ``Intercompany Accounts.''
    The Board is adopting paragraphs 11 through 13 of the standard, 
substantially as reproposed, except for changing the header to 
paragraph 13 and adding a new note to paragraph 13, discussed above.
    Evaluating Whether the Company Has Properly Identified Its Related 
Parties and Relationships and Transactions with Related Parties 
(Paragraphs 14 through 16 and Appendix A of the Standard)

Discussion of Paragraphs 14 Through 16 and Appendix A of Auditing 
Standard No. 18

    Briefly, paragraphs 14 through 16 of the standard address the 
auditor's evaluation of whether the company has properly identified its 
related parties and relationships and transactions with related 
parties. Appendix A includes examples of information and sources of 
information that may be gathered during the audit that could indicate 
that related parties or relationships or transactions with related 
parties previously undisclosed to the auditor might exist.
    Paragraph 14 of the standard requires the auditor to evaluate 
whether the company has properly identified its

[[Page 43188]]

related parties and relationships and transactions with related 
parties. Paragraph 14 states that evaluating whether a company has 
properly identified its related parties and relationships and 
transactions with related parties involves more than assessing the 
process used by the company. Paragraph 14 also states that this 
evaluation requires the auditor to perform procedures to test the 
accuracy and completeness of the related parties and relationships and 
transactions with related parties identified by the company, taking 
into account the information gathered during the audit. Paragraph 14 
further requires that, as part of that evaluation, the auditor should 
read minutes of the meetings of stockholders, directors, and committees 
of directors, or summaries of actions of recent meetings for which 
minutes have not yet been prepared.
    Paragraph 14 of the standard focuses the auditor on a key aspect of 
the objective by requiring the auditor to evaluate whether the company 
has properly identified its related parties and relationships and 
transactions with related parties. Paragraph 14 recognizes that the 
company is responsible for the preparation of its financial statements, 
including, in the first instance, the identification of the company's 
related parties and relationships and transactions with related 
parties, and that the auditor begins the audit with information 
obtained from the company. While paragraph 14 of the standard 
anticipates that the auditor would start his or her work regarding 
related parties with the names of related parties and relationships and 
transactions with related parties identified by the company, the 
auditor may not merely rely on management's representations \93\ as to 
the accuracy and completeness of the information provided to the 
auditor. While management has the primary responsibility for preparing 
the company's financial statements, the auditor should be sensitive 
throughout the audit to the possibility that management may not have 
informed the auditor of all related parties or relationships or 
transactions with related parties.
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    \93\ To further assist the auditor's efforts in identifying 
related parties, the other amendments include a complementary 
provision that expands existing management representations contained 
in AU sec. 333 to state that the company has provided the names of 
all related parties and all relationships and transactions with its 
related parties to the auditor. However, the auditor may not solely 
rely on management's representations.
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    Paragraph 14 also recognizes that the auditor's procedures to 
evaluate whether the company has properly identified its related 
parties should extend beyond the inquiries pursuant to paragraphs 5 
through 7 of the standard. Evaluating whether a company has properly 
identified its related parties and relationships and transactions with 
related parties requires the auditor to perform procedures to test the 
accuracy and completeness of the related parties and relationships and 
transactions with related parties identified by the company.
    A note to paragraph 14 of the standard refers the auditor to 
Appendix A, which describes examples of information and sources of 
information that may be gathered during the audit that could indicate 
that related parties or relationships or transactions with related 
parties previously undisclosed to the auditor might exist. Many of the 
examples contained in Appendix A of the standard are contained in AU 
secs. 334.07-.08. The standard does not require an auditor to perform 
procedures with respect to each source of information referenced in 
Appendix A. The information and sources relevant to a particular audit 
would depend on the facts and circumstances of the audit and, thus, not 
all of the information or sources of information in Appendix A would 
need to be considered in every audit. However, other auditing 
standards, or the performance of auditing procedures in other areas, 
may impose requirements on the auditor to perform auditing procedures 
with respect to certain of those sources (for example, reading 
confirmation responses and responses to inquiries of the company's 
lawyers).\94\ Appendix A also states that the examples contained in 
that Appendix are not intended to represent a comprehensive listing.
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    \94\ See, e.g., AU sec. 330, The Confirmation Process, and AU 
sec. 337, Inquiry of a Client's Lawyer Concerning Litigation, 
Claims, and Assessments.
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    Paragraph 14 precludes the auditor's reliance on the company's 
identification of its related parties without the auditor taking 
additional steps, including following up on possible contradictory 
information gathered during the audit. Thus, while the standard does 
not require the auditor to search public information indiscriminately 
to identify a company's related parties, the standard does anticipate 
that the auditor will take additional steps, including following up on 
inconsistencies or red flags that arise during the audit. For example, 
the auditor might review public documents for information regarding a 
company's related parties and transactions with related parties, 
particularly when such information is readily available.\95\ 
Additionally, a review of relevant available public information might 
be appropriate in situations in which information comes to the 
auditor's attention that suggests that related parties previously 
undisclosed to the auditor might exist.
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    \95\ Paragraph 11 of Auditing Standard No. 12 requires that as 
part of obtaining an understanding of the company the auditor should 
consider reading public information about the company relevant to 
the evaluation of the likelihood of material financial statement 
misstatements.
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    In general, the steps performed by the auditor to evaluate whether 
the company has properly identified its related parties and 
relationships and transactions with related parties include: (i) 
Performing risk assessment procedures to obtain an understanding of the 
company's relationships and transactions with its related parties that 
might reasonably be expected to affect the risks of material 
misstatement of the financial statements; (ii) identifying and 
assessing risks associated with a company's relationships and 
transactions with its related parties, including whether the company 
has properly identified its related parties and relationships and 
transactions with related parties; (iii) designing and performing audit 
procedures that address and respond to the risks of material 
misstatement associated with the company's related parties and 
transactions, including procedures to test the accuracy and 
completeness of the related parties and relationships and transactions 
with related parties identified by the company; and (iv) performing 
specific procedures that address related party relationships or 
transactions identified by the auditor that were previously undisclosed 
by company management. Performing these procedures should position the 
auditor to obtain sufficient evidence to provide reasonable assurance 
to support the auditor's opinion.
    The approach in paragraph 14 also considers that the auditor's 
efforts to identify and evaluate a company's significant unusual 
transactions and obtain an understanding of a company's financial 
relationships and transactions with its executive officers might assist 
the auditor in identifying information that might indicate that related 
parties or relationships or transactions with related parties 
previously undisclosed to the auditor might exist.
    Also, the amendments to AU sec. 560, Subsequent Events, require 
that during the ``subsequent period'' the auditor inquire regarding 
whether there have been any changes in the company's related parties 
and whether the company has entered into any

[[Page 43189]]

significant new related party transactions. This could inform the 
auditor's evaluation of the company's identification of its related 
parties and relationships and transactions with related parties.
    Pursuant to paragraph 15 of the standard, if the auditor identifies 
information that indicates that related parties or relationships or 
transactions with related parties previously undisclosed to the auditor 
might exist, the auditor then performs the procedures necessary to 
determine whether previously undisclosed relationships or transactions 
with related parties, in fact, exist. The standard requires that these 
procedures extend beyond inquiry of management.
    Pursuant to paragraph 16 of the standard, if the auditor determines 
that a related party or relationship or transaction with a related 
party previously undisclosed to the auditor exists, the auditor should 
perform certain procedures targeted at enhancing the auditor's 
understanding of the previously undisclosed related party or 
relationship or transaction. The procedures contained in paragraph 16 
are intended to focus the auditor on (i) obtaining additional 
information and evaluating the related party or relationship or 
transaction with a related party that the auditor has identified, and 
(ii) assessing the impact of the new information on all aspects of the 
audit.
    Specifically, the procedures contained in paragraph 16 require that 
if the auditor determines that an undisclosed related party or 
relationship or transaction exists, the auditor should:
    a. Inquire of management regarding the existence of the related 
party or relationship or transaction with a related party previously 
undisclosed to the auditor and the possible existence of other 
transactions with the related party previously undisclosed to the 
auditor;
    b. Evaluate why the related party or relationship or transaction 
with a related party was previously undisclosed to the auditor;
    c. Promptly communicate to appropriate members of the engagement 
team and other auditors participating in the audit engagement relevant 
information about the related party or relationship or transaction with 
the related party;
    d. Assess the need to perform additional procedures to identify 
other relationships or transactions with the related party previously 
undisclosed to the auditor;
    e. Perform the procedures required by paragraph 12 of the standard 
for each related party transaction previously undisclosed to the 
auditor that is required to be disclosed in the financial statements or 
determined to be a significant risk;
    f. Perform the following procedures, taking into account the 
information gathered from performing the procedures in a. through e. 
above:
    i. Evaluate the implications on the auditor's assessment of 
internal control over financial reporting, if applicable;
    ii. Reassess the risk of material misstatement and perform 
additional procedures as necessary if such reassessment results in a 
higher risk; and
    iii. Evaluate the implications for the audit if management's 
nondisclosure to the auditor of a related party or relationship or 
transaction with a related party indicates that fraud or an illegal act 
may have occurred. If the auditor becomes aware of information 
indicating that fraud or another illegal act has occurred or might have 
occurred, the auditor must determine his or her responsibilities under 
AU secs. 316.79-.82, AU sec. 317, Illegal Acts by Clients, and Section 
10A of the Securities Exchange Act of 1934, 15 U.S.C. 78j-1.
    A footnote to paragraph 16 refers the auditor to AU sec. 333.04, 
which states that, if a representation made by management is 
contradicted by other audit evidence, the auditor should investigate 
the circumstances and consider the reliability of the representation 
made. Based on the circumstances, the auditor should consider whether 
his or her reliance on management's representations relating to other 
aspects of the financial statements is appropriate and justified. 
Another footnote refers the auditor to paragraph 74 of Auditing 
Standard No. 12, which states that when the auditor obtains audit 
evidence during the course of the audit that contradicts the audit 
evidence on which the auditor originally based his or her risk 
assessment, the auditor should revise the risk assessment and modify 
planned audit procedures or perform additional procedures in response 
to the revised risk assessment.
    As described above, the procedures required by paragraphs 16.a.-e. 
are performed to obtain the information necessary to evaluate the 
related party or relationship or transaction with a related party 
previously undisclosed to the auditor that the auditor has determined 
exists. Significantly, because of the potential for fraud, paragraph 
16.b. of the standard requires the auditor to evaluate why the related 
party or relationship or transaction with a related party was 
previously undisclosed to the auditor. If the related party transaction 
is either required to be disclosed or is determined to be a significant 
risk, the auditor is required to perform the procedures in paragraph 12 
of the standard.
    Paragraph 16.f. requires the auditor to take into account the 
information gathered from the procedures in paragraph 16.a.-e. 
regarding the relationship or transaction identified by the auditor to 
assess the impact on the audit. For example, paragraph 16.f.iii. 
requires the auditor to reassess the implications for the audit if the 
company's nondisclosure indicates that fraud or an illegal act may have 
occurred.
    Determining that a related party transaction that was previously 
undisclosed to the auditor exists could have significant implications 
for the audit. This information contradicts representations made by 
management to the auditor and may contradict the auditor's preliminary 
assessment of whether the company has properly identified its related 
parties and relationships and transactions with related parties. 
Identifying such contradictory information requires the auditor to 
reassess the risk of material misstatement and perform additional 
procedures as necessary if such reassessment results in a higher risk.
    The auditor takes the information gathered from performing the 
procedures set forth in paragraph 16 into account when evaluating 
whether the company has properly identified its related parties and 
relationships and transactions with related parties pursuant to 
paragraph 14 of the standard.
    In contrast to the approach set forth in paragraphs 14 through 16, 
the existing standard contains a variety of procedures that are less 
specific and focused. For example, AU sec. 334.05 alerts the auditor to 
the fact that business structure and operating style are occasionally 
deliberately designed to obscure related party transactions. AU sec. 
334.05 states that, in determining the scope of work to be performed 
with respect to possible transactions with related parties, the auditor 
should obtain an understanding of management responsibilities and the 
relationship of each component to the total entity and should consider 
controls over management activities, and the business purpose served by 
the various components of the entity. AU sec. 334.07 states that 
determining the existence of transactions with related parties beyond 
those that are clearly evident requires the application of specific 
audit procedures and provides

[[Page 43190]]

examples of such procedures. AU sec. 334.07 further states that the 
auditor should place emphasis on testing material transactions with 
parties the auditor knows are related to the reporting entity. AU sec. 
334.08 includes procedures that are intended to provide guidance for 
identifying material transactions with parties known to be related and 
for identifying material transactions that may be indicative of the 
existence of previously undetermined relationships.

Discussion of the Comments Received on Paragraphs 14 Through 16 and 
Appendix A of the Reproposed Standard

    The Board considered all comments received, including the following 
significant comments:
    Clarifying the Auditor's Responsibility Regarding Appendix A: Many 
commenters recommended clarifying the auditor's responsibilities for 
the examples of information and sources of information contained in 
Appendix A. Some of the commenters recommended including clarifying 
language regarding the scope of the auditor's responsibilities with 
respect to Appendix A; others suggested qualifying language stating 
that the auditor is not required to perform procedures with respect to 
each type or source of information referenced in Appendix A.
    The Board considered these comments, noting that Appendix A is 
intended to provide examples of information and sources of information 
and does not provide a comprehensive or mandatory listing. Further, 
other auditing standards may impose requirements on the auditor to 
perform procedures regarding the examples contained in Appendix A. 
Accordingly, the suggested qualifying language would not be 
appropriate. The Board, however, made certain revisions intended to 
clarify the applicability of Appendix A by revising the note in 
paragraph 14 and similar language in Appendix A to state that Appendix 
A contains examples of information and sources of information that the 
auditor may gather during the audit.
    Clarifying the Auditor's Responsibility for Evaluating the 
Company's Identification of Its Related Parties: Many commenters 
recommended a number of clarifications to paragraph 14 of the 
reproposed standard. Several commenters recommended incorporating 
footnote 14 into paragraph 14 of the reproposed standard to clarify 
that the auditor's evaluation of the company's identification of its 
related parties and relationships and transactions with related parties 
requires the auditor to perform procedures to test the accuracy and 
completeness of the related parties and relationships and transactions 
with related parties identified by the company. Other commenters 
recommended clarification regarding the extent of the auditor's 
evaluation in paragraph 14 and whether it is based on the information 
gathered during the audit.
    In response to these comments, the Board made a number of 
clarifications. Specifically, the Board incorporated footnote 14 of the 
reproposed standard into paragraph 14 to clarify that the auditor's 
evaluation requires the auditor to perform procedures to test the 
accuracy and completeness of the company's identification. 
Additionally, the revisions give more prominence to the requirement and 
clarify that, in performing the evaluation required by paragraph 14, 
the auditor takes into account the information gathered during the 
audit. This revision, in conjunction with the clarifications to the 
note regarding the examples and sources of information contained in 
Appendix A (discussed below), is intended to further describe the 
auditor's responsibilities for evaluating the company's identification 
of its related parties and relationships and transactions with its 
related parties.
    Examples Included in Appendix A: A few commenters suggested 
revisions to the examples of information or sources of information 
contained in Appendix A to the standard. The Board considered these 
comments, noting that Appendix A contains examples of information and 
sources of information that the auditor may gather during the audit and 
does not represent a comprehensive listing. The Board revised Appendix 
A to include ``disclosures contained on the company's Web site'' (in 
addition to the company's disclosures in SEC filings, which is already 
included as an example in Appendix A) as another example of a source of 
information that may be gathered during the audit that could indicate 
that related parties or relationships or transactions with related 
parties previously undisclosed to the auditor might exist.
    Verifying the Ownership Structure Between the Company and Its 
Related Parties: One commenter stated that verifying the ownership 
structure between the company and its related parties may be one of the 
most difficult aspects of an audit. That commenter recommended that the 
Board outline procedures for verifying the ownership structure between 
the company and the related parties disclosed to the auditor by 
management, including the levels of direct and indirect control, and 
changes in those levels during the period under audit. The Board 
considered this comment, noting that determining the procedures for 
verifying these matters (for example, determining whether the company 
or its management is able to exercise significant influence over 
another entity) requires an evaluation of the facts and circumstances. 
Additionally, in making such a determination, the auditor's response 
should address the risks of material misstatement.\96\ Including 
additional direction in a context that is so heavily facts and 
circumstances driven could make the standard unnecessarily complex and 
prescriptive, making it potentially more difficult to apply.\97\
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    \96\ The auditor may also be required to perform procedures on 
these matters by other auditing standards, such as AU sec. 332.
    \97\ See, e.g., Canadian Public Accountability Board, Auditing 
in Foreign Jurisdictions CPAB Special Report (2012) http://www.cpab-ccrc.ca/en/topics/PublicSpecialReports/Pages/default.aspx, which 
noted that the existence of related parties and transactions are 
more likely to represent an audit risk for operations in foreign 
jurisdictions when the legal or regulatory environment requires 
reliance on complex business structures or when dominant 
shareholders are involved in the operations of the business. That 
report also noted that because the identification of related parties 
may also be more difficult in foreign jurisdictions, it is important 
that auditors have a heightened sensitivity to possible related-
party transactions by performing procedures to determine the 
ownership and management structure of significant customers and 
suppliers.
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    Setting Appropriate Expectations Regarding the Auditor's 
Responsibilities: Some commenters stated that the extent of the 
auditor's procedures necessary for evaluating management's 
identification of its related parties and relationships did not take 
into account the responsibility of management. One commenter 
recommended including additional context, similar to that contained in 
International Standard on Auditing No. 550, Related Parties, to 
recognize that the nature of related party transactions could 
compromise the auditor's ability to detect material misstatements 
associated with related parties, even though the audit is properly 
planned and performed. Another commenter stated that the objective 
appears to require performance of procedures equivalent to a forensic 
engagement to uncover all related parties and transactions.
    The Board considered these comments and did not agree that 
additional changes were necessary to address the appropriate 
expectations for the auditor's responsibilities with respect to 
identifying related parties and relationships and transactions with

[[Page 43191]]

related parties.\98\ Additionally, the Board had already taken note of 
commenters' requests to clarify its proposal to focus the auditor's 
attention first on information provided by management and is also 
adopting revisions to AU sec. 333 to provide for additional written 
representations by management pertaining to its related parties. 
Moreover, the Board declined to pursue an alternative that would have 
designated related party transactions as fraud risks, which would have 
resulted in more forensic-type procedures. Instead, the Board's 
approach overall to the auditor's responsibility to identify a 
company's related parties has been targeted and risk-based, requiring 
heightened scrutiny in areas that have historically represented high 
risk of material misstatement. The Board believes this approach 
appropriately recognizes the auditor's existing responsibilities for 
the identification of related parties and relationships and 
transactions with related parties in a cost-sensitive way.
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    \98\ For example, the auditor's responsibility to perform 
procedures to identify related party transactions that are material 
to the financial statements is reflected in Section 10A(a) of the 
Exchange Act.
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    Applicability of Paragraph 16 to Related Party Transactions 
Identified by the Auditor That Are ``Clearly Trivial'': Several 
commenters recommended that the procedures required by paragraph 16 
should not be required if the related party transaction identified by 
the auditor is ``clearly trivial,'' as that term is described in 
Auditing Standard No. 14.\99\ Those commenters generally noted that 
such an approach would avoid unnecessary work.
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    \99\ Paragraph 10 of Auditing Standard No. 14 states that 
``clearly trivial'' is not another expression for ``not material.'' 
Paragraph 10 also states that matters that are clearly trivial will 
be of a smaller order of magnitude than the materiality level 
established in accordance with Auditing Standard No. 11, and will be 
inconsequential, whether taken individually or in aggregate and 
whether judged by any criteria of size, nature, or circumstances. 
Paragraph 10 further states that when there is any uncertainty about 
whether one or more items is clearly trivial, the matter is not 
considered trivial.
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    The Board considered these comments, noting that the auditor might 
not be able to determine if the previously undisclosed transaction 
identified by the auditor is ``clearly trivial'' without the 
information that would be obtained from the procedures in paragraph 
16.a.-d. of the reproposed standard.'' For example, inquiring of 
management regarding why the transaction was not disclosed to the 
auditor and evaluating that explanation would be important to 
determining whether the transaction is ``clearly trivial.'' Further, 
taking into account information regarding a related party transaction 
identified by the auditor that is ``clearly trivial'' generally would 
not significantly impact the auditor's evaluation of the matters in 
paragraphs 16.f-h. of the reproposed standard.\100\
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    \100\ Paragraphs 16.f-h. of the reproposed standard are now 
contained in paragraphs 16.f.i-iii. of the standard.
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    The use of the phrase ``clearly trivial'' could also result in 
other consequences. For example, providing such an exception could 
inappropriately focus the auditor's evaluation on quantitative 
considerations to the detriment of qualitative considerations and might 
allow management an opportunity to influence the auditor's evaluation. 
In addition, providing such an exception could create confusion 
regarding paragraph 16.h. of the reproposed standard (paragraph 
16.f.iii of the standard), which refers to Section 10A of the Exchange 
Act. Section 10A of the Exchange Act applies to information indicating 
that fraud or another illegal act has or might have occurred, whether 
or not perceived to have a material effect on the financial statements 
of the company.
    However, after considering these comments, the Board did make 
revisions to paragraph 16 to clarify that the procedures performed 
pursuant to paragraph 16 focus the auditor on obtaining additional 
information both by (i) performing the initial procedures in paragraph 
16.a.-e. so that the auditor can evaluate the nature and potential 
impact of the previously undisclosed related party or relationship or 
transaction that the auditor has identified, and (ii) performing 
additional procedures to evaluate the implications for the audit, 
including the auditor's risk assessment, taking into account the 
information gathered from performing the procedures in paragraph 16.a.-
e. These revisions should clarify the auditor's approach.
    The Board also made technical changes to paragraph 16.h. of the 
reproposed standard to more closely align with the corresponding 
requirement contained in paragraph 23 of Auditing Standard No. 14. 
Paragraph 23 of Auditing Standard No. 14 states that if the auditor 
becomes aware of information indicating that fraud or another illegal 
act has occurred or might have occurred, he or she also must determine 
his or her responsibilities under AU secs. 316.79-.82, AU sec. 317, 
Illegal Acts by Clients, and Section 10A of the Exchange Act, 15 U.S.C. 
78j-1.
    As revised, if the auditor determines that a related party or 
relationship or transaction with a related party previously undisclosed 
to the auditor exists, the auditor is required to perform certain 
initial procedures. Those procedures required by paragraphs 16.a.-e. 
focus the auditor on obtaining additional information and evaluating 
the related party or relationship or transaction with a related party 
that the auditor has identified. A footnote to paragraph 16.b. refers 
the auditor to AU sec. 333.04, which states that if a representation 
made by management is contradicted by other audit evidence, the auditor 
should investigate the circumstances and consider the reliability of 
the representation made. After performing the procedures in paragraph 
16.a.-e., the auditor performs the procedures in paragraphs 16.f.i-iii. 
of the standard taking into account the information previously gathered 
by the auditor, to assess the broader impact of the auditor's findings 
on the audit.
    ``Other'' Related Parties Previously Undisclosed to the Auditor: 
One commenter recommended that paragraph 16 be clarified to include 
that the auditor also inquire of management about the possible 
existence of transactions with other undisclosed related parties. The 
Board considered this comment, noting that while this inquiry was not 
explicitly stated, assessing whether there are other undisclosed 
related parties is a component of the auditor's response once a related 
party or a relationship or transaction with a related party previously 
undisclosed to the auditor by management has been identified by the 
auditor.
    Inquiring of management regarding the identification of the 
possible existence of transactions with other undisclosed related 
parties and relationships and transactions with related parties, 
including whether there are any other undisclosed related parties, 
would generally be encompassed in the auditor's procedures performed in 
discharging the auditor's responsibilities once the auditor has 
determined that a related party or relationship or transaction with a 
related party previously undisclosed to the auditor exists. Based on 
the auditor's reassessment of risk, the auditor performs additional 
procedures that would include such inquiries, but also would extend 
beyond inquiring of management.
    Significantly, paragraph 16.f.ii. of the standard \101\ requires 
the auditor to reassess the risks of material misstatement and perform 
additional procedures as necessary, if such

[[Page 43192]]

reassessment results in a higher risk. This would include procedures 
designed to address the risk of transactions with other undisclosed 
related parties.
---------------------------------------------------------------------------

    \101\ Paragraph 16.g. of the reproposed standard is now 
contained in paragraph 16.f.ii. of the standard.
---------------------------------------------------------------------------

    To clarify the auditor's responsibilities regarding other 
undisclosed related parties, the Board added a new footnote to 
paragraph 16 that refers the auditor to paragraph 74 of Auditing 
Standard No. 12, which states that when the auditor obtains audit 
evidence during the course of the audit that contradicts the audit 
evidence on which the auditor originally based his or her risk 
assessment, the auditor should revise the risk assessment and modify 
planned audit procedures or perform additional procedures in response 
to the revised risk assessments.
    The Board is adopting paragraphs 14 through 16 and Appendix A as 
reproposed, with the following changes:
    a. Revising paragraph 14 to highlight that the auditor performs 
procedures to test the accuracy and completeness of management's 
identification, taking into account information gathered during the 
audit;
    b. Clarifying in the note to paragraph 14 that Appendix A contains 
examples of information and sources of information that the auditor may 
gather during the audit;
    c. Revising Appendix A to include a new example, ``disclosures 
contained on the company's Web site'';
    d. Revising paragraph 16 to clarify that the auditor performs the 
procedures in 16.f.i.-iii., taking into account the information 
gathered from performing the procedures in paragraph 16.a.-e.;
    e. Adding a new footnote to paragraph 16.f.ii., referring to 
paragraph 74 of Auditing Standard No. 12, which states that when the 
auditor obtains audit evidence during the course of the audit that 
contradicts the audit evidence on which the auditor originally based 
his or her risk assessment, the auditor should revise the risk 
assessment and modify planned audit procedures or perform additional 
procedures in response to the revised risk assessments; and
    f. Revising paragraph 16.f.iii. to more closely align with 
paragraph 23 of Auditing Standard No. 14, which states if the auditor 
becomes aware of information indicating that fraud or another illegal 
act has occurred or might have occurred, he or she also must determine 
his or her responsibilities under AU secs. 316.79-.82, AU sec. 317, 
Illegal Acts by Clients, and Section 10A of the Securities Exchange Act 
of 1934, 15 U.S.C. 78j-1.
Evaluating Financial Statement Accounting and Disclosures (Paragraphs 
17 and 18 of the Standard)

Discussion of Paragraphs 17 and 18 of Auditing Standard No. 18

    Paragraph 17 of the standard aligns with requirements in Auditing 
Standard No. 14 to require the auditor to evaluate whether related 
party transactions have been properly accounted for and disclosed in 
the financial statements. Paragraph 17 states that this includes 
evaluating whether the financial statements contain the information 
regarding relationships and transactions with related parties essential 
for a fair presentation in conformity with the applicable financial 
reporting framework. A footnote to paragraph 17 refers the auditor to 
paragraphs 30 and 31 of Auditing Standard No. 14.
    The auditor's evaluation of a company's accounting and disclosure 
of relationships and transactions with related parties is important to 
the protection of investor interests because the substance of related 
party transactions might differ materially from their form. 
Furthermore, related party transactions not only may involve difficult 
measurement and recognition issues, but may also be used to engage in 
financial statement fraud and conceal misappropriation of assets.
    Paragraph 17 is intended to align the auditor's evaluation with the 
objective of the standard and to focus the auditor on both the 
accounting and disclosure of the company's relationships and 
transactions with related parties. Footnote 1 to paragraph 1 of the 
standard states that the auditor should look to the requirements of the 
SEC for the company under audit with respect to the accounting 
principles applicable to that company. Unlike the existing standard, 
paragraph 17 of the standard does not include a separate requirement to 
evaluate whether the substance of a related party transaction differs 
materially from its form because that evaluation is part of the 
auditor's evaluation of whether the financial statements have been 
presented fairly in conformity with the applicable financial reporting 
framework pursuant to AU sec. 411.06.
    Consistent with the existing standard, evaluating substance over 
form does not require the auditor to challenge the appropriateness of 
the accounting standards. However, financial statements may not be 
presented fairly if they do not include information about the matters 
that affect their use, understanding, and interpretation.\102\ For 
example, to improve the appearance of its financial condition, a 
company and a related party could attempt to ``dress up'' the 
appearance of the company's balance sheet at period-end. Some period-
end ``window-dressing'' transactions might involve side agreements 
undisclosed to the auditor, while others might represent transactions 
that the auditor is aware of, in which management placed more emphasis 
on the need for a particular accounting treatment than on the 
underlying economic substance of the transaction.
---------------------------------------------------------------------------

    \102\ See AU sec. 411.04.
---------------------------------------------------------------------------

    AU sec. 334 requires the auditor to consider whether sufficient 
appropriate evidence has been obtained to understand each related party 
relationship, as well as the effect of each material related party 
transaction on the financial statements. The existing standard states 
that the auditor should view related party transactions within the 
framework of existing pronouncements, placing primary emphasis on the 
adequacy of disclosure. Further, AU sec. 334.02 states that the auditor 
should be aware that the substance of a particular transaction could be 
significantly different from its form and that financial statements 
should recognize the substance of particular transactions rather than 
merely their legal form. Additionally, Auditing Standard No. 14 
describes the auditor's responsibility for evaluating the presentation 
of financial statements, including disclosures, more generally. 
Auditing Standard No. 14 requires the auditor to evaluate whether the 
financial statements are presented fairly, in all material respects, in 
conformity with the applicable financial reporting framework.\103\ 
Furthermore, AU sec. 411.06 requires the auditor to consider whether 
the substance of transactions or events differs materially from their 
form when evaluating whether the financial statements have been 
presented fairly in accordance with the applicable financial reporting 
framework.
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    \103\ See paragraph 30 of Auditing Standard No. 14.
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Assertions That Transactions With Related Parties Were Conducted on 
Terms Equivalent to Those Prevailing in Arm's-Length Transactions 
(Paragraph 18 of the Standard)

    Paragraph 18 of the standard states that if the financial 
statements include a statement by management that transactions with 
related parties were conducted on terms equivalent to those prevailing 
in an arm's-length transaction, the auditor should determine whether 
the evidence

[[Page 43193]]

obtained supports or contradicts management's assertion.
    Financial reporting frameworks permit management to assert that a 
related party transaction that is required to be disclosed in the 
financial statements was conducted on terms equivalent to those 
prevailing on an arm's-length basis only when support for such an 
assertion exists. Management's refusal to modify such a disclosure when 
support for that statement does not exist represents a departure from 
GAAP and IFRS. Such a misstatement would require the auditor to express 
either a qualified or adverse opinion on the financial statements. A 
decision by management to remove, at the auditor's request, such an 
assertion from the financial statements due to management's inability 
to provide the auditor with sufficient appropriate audit evidence might 
affect the auditor's assessment of internal control over financial 
reporting.
    The requirements in paragraph 18 of the standard are complemented 
by the other amendments to AU sec. 333, which require the auditor to 
obtain written representations from management when management has 
asserted that a transaction with a related party was conducted on terms 
equivalent to those prevailing in an arm's-length transaction.
    AU sec. 334 includes requirements regarding the auditor's 
evaluation of assertions that related party transactions occurred on 
terms equivalent to those occurring on an arm's-length basis. AU sec. 
334.12 notes the difficulty in substantiating such representations and 
states that, except for routine transactions, it will generally not be 
possible to determine whether a particular transaction would have taken 
place if the parties had not been related, or assuming it would have 
taken place, what the terms and manner of settlement would have been. 
AU sec. 334 also states that if such a representation is included in 
the financial statements and the auditor believes that the 
representation is unsubstantiated by management, the auditor should 
express a qualified or adverse opinion because of a departure from 
GAAP, depending on materiality.
    After considering all comments received, the Board is adopting 
paragraphs 17 and 18 of the standard as reproposed, except for the 
addition of a reference to paragraph 30 of Auditing Standard No. 14 in 
footnote 19 to paragraph 17.
Communications With the Audit Committee (Paragraph 19 of the Standard)

Discussion of Paragraph 19 of Auditing Standard No. 18

    Paragraph 19 of the standard requires the auditor to 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 its related parties, as well as other significant 
matters arising from the audit regarding the company's relationships 
and transactions with related parties.
    Both the auditor and the audit committee benefit from a meaningful 
exchange of information regarding significant risks of material 
misstatement in the financial statements and other matters that may 
affect the integrity of the company's financial reports, including 
matters arising from a company's relationships and transactions with 
related parties.
    Paragraph 19 of the standard is intended to work in tandem with 
paragraph 7 of the standard. The inquiries of the audit committee, or 
its chair, pursuant to paragraph 7, can be more effective when they 
occur at an earlier point in the audit, when the auditor is obtaining 
an understanding of the company's relationships and transactions with 
its related parties. This can avoid situations where the auditor's 
communications regarding a company's relationships and transactions 
with its related parties might first occur at the end of the audit. 
This is consistent with Auditing Standard No. 16, which anticipates 
timely and robust communications between the auditor and the audit 
committee throughout the audit. These communications also provide an 
opportunity for the auditor to corroborate the information obtained 
from management regarding the company's relationships and transactions 
with its related parties.
    The communication required by paragraph 19 of the standard provides 
an opportunity for the auditor to communicate information obtained 
during the audit relevant to those earlier inquiries pursuant to 
paragraph 7. For example, the auditor might discuss relationships or 
transactions with related parties that are significant to the company 
that were not previously discussed with the audit committee, or its 
chair. The auditor also would communicate significant matters to the 
audit committee if the auditor encountered these matters during the 
review of interim financial information.\104\
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    \104\ See paragraph .34 of AU sec. 722, Interim Financial 
Information.
---------------------------------------------------------------------------

    In all cases, the auditor's communications with the audit committee 
pursuant to paragraph 19 of the standard would cover all the items 
listed in paragraphs 19.a.-e., to the extent applicable. Such 
communications involve matters such as the identification of related 
parties and relationships and transactions with related parties that 
were previously undisclosed to the auditor, which, as described in the 
paragraph below, may be of particular interest and concern to the audit 
committee. Thus, the auditor's communications pursuant to paragraph 19 
are not intended to be done only when an exception is identified by the 
auditor. Doing so would not provide for the proactive communication 
that should occur with the audit committee regarding what the auditor 
found as a result of the auditor's evaluation of the company's 
identification of, accounting for, and disclosure of, its relationships 
and transactions with its related parties. Further, these 
communications cannot be made by management as the communication 
requirements involve communication of the auditor's evaluation of 
certain matters and management is not in a position to communicate the 
auditor's evaluation and views.
    As noted in paragraph 19, the auditor's communications to the audit 
committee may not be limited to only those examples of significant 
matters included in paragraph 19 of the standard. For example, in 
evaluating the company's identification of, accounting for, and 
disclosure of its relationships and transactions with related parties, 
the auditor might identify other significant matters that might be of 
interest to the audit committee, such as concerns over the company's 
process for identifying related parties and relationships and 
transactions with related parties.
    AU sec. 334 does not include specific requirements regarding the 
auditor's communication with the audit committee. Other existing 
auditing standards, however, require that the auditor communicate 
significant matters to the audit committee, including those encountered 
during a review of interim financial information.\105\
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    \105\ See Auditing Standard No. 16 and AU sec. 722.34.

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[[Page 43194]]

Discussion of the Comments Received on Paragraph 19 of the Reproposed 
Standard

    The Board considered all comments received, including the following 
significant comments:
    Communicating Significant Matters: Many commenters recommended 
revising paragraph 19.a. of the reproposed standard to allow for 
additional auditor judgment. Some of these commenters suggested that 
paragraph 19.a. of the reproposed standard be revised to only require 
the communication of ``significant'' related parties or relationship or 
transactions with related parties that were previously undisclosed to 
the auditor.
    The Board considered these comments and believes that communicating 
all related party relationships and transactions previously undisclosed 
to the auditor to the audit committee is beneficial. For example, such 
communications could inform the audit committee of such matters that 
management had previously concealed from the audit committee as well as 
from the auditor. While the auditor determines the impact of the 
identification of a related party relationship or transaction on the 
audit, these communications can inform the audit committee of matters 
that might be important to their oversight of management and the 
financial reporting process. Further, this communication also serves as 
an opportunity to corroborate management's explanation regarding why 
the related party transaction was undisclosed to the auditor.
    Form of the Communications: At the SAG discussion, the point was 
raised as to whether the auditor's communications with the audit 
committee should be communicated in writing or orally. The Board 
considered this comment, noting that paragraph 19 of the standard is 
aligned with the requirements in Auditing Standard No. 16, which 
includes specific requirements on the nature and timing of auditor 
communications with the audit committee. Paragraph 25 of Auditing 
Standard No. 16 states that generally the communications can be made 
orally or in writing.\106\
---------------------------------------------------------------------------

    \106\ Paragraph 25 of Auditing Standard No. 16 also states that 
the auditor must document the communications in the work papers, 
whether such communications took place orally or in writing.
---------------------------------------------------------------------------

    The Board is adopting paragraph 19 of the standard as reproposed.

Amendments to Certain PCAOB Auditing Standards Regarding Significant 
Unusual Transactions

    Significant unusual transactions can present increased risks of 
material misstatement of the financial statements due to fraud or 
error. The amendments regarding significant unusual transactions being 
adopted by the Board improve the existing standards regarding the 
auditor's identification and evaluation of a company's significant 
unusual transactions.
    Many commenters generally supported the Board's efforts to 
strengthen the existing standards regarding significant unusual 
transactions. A few commenters noted that the improvements could have a 
positive impact on audit quality. However, some commenters suggested 
certain revisions to clarify and refine the reproposed amendments 
regarding significant unusual transactions.
    After considering the comments received, the Board is adopting the 
amendments regarding significant unusual transactions substantially as 
reproposed, with certain minor revisions that include:
     Clarifying the Phrase ``Infrequent or Significant Unusual 
Transactions'' in the Amendments to AU sec. 722 (Identifying 
Significant Unusual Transactions): The amendments to Appendix B of AU 
sec. 722 include revisions to clarify that the ``occurrence of 
infrequent transactions'' and the ``occurrence of significant unusual 
transactions'' are separate examples; and
     Clarifying the Auditor's Evaluation of Identified 
Significant Unusual Transactions in the Amendments to Paragraph .67 of 
AU sec. 316 (Evaluating Significant Unusual Transactions): The 
amendments to AU sec. 316.67 include revisions to clarify that, in 
considering the business purpose (or the lack thereof) of the 
significant unusual transaction, the auditor should evaluate whether 
the transaction involves other parties that do not appear to have the 
financial capability to support the transaction without assistance from 
the company, or any related party of the company.
    The following sections describe the amendments regarding 
significant unusual transactions being adopted by the Board and 
existing requirements, as well as discuss the significant comments 
received and Board responses, where applicable. The sections are 
organized by the following topical areas:

 Identifying Significant Unusual Transactions
 Evaluating Significant Unusual Transactions
Identifying Significant Unusual Transactions

Discussion of the Amendments Regarding Identifying Significant Unusual 
Transactions

    The amendments regarding identifying significant unusual 
transactions: (i) align the description of significant unusual 
transactions in the Board's auditing standards; (ii) enhance the 
requirements for identifying a company's significant unusual 
transactions; and (iii) revise and add to the examples of fraud risk 
factors described in AU sec. 316.

Aligning the Descriptions of Significant Unusual Transactions

    Amendments to AU sec. 316.66: The amendments regarding significant 
unusual transactions revise AU sec. 316.66 to describe significant 
unusual transactions as significant transactions that are outside the 
normal course of business for the company or that otherwise appear to 
be unusual due to their timing, size, or nature. This description is 
consistent with the existing description in paragraph 71.g. of Auditing 
Standard No. 12. The amendments to AU sec. 316.66 also state that 
significant unusual transactions may be used to engage in fraudulent 
financial reporting or conceal misappropriation of assets.
    Conforming Amendments: The amendments regarding significant unusual 
transactions also make conforming changes to introduce a uniform 
description of ``significant unusual transaction'' throughout the 
Board's standards. Specifically, the amendments align the terminology 
in: (i) Paragraph 14 of Auditing Standard No. 5, An Audit of Internal 
Control Over Financial Reporting That Is Integrated with An Audit of 
Financial Statements; (ii) paragraph 12 of Auditing Standard No. 9, 
Audit Planning; (iii) paragraph 13 of Auditing Standard No. 12; (iv) 
paragraph 15.c. of Auditing Standard No. 13; (v), paragraph .85.A.2 of 
AU sec. 316; and (vi) AU sec. 722.55.B1.
    In general, the description of a significant unusual transaction 
included in the amendments permits the auditor flexibility in applying 
the description to different companies of different sizes and in 
different industries. The description of a significant unusual 
transaction is designed so that the auditor determines whether a 
transaction is a significant unusual transaction based on the specific 
facts

[[Page 43195]]

and circumstances of the company under audit.
    A significant unusual transaction does not necessarily need to 
occur infrequently. Whether a transaction constitutes a significant 
unusual transaction should be based upon the specific facts and 
circumstances. The timing or frequency of transactions is only one 
element to be considered in determining whether a transaction is a 
significant unusual transaction.

Enhancing Requirements for Identifying Significant Unusual Transactions

    Existing requirements relating to the auditor's consideration of 
fraud in a financial statement audit recognize that during an audit the 
auditor may become aware of significant transactions that are outside 
the normal course of business for the company or that otherwise appear 
to be unusual given the auditor's understanding of the company and its 
environment.\107\ The risk assessment standards also anticipate that 
the auditor might come across significant transactions that are outside 
the normal course of business for the company or that otherwise appear 
to be unusual due to their timing, size, or nature. For example, 
paragraph 71.g. of Auditing Standard No. 12 states that one factor that 
should be evaluated for the auditor's determination of which risks are 
significant risks is whether the risk involves significant transactions 
outside the normal course of business or that otherwise appear to be 
unusual due to their timing, size, or nature.
---------------------------------------------------------------------------

    \107\ See AU secs. 316.66-.67.
---------------------------------------------------------------------------

    The amendments include changes to existing standards that require 
the performance of procedures as part of the auditor's risk assessment 
process to identify significant unusual transactions. As discussed 
below, these procedures include: (i) Inquiring of management and 
others; (ii) understanding controls relating to significant unusual 
transactions; and (iii) taking into account other information obtained 
during the audit.
    Inquiring of Management and Others (Paragraphs 56-57 of Auditing 
Standard No. 12): The amendments regarding significant unusual 
transactions build on existing requirements in Auditing Standard No. 12 
that require the auditor to make inquiries of management and others 
within the company about the risks of material misstatement.\108\ 
Specifically, the amendments regarding significant unusual transactions 
revise paragraph 56.a. of Auditing Standard No. 12 to require the 
auditor to inquire of company management regarding whether the company 
has entered into any significant unusual transactions and, if so, the 
nature, terms, and business purpose (or the lack thereof) of those 
transactions and whether such transactions involved related parties. 
The amendments regarding significant unusual transactions also revise 
paragraphs 56.b. and 56.c. of Auditing Standard No. 12 to require the 
auditor to inquire of the audit committee and internal audit personnel 
(if applicable), respectively, regarding whether the company has 
entered into any significant unusual transactions.
---------------------------------------------------------------------------

    \108\ See paragraphs 56 and 57 of Auditing Standard No. 12.
---------------------------------------------------------------------------

    The amendments regarding significant unusual transactions also 
amend paragraph 57 of Auditing Standard No. 12, which currently 
requires that the auditor inquire of others within the company about 
their views regarding fraud risks and includes the example of employees 
involved in initiating, recording, or processing complex or unusual 
transactions. The amendments add significant unusual transactions as an 
example of a complex or unusual transaction to paragraph 57 of Auditing 
Standard No. 12.
    Inquiring of management and others within the company regarding the 
existence of significant unusual transactions as part of the auditor's 
risk assessment procedures is an important step--but not the only 
step--in the auditor's identification of significant unusual 
transactions. The auditor might determine that there are significant 
unusual transactions despite management's assertion that there are no 
significant unusual transactions (e.g., through other procedures 
performed during the audit, such as reading minutes of the board of 
directors meetings and performing journal entry testing).
    Understanding Controls Relating to Significant Unusual Transactions 
(Paragraph 73A of Auditing Standard No. 12): Auditing Standard No. 12 
requires that the auditor obtain a sufficient understanding of each 
component of internal control over financial reporting to: (i) Identify 
the types of potential misstatements; (ii) assess the factors that 
affect the risks of material misstatement; and (iii) design further 
audit procedures.\109\
---------------------------------------------------------------------------

    \109\ See paragraph 18 of Auditing Standard No. 12.
---------------------------------------------------------------------------

    The amendments regarding significant unusual transactions build on 
the risk assessment standards by adding paragraph 73A to Auditing 
Standard No. 12. That paragraph requires the auditor to obtain an 
understanding of the controls management has established to identify, 
authorize and approve, and account for and disclose, significant 
unusual transactions in the financial statements, if the auditor has 
not already done so when obtaining an understanding of internal 
control, as described in paragraphs 18 through 40, 72, and 73 of 
Auditing Standard No. 12.
    Taking into Account Other Information Obtained During the Audit (AU 
sec. 316.66): The amendments regarding significant unusual transactions 
add a note to AU sec. 316.66 stating that the auditor's identification 
of significant unusual transactions should take into account 
information obtained from: (i) The risk assessment procedures required 
by Auditing Standard No. 12 (e.g., inquiring of management and others, 
obtaining an understanding of the methods used to account for 
significant unusual transactions, and obtaining an understanding of 
internal control over financial reporting), and (ii) other procedures 
performed during the audit (e.g., reading minutes of the board of 
directors meetings and performing journal entry testing).
    Examples of those procedures include:
     Reading minutes of meetings of the board of directors and 
its committees; \110\
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    \110\ See AU sec. 560.12.c. and AU sec. 722.18.a.
---------------------------------------------------------------------------

     Reading periodic and current reports, and other relevant 
company filings with the SEC and other regulatory agencies; \111\
---------------------------------------------------------------------------

    \111\ See paragraph 11 of Auditing Standard No. 12, which 
requires the auditor to consider reading public information about 
the company relevant to the evaluation of the likelihood of material 
financial statement misstatements as part of obtaining an 
understanding of the company.
---------------------------------------------------------------------------

     Inspecting confirmation responses and responses to 
inquiries of the company's lawyers; \112\
---------------------------------------------------------------------------

    \112\ See paragraph .06 of AU sec. 337.
---------------------------------------------------------------------------

     Obtaining an understanding of the company's selection and 
application of accounting principles, including related disclosures 
(e.g., reading accounting policy manuals and technical memoranda 
prepared by or for management); \113\
---------------------------------------------------------------------------

    \113\ See paragraph 7.c. of Auditing Standard No. 12.
---------------------------------------------------------------------------

     Performing analytical procedures during the audit; \114\ 
and
---------------------------------------------------------------------------

    \114\ See paragraphs 46 through 48 of Auditing Standard No. 12.
---------------------------------------------------------------------------

     Performing journal entry testing, including inquiring of 
individuals involved in the financial reporting process about 
inappropriate or unusual activity relating to the processing of journal 
entries and other adjustments as required by existing standards.\115\
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    \115\ See AU secs. 316.58 through 62.

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[[Page 43196]]

    Also, the auditor might identify significant unusual transactions 
when examining information gathered during the audit. For example, an 
auditor might identify a significant unusual transaction by scanning a 
population of invoices for unusual items when determining a sample of 
items to be tested. By doing so, the auditor might identify an unusual 
item in terms of dollar amount, the date on which the item was shipped 
(e.g., on a Sunday when the shipping department is closed), or an 
unusually high concentration of transactions during a given time 
period.
    Appendix A to the standard includes examples of information that 
may be gathered during the audit that could indicate that related 
parties or relationships or transactions with related parties 
previously undisclosed to the auditor might exist. These examples could 
also be helpful in identifying significant unusual transactions.
    The amendments add a second note to AU sec. 316.66 that states that 
the auditor should take into account information that indicates that 
related parties or relationships or transactions with related parties 
previously undisclosed to the auditor might exist when identifying 
significant unusual transactions.
    Also, the amendments to AU sec. 560 require that during the 
``subsequent period'' the auditor inquire regarding whether the company 
has entered into any significant unusual transactions. This could 
inform the auditor's identification of a company's significant unusual 
transactions.
    Improving the auditor's identification of significant unusual 
transactions also can inform the auditor's evaluation of whether the 
company has properly identified its related parties and relationships 
and transactions with related parties, as a significant unusual 
transaction might also be a related party transaction previously 
undisclosed to the auditor.

Revising and Adding to the Examples of Fraud Risk Factors

    The amendments regarding significant unusual transactions also 
revise certain examples of fraud risk factors contained in AU sec. 316. 
For example, AU sec. 316.85A.2 notes that significant related party 
transactions not in the ordinary course of business or with related 
entities not audited or audited by another firm can provide 
opportunities to engage in fraudulent financial reporting. The 
amendments regarding significant unusual transactions separate that 
existing example into two distinct examples, namely: (i) Related party 
transactions that are also significant unusual transactions (e.g., a 
significant related party transaction outside the normal course of 
business); and (ii) significant transactions with related parties whose 
financial statements are not audited or are audited by another firm. 
The amendments also add contractual arrangements lacking a business 
purpose as an example of a fraud risk factor.

Discussion of the Comments Received on the Reproposed Amendments 
Regarding Identifying Significant Unusual Transactions

    The Board considered all comments received, including the following 
significant comments:
    Identifying Significant Unusual Transactions Is the Auditor's 
Responsibility: One commenter noted that the reproposed procedures for 
identifying significant unusual transactions (performing inquiries, 
understanding controls, and taking other information into account) are 
performed as part of the auditor's risk assessment process rather than 
to enable the auditor to perform an initial identification of 
significant unusual transactions--which, in that commenter's view, is 
the role of management. That commenter suggested clarifying that 
management is responsible for identifying the company's significant 
unusual transactions, consistent with the changes regarding a company's 
related parties. Another commenter stated that, as the size and 
complexity of a company increases, the likelihood of an auditor being 
able to identify significant unusual transactions diminishes 
proportionately.
    The Board considered these comments, noting that the determination 
of whether a transaction is a significant unusual transaction is the 
responsibility of the auditor. The auditor takes management's responses 
to inquiries and other procedures into account when identifying 
significant unusual transactions. However, the information provided by 
management is not the sole consideration. The auditor's procedures for 
identifying significant unusual transactions are performed as part of 
the auditor's risk assessment, and the auditor's procedures should be 
sufficient to identify risks of material misstatement of the financial 
statements, based on the size and complexity of the company.
    Clarifying the Phrase ``Infrequent or Significant Unusual 
Transactions'' in the Amendments to AU sec. 722: AU sec. 722.55 
contains examples of situations about which the auditor would 
ordinarily inquire of management when conducting a review of interim 
financial information. A few commenters suggested revisions to clarify 
the reproposed amendment to the tenth bullet of AU sec. 722.55, which 
as reproposed stated ``the occurrence of infrequent or significant 
unusual transactions.'' In response to comments, the Board revised the 
tenth bullet into two separate items: one bullet relating to the 
occurrence of infrequent transactions and the other relating to the 
occurrence of significant unusual transactions.
    The Board is adopting the amendments regarding the identification 
of significant unusual transactions substantially as reproposed, except 
for the revision to AU sec. 722 discussed above.
Evaluating Significant Unusual Transactions

Discussion of the Amendments Regarding Evaluating Significant Unusual 
Transactions

    The amendments regarding the evaluation of significant unusual 
transactions address the following areas: (i) evaluating the business 
purpose (or the lack thereof) of significant unusual transactions; (ii) 
evaluating the accounting and disclosure of significant unusual 
transactions; and (iii) other matters regarding significant unusual 
transactions.

Evaluating the Business Purpose (or the Lack Thereof) of Significant 
Unusual Transactions

    The amendments regarding significant unusual transactions 
strengthen the auditor's evaluation of whether the business purpose (or 
the lack thereof) for significant unusual transactions indicates that 
those transactions were entered into to engage in fraud.
    Existing AU sec. 316.66 requires that once an auditor becomes aware 
of significant unusual transactions, the auditor should gain an 
understanding of the business rationale for such transactions and 
whether that rationale (or the lack thereof) suggests that the 
transaction may have been entered into to engage in fraudulent 
financial reporting or to conceal the misappropriation of assets. 
Existing AU sec. 316.67 identifies several matters that the auditor 
should consider in understanding the business rationale for those 
transactions.
    The amendments build on the existing requirements in AU secs. 
316.66-.67 and include additional

[[Page 43197]]

procedures to more specifically focus the auditor's attention on 
critically evaluating whether the business purpose (or the lack 
thereof) for significant unusual transactions indicates that such 
transactions may have been entered into to engage in fraudulent 
financial reporting or to conceal the misappropriation of assets.
    Those improvements are accomplished through: (i) revisions to AU 
sec. 316.66; (ii) adding AU sec. 316.66A; and (iii) revisions to AU 
sec. 316.67. Each of those amendments is discussed in further detail 
below.
    Revisions to AU sec. 316.66: Because a company might use a 
significant unusual transaction to engage in fraudulent financial 
reporting or to obscure the company's financial position or operating 
results, existing standards require the auditor to perform procedures 
to evaluate significant unusual transactions identified by the auditor 
and discuss the auditor's evaluation of such transactions with the 
audit committee.\116\ The amendments to AU sec. 316.66 are intended to 
improve the auditor's evaluation of significant unusual transactions, 
including the auditor's evaluation of the business purpose (or the lack 
thereof), and whether the transactions have been appropriately 
accounted for and adequately disclosed in the company's financial 
statements, by requiring the auditor to perform specific procedures to 
evaluate significant unusual transactions. Improving the auditor's 
evaluation of significant unusual transactions should also result in a 
more meaningful exchange of information between the auditor and the 
audit committee.
---------------------------------------------------------------------------

    \116\ See AU secs. 316.66-.67 and paragraph 13.d. of Auditing 
Standard No. 16.
---------------------------------------------------------------------------

    Adding AU sec. 316.66A: The amendments regarding evaluating 
significant unusual transactions add a new paragraph to AU sec. 316, 
paragraph AU sec. 316.66A, which requires that the auditor design and 
perform procedures to obtain an understanding of the business purpose 
(or the lack thereof) of each significant unusual transaction that the 
auditor has identified. The procedures include:
    a. Reading the underlying documentation and evaluating whether the 
terms and other information about the transaction are consistent with 
explanations from inquiries and other audit evidence about the business 
purpose (or the lack thereof) of the transaction;
    b. Determining whether the transaction has been authorized and 
approved in accordance with the company's established policies and 
procedures;
    c. Evaluating the financial capability of the other parties with 
respect to significant uncollected balances, loan commitments, supply 
arrangements, guarantees, and other obligations, if any; and
    d. Performing other procedures as necessary depending on the 
identified and assessed risks of material misstatement.
    A footnote to item c. of the amendments to AU sec. 316.66A also 
states that examples of information that might be relevant to the 
auditor's evaluation of the other party's financial capability include, 
among other things, the audited financial statements of the other 
party, reports issued by regulatory agencies, financial publications, 
and income tax returns of the other party, to the extent available.
    Item d. of the amendments to AU sec. 316.66A provides an 
opportunity for the auditor to scale the audit by supplementing the 
basic required procedures with more in-depth procedures commensurate 
with the auditor's evaluation of the company's facts and circumstances. 
Those procedures should: (i) Address the assessed risks of material 
misstatement; (ii) provide an understanding of the business purpose (or 
the lack thereof) that is sufficient to evaluate whether the 
transaction was entered into to commit fraudulent financial reporting 
or misappropriate assets; and (iii) provide the auditor with sufficient 
audit evidence to evaluate whether the financial statement accounting 
and disclosure requirements have been met.
    Examples of other procedures that might be appropriate, depending 
on the nature of the significant unusual transaction and the risks of 
material misstatement of the financial statements, include:
     Inquiring directly of the other party regarding the 
business purpose of the transaction;
     Reading public information regarding the transaction and 
the parties to the transaction, if available;
     Reading the financial statements or other relevant 
financial information obtained from other parties involved in the 
transaction, if available, to understand how the other party accounted 
for the transaction;
     Evaluating the transferability and value of collateral 
provided by the other party, if any;
     Confirming the terms of the transaction with other parties 
with knowledge of the transaction (e.g., banks, guarantors, agents, or 
attorneys), if any; and
     Confirming whether there are any side agreements or other 
arrangements (either written or oral) with the other party.
    The amendments regarding significant unusual transactions were 
designed to establish basic procedures for the auditor to identify and 
evaluate significant unusual transactions and allow the auditor to 
assess risks and respond to risks based on the facts and circumstances, 
including the size and complexity of the company and the assessed 
significance of the identified risks of material misstatement in the 
financial statements.
    Significant unusual transactions, like all transactions, are 
subject to the requirements contained in AU sec. 411.06, which requires 
that the auditor consider whether the substance of a transaction 
differs materially from its form when evaluating whether the financial 
statements have been presented fairly in accordance with the applicable 
financial reporting framework. That evaluation encompasses an 
understanding of the ``business sense'' of material transactions, which 
was referred to in footnote 6 of AU sec. 334.
    Existing standards require that the auditor design and perform 
audit procedures in a manner that addresses the assessed risks of 
material misstatement for each relevant assertion of each significant 
account and disclosure.\117\ This includes designing and performing 
audit procedures in a manner that addresses the assessed risks of 
material misstatement associated with significant unusual transactions. 
The procedures contained in AU sec. 316.66A work in conjunction with 
the procedures that the auditor performs during the audit to address 
the relevant assertions associated with each significant unusual 
transaction.
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    \117\ See also paragraph 8 of Auditing Standard No. 13.
---------------------------------------------------------------------------

    Revisions to AU sec. 316.67: The amendments regarding significant 
unusual transactions also require the auditor to evaluate certain 
matters when evaluating whether the business purpose (or the lack 
thereof) of a significant unusual transaction suggests that the 
transaction may have been entered into to engage in fraudulent 
financial reporting or to conceal the misappropriation of assets. The 
amendments incorporate the list of matters currently in AU sec. 316.67 
and add the following matters:
     The transaction lacks commercial or economic substance, or 
is part of a larger series of connected, linked, or otherwise 
interdependent arrangements

[[Page 43198]]

that lack commercial or economic substance individually or in the 
aggregate (e.g., the transaction is entered into shortly prior to 
period end and is unwound shortly after period end);
     The transaction occurs with a party that falls outside the 
definition of a related party (as defined by the accounting principles 
applicable to that company), with either party able to negotiate terms 
that may not be available for other, more clearly independent, parties 
on an arm's-length basis; \118\ and
---------------------------------------------------------------------------

    \118\ See Section II.C. of Securities Act Release No. 33-8056, 
Commission Statement about Management's Discussion and Analysis of 
Financial Condition and Results of Operations (January 22, 2002), 
http://www.sec.gov/rules/other/33-8056.htm.
---------------------------------------------------------------------------

     The transaction enables the company to achieve certain 
financial targets.
    These additional matters are intended to improve the auditor's 
evaluation of the business purpose (or the lack thereof) for 
significant unusual transactions, including whether they may have been 
entered into to engage in fraudulent financial reporting or to conceal 
the misappropriation of assets. For example, considering whether a 
transaction enables the company to achieve certain financial targets is 
an important consideration when evaluating whether that transaction has 
been entered into to engage in fraudulent financial reporting or to 
conceal the misappropriation of assets. These additional matters also 
represent areas that may be relevant to the auditor's evaluation of 
whether the financial statements contain the information regarding the 
significant unusual transaction essential for a fair presentation in 
conformity with the applicable financial reporting framework.
    Including these additional matters in the auditor's evaluation of a 
significant unusual transaction can also assist the auditor in the 
identification of related parties or relationships or transactions with 
related parties previously undisclosed to the auditor because it 
focuses the auditor on the substance of the relationship or 
transaction. For example, relationships such as those with entities 
managed by former officers, interlocking directors/ownership, 
significant customers and suppliers, competitors, strategic alliances 
or partnerships, or collaborative arrangements could represent matters 
that involve related parties or relationships or transactions with 
related parties previously undisclosed to the auditor. Further, a 
related party could be involved in a significant unusual transaction 
either directly or indirectly, through the use of an intermediary whose 
involvement in the transaction appears to serve no apparent business 
purpose.
    A footnote to AU sec. 316.67 references the requirement, contained 
in paragraph 16 of the standard, that the auditor perform certain 
procedures in circumstances in which the auditor determines that 
related parties or relationships or transactions with related parties 
previously undisclosed to the auditor exist.
Evaluating the Accounting and Disclosure of Significant Unusual 
Transactions
    The amendments add a new paragraph to AU sec. 316, paragraph .67A, 
to require the auditor to evaluate whether significant unusual 
transactions that the auditor has identified have been properly 
accounted for and disclosed in the financial statements. AU sec. 
316.67A further states that this includes evaluating whether the 
financial statements contain the information regarding significant 
unusual transactions essential for a fair presentation in conformity 
with the applicable financial reporting framework. A footnote directs 
the auditor to paragraphs 30 and 31 of Auditing Standard No. 14, which 
address the auditor's evaluation of the presentation of the financial 
statements, including the disclosures.
    A note to AU sec. 316.67A states that, in evaluating whether the 
financial statements contain the information regarding significant 
unusual transactions essential for a fair presentation in accordance 
with the financial reporting framework, the auditor considers 
management's disclosure regarding significant unusual transactions in 
other parts of the company's SEC filing containing the audited 
financial statements in accordance with AU sec. 550, Other Information 
in Documents Containing Audited Financial Statements.
Other Matters Regarding Significant Unusual Transactions
    The amendments regarding significant unusual transactions also make 
a number of other related amendments, including adding a new paragraph, 
paragraph 11A, to Auditing Standard No. 13 and making a conforming 
amendment to Auditing Standard No. 16.
    The new paragraph 11A to Auditing Standard No. 13 reminds auditors 
that significant unusual transactions can affect the risks of material 
misstatement due to error or fraud, and that the auditor should take 
into account the types of potential misstatements that could result 
from significant unusual transactions in designing and performing 
further audit procedures, including procedures performed pursuant to 
the reproposed amendments to AU secs. 316.66-.67A regarding significant 
unusual transactions.
    The amendments regarding significant unusual transactions also 
amend the auditor communication requirements in Auditing Standard No. 
16. The amendments revise paragraph 13.d. of Auditing Standard No. 16 
to refer to the ``business purpose (or the lack thereof)'' instead of 
the ``business rationale'' of a significant unusual transaction. In the 
Board's view improving the auditor's identification and evaluation of 
significant unusual transactions should enhance the quality of the 
auditor's discussions with the audit committee.
Discussion of the Comments Received on the Reproposed Amendments 
Regarding Evaluating Significant Unusual Transactions
    The Board considered all comments received, including the following 
significant comments:
    Clarifying the Auditor's Evaluation of Identified Significant 
Unusual Transactions: One commenter suggested several clarifying 
revisions to the factors in AU sec. 316.67 that are relevant to the 
auditor's evaluation of whether the business purpose (or the lack 
thereof) of a significant unusual transaction indicates that the 
transaction may have been entered into to engage in fraud. For example, 
that commenter suggested revising the fourth bullet to state ``the 
transaction involves other parties that do not appear to have the 
financial capability to support the transaction without assistance from 
the company, or any related party.'' The Board considered these 
suggestions and agrees that emphasizing that a related party might be 
involved in a significant unusual transaction in place of the company 
is an important clarification, and has revised AU sec. 316.67, 
accordingly.
    Understanding Economic Substance Versus Commercial Substance: One 
commenter stated that reproposed AU sec. 316.67 did not distinguish 
``commercial substance'' (a term used in connection with accounting for 
nonmonetary transactions) from ``economic substance'' (a doctrine 
governing all transactions). That commenter suggested revising this 
factor in AU 316.67 so that ``commercial substance'' is understood to 
only refer to nonmonetary transactions. The Board considered this 
comment, noting that the auditor's evaluation does not impose

[[Page 43199]]

accounting requirements on the auditor as the standard and amendments 
follow a ``framework neutral'' approach.
    Understanding ``Financial Targets'': A few commenters suggested 
improving the auditor's evaluation of whether a significant unusual 
transaction enables the company to achieve certain financial targets 
pursuant to AU sec. 316.67, by including required procedures to obtain 
an understanding of the company's financial targets. The Board 
considered these comments noting that the auditor's understanding of a 
company's financial targets is already informed by information obtained 
during the auditor's risk assessment process.\119\ The procedures to 
obtain an understanding of the company's financial relationships and 
transactions with its executive officers required by the other 
amendments to Auditing Standard No. 12 further inform the auditor's 
understanding. The information obtained from such procedures informs 
the auditor's evaluation of whether a company's significant unusual 
transaction enables the company to achieve certain financial targets.
---------------------------------------------------------------------------

    \119\ See paragraphs 16 and 17 of Auditing Standard No. 12.
---------------------------------------------------------------------------

    The Board is adopting the amendments regarding the evaluation of 
significant unusual transactions substantially as reproposed, except 
for the revisions discussed above to AU sec. 316.67 and the addition of 
a reference to paragraph 30 of Auditing Standard No. 14 in footnote 25B 
of AU sec. 316.67A.
Other Amendments to PCAOB Auditing Standards
    The Board is also adopting other amendments to PCAOB auditing 
standards, including: (i) Amendments regarding a company's financial 
relationships and transactions with its executive officers; (ii) other 
new requirements that complement the standard and amendments; and (iii) 
amendments that conform other auditing standards to the standard and 
amendments being adopted by the Board, including conforming amendments 
that revise the references to the Board's superseded auditing standard, 
AU sec. 334.
    After considering the comments received, the Board is adopting the 
other amendments substantially as reproposed. The Board is, however, 
making a number of minor clarifications in response to comments. These 
include:
     Clarifying the Auditor's Inquiries of Management (AU sec. 
560): The amendments to paragraph 12 of AU sec. 560 include revisions 
to clarify that the auditor should inquire regarding both whether there 
have been any changes in the company's related parties and whether 
there have been any significant new related party transactions; and
     Revising the First Illustrative Letter in AU sec. 722 (AU 
sec. 722): The amendments to AU sec. 722 include revisions to clarify 
that the auditor should obtain a representation from management that 
management has provided ``all financial records and related data, 
including the names of all related parties and all relationship and 
transactions with related parties'' whether the auditor is using the 
first illustrative letter or the second illustrative letter contained 
in AU sec. 722.
    The following sections describe the other amendments being adopted 
by the Board and existing requirements, as well as discuss the 
significant comments received and Board responses, including revisions 
made, where applicable. The sections are organized by the following 
areas:
     Auditing Standard No. 12, Identifying and Assessing Risks 
of Material Misstatement
     AU sec. 315, Communications Between Predecessor and 
Successor Auditors
     AU sec. 316, Consideration of Fraud in a Financial 
Statement Audit
     AU sec. 333, Management Representations
     AU sec. 560, Subsequent Events
     AU sec. 722, Interim Financial Information
Auditing Standard No. 12, Identifying and Assessing Risks of Material 
Misstatement
Discussion of the Amendments to Auditing Standard Auditing Standard No. 
12
    In some circumstances, a company's financial relationships and 
transactions with its executive officers can create risks of material 
misstatement that relate pervasively to the financial statements. The 
other amendments to Auditing Standard No. 12 require the auditor to 
perform specific procedures to obtain an understanding of a company's 
financial relationships and transactions with its executive officers as 
part of the auditor's risk assessment.
    As described in the following sections, the other amendments to 
Auditing Standard No. 12: (i) Add a new paragraph, paragraph 10A, to 
Auditing Standard No. 12; (ii) revise paragraph 11 of Auditing Standard 
No. 12; and (iii) make a related conforming amendment to the risk 
assessment standards.
    Paragraph 10A of Auditing Standard No. 12: The other amendments add 
paragraph 10A to Auditing Standard No. 12 to require the auditor to 
perform procedures to obtain an understanding of the company's 
financial relationships and transactions with its executive officers. 
Paragraph 10A states that those procedures should be designed to 
identify risks of material misstatement and should include, but not be 
limited to: (i) Reading the employment and compensation contracts 
between the company and its executive officers; and (ii) reading the 
proxy statements and other relevant company filings with the SEC and 
other regulatory agencies that relate to the company's financial 
relationships and transactions with its executive officers. The other 
amendments are intended to assist the auditor in identifying and 
assessing risks associated with a company's financial relationships and 
transactions with its executive officers. The other amendments 
anticipate that the additional procedures to be performed would 
contribute to the auditor's consideration of fraud in a financial 
statement audit pursuant to AU sec. 316, which recognizes certain 
incentives and pressures on management to commit fraud as examples of 
fraud risk factors.\120\
---------------------------------------------------------------------------

    \120\ See AU sec. 316.85, which provides examples of fraud risk 
factors that could result in incentives and pressures to commit 
fraud, including available information that indicates that 
management's or the board of directors' personal financial situation 
is threatened by the entity's financial performance arising from: 
(i) Significant financial interests in the entity; (ii) significant 
portions of their compensation (e.g., bonuses, stock options, and 
earn-out arrangements) being contingent upon achieving aggressive 
targets for stock price, operating results, financial position, or 
cash flow; or (iii) personal guarantees of debts of the entity.
---------------------------------------------------------------------------

    Performing procedures to obtain an understanding of a company's 
financial relationships and transactions with its executive officers 
assists the auditor in understanding whether those relationships and 
transactions affect the risks of material misstatement.\121\ For

[[Page 43200]]

example, the auditor could consider whether the company's internal 
control over financial reporting is designed and operating to address 
the risk that management might seek accounting results solely to boost 
certain executive officers' compensation. This understanding could also 
assist the auditor in determining areas where management bias might 
occur (for example, certain accounting estimates, including fair value 
measurements).
---------------------------------------------------------------------------

    \121\ For example, a May 2010 academic study that examined SEC 
accounting and auditing enforcement releases from 1998 to 2007 noted 
that the most commonly cited motivations for fraud included the need 
to: (i) Meet external earnings expectations of analysts and others; 
(ii) meet internally set financial targets or make the company look 
better; (iii) conceal the company's deteriorating financial 
condition; (iv) increase the stock price; (v) bolster financial 
position for pending equity or debt financing; (vi) increase 
management compensation through achievement of bonus targets and 
through enhanced stock appreciation; and (vii) cover up assets 
misappropriated for personal gain. That study indicated that the 
chief executive officer and/or chief financial officer were named in 
89 percent of the cases involving fraudulent financial reporting 
brought by the SEC during that period. See M. Beasley, J. Carcello, 
D. Hermanson, and T. Neal, Fraudulent Financial Reporting 1998-2007: 
An Analysis of U.S. Public Companies, Committee of Sponsoring 
Organizations of the Treadway Commission (May 2010) at 3, http://www.coso.org/documents/COSOFRAUDSTUDY2010_001.pdf.
---------------------------------------------------------------------------

    Reading proxy statements and other relevant company filings with 
the SEC that are available to the auditor can provide the auditor with 
relevant information regarding a company's financial relationships and 
transactions with its executive officers that informs the auditor's 
understanding of the company. In addition, the risk assessment 
standards require that the auditor consider reading public information 
about the company, for example, SEC filings.\122\
---------------------------------------------------------------------------

    \122\ See paragraph 11 of Auditing Standard No. 12.
---------------------------------------------------------------------------

    The information obtained regarding a company's financial 
relationships and transactions with its executive officers, in 
conjunction with other information obtained during the risk assessment 
process (e.g., information about company performance measures),\123\ 
could be used to identify account balances that are likely to be 
affected and that could have a significant effect on the financial 
statements. That information could be used by the auditor to identify 
and assess risks of material misstatement due to fraud and to design 
appropriate audit responses. In addition, obtaining an understanding of 
a company's financial relationships and transactions with its executive 
officers could identify information that indicates the existence of 
related party relationships or transactions previously undisclosed to 
the auditor.
---------------------------------------------------------------------------

    \123\ See paragraphs 16 and 17 of Auditing Standard No. 12.
---------------------------------------------------------------------------

    The amendments to paragraph 10A are not intended to call into 
question the policies and procedures of the company with respect to its 
compensation arrangements with executive officers, but rather to assist 
the auditor in identifying and assessing risks of material misstatement 
associated with those financial relationships and transactions. Such 
risks could include unrecognized compensation, self-dealing or other 
conflicts of interest, or possible illegal acts. If present, these 
conditions may call into question the integrity of management's 
representations or represent violations of the company's established 
policies and procedures. In addition, these procedures could identify 
potential instances of management override of internal controls that 
could inform the auditor whether others in the company are willing to 
challenge management or whether management might be dominating others 
in the company.
    The purpose of the procedures in paragraph 10A is to further the 
auditor's risk assessment rather than to require the auditor to 
determine the appropriateness of a company's compensation agreements 
with its executive officers. The amendments would not require the 
auditor to assess the appropriateness of the compensation of executive 
officers. The procedures performed are intended to occur in the context 
of the auditor's process for assessing the risks of material 
misstatement of the company's financial statements.
    The other amendments do not change the existing requirement in 
paragraph 10 of Auditing Standard No. 12 to consider obtaining an 
understanding of compensation arrangements with senior management. The 
population for the procedures required by paragraph 10A of the other 
amendments is the list of ``executive officers,'' as defined in SEC 
Rule 3b-7 or included on Schedule A of Form BD,\124\ while the existing 
requirement in paragraph 11 of Auditing Standard No. 12 continues to 
apply to what may be a larger population of a company's management.
---------------------------------------------------------------------------

    \124\ See Exchange Act Rule 3b-7, 17 CFR 240.3b-7, and Schedule 
A of Form BD. See generally Item 401(b) of Regulation S-K, 17 CFR 
229.401(b).
---------------------------------------------------------------------------

    The term ``senior management'' is not a defined term in Auditing 
Standard No. 12. For certain companies or brokers or dealers, senior 
management might be the same population as its executive officers. 
Further, the individuals the company considers to be its ``senior 
management'' may differ among issuers and among broker-dealers. The 
existing standard anticipates that a company's or broker's or dealer's 
facts and circumstances may affect the composition of its ``senior 
management.'' The auditor could: (i) Gain an understanding of the 
compensation arrangements with a larger group of ``senior management'' 
under Auditing Standard No. 12 in order to obtain an understanding of 
the company and then (ii) perform the procedures under the other 
reproposed amendments regarding the financial arrangements with a 
smaller group of ``executive officers.''
    The other amendments do not require the auditor to evaluate the 
company's identification of its ``executive officers,'' for SEC filing 
and other regulatory purposes. In the Board's view, the SEC rules cited 
in the amendments provide a definition of the term ``executive 
officers'' that provides sufficient direction to auditors.\125\
---------------------------------------------------------------------------

    \125\ See Item 401(b) of Regulation S-K, 17 CFR 229.401(b). For 
a discussion of ``executive officer'' for foreign private issuers, 
see the discussion in this section titled ``Identifying the 
Executive Officers of Foreign Private Issuers.''
---------------------------------------------------------------------------

    Amendments to Paragraph 11: The other amendments also include other 
changes designed to strengthen the auditor's consideration of the risks 
of material misstatement associated with financial relationships and 
transactions with its executive officers.
    For example, the amendments to Auditing Standard No. 12 amend 
paragraph 11 of Auditing Standard No. 12 to require the auditor to 
consider making inquiries regarding the structuring of the company's 
compensation for executive officers to the chair of the compensation 
committee, or the compensation committee's equivalent, and any 
compensation consultants engaged by either the compensation committee 
or the company.
    An auditor performing this inquiry could take into account other 
available audit evidence, such as disclosures in SEC filings that: (i) 
describe the company's compensation policies and practices that present 
material risks to the company \126\ and (ii) disclose fees paid to 
compensation consultants, in certain circumstances.\127\ An auditor 
performing this inquiry could inquire of the audit committee, or its 
chair, regarding its views on executive officer compensation at the 
same time the auditor makes inquiries regarding how the audit committee 
exercises oversight of the company's assessment of fraud risks and the 
establishment of controls to address fraud risks as required by 
paragraph 56.b.(4) of Auditing Standard No. 12.
---------------------------------------------------------------------------

    \126\ See Securities Act Release No. 33-9089, Proxy Disclosure 
Enhancements (December 16, 2009), http://www.sec.gov/rules/final/2009/33-9089.pdf.
    \127\ See Item 407(e)(3)(iii) of Regulation S-K.
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    In addition, the amendments to paragraph 11 of Auditing Standard 
No. 12 also require the auditor to consider performing procedures to 
obtain an understanding of established policies and procedures 
regarding the authorization and approval of executive officer expense 
reimbursements.

[[Page 43201]]

    Based on the auditor's assessment of risk, the auditor might 
determine that additional procedures are necessary. For example, the 
auditor might read available reports from the internal audit function 
that contain an evaluation of the expense report process. In other 
cases, the auditor might determine that it is necessary to inspect 
executive officer expense reimbursement documentation for unusual 
items.
    Conforming Amendment to the Risk Assessment Standards: The other 
amendments include a conforming amendment to Auditing Standard No. 12. 
The change aligns Auditing Standard No. 12 with the requirement in 
paragraph 3 of the standard, which states that the procedures in 
paragraphs 4 through 9 of the standard are performed in conjunction 
with the risk assessment procedures required by Auditing Standard No. 
12. That amendment removes the note to the final bullet of paragraph 10 
of Auditing Standard No. 12.

Discussion of the Comments Received on the Reproposed Amendments to 
Auditing Standard No. 12

    The Board considered all comments received, including the following 
significant comments:
    Revisions Included in Paragraph 10A of the Reproposed Amendments: 
Commenters who commented on the revisions included in paragraph 10A of 
the reproposed amendments to Auditing Standard No. 12 generally were 
supportive of the revisions to the reproposed amendments. Some 
commenters stated that it is sufficiently clear that the auditor: (i) 
should obtain an understanding of the company's financial relationships 
and transactions with its executive officers as part of the auditor's 
risk assessment; and (ii) is not required to assess the appropriateness 
of executive officer compensation. One commenter stated that the 
reproposed amendments addressed their concerns regarding the proposed 
amendments. Another commenter recommended including additional language 
stating that the amendments are not intended to call into question the 
policies and procedures of the company. The Board considered these 
comments and believes that the revisions contained in the reproposed 
amendments sufficiently acknowledge that the auditor is not required to 
assess the appropriateness or reasonableness of compensation 
arrangements with executive officers.
    Alternatives to Reading Each Compensation Arrangement: One 
commenter expressed their support for the auditor to obtain an 
understanding of compensation arrangements with the company's executive 
officers. That commenter suggested including further clarification to 
these amendments, including, for example, considering whether such an 
understanding could be achieved by the auditor assessing the company's 
internal control over such arrangements as opposed to reading each 
compensation arrangement. The Board considered this comment, but noted 
that the purpose of these procedures is to obtain information regarding 
individuals who perform specific functions at the company, as part of 
the auditor's risk assessment. Relying on a company's process may not 
provide the information necessary for the auditor to identify 
incentives and pressures that may result in risks of material 
misstatement. Further, reading the documents underlying the financial 
relationships and transactions with a company's executive officers 
could identify information that indicates that related parties or 
relationships or transactions with related parties previously 
undisclosed to the auditor might exist and also informs the auditor's 
evaluation of whether a significant unusual transaction enables the 
company to achieve financial targets as part of the auditors evaluation 
pursuant to AU sec. 316.67.
    Identifying the ``Executive Officers'' of Foreign Private Issuers: 
One commenter expressed concern that the auditor would need to 
determine which individuals fall within the definition of ``executive 
officers'' if foreign private issuers do not identify ``executive 
officers'' in their filings with the SEC. The Board considered this 
comment and determined not to make revisions.
    The auditor's risk assessment procedures with respect to a 
company's financial relationships and transactions with its executive 
officers begins with the company's identification of its executive 
officers. These procedures do not require the auditor to evaluate the 
company's identification of its executive officers for SEC filing or 
other regulatory purposes. The company's identification of its 
executive officers is generally available from its SEC filings or other 
company information.
    For example, foreign private issuers might identify their executive 
officers in their SEC filings:
     Some foreign private issuers currently disclose their 
``executive officers'' in their filings with the SEC (e.g., some 
foreign private issuers simply disclose ``executive officers'' in Form 
20-F, and some foreign private issuers voluntarily file their annual 
report on Form 10-K and disclose their executive officers).
     Some home country filing requirements require a foreign 
company to determine executive officers using a similar definition to 
Rule 3b-7. For example, in Canada, National Instrument 51-102, 
Continuous Disclosure Obligations states that ``executive officer 
means, for a reporting issuer, an individual who is (a) a chair, vice-
chair or president; (b) a vice-president in charge of a principal 
business unit, division or function including sales, finance or 
production; or (c) performing a policy-making function in respect of 
the issuer.'' Canadian foreign private issuers are also required to 
disclose such individuals in annual information filings with the SEC.
    Further, the individuals comprising a company's ``[d]irectors and 
senior management'' determined pursuant to item F. of the General 
Instructions to Form 20-F would include, among others, those 
individuals who, on the basis of title or policy making function, 
qualify as ``executive officers'' under Rule 3b-7.
    In addition, foreign private issuers might identify their executive 
officers for a number of other reasons, for example:
     If more than 50% of a foreign company's voting securities 
are held by U.S residents, the company must determine its eligibility 
to be a ``foreign private issuer'' by considering, among other things, 
whether the majority of its ``executive officers'' or directors are 
U.S. citizens or residents.\128\
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    \128\ ``Foreign private issuer'' is defined in Rule 405 of 
Regulation C under the Securities Act of 1933 and Rule 3b-4(c) under 
the Exchange Act.
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     A foreign private issuer listed on the New York Stock 
Exchange (``NYSE'') would need to identify its executive officers for 
purposes of complying with Section 303A.12(b), Certification 
Requirements of the NYSE Listed Company Manual, which requires that 
each listed company chief executive officer must promptly notify the 
NYSE in writing after any executive officer of the listed company 
becomes aware of any non-compliance with any applicable provisions of 
Section 303A of the NYSE Listed Company Manual.
    Although the Board did not revise the amendments to Auditing 
Standard No. 12 for this comment, the Board's consideration of this 
comment did prompt a change to the amendments to AU sec. 316.81A to 
include a reference to Item 16F of Form 20-F to remind auditors of 
foreign private issuers of their responsibilities.
    Performing Procedures Relating to Individuals Outside of the 
Company's Executive Officers: Some commenters

[[Page 43202]]

suggested that the auditor's procedures should not be limited to 
``executive officers,'' because compensation arrangements with persons 
outside the definition of ``executive officers'' (e.g., the most highly 
compensated individuals, or individuals holding a material block of 
stock options that are in a position to influence the company) also 
might create incentives and pressures that could create risks of 
material misstatement.
    The Board considered these comments, noting that the intent of the 
amendments was to sharpen the auditor's focus on a company's financial 
relationships and transactions with individuals that could pose 
increased risks of material misstatement because of the ability of 
those individuals to have direct involvement in the company's financial 
reporting. However, the amendments do not change the existing 
requirement that the auditor consider obtaining an understanding of the 
compensation arrangements with what may be a larger group of 
individuals, a company's senior management. The Board agrees that 
financial relationships with individuals outside of a company's 
executive officers also may warrant the auditor's attention. However, 
obtaining an understanding of the compensation arrangements with 
individuals outside of management should be based upon the company's 
facts and circumstances.
    Expanding the Examples of Executive Officer Compensation: One 
commenter suggested including in the amendments a discussion of the 
basic components of many of today's executive compensation plans and 
requiring the auditor to read and understand each of the documents 
underlying those common components. The Board considered this comment 
but did not make changes, noting that the requirement to obtain an 
understanding of the company's financial relationships and transactions 
with its executive officers is intended to provide an overarching 
requirement for the auditor that can be applied to all companies as 
part of the auditor's risk assessment procedures and apply to companies 
of different size and complexity. Additionally, the Board notes that 
the auditor might have an overall understanding of the issues pertinent 
to compensation arrangements with the company's executive officers due 
to the existing responsibility under Auditing Standard No. 12 to 
consider obtaining an understanding of the compensation arrangements 
with the company's senior management.
    The Board is adopting the amendments to Auditing Standard No. 12 as 
reproposed.
AU sec. 315, Communications Between Predecessor and Successor Auditors
Discussion of the Amendments to AU sec. 315
    The Board is adopting amendments to AU sec. 315, Communications 
Between Predecessor and Successor Auditors. AU sec. 315 provides 
guidance on communications between predecessor and successor auditors 
when a change of auditors is in process or has taken place, but does 
not specifically address a company's relationships or transactions with 
its related parties or its significant unusual transactions. AU sec. 
334 notes that determining the existence of relationships with related 
parties requires the application of audit procedures that may include 
inquiring of predecessor auditors concerning their knowledge of 
existing relationships and the extent of management involvement in 
material transactions.\129\
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    \129\ See AU sec. 334.07.g. and AU secs. 9334.12-.13.
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    The amendments to AU sec. 315 require the auditor to make inquiries 
regarding the predecessor auditor's understanding of the company's 
relationships and transactions with related parties and significant 
unusual transactions. The amendments also include within the successor 
auditor's review of the predecessor auditor's working papers any 
documentation regarding relationships and transactions with related 
parties and significant unusual transactions.
    Inquiring of a predecessor auditor regarding the company's 
relationships and transactions with related parties and significant 
unusual transactions can assist the successor auditor in determining 
whether to accept the engagement. Such inquiries also can benefit the 
successor auditor in obtaining an understanding of the company's 
relationships and transactions with its related parties and in 
identifying significant unusual transactions.
    After considering all comments received, the Board is adopting the 
amendments to AU sec. 315 as reproposed.
AU sec. 316, Consideration of Fraud in a Financial Statement Audit
Discussion of the Amendments to AU sec. 316
    The amendments to AU sec. 316 expand the discussion in the standard 
regarding certain audit requirements contained in Section 10A of the 
Exchange Act. The amendments emphasize the auditor's responsibility to 
investigate and disclose possible fraud to management, the audit 
committee and, upon the satisfaction of certain conditions, the SEC, 
consistent with the auditor's responsibility under Section 10A of the 
Exchange Act.
    Improving the auditor's identification and evaluation of 
significant unusual transactions could lead to more instances of 
auditors becoming aware of indications that fraud or another illegal 
act has or may have occurred.
    In addition, the other amendments to AU sec. 316 also add a new 
example of a fraud risk factor, the exertion of dominant influence by 
or over a related party.
    The Board's consideration of the comments received regarding the 
amendments to paragraph 10A of Auditing Standard No. 12, regarding the 
audits of foreign private issuers, prompted a change to the amendments 
to AU sec. 316.81A. Specifically, to assist auditors of foreign private 
issuers with their responsibility when there is a change in a 
registrant's certifying accountants, a reference to Item 16F of Form 
20-F in the amendments to AU sec. 316.81A has been included.
    After considering all comments received, the Board is adopting the 
amendments to AU sec. 316 as reproposed, except for adding a reference 
to Item 16F of Form 20-F to AU sec. 316.81A.
AU sec. 333, Management Representations

Discussion of the Amendments to AU sec. 333

    The amendments to AU sec. 333 require that the auditor obtain 
certain written representations each interim period regarding a 
company's relationships and transactions with its related parties. AU 
sec. 333 currently requires auditors to obtain written representations 
from management for the periods covered by the auditor's report. That 
standard addresses representations covering financial statements; 
completeness of information; recognition, measurement, and disclosure; 
and subsequent events. Additionally, AU sec. 333 currently requires the 
auditor to obtain a representation regarding the recognition, 
measurement, and disclosure of related party transactions.
    The amendments to AU sec. 333.06 require that the auditor obtain 
written representations from management indicating that management has 
disclosed to the auditor the names of all of the company's related 
parties and all relationships and transactions with related parties. 
The standard also amends AU sec. 333.06 to require the

[[Page 43203]]

auditor to obtain a written representation from management that there 
are no side agreements or other arrangements (either written or oral) 
undisclosed to the auditor.
    Side agreements or other arrangements (either written or oral) 
undisclosed to the auditor could represent a risk of material 
misstatement of the financial statements for both related party and 
significant unusual transactions. For example, the lack of an arm's-
length relationship in related party transactions can raise questions 
about whether all transaction terms have been disclosed to the auditor. 
Similarly, significant unusual transactions occurring close to the end 
of the period that pose difficult substance over form questions also 
could involve side agreements or other arrangements undisclosed to the 
auditor. The existence of implicit or informal understandings (either 
written or oral) could have a significant impact on the financial 
accounting and disclosure of relationships and transactions with 
related parties and significant unusual transactions.
    In addition, the amendments to AU sec. 333 require that the auditor 
obtain written representations from management in situations in which 
the financial statements include an assertion by management that 
transactions with related parties were conducted on terms equivalent to 
those prevailing in an arm's-length transaction. This requirement 
complements the auditor's evaluation, required by paragraph 18 of the 
standard, when management has asserted that a transaction with a 
related party was conducted on terms equivalent to those prevailing in 
an arm's-length transaction.
    After considering all comments received, the Board is adopting the 
amendments to AU sec. 333 as reproposed.
AU sec. 560, Subsequent Events

Discussion of the Amendments to AU sec. 560

    AU sec. 560 currently requires the auditor to perform auditing 
procedures with respect to the period after the balance-sheet date for 
the purpose of ascertaining the occurrence of subsequent events that 
may require adjustment or disclosure essential to a fair presentation 
of the financial statements in conformity with generally accepted 
accounting principles.\130\ AU sec. 560 currently does not require the 
auditor to inquire regarding the company's relationships and 
transactions with its related parties and its significant unusual 
transactions.
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    \130\ See AU sec. 560.12.
---------------------------------------------------------------------------

    The amendments to AU sec. 560.12 require that during the 
``subsequent period'' the auditor inquire regarding related party 
transactions and significant unusual transactions. Events or 
transactions that occur subsequent to the balance sheet date, but prior 
to the issuance of the financial statements, may have a material effect 
on the financial statements. Making specific inquiries during the 
``subsequent period'' regarding a company's relationships and 
transactions with its related parties and its significant unusual 
transactions can benefit the auditor's identification of matters that 
might require disclosure in the financial statements.

Discussion of the Comments Received on the Reproposed Amendments to AU 
sec. 560

    The Board considered all comments received, including the following 
significant comment:
    Clarifying the Auditor's Inquiries of Management: One commenter 
recommended revising the inquiry in item v. of the reproposed 
amendments to AU sec. 560.12 to clarify that there are two separate 
inquiries. The Board considered this comment and in the interest of 
clarity, revised the reproposed amendments to place each inquiry into a 
separate bullet.
    The Board is adopting the amendments to AU sec. 560 substantially 
as reproposed, with the clarifying change noted above.
AU sec. 722, Interim Financial Information

Discussion of Amendments to Auditing Standard No. 12

    AU sec. 722 currently requires the auditor to inquire of management 
that has responsibility for financial and accounting matters concerning 
unusual or complex matters that might have an effect on the interim 
financial information. Generally, the amendments to AU sec. 722 require 
that the auditor obtain certain written representations each interim 
period regarding a company's relationships and transactions with its 
related parties. The other amendments revise AU sec. 722 to be 
consistent with the amendments to AU sec. 333 that require the auditor 
to obtain written representations each interim period regarding the 
company's related parties and the absence of side agreements or other 
arrangements.

Discussion of the Comments Received on the Reproposed Amendments to AU 
sec. 722

    The Board considered all comments received, including the following 
significant comment:
    Revising the First Illustrative Letter in AU sec. 722: One 
commenter recommended that a change that had been made in the 
reproposal to expand item 2.a. of the second illustrative letter of AU 
sec. 722 should also be made to the corresponding item in the first 
illustrative representation letter. That commenter recommended that 
item 2.a. in the first illustrative letter be revised to state that 
management has made available to the auditor ``all financial records 
and related data, including the names of all related parties and all 
relationships and transactions with related parties.'' The Board 
considered this comment and made the revisions suggested by the 
commenter so that the letters were consistent.
    The Board is adopting the amendments to AU sec. 722 substantially 
as reproposed, with the clarification discussed above.
Audits of Brokers and Dealers
    Section 982 of the Dodd-Frank Wall Street Reform and Consumer 
Protection Act \131\ provided the Board with oversight authority with 
respect to audits of brokers and dealers that are registered with the 
SEC. On July 30, 2013, the SEC adopted amendments to SEC Rule 17a-5 
under the Exchange Act to require, among other things, that audits of 
brokers' and dealers' financial statements be performed in accordance 
with the standards of the PCAOB for fiscal years ending on or after 
June 1, 2014.\132\
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    \131\ Public Law 111-203, 124 Stat. 1376 (July 21, 2010).
    \132\ See Rule 17a-5, 17 CFR 240.17a-5 SEC, Broker-Dealer 
Reports, Exchange Act Release No. 34-70073, (July 30, 2013), 78 
Federal Register 51910 (August 21, 2013), http://www.sec.gov/rules/final/2013/34-70073.pdf.
---------------------------------------------------------------------------

    In its reproposal, the Board solicited comment regarding whether 
there were specific issues relating to audits of brokers and dealers of 
which the Board should be aware. Commenters did not provide examples of 
specific audit issues, but did provide views on the applicability of 
the standard and amendments to audits of brokers and dealers. For 
example, many commenters stated that the reproposed standard and 
amendments should apply to audits of brokers and dealers and provided 
various rationales. Some commenters noted that the financial reporting 
risks that the reproposal is designed to target also exist at these 
entities and in some

[[Page 43204]]

cases more prevalently. Other commenters noted that the scalability of 
the standard and amendments allow the auditor to focus on the specifics 
of the company, making the standard and amendments appropriate for 
audits of brokers and dealers.
    Further, at the May 17, 2012 SAG meeting, the point was raised that 
a robust auditing standard on related parties was important for both 
regulators of brokers and dealers and for users of their financial 
statements. Several scenarios were discussed by which related party 
transactions might be improperly used by brokers and dealers, including 
scenarios where the brokers and dealers could use related party 
transactions to: (i) Overpay for goods and services and disguise 
capital withdrawals; (ii) avoid the imposition of higher capital 
requirements and capital charges; (iii) structure a broker's or 
dealer's business model to appear smaller; and (iv) transfer customer 
assets to parties that are not approved custodians.
    Additionally, the results of the Board's oversight activities 
regarding audits of brokers and dealers have identified deficiencies 
regarding the auditor's efforts in the area of related parties, 
suggesting that this is an area warranting heightened scrutiny.\133\
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    \133\ See The Report on the Progress of the Interim Inspection 
Program Related to Audits of Brokers and Dealers (August 20, 2012) 
and the Second Report on the Progress of the Interim Inspection 
Program Related to Audits of Brokers and Dealers (August 19, 2013).
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    The standard and amendments, if approved by the SEC, will be 
applicable to all audits performed pursuant to PCAOB standards, 
including audits of brokers and dealers.
Effective Date
    The Board determined that the 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, 
including reviews of interim financial information within those fiscal 
years.
    In determining the effective date, the Board considered the 
comments received. Many commenters noted that the effective date in the 
reproposing release was reasonable, if the final standard and 
amendments were approved three to four months prior to the effective 
date contemplated in the reproposing release. Those commenters 
generally indicated that this would have allowed sufficient time for 
firms to incorporate the new requirements into their methodologies, 
guidance, audit programs, and staff training. Given the date of the 
adoption of the standard and amendments, the Board determined that the 
standard and amendments should be applicable, subject to SEC approval, 
to audits of financial statements for fiscal years beginning on or 
after December 15, 2014.
    One commenter recommended that the amendments to AU sec. 722 become 
effective in the first interim period following the first annual period 
that the standard and amendments are effective. The Board considered 
this comment but noted that the amendments to AU sec. 722, which 
encompass inquiries of and representations from management, are 
designed to complement the standard and amendments. Performing those 
procedures for reviews of interim financial information during the 
first year of implementation (the fiscal year beginning on or after 
December 15, 2014) can inform the auditor's efforts in these critical 
areas for the audit performed during the first year of implementation.

2. Comparison of the Objective and Key Requirements of the Proposed 
Rules With the Analogous Standards of the International Auditing and 
Assurance Standards Board and the Auditing Standards Board of the 
American Institute of Certified Public Accountants

Introduction
    This comparison, which was prepared for informational purposes 
only, compares certain significant differences between the objective 
and certain key requirements of the standard and amendments with the 
analogous standards of the IAASB and the ASB of the AICPA.
    This comparison is not a summary of, or a substitute for, the 
standard or the amendments. This comparison may not represent the views 
of the IAASB or the ASB regarding the interpretations of their 
standards.
    The analogous standards of the IAASB discussed in this comparison 
include:
     International Standard on Auditing 550, Related Parties 
(``ISA 550'');
     International Standard on Auditing 210, Agreeing the Terms 
of Audit Engagements (``ISA 210'');
     International Standard on Auditing 240, The Auditor's 
Responsibilities Relating to Fraud in an Audit of Financial Statements 
(``ISA 240'');
     International Standard on Auditing 315, Identifying and 
Assessing the Risks of Material Misstatement through Understanding the 
Entity and Its Environment (``ISA 315'');
     International Standard on Auditing 510, Initial Audit 
Engagements-Opening Balances (``ISA 510'');
     International Standard on Auditing 560, Subsequent Events 
(``ISA 560'');
     International Standard on Auditing 580, Written 
Representations (``ISA 580'');
     International Standard on Auditing 600, Special 
Considerations--Audits of Group Financial Statements (Including the 
Work of Component Auditors) (``ISA 600''); and
     International Standard on Review Engagements 2410, Review 
of Interim Financial Information Performed by the Independent Auditor 
of the Entity, (``ISRE 2410'').
    The analogous standards of the ASB discussed in this comparison 
include:
     AU-C Section 550, Related Parties (``AU-C Section 550'');
     AU-C Section 210, Terms of Engagement (``AU-C Section 
210'');
     AU-C Section 240, Consideration of Fraud in a Financial 
Statement Audit (``AU-C Section 240'');
     AU-C Section 315, Understanding the Entity and Its 
Environment and Assessing the Risks of Material Misstatement (``AU-C 
Section 315'');
     AU-C Section 510, Opening Balances--Initial Audit 
Engagements, Including Reaudit Engagements (``AU-C Section 510'');
     AU-C Section 560, Subsequent Events and Subsequently 
Discovered Facts (``AU-C Section 560'');
     AU-C Section 580, Written Representations (``AU-C Section 
580'');
     AU-C Section 600, Special Considerations--Audits of Group 
Financial Statements (Including the Work of Component Auditors) (``AU-C 
Section 600''); and
     AU-C Section 930, Interim Financial Information (``AU-C 
Section 930'').\134\
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    \134\ These AU-C sections are contained in Statement on Auditing 
Standards No. 122, Statement on Auditing Standards: Clarification 
and Recodification (``SAS No. 122''). In October 2011, the ASB 
adopted SAS No. 122, which contains 39 clarified SASs with ``AU-C'' 
section numbers for each clarified SAS. The ``AU-C'' is a temporary 
identifier to avoid confusion with references to existing ``AU'' 
sections in AICPA Professional Standards.
---------------------------------------------------------------------------

    This comparison is organized in the following sections: The 
auditing standard; the amendments regarding significant unusual 
transactions; and the other amendments to PCAOB auditing 
standards.\135\ This comparison does not

[[Page 43205]]

cover the application and explanatory material in the analogous 
standards of the IAASB or ASB.\136\
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    \135\ This comparison does not cover the requirements contained 
in the risk assessment standards. Appendix 11 of PCAOB Release No. 
2010-004, Auditing Standards Related to Auditor's Assessment of and 
Response to Risk and Related Amendments to PCAOB Standards, contains 
a comparison of the objectives and requirements of those standards 
with the analogous standards of the IAASB and the ASB.
    \136\ Paragraph A59 of International Standard on Auditing 200, 
Overall Objectives of the Independent Auditor and the Conduct of an 
Audit in Accordance with International Standards on Auditing, states 
that the Application and Other Explanatory Material section of the 
ISAs ``does not in itself impose a requirement,'' but ``is relevant 
to the proper application of the requirements of an ISA.'' Paragraph 
A63 of AU-C Section 200, Overall Objectives of the Independent 
Auditor and the Conduct of an Audit in Accordance with Generally 
Accepted Auditing Standards, states that although application and 
other explanatory material ``does not in itself impose a 
requirement, it is relevant to the proper application of the 
requirements of an AU-C section.''
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Auditing Standard, Related Parties
Introduction (Paragraph 1 of the Standard)
PCAOB
    The standard refers auditors to the requirements of the SEC for the 
company under audit with respect to the accounting principles 
applicable to that company, including the definition of the term 
``related parties,'' and the financial statement disclosure 
requirements with respect to related parties. The standard does not 
include a definition for an arm's-length transaction.
IAASB
    Paragraph 10(b) of ISA 550 defines a related party as a party that 
is either:
    i. A related party as defined in the applicable financial reporting 
framework; or
    ii. Where the applicable financial reporting framework establishes 
minimal or no related party requirements:
    a. A person or other entity that has control or significant 
influence, directly or indirectly through one or more intermediaries, 
over the reporting entity;
    b. Another entity over which the reporting entity has control or 
significant influence, directly or indirectly through one or more 
intermediaries; or
    c. Another entity that is under common control with the reporting 
entity through having:
    (i) Common controlling ownership;
    (ii) Owners who are close family members; or
    (iii) Common key management.
    However, entities that are under common control by a state (that 
is, a national, regional or local government) are not considered 
related unless they engage in significant transactions or share 
resources to a significant extent with one another.
    ISA 550 also defines an arm's-length transaction as a transaction 
conducted on such terms and conditions as between a willing buyer and a 
willing seller who are unrelated and are acting independently of each 
other and pursuing their own best interests.
ASB
    AU-C Section 550 defines a related party as that term is defined in 
generally accepted accounting principles. AU-C Section 550 also 
contains a definition of arm's-length transaction that is similar to 
the definition in ISA 550.
    Objective (Paragraph 2 of the Standard)
PCAOB
    Paragraph 2 of the standard states that 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.
IAASB
    Paragraph 9 of ISA 550 states that the objectives of the auditor 
are:
    (a) Irrespective of whether the applicable financial reporting 
framework establishes related party requirements to obtain an 
understanding of related party relationships and transactions 
sufficient to be able:
    i. To recognize fraud risk factors, if any, arising from related 
party relationships and transactions that are relevant to the 
identification and assessment of the risks of material misstatement due 
to fraud; and
    ii. To conclude, based on the audit evidence obtained, whether the 
financial statements, insofar as they are affected by those 
relationships and transactions:
    a. Achieve fair presentation (for fair presentation frameworks); or
    b. Are not misleading (for compliance frameworks); and
    (b) In addition, where the applicable financial reporting framework 
establishes related party requirements, to obtain sufficient 
appropriate audit evidence about whether related party relationships 
and transactions have been appropriately identified, accounted for and 
disclosed in the financial statements in accordance with the framework.
ASB
    Paragraph 9 of AU-C Section 550 contains a similar objective to the 
objective in ISA 550 for fair presentation frameworks.
Performing Risk Assessment Procedures To Obtain an Understanding of the 
Company's Relationships and Transactions With Its Related Parties 
(Paragraphs 3-9 of the Standard)
PCAOB
    Paragraph 3 of the standard requires that the auditor perform 
procedures to obtain an understanding of the company's relationships 
and transactions with its related parties that might reasonably be 
expected to affect the risks of material misstatement of the financial 
statements in conjunction with performing risk assessment procedures in 
accordance with Auditing Standard No. 12, Identifying and Assessing 
Risks of Material Misstatement. Paragraph 3 of the standard states that 
the procedures performed to obtain an understanding of the company's 
relationships and transactions with its related parties include:
    a. Obtaining an understanding of the company's process (paragraph 
4);
    b. Performing inquiries (paragraphs 5-7); and
    c. Communicating with the audit engagement team and other auditors 
(paragraphs 8-9).
    A note to paragraph 3 of the standard states that obtaining an 
understanding of the company's relationships and transactions with its 
related parties includes obtaining an understanding of the nature of 
the relationships between the company and its related parties and of 
the terms and business purposes (or the lack thereof) of the 
transactions involving related parties.
    Another note to paragraph 3 of the standard states that performing 
the risk assessment procedures described in paragraphs 4-9 of the 
standard in conjunction with the risk assessment procedures required by 
Auditing Standard No. 12 is intended to provide the auditor with a 
reasonable basis for identifying and assessing risks of material 
misstatement associated with related parties and relationships and 
transactions with related parties.
IAASB
    Paragraph 11 of ISA 550 states that as part of the risk assessment 
procedures and related activities required by ISA 315 and ISA 240, the 
auditor shall perform the audit procedures and related activities set 
out in paragraphs 12-17 of ISA 550 to obtain information relevant to 
identifying the risks of material misstatement associated with related 
party relationships and transactions.

[[Page 43206]]

ASB
    AU-C Section 550 contains similar requirements to those in ISA 550.

Obtaining an Understanding of the Company's Process (Paragraph 4 of the 
Standard)

PCAOB
    Paragraph 4 of the standard requires that in conjunction with 
obtaining an understanding of internal control over financial 
reporting, the auditor obtain an understanding of the company's process 
for:
    a. Identifying related parties and relationships and transactions 
with related parties;
    b. Authorizing and approving transactions with related parties; and
    c. Accounting for and disclosing relationships and transactions 
with related parties in the financial statements.
IAASB
    Paragraph 14 of ISA 550 requires that the auditor shall inquire of 
management and others within the entity, and perform other risk 
assessment procedures considered appropriate, to obtain an 
understanding of the controls, if any, that management has established 
to:
    a. Identify, account for, and disclose related party relationships 
and transactions in accordance with the applicable financial reporting 
framework;
    b. Authorize and approve significant transactions and arrangements 
with related parties; and
    c. Authorize and approve significant transactions and arrangements 
outside the normal course of business.
ASB
    Paragraph 15 of AU-C Section 550 contains similar requirements to 
those in ISA 550.

Performing Inquiries (Paragraphs 5-7 of the Standard)

PCAOB
    Paragraph 5 of the standard requires the auditor to 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.
    Paragraph 6 of the standard requires the auditor to inquire of 
others within the company regarding their knowledge of the matters in 
paragraph 5 of the standard. Paragraph 6 also requires the auditor 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:
    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.
    Paragraph 7 of the standard requires the auditor to inquire of the 
audit committee, or its chair, 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.
IAASB
    Paragraph 13 of ISA 550 requires the auditor to inquire of 
management regarding:
    a. The identity of the entity's related parties, including changes 
from the prior period;
    b. The nature of the relationships between the entity and these 
related parties; and
    c. Whether the entity entered into any transactions with these 
related parties during the period and, if so, the type and purpose of 
the transactions.
ASB
    Paragraph 14 of AU-C Section 550 contains similar requirements to 
those in ISA 550.
Identifying and Assessing Risks of Material Misstatement (Paragraph 10 
of the Standard)
PCAOB
    Paragraph 10 of the standard aligns with the existing requirements 
for the auditor to identify and assess the risks of material 
misstatement at the financial statement level and the assertion level. 
Paragraph 10 states that this includes identifying and assessing the 
risks of material misstatement associated with related parties and 
relationships and transactions with related parties, including whether 
the company has properly identified, accounted for, and disclosed its 
related parties or relationships or transactions with related parties. 
Paragraph 59 of Auditing Standard No. 12 requires that the auditor 
identify which risks are significant risks. Further, paragraph 71 of 
Auditing Standard No. 12 provides factors that the auditor should 
evaluate in determining which risks are significant risks. Those 
factors include: (i) whether the risk involves significant transactions 
with related parties; (ii) whether the risk involves significant 
transactions that are outside the normal course of business; and (iii) 
whether the risk is a fraud risk. The amendments regarding significant 
unusual transactions revise paragraph .85A.2 of AU sec. 316, 
Consideration of Fraud in a Financial Statement Audit, to state that a 
related party transaction that is also a significant unusual 
transaction (e.g., a significant related party transaction outside the 
normal course of business) is an example of a fraud risk factor.
    A note to paragraph 10 of the standard states that, in identifying 
and assessing the risks of material misstatement associated with 
related parties and relationships and transactions with related 
parties, the auditor should take into account the information obtained 
from performing the procedures in paragraphs 4-9 of the standard and 
from performing the risk assessment procedures required by Auditing 
Standard No. 12.
IAASB and ASB
    Paragraph 18 of ISA 550 and paragraph 19 of AU-C Section 550 
require that the auditor identify and assess the risks of material 
misstatement associated with related party relationships and 
transactions and determine whether any of those risks are

[[Page 43207]]

significant risks. ISA 550 and AU-C Section 550 require the auditor to 
treat identified significant related party transactions outside the 
normal course of business as giving rise to significant risks.
Responding to the Risks of Material Misstatement (Paragraphs 11-13 of 
the Standard)
PCAOB
    Paragraph 11 of the standard aligns with existing requirements that 
the auditor design and implement audit responses that address the 
identified and assessed risks of material misstatement. Paragraph 11 of 
the standard states that this includes designing and performing audit 
procedures in a manner that addresses the risks of material 
misstatement associated with related parties and relationships and 
transactions with related parties.
    A note to paragraph 11 of the standard states that the auditor 
should look to the requirements of AU secs. 316.66-.67A for related 
party transactions that are also significant unusual transactions (for 
example, significant related party transactions outside the normal 
course of business). That note further states that for such related 
party transactions, AU sec. 316.67 requires that the auditor evaluate 
whether the business purpose (or the lack thereof) of the transactions 
indicates that the transactions may have been entered into to engage in 
fraudulent financial reporting or conceal misappropriation of assets.
IAASB
    Paragraph 20 of ISA 550 requires that the auditor designs and 
performs further audit procedures to obtain sufficient appropriate 
audit evidence about the assessed risks of material misstatement 
associated with related party relationships and transactions. These 
audit procedures shall include those required by paragraphs 21-24 of 
ISA 550.
ASB
    Paragraph 21 of AU-C Section 550 contains similar requirements to 
those in ISA 550.
Transactions With Related Parties Required to Be Disclosed in the 
Financial Statements or Determined to Be a Significant Risk (Paragraph 
12 of the Standard)
PCAOB
    Paragraph 12 of the standard requires that for each related party 
transaction that is either required to be disclosed in the financial 
statements or determined to be a significant risk, the auditor should:
    a. Read the underlying documentation and evaluate whether the terms 
and other information about the transaction are consistent with 
explanations from inquiries and other audit evidence about the business 
purpose (or the lack thereof) of the transaction;
    b. Determine whether the transaction has been authorized and 
approved in accordance with the company's established policies and 
procedures regarding the authorization and approval of transactions 
with related parties;
    c. Determine whether any exceptions to the company's established 
policies or procedures were granted;
    d. Evaluate the financial capability of the related parties with 
respect to significant uncollected balances, loan commitments, supply 
arrangements, guarantees, and other obligations, if any; and
    e. Perform other procedures as necessary to address the identified 
and assessed risks of material misstatement.
    A note to paragraph 12 of the standard states that the applicable 
financial reporting framework may allow the aggregation of similar 
related party transactions for disclosure purposes. If the company has 
aggregated related party transactions for disclosure purposes in 
accordance with the applicable financial reporting framework, the 
auditor may perform the procedures in paragraph 12 for only a selection 
of transactions from each aggregation of related party transactions 
(versus all transactions in the aggregation), commensurate with the 
risks of material misstatement.
IAASB
    Paragraph 23 of ISA 550 requires that for identified significant 
related party transactions outside the entity's normal course of 
business, the auditor shall:
    a. Inspect the underlying contracts or agreements, if any, and 
evaluate whether:
    i. The business rationale (or lack thereof) of the transactions 
suggests that they may have been entered into to engage in fraudulent 
financial reporting or to conceal misappropriation of assets;
    ii. The terms of the transactions are consistent with management's 
explanations; and
    iii. The transactions have been appropriately accounted for and 
disclosed in accordance with the applicable financial reporting 
framework; and
    b. Obtain audit evidence that the transactions have been 
appropriately authorized and approved.
ASB
    Paragraph 24 of AU-C Section 550 contains similar requirements to 
those in ISA 550.
Evaluating Whether the Company Has Properly Identified Its Related 
Parties and Relationships and Transactions With Related Parties 
(Paragraphs 14-16 of the Standard)
PCAOB
    Paragraph 14 of the standard requires that the auditor evaluate 
whether the company has properly identified its related parties and 
relationships and transactions with related parties. Evaluating whether 
a company has properly identified its related parties and relationships 
and transactions with related parties involves more than assessing the 
process used by the company. This evaluation requires the auditor to 
perform procedures to test the accuracy and completeness of the related 
parties and relationships and transactions with related parties 
identified by the company, taking into account information gathered 
during the audit. Paragraph 14 requires that as part of that 
evaluation, the auditor should read minutes of the meetings of 
stockholders, directors, and committees of directors, or summaries of 
actions of recent meetings for which minutes have not yet been 
prepared.
    A note to paragraph 14 of the standard states that Appendix A 
contains examples of information and sources of information that may be 
gathered during the audit that could indicate that related parties or 
relationships or transactions with related parties previously 
undisclosed to the auditor might exist.
    Other PCAOB auditing standards might impose requirements relating 
to the sources of information that could indicate that related parties 
or relationships or transactions with related parties previously 
undisclosed to the auditor might exist (e.g., reading confirmation 
responses and responses to inquiries of the company's lawyers).\137\
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    \137\ See, e.g., AU sec. 330, The Confirmation Process, and AU 
sec. 337, Inquiry of a Client's Lawyer Concerning Litigation, 
Claims, and Assessments.
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    Paragraph 15 of the standard requires that if the auditor 
identifies information that indicates that related parties or 
relationships or transactions with related parties previously 
undisclosed to the auditor might exist, the auditor should perform the 
procedures necessary to determine whether previously undisclosed 
relationships or transactions with related parties, in fact, exist. 
Paragraph 15 also states that those

[[Page 43208]]

procedures should extend beyond inquiry of management.
    Paragraph 16 of the standard describes the procedures that the 
auditor is required to perform if the auditor determines that a related 
party or relationship or transaction with a related party previously 
undisclosed to the auditor exists. Paragraph 16 of the standard 
requires that the auditor:
    a. Inquire of management regarding the existence of the related 
party or relationship or transaction with a related party previously 
undisclosed to the auditor and the possible existence of other 
transactions with the related party previously undisclosed to the 
auditor;
    b. Evaluate why the related party or relationship or transaction 
with a related party was previously undisclosed to the auditor;
    c. Promptly communicate to appropriate members of the engagement 
team and other auditors participating in the audit engagement relevant 
information about the related party or relationship or transaction with 
the related party;
    d. Assess the need to perform additional procedures to identify 
other relationships or transactions with the related party previously 
undisclosed to the auditor;
    e. Perform the procedures required by paragraph 12 of the standard 
for each related party transaction previously undisclosed to the 
auditor that is required to be disclosed in the financial statements or 
determined to be a significant risk;
    f. Perform the following procedures, taking into account the 
information gathered from performing the procedures in a. through e. 
above:
    (i) Evaluate the implications on the auditor's assessment of 
internal control over financial reporting, if applicable;
    (ii) Reassess the risk of material misstatement and perform 
additional procedures as necessary if such reassessment results in a 
higher risk; and
    (iii) Evaluate the implications for the audit if management's 
nondisclosure to the auditor of a related party or relationship or 
transaction with a related party indicates that fraud or an illegal act 
may have occurred. If the auditor becomes aware of information 
indicating that fraud or another illegal act has occurred or might have 
occurred, the auditor must determine his or her responsibilities under 
AU secs. 316.79-.82, AU sec. 317, Illegal Acts by Clients, and Section 
10A of the Securities Exchange Act of 1934, 15 U.S.C. 78j-1.
IAASB and ASB
    Paragraph 15 of ISA 550 requires the auditor to remain alert, 
during the audit, when inspecting records or documents, for 
arrangements or other information that may indicate the existence of 
related party relationships or transactions that management has not 
previously identified or disclosed to the auditor. Paragraph 15 of ISA 
550 further requires that, in particular, the auditor inspect the 
following for indications of the existence of related party 
relationships or transactions that management has not previously 
identified or disclosed to the auditor:
    (a) Bank and legal confirmations obtained as part of the auditor's 
procedures;
    (b) Minutes of meetings of shareholders and of those charged with 
governance; and
    (c) Such other records and documents as the auditor considers 
necessary in the circumstances of the entity.
    Paragraph 21 of ISA 550 requires that if the auditor identifies 
arrangements or information that suggests the existence of related 
party relationships or transactions that management has not previously 
identified or disclosed to the auditor, the auditor shall determine 
whether the underlying circumstances confirm the existence of those 
relationships and transactions.
    Paragraph 22 of ISA 550 requires that if the auditor identifies 
related parties or significant related party transactions that 
management has not previously identified or disclosed to the auditor, 
the auditor shall:
    a. Promptly communicate the relevant information to the other 
members of the engagement team;
    b. Where the applicable financial reporting framework establishes 
related party requirements;
    (i) Request management to identify all transactions with the newly 
identified related parties for the auditor's further evaluation;
    (ii) Inquire as to why the entity's controls over related party 
relationships and transactions failed to enable the identification or 
disclosure of the related party relationships or transactions;
    c. Perform appropriate substantive audit procedures relating to 
such newly identified related parties or significant related party 
transactions;
    d. Reconsider the risk that other related parties or significant 
related party transactions may exist that management has not previously 
identified or disclosed to the auditor and perform additional audit 
procedures as necessary; and
    e. If the nondisclosure by management appears intentional (and 
therefore indicative of a risk of material misstatement due to fraud), 
evaluate the implications for the audit.
ASB
    AU-C Section 550 contains similar requirements to those in ISA 550.
Evaluating Financial Statement Accounting and Disclosures (Paragraphs 
17-18 of the Standard)
PCAOB
    Paragraph 17 of the standard aligns with the existing requirement 
that the auditor evaluate whether related party transactions have been 
properly accounted for and disclosed in the financial statements. 
Paragraph 17 states that this includes evaluating whether the financial 
statements contain the information regarding relationships and 
transactions with related parties essential for a fair presentation in 
conformity with the applicable financial reporting framework.
IAASB
    Paragraph 25 of ISA 550 requires that in forming an opinion on the 
financial statements, the auditor shall evaluate:
    a. Whether the identified related party relationships and 
transactions have been appropriately accounted for and disclosed in 
accordance with the applicable financial reporting framework; and
    b. Whether the effects of the related party relationships and 
transactions:
    (i) Prevent the financial statements from achieving fair 
presentation (for fair presentation frameworks); or
    (ii) Cause the financial statements to be misleading (for 
compliance frameworks).
ASB
    Paragraph 26 of AU-C Section 550 contains similar requirements to 
the requirements in ISA 550 for fair presentation frameworks.
Assertions That Transactions With Related Parties Were Conducted on 
Terms Equivalent to Those Prevailing in Arm's-Length Transactions 
(Paragraph 18 of the Standard)
PCAOB
    Paragraph 18 of the standard requires that if the financial 
statements include a statement by management that transactions with 
related parties were conducted on terms equivalent to those prevailing 
in an arm's-length transaction, the auditor should determine whether 
the evidence obtained supports or contradicts

[[Page 43209]]

management's assertion. If the auditor is unable to obtain sufficient 
appropriate audit evidence to substantiate management's assertion, and 
if management does not agree to modify the disclosure, the auditor 
should express a qualified or adverse opinion.
    A note to paragraph 18 of the standard further states that a 
preface to a statement such as ``management believes that'' or ``it is 
the company's belief that'' does not change the auditor's 
responsibilities.
IAASB
    Paragraph 24 of ISA 550 states that if management has made an 
assertion in the financial statements to the effect that a related 
party transaction was conducted on terms equivalent to those prevailing 
in an arm's length transaction, the auditor shall obtain sufficient 
appropriate audit evidence about the assertion.
ASB
    Paragraph 25 of AU-C Section 550 contains similar requirements to 
those in ISA 550.
Communications With the Audit Committee (Paragraph 19 of the Standard)
PCAOB
    Paragraph 19 of the standard requires that the auditor 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. Paragraph 19 of the standard 
also requires that the auditor communicate 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.
IAASB
    Paragraph 27 of ISA 550 requires that the auditor communicate with 
those charged with governance significant matters arising during the 
audit in connection with the entity's related parties.
ASB
    Paragraph 27 of AU-C Section 550 contains similar requirements to 
those in ISA 550.
Amendments to Certain PCAOB Auditing Standards Regarding Significant 
Unusual Transactions
Identifying Significant Unusual Transactions
PCAOB
    The amendments to paragraph 56.a. of Auditing Standard No. 12 
require the auditor to inquire of management regarding whether the 
company has entered into any significant unusual transactions and, if 
so, the nature, terms, and business purpose (or the lack thereof) of 
those transactions and whether such transactions involve related 
parties. The amendments regarding significant unusual transactions to 
paragraph 56.b. of Auditing Standard No. 12 require that the auditor 
inquire of the audit committee or equivalent, or its chair, regarding 
whether the company has entered into any significant unusual 
transactions. The amendments regarding significant unusual transactions 
to paragraph 56.c. of Auditing Standard No. 12 require similar 
inquiries of internal audit personnel.
    A note to AU sec. 316.66 states that the auditor should take into 
account information that indicates that related parties or 
relationships or transactions with related parties previously 
undisclosed to the auditor might exist when identifying significant 
unusual transactions.
    That note refers the auditor to paragraphs 14-16 of Auditing 
Standard No. 18. That note further states that Appendix A of the 
standard includes examples of such information and examples of sources 
of such information.
IAASB and ASB
    ISA 315, ISA 550, AU-C Section 315, and AU-C Section 550 do not 
contain similar requirements for the auditor to those in the PCAOB's 
amendments described above.
Evaluating Significant Unusual Transactions
PCAOB
    The amendments regarding significant unusual transactions add 
paragraph .66A to AU sec. 316. That paragraph requires the auditor to 
design and perform procedures to obtain an understanding of the 
business purpose (or the lack thereof) of each significant unusual 
transaction that the auditor has identified. AU sec. 316.66A requires 
that those procedures include the following:
    a. Reading the underlying documentation and evaluating whether the 
terms and other information about the transaction are consistent with 
explanations from inquiries and other audit evidence about the business 
purpose (or the lack thereof) of the transaction;
    b. Determining whether the transaction has been appropriately 
authorized and approved in accordance with the company's established 
policies and procedures;
    c. Evaluating the financial capability of the other parties with 
respect to significant uncollected balances, loan commitments, supply 
arrangements, guarantees, and other obligations, if any; and
    d. Performing other procedures as necessary depending on the 
identified and assessed risks of material misstatement.
    The amendments to AU sec. 316.67 require that the auditor evaluate 
whether the business purpose (or the lack thereof) indicates that the 
significant unusual transaction may have been entered into to engage in 
fraudulent financial reporting or conceal misappropriation of assets. 
The amendments require that, in making that evaluation, the auditor 
evaluate whether:
     The form of the transaction is overly complex (e.g., the 
transaction involves multiple entities within a consolidated group or 
unrelated third parties);
     The transaction involves unconsolidated related parties, 
including variable interest entities;
     The transaction involves related parties or relationships 
or transactions with related parties previously undisclosed to the 
auditor;
     The transaction involves other parties that do not appear 
to have the financial capability to support the transaction without 
assistance from the company, or any related party of the company;
     The transaction lacks commercial or economic substance, or 
is part of a

[[Page 43210]]

larger series of connected, linked, or otherwise interdependent 
arrangements that lack commercial or economic substance individually or 
in the aggregate (e.g., the transaction is entered into shortly prior 
to period end and is unwound shortly after period end);
     The transaction occurs with a party that falls outside the 
definition of a related party (as defined by the accounting principles 
applicable to that company), with either party able to negotiate terms 
that may not be available for other, more clearly independent, parties 
on an arm's-length basis;
     The transaction enables the company to achieve certain 
financial targets;
     Management is placing more emphasis on the need for a 
particular accounting treatment than on the underlying economic 
substance of the transaction (e.g., accounting-motivated structured 
transaction); and
     Management has discussed the nature of and accounting for 
the transaction with the audit committee or another committee of the 
board of directors or the entire board.
    Further, the amendments add paragraph 11A to Auditing Standard No. 
13. That paragraph requires that because significant unusual 
transactions can affect the risks of material misstatement due to error 
or fraud, the auditor should take into account the types of potential 
misstatements that could result from significant unusual transactions 
in designing and performing further audit procedures, including 
procedures performed pursuant to AU secs. 316.66-.67A.
    The amendments to AU sec. 316.67A require that the auditor evaluate 
whether significant unusual transactions identified by the auditor have 
been properly accounted for and disclosed in the financial statements.
IAASB
    Paragraph 16 of ISA 550 requires that if the auditor identifies 
significant transactions outside the entity's normal course of business 
when performing the audit procedures required by paragraph 15 or 
through other audit procedures, the auditor shall inquire of management 
about:
    (a) The nature of these transactions; and
    (b) Whether related parties could be involved.
    Paragraph 32(c) of ISA 240 requires the auditor to evaluate whether 
the business rationale (or the lack thereof) of a significant 
transaction outside the normal course of business suggests that the 
transaction may have been entered into to engage in fraudulent 
financial reporting or to conceal misappropriation of assets. Paragraph 
23 of ISA 550 requires the auditor to perform certain procedures for 
identified significant related party transactions outside the entity's 
normal course of business.
ASB
    AU-C Section 550 and AU-C Section 240 contain similar requirements 
to those in ISA 550 and ISA 240.
Other Amendments to PCAOB Auditing Standards
Auditing Standard No. 12, Identifying and Assessing Risks of Material 
Misstatement
PCAOB
    The other amendments to paragraph 10A of Auditing Standard No. 12 
require that to assist in obtaining information for identifying and 
assessing risks of material misstatement of the financial statements 
associated with a company's relationships and transactions with its 
executive officers (e.g., executive compensation, including 
perquisites, and any other arrangements), the auditor should perform 
procedures to obtain an understanding of the company's financial 
relationships and transactions with its executive officers. The 
procedures should be designed to identify risks of material 
misstatement and should include, but not be limited to (1) reading the 
employment and compensation contracts between the company and its 
executive officers and (2) reading the proxy statements and other 
relevant company filings with the SEC and other regulatory agencies 
that relate to the company's financial relationships and transactions 
with its executive officers. The other amendments to Auditing Standard 
No. 12 also include a definition of executive officer that aligns with 
definitions used in SEC filings.
    In addition, the other amendments amend paragraph 11 of Auditing 
Standard No. 12 to require the auditor to consider:
     Inquiring of the chair of the compensation committee, or 
the compensation committee's equivalent, and any compensation 
consultants engaged by either the compensation committee or the company 
regarding the structuring of the company's compensation for executive 
officers; and
     Obtaining an understanding of the company's established 
policies and procedures regarding the authorization and approval of 
executive officer expense reimbursements.
IAASB and ASB
    ISA 315 and AU-C Section 315 do not contain similar requirements 
for the auditor to those in the PCAOB's amendments described above.
AU sec. 315, Communications Between Predecessor and Successor Auditors
PCAOB
    The other amendments to other PCAOB Auditing Standards amend AU 
sec. 315, Communications Between Predecessor and Successor Auditors, to 
require the auditor to inquire of the predecessor auditor regarding the 
predecessor auditor's understanding of the nature of the company's 
relationships and transactions with related parties and significant 
unusual transactions. The other amendments also require the successor 
auditor to review documentation regarding related parties and 
significant unusual transactions.
IAASB and ASB
    Neither ISA 210 and ISA 510, nor AU-C Section 210 and AU-C Section 
510 contain similar requirements to those in the PCAOB's amendments 
described above.
AU sec. 316, Consideration of Fraud in a Financial Statement Audit
PCAOB
    The other amendments to AU sec. 316.81A describe the auditor's 
responsibility, under certain conditions, to disclose possible fraud to 
the SEC to comply with certain legal and regulatory requirements. These 
requirements include reports in connection with the termination of the 
engagement, such as when the entity reports an auditor change on Form 
8-K and the fraud or related risk factors constitute a reportable event 
or are the source of a disagreement, as these terms are defined in Item 
304 of Regulation S-K and Item 16F of Form 20-F. These requirements 
also include reports that may be required pursuant to Section 10A(b) of 
the Securities Exchange Act of 1934 (the ``Exchange Act'') relating to 
an illegal act that the auditor concludes has a material effect on the 
financial statements.
IAASB and ASB
    ISA 240 and AU-C Section 240 do not inform the auditor of certain 
obligations under Section 10A of the Exchange Act, which is applicable 
to auditors of U.S. public companies registered with the PCAOB.

[[Page 43211]]

AU sec. 333, Management Representations
PCAOB
    The other amendments to AU sec. 333, Management Representations, 
require that the auditor obtain written representations from management 
that there are no side agreements or other arrangements (either written 
or oral) undisclosed to the auditor. The other amendments to AU sec. 
333 also require the auditor to obtain written representation from 
management if the financial statements include a statement by 
management that transactions with related parties were conducted on 
terms equivalent to those prevailing in an arm's-length transaction.
IAASB and ASB
    Neither ISA 580 and ISRE 2410, nor AU-C Section 580, and AU-C 
Section 930 contain similar requirements to those in the PCAOB's 
amendments described above.
AU sec. 560, Subsequent Events
PCAOB
    The other amendments amend paragraph .12 of AU sec. 560, Subsequent 
Events, to require that during the ``subsequent period'' the auditor 
inquire of and discuss with officers and other executives having 
responsibility for financial and accounting matters (limited where 
appropriate to major locations) as to:
     Whether there have been any changes in the company's 
related parties;
     Whether there have been any significant new related party 
transactions; and
     Whether the company has entered into any significant 
unusual transactions.
IAASB and ASB
    ISA 560 and AU-C Section 560 do not contain similar requirements to 
those in the PCAOB's amendments described above.
AU sec. 722, Interim Financial Information
PCAOB
    The other amendments to AU sec. 722, Interim Financial Information, 
require that the auditor obtain written representations from management 
that there are no side agreements or other arrangements (either written 
or oral) undisclosed to the auditor. The other amendments to AU sec. 
722 also require the auditor to obtain written representations from 
management when management has made an assertion that a transaction 
with a related party was conducted on terms equivalent to those 
prevailing in arm's-length transactions.
IAASB
    ISA 550 and ISRE 2410 do not contain similar requirements to those 
in the PCAOB's amendments described above.
ASB
    AU-C Section 550 and AU-C Section 930 do not contain similar 
requirements to those in the PCAOB's amendments described above.

D. Economic Considerations, Including for Audits of Emerging Growth 
Companies

    This discussion describes the Board's approach in adopting the 
standard and amendments as well as the Board's consideration of the 
economic impacts of the standard and amendments, including economic 
considerations pertinent to audits of EGCs.\138\ Additionally, this 
discussion summarizes the views of commenters with respect to the 
economic impacts of the standard and amendments.
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    \138\ Section 3(a)(80) of the Exchange Act defines the term 
``emerging growth company.''
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Introduction and Statutory Background
    The Board is adopting the standard and amendments pursuant to its 
authority under the Act.\139\ The standard and amendments must be 
approved by the Commission before they are effective. Pursuant to 
Section 107(b)(3) of the Act, the Commission shall approve a proposed 
standard if it finds that the standard is ``consistent with the 
requirements of [the] Act and the securities laws, or is necessary or 
appropriate in the public interest or for the protection of 
investors.''
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    \139\ Public Law 107-204. Pursuant to Section 101 of the Act, 
the mission of the Board is to oversee the audit of companies that 
are subject to the securities laws, and related matters, in order to 
protect the interests of investors and further the public interest 
in the preparation of informative, accurate, and independent audit 
reports. Section 103 of the Act authorizes the Board to adopt 
auditing standards for use in public company audits ``as required by 
this Act or the rules of the [U.S. Securities and Exchange] 
Commission, or as may be necessary or appropriate in the public 
interest or for the protection of investors.'' In addition, Section 
982 of the Dodd-Frank Wall Street Reform and Consumer Protection Act 
(the ``Dodd-Frank Act'') expanded the authority of the PCAOB to 
oversee the audits of registered brokers and dealers, as defined in 
the Exchange Act. See Public Law 111-203.
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    In the Board's view, the adoption of the standard and amendments is 
in the public interest and contributes to investor protection by 
establishing specific auditor performance requirements designed to 
heighten the auditor's attention to areas associated with risks of 
fraudulent financial reporting and that may also involve risks of 
error. New required audit procedures are intended to improve the 
auditor's identification, understanding, and evaluation of transactions 
in the critical areas, which can pose difficult measurement, 
recognition, and disclosure issues due to factors such as transaction 
structure, complexity, and/or relationship to company financial 
targets. Additionally, the standard and amendments establish audit 
committee communication requirements designed to promote and enhance 
communications and understanding between the auditor and the audit 
committee.
    The auditor's heightened scrutiny of transactions in the critical 
areas, and the enhanced understanding of such transactions both by the 
auditor and the audit committee, should improve the quality of the 
audit and also may result in improvements in companies' accounting and 
disclosures in these areas. Additionally, the new requirements are 
aligned with the Board's risk assessment standards \140\ and reflect a 
cohesive audit approach that should improve the auditor's risk-based 
consideration of the critical areas, as well as provide opportunities 
for efficient implementation.
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    \140\ In 2010, the Board adopted eight auditing standards to 
establish a framework for the auditor's assessment of and response 
to the risks of material misstatement in an audit (the ``risk 
assessment standards''), which reflect the Board's view of the 
auditor's fundamental approach to the audit. The risk assessment 
standards cover the entire audit process, from initial planning 
activities to evaluating audit evidence to forming the opinion to be 
expressed in the auditor's report. See Auditing Standards Related to 
the Auditor's Assessment of and Response to Risk and Related 
Amendments to PCAOB Standards, PCAOB Release 2010-004 (August 5, 
2010).
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    The Act was amended by Section 104 of the Jumpstart Our Business 
Startups Act JOBS Act \141\ to provide that any additional rules 
adopted by the Board subsequent to April 5, 2012, do not apply to the 
audits of EGCs unless the SEC ``determines that the application of such 
additional requirements is necessary or appropriate in the public 
interest, after considering the protection of investors and whether the 
action will promote efficiency, competition, and capital formation.'' 
\142\ As a result, if the standard and amendments are approved by the 
SEC, they will be subject to a separate determination by the SEC 
regarding their applicability to audits of EGCs.
---------------------------------------------------------------------------

    \141\ Public Law 112-106 (April 5, 2012).
    \142\ See Section 103(a)(3)(C) of the Act, as added by Section 
104 of the JOBS Act.
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    The Board is recommending that the SEC determine that the standard 
and amendments should apply to audits of

[[Page 43212]]

EGCs. To assist the SEC in making this determination, the Board is 
providing information herein specifically related to audits of EGCs.
    The discussion below includes information regarding: (i) The Need 
for the Standard and Amendments; (ii) The Baseline (encompassing both 
existing requirements and audit practices); (iii) The Board's Approach 
and Consideration of Alternatives; (iv) The Economic Impacts of the 
Standard and Amendments, including Benefits and Costs; and (v) Economic 
Considerations Pertaining to Audits of EGCs, including Efficiency, 
Competition, and Capital Formation.
Need for the Standard and Amendments
Introduction
    Investors are often widely dispersed and significant in number and 
thus must rely on management to operate and control the company. As a 
result, investors possess less information about the company than the 
company's management, a situation that can be described as information 
asymmetry \143\ between investors and management. Management prepares 
the company's financial statements that investors use to evaluate a 
company's financial performance and management's stewardship of the 
company. An audit provides investors with independent, reasonable 
assurance that the company's financial statements are fairly presented, 
in accordance with the relevant accounting framework, and comply with 
applicable requirements.
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    \143\ Information asymmetry refers to situations involving two 
or more parties in a relationship in which one party has more, or 
better, information than the other party. For more information on 
matters related to the separation of ownership and control of 
companies and the implications on financial markets, see, e.g., 
Adolph A. Berle and Gardiner C. Means, The Modern Corporation and 
Private Property, 2 Harcourt, Brace and World, New York passim 
(1967); Michael C. Jensen and William H. Meckling, Theory of the 
Firm: Managerial Behavior, Agency Costs, and Ownership Structure, 3 
Journal of Financial Economics 305 passim (1976); and Paul M. Healy 
and Krishna G. Palepu, Information Asymmetry, Corporate Disclosure, 
and the Capital Markets: A Review of the Empirical Disclosure 
Literature, 31 Journal of Accounting and Economics 405 passim 
(2001).
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    A key objective of PCAOB standards is to improve the likelihood 
that the auditor will detect material misstatements in company 
financial statements, whether due to error or fraud.\144\ The auditor, 
as a gatekeeper \145\ in the financial reporting system, can mitigate 
risks of material misstatement in the financial statements and, thus, 
risks to investors arising out of their reliance on misstated financial 
statements, by focusing appropriate auditing effort in areas that 
warrant heightened scrutiny. Increased attention by the auditor should, 
in the Board's view, increase the likelihood of the auditor identifying 
material misstatements.
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    \144\ Strengthening the requirements for auditing in the 
critical areas should similarly promote improved performance on 
audits of broker-dealer financial statements. The approach set forth 
in the standard should direct auditors to devote more time to areas 
requiring heightened scrutiny. The auditor's enhanced focus on these 
areas should improve the reliability of information used in 
regulatory oversight, which, in turn, should enhance investor 
protection.
    \145\ According to the SEC, ``The federal securities laws, to a 
significant extent, make independent auditors ``gatekeepers'' to the 
public securities markets. These laws require, or permit us to 
require, financial information filed with us to be certified (or 
audited) by independent public accountants. Without an opinion from 
an independent auditor, the company cannot satisfy the statutory and 
regulatory requirements for audited financial statements and cannot 
sell its securities to the public. The auditor is the only 
professional that a company must engage before making a public 
offering of securities and the only professional charged with the 
duty to act and report independently from management.'' See SEC 
Securities Act Release No. 33-7870, Proposed Rule: Revision of the 
Commission's Auditor Independence Requirements (June 30, 2000) at 
Section II.A. See also, SEC Securities Act Release No. 33-7919, 
Final Rule: Revision of the Commission's Auditor Independence 
Requirements (November 21, 2000) at Section III.A.
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    In considering the need to improve existing auditing standards 
relating to the critical areas, the Board took into account a variety 
of factors. Most significantly, the Board considered the need for the 
standard and amendments against the backdrop of several decades of 
financial reporting frauds involving related party transactions, 
significant unusual transactions and financial relationships and 
transactions with executive officers. Prominent corporate scandals 
involving these critical areas include many that served as a catalyst 
for the enactment of the Act.\146\ The critical areas addressed by the 
standard and amendments have continued to be contributing factors in 
more recent enforcement cases.\147\ These corporate scandals undermine 
investor confidence and have resulted in significant losses to 
investors, as well as the loss of many jobs.\148\ As discussed below, 
the Board's oversight activities indicate that auditors' scrutiny of 
these critical areas continues to be an area of concern.
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    \146\ The following illustrative list provides examples of 
prominent corporate scandals that involve the critical areas. The 
following list is not all-inclusive and, in some cases, examples 
involve more than one critical area: (i) With respect to related 
party transactions: Hollinger, Inc., see SEC Complaint, SEC, 
Plaintiff v. Conrad M. Black, F. David Radler and Hollinger, Inc. 
(November 15, 2004); MCA Financial Corporation, see SEC AAER No. 
2076, In The Matter of Grant Thornton LLP, Doeren Mayhew & Co. P.C., 
Peter M. Behrens, CPA, Marvin J. Morris, CPA, and Benedict P. 
Rybicki, CPA, Respondent (August 5, 2004); and Adelphia 
Communications Corporation, see SEC AAER No. 1599, SEC v. Adelphia 
Communications Corporation, John J. Rigas, Timothy J. Rigas, Michael 
J. Rigas, James P. Rigas, James R. Brown, and Michael C. Mulcahey, 
02 Civ. 5776 (KW) (S.D.N.Y.) (July 24, 2002); (ii) with respect to 
significant unusual transactions: Enron Corporation, see SEC 
Spotlight on Enron, https://www.sec.gov/spotlight/enron.htm; Refco, 
Inc., see SEC Complaint, SEC, Plaintiff, v. Phillip R. Bennett, 
Defendant (February 19, 2008); and (iii) with respect to financial 
relationships and transactions with executive officers: Tyco 
International, Ltd., see SEC AAER No. 3010, SEC v. L. Dennis 
Kozlowski, Mark H. Swartz, and Mark A. Belnick, 02-CV-7312 (RWS) 
(S.D.N.Y. filed Sept. 12, 2002) (July 14, 2009); WorldCom, Inc., see 
Restoring Trust, Report to The Hon. Jed S. Rakoff The United States 
District Court for the Southern District of New York On Corporate 
Governance for the Future of MCI (August 2003) at 17-19. 
Additionally, Section 704 of the Act directed the SEC to study 
enforcement actions over the five years preceding its enactment ``to 
identify areas of issuer financial reporting that are most 
susceptible to fraud, inappropriate manipulation, or inappropriate 
earnings management'' (the ``SEC Section 704 Study''). As part of 
the study, the SEC examined 227 enforcement matters and found that 
23 cases included the failure to disclose related party 
transactions. See Report Pursuant to Section 704 of the Sarbanes-
Oxley Act of 2002 (January 24, 2003) at 6.
    \147\ See, e.g., SEC AAER No. 3447, SEC v. Keyuan 
Petrochemicals, Inc. and Aichun Li (February 28, 2013), and SEC AAER 
No. 3385, SEC v. China Natural Gas, Inc. and Qinan Ji (May 14, 
2012).
    \148\ For example, Enron Corporation was the nation's largest 
natural gas and electric marketer, with reported annual revenue of 
more than $150 billion. When it filed for bankruptcy on December 2, 
2001, its stock price had dropped in less than a year from more than 
$80 per share to less than $1. See SEC Settles Civil Fraud Charges 
Filed Against Richard A. Causey, Former Enron Chief Accounting 
Officer; Causey Barred From Acting as an Officer or Director of a 
Public Company SEC Litigation Release No. 19996 (February 9, 2007).
---------------------------------------------------------------------------

    Additionally, the Board considered: (i) Input from the SAG; (ii) 
studies that suggested the need to improve existing auditing standards 
to address areas that could pose increased risks of material 
misstatement; (iii) the actions of other standard setters, such as the 
IAASB and the ASB of the AICPA, who had revised their auditing 
standards in certain analogous areas in 2008 and 2011, respectively; 
and (iv) information obtained through the Board's oversight activities. 
The Board also considered input from commenters on its

[[Page 43213]]

proposal \149\ and reproposal.\150\ Commenters were broadly supportive 
of the Board's standard-setting efforts and generally agreed that 
improvements to the existing auditing standards were appropriate.\151\
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    \149\ See the proposing release, which included: (i) An auditing 
standard, Related Parties (``proposed standard''); (ii) amendments 
to certain PCAOB auditing standards regarding significant unusual 
transactions (``proposed amendments regarding significant unusual 
transactions''); and (iii) other amendments to PCAOB auditing 
standards (``other proposed amendments''). Collectively, these are 
referred to as the ``proposed standard and amendments.''
    \150\ See the reproposing release, which included: (i) An 
auditing standard, Related Parties (``reproposed standard''); (ii) 
amendments to certain PCAOB auditing standards regarding significant 
unusual transactions (``reproposed amendments regarding significant 
unusual transactions''); and (iii) other proposed amendments to 
PCAOB auditing standards (``other reproposed amendments''). 
Collectively, these are referred to as the ``reproposed standard and 
amendments.''
    \151\ Section C provides additional discussion of the standard 
and amendments, as well as discussion of significant comments 
received and the Board's consideration of such comments.
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The Need for Improved Requirements in the Critical Areas
    The following discussion describes the need for improvements to 
existing auditing requirements in each critical area. As more fully 
described below, the Board believes that its existing standards do not 
contain sufficient required procedures and are not sufficiently risk-
based in critical areas that warrant heightened scrutiny. Increased 
auditor attention to the critical areas should, in the Board's view, 
increase the likelihood of the auditor identifying material 
misstatements.
    Relationships and Transactions With Related Parties: The auditor's 
attention to a company's transactions with its related parties is 
important because the substance of such transactions may differ 
materially from their form.\152\ A related party relationship provides 
the parties with the ability to negotiate transactions on terms that 
may not be available to other parties on an arm's-length basis. Such 
non-arm's length transactions potentially provide more of an 
opportunity for management to act in its own interests,\153\ rather 
than in the interests of the company and its investors and, in some 
instances, such transactions have been used to facilitate financial 
statement fraud and asset misappropriation.\154\ Related party 
transactions also may involve difficult measurement and recognition 
issues that can lead to errors in financial statements.
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    \152\ For example, to improve the appearance of its financial 
condition, a company and a related party could attempt to ``dress 
up'' the appearance of the company's balance sheet at period end by 
agreeing to have the company temporarily pay down its related party 
debt prior to the balance sheet date while having an undisclosed 
side agreement to subsequently borrow the same or a comparable 
amount shortly after period end.
    \153\ See, e.g., paragraph 15 of FASB Statement No. 57, Related 
Parties, which states ``[w]ithout disclosure to the contrary, there 
is a general presumption that transactions reflected in financial 
statements have been consummated on an arm's-length basis between 
independent parties. However, that presumption is not justified when 
related party transactions exist because the requisite conditions of 
competitive, free-market dealings may not exist. Because it is 
possible for related party transactions to be arranged to obtain 
certain results desired by the related parties, the resulting 
accounting measures may not represent what they usually would be 
expected to represent.''
    \154\ As noted above, the SEC Section 704 Study identified areas 
of issuer financial reporting that are most susceptible to fraud, 
inappropriate manipulation or inappropriate earnings management. As 
part of that study, the SEC examined 227 enforcement matters and 
found that 23 cases included the failure to disclose related party 
transactions. See SEC Section 704 Study.
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    The importance to investors of the auditing of related party 
transactions was emphasized by the U.S. Congress in 1995 through the 
enactment of Section 10A of the Exchange Act, which requires that each 
audit of financial statements of an issuer include ``procedures 
designed to identify related party transactions that are material to 
the financial statements or otherwise require disclosure therein.'' 
\155\ Additionally, SEC actions have identified related party 
transactions as warranting heightened scrutiny by auditors.\156\
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    \155\ Section 10A(a)(2) of the Exchange Act, 15 U.S.C. 78j-
1(a)(2).
    \156\ See, e.g., SEC AAER No. 3427, In the Matter of the 
Application of Wendy McNeely, CPA, at 10-12 (December 13, 2012), 
which states, in part, that the SEC and the courts have repeatedly 
held that related party transactions require heightened scrutiny by 
auditors. See also McCurdy v. SEC, 396 F3d 1258, 1261 (D.C. Cir. 
2005) (citing Howard v. SEC, 376 F3d 1136, 1149 (D.C. Cir. 2004) 
noting that related-party transactions ``are viewed with extreme 
skepticism in all areas of finance,'' aff'g James Thomas McCurdy, 
CPA, 57 S.E.C. 277 (2004)).
---------------------------------------------------------------------------

    The Board's existing standard for the auditing of related party 
transactions, AU sec. 334, Related Parties,\157\ was issued in 1983, 
and has not been substantively revised since then. Among other things, 
AU sec. 334 has not been revised to align with the Board's risk 
assessment standards, which provide an overall framework for the 
auditor's assessment of and response to the risks of material 
misstatement. Additionally, as discussed below, the existing standard 
does not reflect an approach that promotes heightened scrutiny by the 
auditor of a company's relationships and transactions with related 
parties.
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    \157\ AU sec. 334 is one of the Board's interim auditing 
standards. Shortly after the Board's inception, the Board adopted 
the existing standards of the AICPA, as in existence on April 16, 
2003, on an initial, transitional basis. See Establishment of 
Interim Professional Auditing Standards, PCAOB Release No. 2003-006 
(April 18, 2003).
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    AU sec. 334 provides guidance for the auditor, rather than 
explicitly requiring the performance of specific procedures.\158\ For 
example, AU sec. 334 includes examples of procedures that the auditor 
could perform, and indicates that such procedures may not be required 
in every audit. Such an approach can lead to inadequate auditor effort 
in an area that historically has posed increased risks of material 
misstatement. Additionally, the existing standard suggests that related 
party transactions need not be considered by the auditor as outside the 
ordinary course of business for a company, unless the auditor is aware 
of evidence to the contrary. As a result, the auditor may not exercise 
sufficient professional skepticism in an area that Congress and the SEC 
have indicated requires heightened scrutiny.
---------------------------------------------------------------------------

    \158\ See discussion of The Baseline for a detailed discussion 
of the existing requirements applicable to the critical areas.
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    The need to revise and strengthen AU sec. 334 has been supported by 
a number of prominent studies, including studies conducted by the 
auditing profession prior to the enactment of the Act and the 
establishment of the Board. For example, the AICPA recommended, after 
studying over 200 cases reported by their members in which allegations 
of an audit failure were made, that ``required audit procedures be 
broadened to help ensure the auditor gains a more complete 
understanding of related party transactions, including the business 
aspects of transactions.'' \159\
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    \159\ The Quality Control Inquiry Committee of the AICPA's SEC 
Practice Section issued a report (the ``QCIC Report'') making this 
recommendation in 2002. See AICPA SEC Practice Section, Memo To 
Managing Partners of SECPS Member Firms, ``Recommendations for the 
Profession Based on Lessons Learned from Litigation'' (October 
2002), which includes the QCIC Report as an attachment.
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    Additionally, the Board considered a synthesis of the academic 
literature on auditing related party transactions that states that 
various high profile frauds demonstrate how related party transactions 
can be used to mislead users of financial statements.\160\ The authors 
find that related party transactions are as common in companies alleged 
to have committed fraud as in companies in which no fraud has been 
detected. However, the authors also find that ``. . . when fraud does 
exist, the presence of related party transactions is one of the top 
reasons

[[Page 43214]]

cited for audit failures.'' \161\ The authors conclude that the 
findings in academic literature, combined with the significance of 
related party transactions in corporate scandals, ``are consistent with 
the PCAOB's reconsideration of auditing of related party 
transactions.'' \162\
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    \160\ See Elizabeth A. Gordon, Elaine Henry, Timothy J. Louwers, 
and Brad J. Reed, Auditing Related Party Transactions: A Literature 
Overview and Research Synthesis, Accounting Horizons 21 (1): 81-102 
(2007).
    \161\ Id. at 82.
    \162\ Id. at 81. A subsequent study conducted by the same 
authors analyzes 43 SEC enforcement actions against auditors related 
to the examination of related party transactions and identified 
audit practice issues in that area. The authors found that the 
majority of this sample involved inadequate examination of the 
related party transaction by the auditor. Although the authors 
concluded that the audit failures described in these SEC cases were 
more likely attributable to a lack of professional skepticism and 
due professional care than deficiencies in the existing standards, 
the authors provide suggestions to improve audit practice regarding 
the auditing of related party transactions. Among other things, the 
authors suggest that auditors use guidance published by the AICPA in 
a 2001 ``Related Party Transaction Toolkit'' that suggests that the 
auditor should perform many of the procedures described as guidance 
in AU sec. 334 to determine the existence of related parties and 
identify transactions with known related parties. See Timothy J. 
Louwers, Elaine Henry, Brad J. Reed, and Elizabeth A. Gordon, 
Deficiencies in Auditing Related-Party Transactions: Insights from 
AAERs, Current Issues in Auditing 2 (2): A10-A16 (2008).
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    While the Board recognizes that transactions with related parties 
are also used for legitimate purposes, including the efficient 
procurement of resources,\163\ the Board has concluded that the 
auditing of related party transactions warrants heightened scrutiny. 
Notably, the Board has observed, through its oversight activities, 
deficiencies in the auditing of related party transactions, 
particularly with respect to audits of smaller public companies. 
Additionally, as prominent corporate scandals over the past several 
decades illustrate, issues involving the scrutiny of related party 
transactions also arise in the audits of large public companies.
---------------------------------------------------------------------------

    \163\ See Elizabeth A. Gordon, Elaine Henry, and Darius Palia, 
Related Party Transactions and Corporate Governance 9 Advances in 
Financial Economics 1-27, (2004).
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    As a result of these and other considerations discussed throughout 
this release, the Board has determined that there is a need to improve 
its existing auditing standard regarding related parties. In the 
Board's view, AU sec. 334 does not contain sufficient required 
procedures, is not risk-based, and does not promote the necessary 
heightened scrutiny of related party transactions.
    Significant Unusual Transactions: The identification and evaluation 
of a company's significant unusual transactions is important to the 
audit because such transactions can create complex accounting and 
financial disclosure issues that create risks of error. Additionally, 
in some cases, significant unusual transactions have been used to 
engage in fraudulent financial reporting. For example, significant 
unusual transactions that are close to period end may be entered into 
to obscure a company's financial position or operating results (e.g., 
so-called ``window-dressing''). Others may involve counterparties that 
are willing to structure transactions to achieve desired accounting 
results. In such cases, company management may place more emphasis on 
the need for a particular accounting treatment than on the underlying 
economic substance of the transaction.
    The Board has considered studies that highlight the risks of 
material misstatements associated with a company's significant unusual 
transactions. For example, the Report Prepared by the Permanent 
Subcommittee on Investigations of the Committee on Governmental Affairs 
found that ``some U.S. financial institutions and public companies have 
been misusing structured finance vehicles . . . to carry out sham 
transactions that have no legitimate business purpose and mislead 
investors, analysts, and regulators about companies' activities, tax 
obligations, and true financial condition.'' \164\ Another study 
attributed an increased risk of financial misstatement to transactions 
in which the substance of the transactions might differ materially from 
their form.\165\
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    \164\ See Senate Committee on Governmental Affairs, Permanent 
Subcommittee on Investigations of the Committee on Governmental 
Affairs, Fishtail, Bacchus, Sundance, and Slapshot: Four Enron 
Transactions Funded and Facilitated by U.S. Financial Institutions 
(January 2, 2003), http://www.gpo.gov/fdsys/pkg/CPRT-107SPRT83559/pdf/CPRT-107SPRT83559.pdf.
    \165\ See SEC Report and Recommendations Pursuant to Section 
401(c) of the Sarbanes-Oxley Act of 2002 On Arrangements with Off-
Balance Sheet Implications, Special Purpose Entities, and 
Transparency of Filings by Issuers (June 15, 2005), http://sec.gov/news/studies/soxoffbalancerpt.pdf.
---------------------------------------------------------------------------

    Additionally, SEC enforcement actions have highlighted the need for 
the auditor to scrutinize complex unusual transactions, including 
understanding their underlying economic purpose.\166\ Other SEC cases 
have addressed instances in which structured transactions obscured the 
economic substance of transactions that had a material impact on the 
company's financial statements.\167\
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    \166\ See, e.g., SEC AAER No. 2775, In the Matter of Michael 
Lowther, CPA, Respondent (January 28, 2008), which discusses the 
2001 financial reporting fraud at Enron, which included the use of 
complex structured transactions to obscure the economic substance of 
certain financing transactions that had a material impact on Enron's 
financial statements.
    \167\ See, e.g., SEC AAER No. 1631, In the Matter of Dynegy, 
Inc., Respondent (September 24, 2002). In that action, the 
Commission determined that Dynegy entered into two massive ``round-
trip'' electricity transactions, that is, simultaneous, pre-arranged 
buy-sell trades at the same price, terms and volume, in which 
neither Dynegy nor its trading counterparty earned a profit or 
incurred a loss and that such transactions lacked economic 
substance.
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    The risk assessment standards require the auditor to consider the 
risks of material misstatement posed by significant unusual 
transactions as part of the auditor's risk assessment during the 
financial statement audit.\168\ However, the auditing requirements 
regarding significant unusual transactions are principally contained in 
AU sec. 316, Consideration of Fraud in a Financial Statement 
Audit.\169\ That standard provides that the auditor considers the risks 
of fraud relating to a significant transaction outside the normal 
course of business for a company if the auditor ``becomes aware'' of 
such a transaction.\170\ There is no express requirement in AU sec. 
316, however, for the auditor to perform specific procedures to 
identify such transactions or to obtain the information necessary to 
evaluate the accounting for and disclosure of such transactions, which 
are key considerations in promoting the auditor's heightened scrutiny 
of a company's significant unusual transactions.
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    \168\ See, e.g., paragraph 71.g. of Auditing Standard No. 12, 
Identifying and Assessing Risks of Material Misstatement.
    \169\ See paragraphs .66-.67 of AU sec. 316.
    \170\ See discussion of The Baseline for a more detailed 
discussion of the existing standards applicable to the critical 
areas.
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    The Board's staff identified areas of potential weaknesses in the 
auditor's consideration of significant unusual transactions and in 
April 2010 issued Staff Audit Practice Alert No. 5, Auditor 
Considerations Regarding Significant Unusual Transactions.\171\ That 
alert discusses a range of auditor practice issues pertaining to 
significant unusual transactions, including the auditor's understanding 
of transactions close to period end that pose difficult substance over 
form issues. Similarly, the IAASB staff issued guidance in August 2010 
that addressed the auditing of significant unusual or highly complex 
transactions.\172\
---------------------------------------------------------------------------

    \171\ See Staff Audit Practice Alert No. 5, Auditor 
Considerations Regarding Significant Unusual Transactions (April 7, 
2010).
    \172\ See IAASB Staff Questions and Answers, Auditor 
Considerations Regarding Significant Unusual or Highly Complex 
Transactions (August 2010).
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    As a result of these and other considerations discussed throughout

[[Page 43215]]

this release, the Board has determined that there is a need to improve 
its existing auditing standards regarding significant unusual 
transactions. In the Board's view, the existing standards in this area 
do not contain sufficient required procedures to promote the heightened 
scrutiny necessary for the auditor to identify and evaluate 
transactions that may be used to intentionally obscure a company's 
financial results or that may result in erroneous financial reporting.
    Financial Relationships and Transactions with Executive Officers: 
Understanding a company's relationships and transactions with its 
executive officers is important to an auditor because a company's 
executive officers are generally in a position to determine or 
influence a company's accounting and disclosures. A company's financial 
relationships and transactions with its executive officers (e.g., 
executive compensation) can create incentives and pressures for 
executive officers to meet financial targets, which can result in risks 
of material misstatement of a company's financial statements. 
Additionally, a company's executive officers, because of their role in 
the financial reporting process, are in a unique position to commit 
fraud.\173\
---------------------------------------------------------------------------

    \173\ See, for example, AU sec. 316.08.
---------------------------------------------------------------------------

    Cases involving fraudulent financial reporting illustrate how a 
company's financial relationships and transactions with its executive 
officers can create incentives and pressures that can result in risks 
of material misstatement, including fraud risks.\174\ Research that 
analyzed SEC AAERs from 1998 to 2007 also identified potential 
motivations for engaging in fraudulent financial reporting that relate 
to a company's financial targets.\175\ For example, the study noted 
that the most commonly cited motivations for fraud included the need 
to: (i) Meet internal or external earnings expectations of analysts and 
others; (ii) meet internally set financial targets or make the company 
look better; (iii) conceal the company's deteriorating financial 
condition; (iv) increase the stock price; (v) bolster financial 
position for pending equity or debt financing; (vi) increase management 
compensation through achievement of bonus targets and through enhanced 
stock appreciation; and (vii) cover up assets misappropriated for 
personal gain. The cited motivations support a conclusion that a 
company's financial relationships and transactions with its executive 
officers can create incentives and pressures that can result in risks 
of material misstatement to a company's financial statements. That 
study noted that the chief executive officer and/or the chief financial 
officer were named in 89 percent of the cases involving fraudulent 
financial reporting brought by the SEC during that period.
---------------------------------------------------------------------------

    \174\ For example, over the last decade, the SEC has brought a 
number of cases where management allegedly manipulated compensation 
expense recognized in the financial statements, while simultaneously 
obtaining additional compensation for themselves through options 
backdating. See SEC Spotlight on Stock Options Backdating, which 
lists AAERs, Commission speeches and testimony, Commission staff 
speeches, testimony and letters; and non-SEC documents relating to 
stock options backdating, http://www.sec.gov/spotlight/optionsbackdating.htm.
    \175\ See Mark S. Beasley, Joseph V. Carcello, Dana R. 
Hermanson, and Terry L. Neal, 2010. Fraudulent Financial Reporting 
1998-2007: An Analysis of U.S. Public Companies, Committee of 
Sponsoring Organizations of the Treadway Commission (May 2010) at 3, 
http://www.coso.org/documents/COSOFRAUDSTUDY2010_001.pdf.
---------------------------------------------------------------------------

    Under the Board's risk assessment standards, the auditor is 
required to consider obtaining an understanding of compensation 
arrangements with the company's ``senior management'' as part of 
obtaining an understanding of the company.\176\ In the Board's view 
this continues to be an important consideration for the auditor during 
the risk assessment process. However, the Board's risk assessment 
standards require the auditor to ``consider'' performing procedures to 
obtain an understanding of certain compensation arrangements as part of 
``obtaining an understanding of the company'' during the auditor's 
overall risk assessment, but does not require the performance of 
specific procedures to obtain such an understanding.\177\ Most 
significantly, the Board's risk assessment standards do not require the 
auditor to perform specific procedures to obtain an understanding of 
financial relationships and transactions with executive officers, which 
can motivate or affect company accounting or reporting decisions.
---------------------------------------------------------------------------

    \176\ See paragraph 11 of Auditing Standard No. 12.
    \177\ See discussion of The Baseline for a detailed discussion 
of the existing standards applicable to the critical areas.
---------------------------------------------------------------------------

    As a result of these and other considerations discussed throughout 
this release, the Board has determined that there is a need to improve 
its existing risk assessment standards relating to the auditor's 
consideration of a company's financial relationships and transactions 
with its executive officers. In the Board's view, its risk assessment 
standards in this area are not sufficiently targeted to promote 
heightened scrutiny of potential risks of material misstatement arising 
from a company's financial relationships and transactions with its 
executive officers, in view of the unique role played by the company's 
executive officers in the company's financial reporting process.
How the Standard and Amendments Address the Need
    The Board has determined to improve its requirements relating to 
identifying, understanding, and addressing certain areas that are 
widely acknowledged to represent increased risks of material 
misstatement in company financial statements. As more fully discussed 
below, these improvements are intended to strengthen the audit of the 
company's financial statements by improving the auditor's ability to 
identify and address such risks. In the Board's view, a more focused 
approach with specific performance requirements should foster the 
heightened scrutiny that the Board believes is warranted in the 
critical areas. Such an approach should help mitigate the information 
asymmetry between company management and investors.
    The following sections describe key aspects of the standard and 
amendments being adopted by the Board, with a focus on how they address 
the need for improvement described above.\178\
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    \178\ A section-by-section discussion of the standard and 
amendments is located in Section C.
---------------------------------------------------------------------------

    Auditing Standard No. 18, Related Parties: The Board is superseding 
AU sec. 334 and adopting a new standard that establishes specific 
procedures intended to strengthen auditor performance requirements 
regarding the auditing of related party transactions. The new 
requirements establish specific procedures, rather than the approach in 
the existing standard, which provides guidance and example procedures 
for the auditor's consideration.
    The standard reflects the following key improvements from the 
existing standard:
     Adding Basic Requirements: AU sec. 334 suggests procedures 
for the auditor's consideration, noting that not all of them may be 
required in every audit. The standard requires basic procedures for the 
auditor's response to risks of material misstatement associated with a 
company's relationships and transactions with its related parties. 
Specifically, the standard focuses on those related party transactions 
that require disclosure in the financial statements or that are 
determined to be a significant risk. The basic procedures are designed 
to assist the auditor in identifying red flags that indicate potential 
risks of material misstatement. The standard also requires more in-
depth procedures that are designed to be scalable and

[[Page 43216]]

commensurate with the company's facts and circumstances.
     Enhancing Procedures to Obtain an Understanding of the 
Company's Relationships and Transactions With Its Related Parties: 
Unlike AU sec. 334, which includes limited direction for obtaining an 
understanding of the company's relationships and transactions with its 
related parties, the standard requires the performance of specific 
procedures in this area, including obtaining an understanding of the 
terms and business purposes (or the lack thereof) of related party 
transactions.
     Aligning With the Risk Assessment Standards: The standard 
is designed to align with and build upon the risk assessment standards. 
The procedures are intended to be performed in conjunction with the 
procedures performed during the auditor's risk assessment.
     Improving the Auditor's Focus on Accounting: AU sec. 334 
states that the auditor should place primary emphasis on the adequacy 
of disclosure of related party transactions. The standard requires that 
the auditor evaluate both the accounting for, and disclosure of, 
related party transactions.
     Emphasizing a Complementary Audit Approach: The standard 
specifically requires the auditor to take into account other work 
performed during the audit, for example, information gathered with 
respect to significant unusual transactions, when evaluating the 
company's identification of its related party transactions.
     Adding Audit Committee Communications: AU sec. 334 does 
not mention communications with audit committees regarding related 
party transactions. The standard being adopted by the Board anticipates 
two-way communication between the auditor and the audit committee 
regarding such transactions. This reflects the fact that the new 
performance requirements contained in the standard and amendments 
relate to sensitive areas of the audit that potentially involve the 
interests of company management and, thus, warrant discussion with the 
audit committee. Specifically, the auditor is required to make 
inquiries of the audit committee (or its chair) when the auditor is 
obtaining an understanding of the company, which should occur during 
the auditor's risk assessment. During these initial communications, the 
auditor obtains information regarding a company's significant related 
party transactions and any such relationships or transactions that are 
of concern to members of the audit committee. The standard further 
requires that the auditor communicate to the audit committee regarding 
the auditor's overall evaluation of the company's identification of, 
accounting for, and disclosure of its relationships and transactions 
with related parties, including any significant matters the auditor 
identified during the audit. Among other things, the matters to be 
communicated related to the auditor's evaluation include the 
identification of any related parties (or relationships or transactions 
with related parties) that were previously undisclosed to the auditor.
    Amendments Regarding Significant Unusual Transactions: In this 
area, the Board is: (i) Revising AU sec. 316; (ii) making targeted 
amendments to certain risk assessment standards (e.g., Auditing 
Standards Nos.12 and 13); and (iii) making related changes to other 
PCAOB auditing standards. These amendments include specific procedures 
designed to improve the auditor's identification and evaluation of a 
company's significant unusual transactions. Among other things, they 
require the auditor to perform specific procedures to (i) identify 
significant unusual transactions and (ii) obtain an understanding of 
the business purpose (or the lack thereof) of the company's significant 
unusual transactions, including whether the transaction was entered 
into to engage in fraud. In the Board's view, adding specific 
procedures promotes audit quality by providing the auditor with more 
insight into the nature of a company's significant unusual 
transactions, which should enable the auditor to better evaluate 
whether the financial statements are fairly stated.
    The amendments regarding significant unusual transactions are 
designed to improve existing Board standards in the following key 
respects:
     Improving Requirements for Identifying Significant Unusual 
Transactions: The amendments regarding significant unusual transactions 
require the performance of specific procedures intended to improve the 
auditor's identification of significant unusual transactions, for 
example, by amending Auditing Standard No. 12 to require the auditor to 
make inquiries of management and others.
     Improving the Auditor's Evaluation of Significant Unusual 
Transactions: The amendments to AU secs. 316.66-.67A include basic 
procedures for obtaining information for evaluating significant unusual 
transactions. The basic procedures include: (i) Reading the underlying 
documentation relating to significant unusual transactions and 
evaluating whether the terms and other information about the 
transaction are consistent with explanations from inquiries and other 
audit evidence about the business purpose (or the lack thereof) of the 
transaction; (ii) determining whether the transaction has been 
authorized and approved in accordance with the company's established 
policies and procedures; and (iii) evaluating the financial capability 
of the other parties to the transaction with respect to significant 
uncollected balances, guarantees, and other obligations.
     Enhancing Attention to the Business Purpose (or the Lack 
Thereof) of Significant Unusual Transactions: The amendments to AU 
secs. 316.66-.67 enhance the auditor's evaluation of the business 
purpose of significant unusual transactions by, among other things, 
expanding the factors considered by the auditor in evaluating whether 
the business purpose (or the lack thereof) indicates that such 
transactions may have been entered into to engage in fraudulent 
financial reporting or conceal misappropriation of assets.
     Emphasizing Accounting and Disclosure: The amendments 
regarding significant unusual transactions to AU sec. 316.67A are 
intended to heighten the auditor's attention to accounting matters 
relative to significant unusual transactions by emphasizing that 
existing requirements include evaluating whether the financial 
statements contain the information essential for a fair presentation of 
the financial statements in conformity with the applicable financial 
reporting framework.
     Emphasizing a Complementary Audit Approach: The amendments 
regarding significant unusual transactions specifically require the 
auditor to take into account other work performed during the audit, for 
example, information gathered with respect to related party 
transactions, when identifying significant unusual transactions.
     Enhancing Audit Committee Communications: The amendments 
regarding significant unusual transactions are intended to improve the 
quality of the auditor's communications with the audit committee 
regarding the business purpose (or the lack thereof) of significant 
unusual transactions.\179\
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    \179\ See, e.g., paragraph 13.d of Auditing Standard No. 16, 
Communications with Audit Committees.
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     Conforming Descriptions of Significant Unusual 
Transactions: The amendments introduce a uniform description of 
``significant unusual transactions'' throughout the Board's standards.

[[Page 43217]]

    Amendments Regarding Financial Relationships and Transactions With 
Executive Officers: The Board is revising Auditing Standard No. 12 to 
require the auditor to perform specific procedures during the risk 
assessment process to obtain an understanding of the company's 
financial relationships and transactions with its executive officers. 
In doing so, the auditor would consider, among other things, the 
potential for increased risks of material misstatement that could arise 
out of the company's compensation arrangements with its executive 
officers.\180\
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    \180\ The population of the company's ``executive officers'' is 
determined by reference to SEC rules and forms. See Section C--Other 
Amendments to PCAOB Auditing Standards for a discussion of the 
applicable definition of the term ``executive officer.''
---------------------------------------------------------------------------

    The revisions improve the existing audit requirements by requiring 
the auditor to perform specific procedures to obtain an understanding 
of a company's financial relationships and transactions with its 
executive officers, as part of the auditor's risk assessment. 
Specifically, the amendments revise Auditing Standard No. 12 to state 
that the auditor ``should perform'' specified procedures to obtain an 
understanding of the company's financial relationships and transactions 
with its ``executive officers'' as part of the auditor's risk 
assessment.
    As noted previously, under the existing risk assessment standards, 
the auditor is required to ``consider'' obtaining an understanding of 
compensation arrangements with senior management as part of obtaining 
an understanding of the company during the auditor's risk 
assessment.\181\ The Board's standards currently do not explicitly 
require that the auditor obtain information regarding incentives or 
pressures for the company's executive officers to achieve a particular 
financial position or operating result as a result of performance based 
compensation arrangements. The Board has determined to supplement its 
existing requirements, and has determined that the requirement that the 
auditor ``should perform'' procedures relating to executive officer 
compensation arrangements is appropriate to promote heightened 
scrutiny.
---------------------------------------------------------------------------

    \181\ See paragraph 11 of Auditing Standard No. 12.
---------------------------------------------------------------------------

    In the Board's view, a focus on the company's executive officers 
during the risk assessment process is appropriate in that they 
generally play a key role in the company's accounting decisions and in 
a company's financial reporting. However, the new required procedures 
do not require the auditor to make a determination regarding the 
appropriateness of a company's compensation agreements with its 
executive officers.
The Baseline
    To consider the economic impacts (including likely benefits and 
costs) of the standard and amendments, a ``baseline'' has been 
identified that can be used as a benchmark against which the standard 
and amendments can be compared. The baseline, described below, includes 
existing requirements and also considers audit practices.
Existing Requirements
    The auditor's overall responsibility to perform a risk-based audit 
is contained in the Board's risk assessment standards, Auditing 
Standards Nos. 8 through 15, which became effective for auditors in 
December 2010.\182\ Among other things, the risk assessment standards 
require the auditor to consider the risks of material misstatement, 
whether due to error or fraud, throughout the audit.\183\
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    \182\ See PCAOB Release 2010-004 (August 5, 2010).
    \183\ More generally, auditors are required to comply with all 
standards of the PCAOB, including existing requirements to perform 
the audit with due professional care, and to obtain sufficient 
appropriate audit evidence to support the audit opinion. See, e.g., 
AU sec. 230, Due Professional Care in the Performance of Work, and 
Auditing Standard No. 15, Audit Evidence.
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    The existing requirements that the Board is strengthening through 
adoption of the standard and amendments are discussed below.
    Relationships and Transactions With Related Parties: The risk 
assessment standards anticipate that the auditor will consider certain 
risks inherent in significant transactions with related parties in 
determining the significant risks of the audit \184\ and in 
establishing the materiality level for the audit of the financial 
statements.\185\ However, the existing auditing requirements relating 
to relationships and transactions with related parties are contained 
primarily in AU sec. 334, one of the Board's interim standards.
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    \184\ See paragraph 71.e. of Auditing Standard No. 12.
    \185\ See paragraph 7 of Auditing Standard No. 11, Consideration 
of Materiality in Planning and Performing an Audit, which states 
that lesser amounts of misstatements could influence the judgment of 
a reasonable investor because of qualitative factors, e.g., because 
of the sensitivity of circumstances surrounding misstatements, such 
as conflicts of interest in related party transactions.
---------------------------------------------------------------------------

    AU sec. 334 recognizes that the auditor performs procedures to 
identify and evaluate a company's relationships and transactions with 
its related parties as part of performing an audit of financial 
statements. However, as noted above, it provides guidance and examples 
of procedures for the auditor's consideration, rather than specific 
required procedures.
    Examples of procedures in AU sec. 334 include: (i) Procedures to 
obtain information from management (such as obtaining the names of all 
related parties and inquiring whether there were any transactions with 
these parties during the period); (ii) procedures intended to assist 
the auditor in identifying related parties that have not been disclosed 
to the auditor by management (such as reviewing filings with the SEC, 
reviewing company accounting records and certain invoices, and making 
inquiries of other auditors); and (iii) procedures the auditor 
considers, as necessary, to understand the purpose, nature, and extent 
of identified related party transactions (such as obtaining an 
understanding of the business purpose of the transaction). Notably, AU 
sec. 334 states that not all of the procedures may be required in every 
audit.
    AU sec. 334 states that the auditor should place primary emphasis 
on the adequacy of disclosure of related party transactions. 
Significantly, the existing standard also states that, in the absence 
of evidence to the contrary, related party transactions should not be 
assumed to be outside the ordinary course of business.\186\ Thus, AU 
sec. 334 could be misunderstood to create a ``presumption of validity'' 
for the business purpose of related party transactions in situations 
where experience suggests a need for heightened scrutiny.\187\
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    \186\ See AU sec. 334.06.
    \187\ This is in contrast to the approach reflected in the 
standard, which emphasizes the auditor's responsibilities for 
identifying and assessing risks of material misstatement associated 
with related parties and relationships and transactions with related 
parties.
---------------------------------------------------------------------------

    Significant Unusual Transactions: The risk assessment standards 
anticipate that the auditor will consider risks of material 
misstatement in a company's financial statements, including those posed 
by significant unusual transactions.\188\ However, the more specific 
auditing requirements regarding significant unusual transactions are 
principally contained in AU sec. 316.\189\ Specifically, AU sec. 316.66 
recognizes that during a financial statement audit, the auditor may 
become aware of significant transactions that are outside the normal 
course of business for the company or that otherwise appear to be 
unusual given the auditor's understanding of the

[[Page 43218]]

company and its environment. AU sec. 316.66 requires that, if the 
auditor becomes aware of significant unusual transactions during the 
course of an audit, the auditor should gain an understanding of the 
business rationale of such transactions and whether that rationale (or 
the lack thereof) suggests that such transactions may have been entered 
into to engage in fraudulent financial reporting or to conceal the 
misappropriation of assets. However, AU sec. 316 does not specify the 
procedures to perform to identify significant unusual transactions or 
to obtain necessary information to understand their business purpose 
(or the lack thereof).
---------------------------------------------------------------------------

    \188\ See paragraph 71.g. of Auditing Standard No. 12.
    \189\ See AU secs. 316.66-.67.
---------------------------------------------------------------------------

    Financial Relationships and Transactions With Executive Officers: 
The risk assessment standards require the auditor to consider obtaining 
an understanding of compensation arrangements with senior management 
(including incentive compensation arrangements, changes or adjustments 
to those arrangements, and special bonuses) as part of obtaining an 
understanding of the company.\190\ While this encompasses a company's 
executive officers, the existing standards do not specifically require 
the auditor to obtain an understanding of the incentives and pressures 
posed by executive officer compensation arrangements that can influence 
a company's accounting and disclosures.
---------------------------------------------------------------------------

    \190\ See paragraph 11 of Auditing Standard No. 12.
---------------------------------------------------------------------------

Audit Practices
    The Board's understanding of audit practices is based on the 
Board's general knowledge of audit firm practice arising out of 
information gathered from its oversight activities, including its 
inspection, enforcement, and standard-setting activities. Additionally, 
the Board's understanding also has been informed by a range of studies 
and other materials it considered in determining the need for 
improvement of its existing standards. Based on this understanding, the 
Board believes that audit practices associated with the auditor's 
efforts regarding the critical areas are inconsistent.
    The Board is aware that some firms have adopted audit methodologies 
that require their engagement teams to perform specific procedures 
regarding related party transactions not currently required by AU sec. 
334. This may have occurred for a number of reasons. For example, the 
analogous standards of the IAASB and ASB require the auditor to inquire 
of management regarding the entity's related parties.\191\ Audit 
practice also may have been impacted by guidance issued by the AICPA 
encouraging auditors to perform many of the procedures suggested in AU 
sec. 334 for the auditor's consideration.\192\ Additionally, some 
auditors may already perform additional procedures arising out of their 
consideration of the risks of significant transactions with related 
parties as potential significant risks.\193\
---------------------------------------------------------------------------

    \191\ See paragraph 13 of ISA 550, Related Parties, and 
paragraph 14 of AU-C 550, Related Parties.
    \192\ See AICPA Practice Alert No. 95-3, Auditing Related 
Parties and Related-Party Transactions, which indicated the auditor 
should perform most, if not all, of the examples of procedures in AU 
sec. 334 for determining the existence of related parties and 
identifying transactions with known related parties, and AICPA 
Toolkit, Accounting and Auditing for Related Parties and Related 
Party Transactions (2001).
    \193\ See paragraph 71.e. of Auditing Standard No. 12.
---------------------------------------------------------------------------

    Further, some auditors may already perform additional procedures 
regarding significant unusual transactions as a result of robust risk 
assessments and as a result of guidance from Board staff and the 
IAASB.\194\ Additionally, there has been considerable interest in 
issues relating to executive compensation, which may have resulted in 
heightened attention to such issues by some auditors.\195\
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    \194\ See Staff Audit Practice Alert No. 5 (April 7, 2010). See 
also IAASB Staff Questions and Answers, Auditor Considerations 
Regarding Significant Unusual or Highly Complex Transactions (August 
2010).
    \195\ See, e.g., Staff Audit Practice Alert No. 1, Matters 
Related To Timing And Accounting For Option Grants (July 28, 2006).
---------------------------------------------------------------------------

    The Board also is aware through its oversight activities that some 
firms have exhibited deficient auditing practices with respect to the 
critical areas. For example, the Board has identified deficiencies 
regarding the auditing of related party transactions through its 
triennial inspection program, which focuses on inspections of smaller 
domestic audit firms. Deficiencies identified include failures to test 
for undisclosed related parties or transactions with related parties, 
as well as failures to obtain an understanding of the business purpose 
of known related party transactions.\196\
---------------------------------------------------------------------------

    \196\ See Report on 2007-2010 Inspections of Domestic Firms that 
Audit 100 or Fewer Public Companies, PCAOB Release No. 2013-001, at 
29 (February 25, 2013), http://pcaobus.org/Inspections/Documents/02252013_Release_2013_001.pdf, which states, in part, 
``Inspections staff have observed deficiencies related to firms' 
failures to test for undisclosed related parties or transactions 
with undisclosed related parties. Some of those firms failed to 
identify and address the lack of disclosure of related party 
transactions in the financial statements. Inspections staff have 
also identified deficiencies relating to the firms' failure to 
obtain an understanding of the nature and business purpose of 
transactions with related parties and to evaluate whether the 
accounting for those transactions reflects their economic 
substance.'' See also, Report on the PCAOB's 2004, 2005, and 2006 
Inspections of Domestic Triennially Inspected Firms, PCAOB Release 
No. 2007-010, at 7 (October 22, 2007), http://pcaobus.org/Inspections/Documents/2007_10-22_4010_Report.pdf.
---------------------------------------------------------------------------

    Additionally, a number of the Board's settled enforcement cases 
have involved related party transactions.\197\ Those PCAOB enforcement 
actions have identified, among other things:
---------------------------------------------------------------------------

    \197\ See, e.g., Order Instituting Disciplinary Proceedings, 
Making Findings, and Imposing Sanctions: In the Matter of P. Parikh 
& Associates, Ashok B. Rajagiri, CA, Sandeep P. Parikh, CA, and 
Sundeep P S G Nair, CA, Respondents, PCAOB Release No. 105-2013-002 
(April 24, 2013); Order Instituting Disciplinary Proceedings, Making 
Findings, and Imposing Sanctions: In the Matter of Jaspers + Hall, 
PC, Thomas M. Jaspers, CPA, and Patrick A. Hall, CPA, Respondents, 
PCAOB Release No. 105-2008-002 (October 21, 2008); Order Instituting 
Disciplinary Proceedings, Making Findings, and Imposing Sanctions: 
In the Matter of Williams & Webster, P.S., Kevin J. Williams, CPA, 
and John G. Webster, CPA, Respondents, PCAOB Release No. 105-2007-1 
(June 12, 2007); and Order Instituting Disciplinary Proceedings, 
Making Findings, and Imposing Sanctions: In the Matter of Kenny H. 
Lee CPA Group, Inc., and Kwang Ho Lee, CPA, Respondents, PCAOB 
Release No. 105-2005-022 (November 22, 2005).
---------------------------------------------------------------------------

     Failures to perform sufficient procedures for known 
related party transactions; \198\
---------------------------------------------------------------------------

    \198\ See Order Instituting Disciplinary Proceedings, Making 
Findings and Imposing Sanctions: In the Matter of Kenny H. Lee CPA 
Group, Inc., and Kwang Ho Lee, CPA, Respondents, PCAOB Release No. 
105-2005-022 (November 22, 2005) and Order Instituting Disciplinary 
Proceedings, Making Findings and Imposing Sanctions: In the Matter 
of Williams & Webster, P.S., Kevin J. Williams, CPA, and John G. 
Webster, CPA, Respondents, PCAOB Release No. 105-2007-1 (June 12, 
2007).
---------------------------------------------------------------------------

     Failures to address management's failure to disclose known 
related party transactions; \199\ and
---------------------------------------------------------------------------

    \199\ See Order Instituting Disciplinary Proceedings, Making 
Findings and Imposing Sanctions: In the Matter of Turner Stone & 
Company, LLP and Edward Turner, CPA, Respondents, PCAOB Release No. 
2006-010 (December 19, 2006) and Order Instituting Disciplinary 
Proceedings, Making Findings and Imposing Sanctions: In the Matter 
of Timothy L. Steers, CPA, LLC, and Timothy L. Steers, CPA, 
Respondents, PCAOB Release No. 105-2007-004 (November 14, 2007).
---------------------------------------------------------------------------

     Failures to take sufficient steps to determine whether a 
transaction was a related party transaction, when available information 
indicated that it was.\200\
---------------------------------------------------------------------------

    \200\ See Order Instituting Disciplinary Proceedings, Making 
Findings and Imposing Sanctions: In the Matter of Cordovano and 
Honeck, P.C. and Samuel D. Cordovano, CPA, Respondents, PCAOB 
Release No. 2008-004 (December 18, 2008) and Order Instituting 
Disciplinary Proceedings, Making Findings and Imposing Sanctions: In 
the Matter of Clyde Bailey, P.C., and Clyde B. Bailey, CPA, 
Respondents, PCAOB Release No. 2005-021 (November 22, 2005).
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    The types of deficiencies observed by the Board through its 
oversight activities

[[Page 43219]]

indicate that auditor practice regarding related parties is 
inconsistent under the existing auditing framework in a wide range of 
areas, suggesting that this is a challenging area warranting additional 
auditor effort and focus.
The Board's Approach and Consideration of Alternatives
    During the standard-setting process, the Board considered a number 
of alternatives and made a number of key policy choices with the goal 
of improving audit quality in the critical areas, while also providing 
opportunities for an efficient implementation. The following discussion 
highlights alternatives and policy choices considered by the Board as 
part of its economic considerations.
Consideration of Alternatives
    Prior to the Board's decision to propose the standard and 
amendments, the Board requested input from its SAG, as early as 
2004.\201\ During these meetings, the Board engaged the SAG in a 
discussion of issues relating to the auditing of related party 
transactions. Additionally, the Board discussed whether and, if so, 
how, to improve its existing standards in complementary areas that 
might be considered to pose similar risks of material misstatement.
---------------------------------------------------------------------------

    \201\ Prior to the issuance of the proposal, the SAG discussed 
the topic of related parties at meetings on September 8-9, 2004, 
June 21, 2007, and October 14-15, 2009. See the SAG Meeting Archive 
at http://pcaobus.org/Standards/SAG/Pages/SAGMeetingArchive.aspx.
---------------------------------------------------------------------------

    As part of its standard-setting process, the Board initially 
considered whether new requirements were necessary. This included a 
review of the Board's oversight efforts through the Board's inspection 
and enforcement programs to determine the type, range, and prevalence 
of audit deficiencies cited. In addition, before issuing its proposal, 
the Board issued Staff Audit Practice Alert No. 5 in April 2010, which 
discussed a range of auditor practice issues identified by the PCAOB 
staff pertaining to significant unusual transactions.\202\
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    \202\ See Staff Audit Practice Alert No. 5 (April 7, 2010).
---------------------------------------------------------------------------

    Staff Audit Practice Alert No. 5 was issued to remind auditors of 
the risks associated with significant unusual transactions and to 
compile selected, relevant requirements from existing PCAOB auditing 
standards into one document. Given that the alert only highlights 
circumstances for auditor consideration, it did not alter audit 
requirements with respect to significant unusual transactions.
    In considering whether new requirements were necessary, the Board 
assessed a range of factors, and concluded that it was appropriate to 
develop standards with more specific requirements to address the 
critical areas.
    As part of its considerations, the Board considered whether AU sec. 
334 could be amended to include new specific procedures. The Board 
determined that the nature and extent of revisions necessary, including 
changes to align a revised AU sec. 334 with the risk assessment 
standards, would essentially result in a new standard. Thus, the Board 
determined that it was appropriate to propose a new standard regarding 
related parties, rather than amend the existing standard.
    In considering how to address the other types of relationships and 
transactions that the Board had identified as posing similar risks--
significant unusual transactions and a company's financial 
relationships and transactions with executive officers--the Board 
determined that issuing staff guidance could not make the changes that 
were necessary to strengthen the existing audit requirements to address 
the risks that had been identified in these areas. However, the Board 
determined that new stand-alone standards were not necessary but that 
appropriate improvements in audit quality could be achieved by 
amendments to its existing audit requirements in those areas.
    As the Board considered the types and extent of changes to make in 
its existing standards, it considered several alternatives, including 
some discussed with its SAG.\203\ Some alternatives considered 
included:
---------------------------------------------------------------------------

    \203\ See the SAG Meeting Archive at http://pcaobus.org/Standards/SAG/Pages/SAGMeetingArchive.aspx, for the October 14-15, 
2009 SAG meeting.
---------------------------------------------------------------------------

    Consideration of Related Party Transactions as Fraud Risk: In view 
of the potential for increased risks of material misstatement arising 
from these critical areas, the Board considered whether relationships 
and transactions with related parties should be presumed to be a fraud 
risk. Under existing auditing standards, this approach would require 
auditors to devote considerable audit effort to identifying and 
evaluating relationships and transactions with related parties, in all 
instances. However, the Board recognizes that many related party 
transactions might not, in fact, represent fraud risks or other 
significant risks, a view that was further informed by discussions with 
the SAG.\204\ Accordingly, as such an alternative could have resulted 
in potentially unnecessary audit effort, the Board determined to take a 
targeted approach that would focus on the auditor obtaining sufficient 
information to identify, assess, and respond to transactions that pose 
increased risks of material misstatement, while, at the same time 
aligning the new requirements with the risk assessment standards.
---------------------------------------------------------------------------

    \204\ See SAG Meeting Archive for the October 14-15, 2009 SAG 
meeting.
---------------------------------------------------------------------------

    Consideration of Relationships and Transactions Posing Similar 
Risks: The Board also considered whether to address relationships and 
transactions that might fall outside the definition of a ``related 
party'' but that might pose similar risks. After obtaining input from 
the SAG regarding this approach,\205\ the Board decided that the 
auditor should consider transactions that might pose similar risks, 
such as a company's significant unusual transactions, because these 
transactions not only may involve related parties previously 
undisclosed to the auditor but also could pose increased risks of 
material misstatement. Additionally, the Board concluded that linking 
the auditor's efforts regarding related parties and significant unusual 
transactions should help auditors ``connect the dots'' between these 
areas.
---------------------------------------------------------------------------

    \205\ Id.
---------------------------------------------------------------------------

The Board's Approach and Choices Considered in Developing the Board's 
Standard and Amendments
    The following discussion describes key policy choices considered by 
the Board as it developed the standard and amendments, and as the Board 
moved from its proposal to its reproposal and then to the adoption of 
the standard and amendments. In developing the standard and amendments, 
the Board determined to develop an audit approach that would promote 
heightened scrutiny in the critical areas, but that would also provide 
opportunity for efficient implementation. Key policy choices included:
    Aligning With the Risk Assessment Standards: In the Board's view, 
its overall risk assessment approach promotes a cohesive audit, with 
opportunities to integrate audit effort where appropriate, and 
positions the auditor to identify areas in which there may be increased 
risks of material misstatement in company financial statements. Such an 
approach could also serve to minimize audit costs. The Board, thus, 
determined that its new requirements should be explicitly aligned with 
its risk assessment standards. In response to comments on its proposal, 
the Board took steps in its reproposal to more closely align the

[[Page 43220]]

reproposed standard and amendments with its risk assessment standards. 
Those who commented on this aspect of the reproposal generally agreed 
that the revisions improved the alignment with the risk assessment 
standards. This risk assessment focus is retained in the standard and 
amendments being adopted by the Board.
    Providing Opportunity for a Scaled Approach: Similar to the risk 
assessment standards, the Board determined that the standard should 
reflect a scaled approach, which establishes basic required procedures 
that are supplemented by more in-depth procedures that are commensurate 
with the company's facts and circumstances. Such facts and 
circumstances may include the size or complexity of the transaction, 
the nature of the company's relationships or transactions with its 
related parties, and the related risk of material misstatements in the 
financial statements.
    Most commenters, including several large audit firms, agreed that 
the reproposed standards and amendments provide a scaled approach, 
permitting the auditor to vary the level of audit work in proportion to 
the nature and number of a company's relationships and transactions 
with related parties and significant unusual transactions. Some of 
these commenters supported the Board's view that the level of audit 
effort will vary in proportion to the number and nature of a company's 
related party relationships and transactions, its significant unusual 
transactions, its financial relationships and transactions with 
executive officers, and the company's process to identify such matters. 
Another commenter stated that an audit approach that begins with basic 
procedures, and supplements them with more in-depth procedures as 
needed, is a scalable approach that allows the auditor to focus on the 
significant risks, regardless of the size or nature (e.g., broker or 
dealer or EGC) of the issuer. A few commenters, however, objected to 
the concept of basic required procedures and advocated for an approach 
that would leave the determination of the procedures necessary to the 
auditor's judgment.
    The Board considered commenter views and determined that requiring 
the auditor to perform basic procedures in areas that could pose 
increased risks of material misstatement would heighten attention by 
the auditor to such areas and also provide a basis for the auditor to 
identify red flags that require further attention. However, as 
discussed below, the Board did revise certain aspects of its proposal 
to permit additional auditor judgment in certain areas of the audit 
that it determined appropriate.
    Addressing Complementary Audit Areas: The Board determined that the 
standard and amendments should include linkages that would address 
risks of material misstatement arising from complementary areas of the 
audit. For example, the auditor's work in identifying and evaluating 
significant unusual transactions could assist the auditor in 
identifying related parties or relationships or transactions with 
related parties previously undisclosed to the auditor by management. 
This linked approach encourages the auditor to ``connect the dots'' 
between different aspects of the audit, which could improve audit 
effectiveness, as well as provide opportunities for efficient 
implementation. In its reproposal, the Board made revisions to improve 
the linkages between the reproposed standard and amendments. This 
approach is retained in the standard and amendments being adopted by 
the Board.
    Using Existing Concepts and Procedures: The Board determined to 
include some existing auditing concepts and procedures in its proposal. 
This approach was intended to permit audit firms to build on existing 
methodologies and training. Further, this approach could minimize the 
costs of implementing the standard and amendments. In its reproposal, 
the Board sought comment on such issues. Several audit firms who 
commented on the reproposal indicated that they would be able to update 
their methodologies and train staff to apply the standard and 
amendments in a short period, suggesting that the implementation of the 
standard and amendments would not be unduly burdensome.
    Additionally, commenters raised a variety of policy choices for 
consideration by the Board, including the following: \206\
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    \206\ Additionally, see Appendix 4 of the reproposing release 
for discussion more generally of the Board's response to significant 
comments received on the Board's February 28, 2012 proposal.
---------------------------------------------------------------------------

    Expanding Auditor Judgment: In response to comments, the Board made 
some changes to allow for additional auditor judgment than originally 
provided for in the proposal. For example, in its proposal, any related 
party relationships or transactions not previously disclosed to the 
auditor would have been considered to be a significant risk and would 
have required the auditor to perform specific procedures in response. 
Some commenters stated that an undisclosed related party transaction 
could be inconsequential in nature and, in such circumstances, treating 
the transaction as a significant risk and performing all of the 
procedures set forth in the proposed standard would be unnecessary. 
Other commenters suggested it might be appropriate to perform some, but 
not all, of the related procedures in the proposed standard. After 
consideration of comments, the Board removed the proposed requirement 
that the auditor always treat undisclosed related party transactions as 
a significant risk. Instead, the additional procedures would only be 
required in circumstances where previously undisclosed transactions 
were determined by the auditor to require disclosure in the financial 
statements or consideration as a significant risk. This change, which 
is being retained in the standard being adopted by the Board, could 
eliminate potentially unnecessary audit work.
    Clarifying the Auditor's Responsibilities to Identify a Company's 
Related Parties: In response to comments, the Board made clarifications 
to the proposed standard to emphasize that the auditor's efforts to 
identify a company's related parties and relationships and transactions 
with its related parties begins with management's work. The clarified 
approach taken in the Board's reproposal recognizes that the company is 
responsible, in the first instance, for the preparation of its 
financial statements, including the identification of the company's 
related parties, and that the auditor begins the audit with information 
obtained from the company. This approach has been retained in the 
standard being adopted by the Board. Additionally, in response to other 
comments made regarding the reproposed standard, several other 
clarifying changes have been made in this area. Those changes include 
emphasizing more prominently the auditor's responsibility to perform 
procedures to test the accuracy and completeness of the company's 
identification of its related parties, and that in doing so, the 
auditor takes into account the information gathered during the audit.
    Clarifying the Requirements Regarding a Company's Financial 
Relationships and Transactions With Its Executive Officers: The Board 
made two key policy choices relating to the amendments pertaining to a 
company's financial relationships and transactions with its executive 
officers: (i) The relationship of the amendments to the risk assessment 
process; and (ii) the

[[Page 43221]]

appropriate scope of the population for the auditor's required 
procedures.
    As discussed previously, the Board determined to supplement its 
existing risk assessment requirements regarding a company's financial 
relationships and transactions with its executive officers. As 
proposed, the other amendments provided that the auditor should perform 
procedures to obtain an understanding of a company's financial 
relationships and transactions with its executive officers. While some 
commenters were fully supportive of this requirement and recognized 
that it did not represent a radical departure from existing standards, 
other commenters expressed concern that this would require the auditor 
to make an assessment regarding the appropriateness or reasonableness 
of executive compensation arrangements. In its reproposal, the Board 
clarified that these procedures would be performed as part of the risk 
assessment process and explicitly stated that its amendment does not 
require the auditor to make any determination regarding the 
appropriateness or reasonableness of the company's compensation 
arrangements with its executive officers. Commenters who addressed this 
area of the Board's reproposal generally indicated that the revisions 
were appropriate. The amendments being adopted by the Board retain the 
approach taken in its reproposal.
    Additionally, the Board also considered the appropriate population 
for the auditor's consideration of financial relationships and 
transactions. The Board determined that the auditor's consideration of 
a company's financial relationships and transactions need not extend to 
the company's entire senior management population, but that a focus on 
a potentially smaller group within that population--executive 
officers--was appropriate. This focus is appropriate because a 
company's executive officers generally are in a unique position to 
determine the company's accounting and financial statement disclosures.
    In considering the appropriate population for the auditor's 
consideration, the Board took note of a range of diverse comments, 
including those from commenters who advocated that the auditor's 
procedures should include a broader group than the company's executive 
officers; others who stated that the auditor's focus on a company's 
executive officers was the most appropriate group; and another who 
argued for a narrower group, for example, a company's ``named executive 
officers,'' (``NEOs''). Under SEC rules, NEOs generally consist of five 
individuals--the principal executive officer, the principal financial 
officer, and the next three most highly paid executive officers of a 
company as of the end of the most recently completed fiscal year.\207\ 
The Board considered the use of the NEO approach, but determined that 
it might focus the auditor's attention on highly paid individuals (with 
high compensation due to activity unrelated to financial reporting), 
rather than individuals with more direct involvement in the financial 
reporting process.
---------------------------------------------------------------------------

    \207\ See Item 402(a)(3) of Regulation S-K.
---------------------------------------------------------------------------

    After considering these comments, the Board determined that a 
company's executive officers is the most appropriate population for the 
auditor's efforts.\208\ In the Board's view, this targeted approach 
could serve to limit potentially unnecessary audit effort and related 
costs.
---------------------------------------------------------------------------

    \208\ In considering the appropriate population for the 
auditor's inquiry, the Board took note of a study that indicated 
that the median number of ``executive officers'' for the Standard 
and Poor's 500 is 8 (the mean is 8.71), and the median number of 
executive officers for the Russell 2000 is 5 (the mean is 6.12). See 
Broc Romanek, Study: Benchmarking the Number of ``Executive 
Officers,'' The Corporate Counsel.net and LogixData (March 2, 2011).
---------------------------------------------------------------------------

The Economic Impacts of the Standard and Amendments, Including Benefits 
and Costs
    This section contains a discussion of the economic impacts 
considered as the standard and amendments were developed, including 
consideration of likely benefits and costs.
    At present, there is limited data and research available regarding 
the economic impact of discrete changes to auditing standards.\209\ As 
a result, many of the benefits and costs discussed below are difficult 
to quantify reliably. The resulting benefits to investors, markets, and 
others from more reliable financial reporting are complex and not 
capable of reliable quantification at this time. Likewise, limited, if 
any, public data exists to forecast the costs of performing additional 
audit procedures in the critical areas or the spillover effect on 
companies. Therefore, the economic discussion below is qualitative in 
nature.
---------------------------------------------------------------------------

    \209\ The Board established a Center for Economic Analysis to, 
among other things, promote and encourage academic research relating 
to the role of the audit in capital formation and investor 
protection. See PCAOB Announces Center for Economic Analysis, 
(November 6, 2013) http://pcaobus.org/News/Releases/Pages/11062013_CenterEconomicAnalysis.aspx.
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    The Board's consideration of the impacts of the standard and 
amendments, as with all aspects of the Board's standard-setting 
process, takes into account commenters' views.\210\ As part of the 
standard-setting process, the Board asked commenters to provide 
information, as well as empirical data, regarding both benefits and 
costs, and other effects related to the reproposed standard and 
amendments. In response, commenters provided views regarding whether 
the standard and amendments would improve audit quality, as well as 
their views regarding potential audit costs and implementation issues. 
However, commenters did not provide empirical data.\211\
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    \210\ The comment letters are available at http://pcaobus.org/Rules/Rulemaking/Pages/Docket038Comments.aspx.
    \211\ Additionally, Section C provides detail regarding the 
Board's consideration of significant comments received relating to 
the specific requirements of the standard and amendments.
---------------------------------------------------------------------------

    In general, commenters largely supported the Board's standard-
setting efforts, and agreed that the existing standards should be 
improved in the critical areas. Commenters also generally agreed that 
the standard and amendments could benefit audit quality. Some 
commenters also noted the standard and amendments could result in 
improvements in the auditor's: (i) Identification of material 
misstatements; (ii) risk assessment for the audit; and (iii) 
application of professional skepticism. In addition, benefits noted 
also included improvements to audit committee communications and 
company financial statement disclosures.
    Commenters who addressed potential costs provided qualitative 
information that was generally consistent with the discussion of 
potential costs in the reproposing release. While commenters noted that 
there would be some increased costs, they did not provide data 
regarding the extent of such costs. However, commenters generally 
agreed that the standard and amendments were appropriate and should 
apply to audits of companies of all types and sizes.
    Commenters also provided views on issues relating to scalability 
and costs. For example, one commenter stated that the reproposed 
standard and amendments would not require significant incremental 
management or auditor resources, but the amount of resources required 
could be meaningfully greater for companies with a significant number 
of related party transactions or significant unusual transactions. In 
general, the Board would not expect there to be significant cost 
implications for audits of companies that do not have complex or 
extensive: (i) Relationships or transactions with related parties; (ii)

[[Page 43222]]

significant unusual transactions; or (iii) financial relationships and 
transactions with the company's executive officers.
    The following sections include a description of the Board's 
consideration of: Benefits; Costs; Smaller Audit Firms and Smaller 
Companies; and Other Economic Considerations.
Benefits
    The Board believes that the standard and amendments will benefit 
investors by requiring auditors to focus appropriate auditing effort on 
areas that represent increased risks and, thus, warrant heightened 
scrutiny during the audit. As noted previously, to the extent that the 
standard and amendments improve the likelihood that the auditor will 
detect material misstatements in the financial statements, audit 
quality will be improved in ways that should also improve financial 
statement accounting and disclosures, which should in turn reduce the 
information asymmetry between investors and company management.
    The standard and amendments take a targeted approach that is 
intended to focus the auditor's attention on accounting and disclosures 
relating to potentially complex and risky relationships and 
transactions that historically have been associated with cases 
involving fraudulent financial reporting. The magnitude and number of 
such cases, which have resulted in significant losses to investors, 
underscore the benefits to investors of strengthening the existing 
auditing requirements in these areas. Increased focus on the critical 
areas by auditors should increase the probability of auditors detecting 
potential fraudulent or erroneous financial reporting \212\ and should 
also deter fraudulent financial reporting because management will be 
aware that auditors are likely to expend additional effort assessing 
the economic substance of transactions in the critical areas.
---------------------------------------------------------------------------

    \212\ See Mark Zimbelman, The Effects of SAS No. 82 on Auditors 
Planning Decisions, 35 Journal of Accounting Research, 75 passim 
(1997).
---------------------------------------------------------------------------

    Existing auditing standards addressing the critical areas largely 
provide guidance and examples of procedures, rather than requiring 
specific procedures. This can result in inadequate and inconsistent 
application of existing standards, as well as the auditor's failure to 
perform sufficient procedures in the critical areas, which warrant 
heightened scrutiny. Rather than providing examples of procedures that 
may not be required in every audit, the standard and amendments require 
the auditor to perform specific procedures. The new specific 
requirements in the standard and amendments are designed to assist the 
auditor in identifying red flags that warrant heightened scrutiny. The 
performance of basic required procedures should increase the 
probability of the auditor uncovering events that impact investors, 
such as fraud and material errors, and provide investors with increased 
confidence regarding the reliability of the audited financial 
statements.
    Additionally, the standard and amendments take a wholistic view of 
the audit by requiring the auditor to consider the links and 
relationships between a company's related party transactions and 
significant unusual transactions. For example, the auditor's work in 
identifying and evaluating significant unusual transactions should 
assist the auditor in identifying and evaluating related parties, or 
transactions with related parties previously undisclosed to the 
auditor. Emphasizing the complementary nature of the auditor's efforts 
regarding these areas should help the auditor to ``connect the dots'' 
between different aspects of the audit. The complementary approach is 
intended to enhance audit efficiency as well as audit effectiveness in 
that it may increase the probability of the auditor's uncovering 
potential material fraud or error in a company's financial statements.
    Likewise, the standard and amendments are aligned with the Board's 
risk assessment standards and, thus, should enhance the auditor's 
overall risk assessment more generally by making the auditor more 
effective in identifying and assessing risks of material misstatement 
in the critical areas, and in designing and performing better audit 
procedures to address such risks. Additionally, the standard and 
amendments feature a scaled approach that requires the auditor to 
supplement the basic required procedures with more in-depth procedures 
in response to risks identified. Alignment with the risk assessment 
standards and the use of a scaled approach promotes a cohesive audit 
approach that should contribute to improved audit quality and provide 
opportunities for efficient implementation.
    The auditor's heightened attention to transactions in the critical 
areas also could result in the auditor obtaining more information about 
the company's financial position. For example, the standards and 
amendments emphasize the auditor's understanding of the business 
purpose (or the lack thereof) of transactions in the critical areas. A 
better understanding of the business purpose should better position the 
auditor to understand and address such transactions, which often pose 
difficult measurement and recognition issues, due to factors such as 
transaction structure, complexity, and/or relationship to company 
financial targets. Such an approach should promote audit quality by 
providing the auditor with more insight into the nature of transactions 
in the critical areas, which could allow the auditor to better evaluate 
whether the financial statements are fairly stated.
    The auditor's increased attention to the critical areas also may 
result in increased attention by companies to their accounting and 
disclosures, which could result in higher quality financial reporting. 
Higher quality financial reporting improves the quality of information 
available to the market and reduces information asymmetry between 
investors and company management. Improving the quality of financial 
reporting can reduce investors' uncertainty about the information being 
provided in company financial statements, foster increased public 
confidence in the financial markets, and enhance capital formation and 
the efficiency of capital allocation decisions. Research shows that 
decreasing the level of information asymmetry reduces the cost of 
capital for issuers.\213\ In addition, if management produces more 
accurate disclosures, research shows that this increased quality of 
disclosures to financial statement users also reduces the cost of 
capital.\214\
---------------------------------------------------------------------------

    \213\ See David Easley and Maureen O'Hara, 2004. Information and 
the Cost of Capital. The Journal of Finance 59 (4): 1553-1583.
    \214\ See Richard A. Lambert, Christian Leuz, and Robert E. 
Verrecchia, 2012. Information Asymmetry, Information Precision, and 
the Cost of Capital. Review of Finance 16 (1): 1-29.
---------------------------------------------------------------------------

    Further, new audit committee communication requirements would 
promote communications regarding, and improve the auditor's 
understanding of, the critical areas. For example, the auditor's 
understanding of related party transactions would be informed by an 
initial audit committee communication during the risk assessment that 
is intended to help the auditor identify the company's significant 
related party transactions, as well as to inform the auditor of any 
concerns audit committee members may have regarding the company's 
relationships or transactions with its related parties. Later in the 
audit, the auditor is required to discuss with the audit committee the 
auditor's evaluation of the company's identification of, accounting 
for, and disclosure of, the company's related

[[Page 43223]]

party transactions, including any that were previously undisclosed to 
the auditor. In addition, improving the auditor's understanding of: (i) 
The business purpose (or the lack thereof) of a company's significant 
unusual transactions and (ii) a company's financial relationships and 
transactions with its executive officers, can enhance already existing 
required audit committee communications related to significant unusual 
transactions and significant risks.
    These improved communication requirements should result in both 
auditors and audit committees becoming better informed and thus better 
equipped to fulfill their respective roles in the company's financial 
reporting. Through these communications, the auditor becomes better 
informed about the company, enabling the auditor to be more effective 
in identifying and addressing risks of material misstatement in the 
company's financial statements. A better informed audit committee can 
contribute to management oversight, which may lead management to 
improve the company's financial reporting. As noted above, research has 
indicated that improving the quality of financial reporting reduces 
investors' uncertainty about the information being provided in 
companies' financial reports and, thus, increases efficiency in capital 
allocation and fosters capital formation. For example, increased level 
and/or quality of financial reporting has been found to decrease the 
cost of equity, decrease the cost of debt, and decrease bid-ask 
spreads.\215\
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    \215\ See Christine A. Botosan, and Marlene A. Plumlee. 2002. A 
Re-examination of Disclosure Level and the Expected Cost of Equity 
Capital, 40 Journal of Accounting Research 21-40, (2002), Partha 
Sengupta, Corporate Disclosure Quality and the Cost of Debt., 73 The 
Accounting Review 459-474, (1998), and Michael Welker, Disclosure 
Policy, Information Asymmetry, and Liquidity in Equity Markets, 11 
Contemporary Accounting Research 801-827 (1995), respectively.
---------------------------------------------------------------------------

    Commenters largely agreed with the Board that the standard and 
amendments could improve audit quality. In addition, specific benefits 
suggested by commenters included: (i) Higher quality financial 
statement disclosures; (ii) improving investors' confidence in audited 
financial statements; (iii) improving the audit's effectiveness and 
informational value; (iv) more relevant consideration of issues facing 
the company; (v) increasing audit committee knowledge; and (vi) 
improving the audit committees' abilities to fulfill their duties. 
Additionally, another commenter stated that management may be more 
attentive to written procedures and responsibilities for related party 
transactions as a result of the reproposed standard. Specific comments 
in each area include:
     Relationships and Transactions With Related Parties: Many 
commenters stated that the reproposed standard would improve the 
auditor's overall understanding of a company's relationships and 
transactions with its related parties. Some commenters suggested that 
obtaining such an understanding would: (i) Assist the auditor in 
obtaining sufficient appropriate audit evidence and increase the 
likelihood of identifying material misstatements; and (ii) enhance the 
exercise of professional skepticism in the performance of the audit.
     Significant Unusual Transactions: A few commenters 
suggested that requiring procedures to improve the auditor's 
identification and evaluation of a company's significant unusual 
transactions could improve audit quality by: (i) Increasing the 
likelihood of identifying material misstatements; (ii) promoting the 
exercise of professional skepticism; (iii) improving financial 
statement disclosures; and (iv) improving audit committees' abilities 
to fulfill their duties.
     Financial Relationships and Transactions with Executive 
Officers: Commenters providing views on audit quality issues indicated 
that obtaining an understanding of a company's financial relationships 
and transactions with its executive officers could improve audit 
quality by: (i) Improving the auditor's identification of risks of 
material misstatement; (ii) resulting in more relevant audit testing; 
and (iii) improving the auditor's assessment of fraud risk.
    With respect to the baseline, the Board notes that, as described 
previously, some firms may perform procedures that go beyond existing 
requirements. Consequently, the application of the standard and 
amendments should generate greater benefits to audits of companies 
whose auditors are not currently performing a comprehensive risk-based 
audit or are performing only the most cursory of procedures under AU 
sec. 334. Benefits also include promoting consistency in audit 
practices among audit firms by establishing auditor performance 
requirements.
Costs
    In general, the Board recognizes that imposing new requirements 
will involve some additional audit effort and related costs, both to 
audit firms and companies.
    The Board anticipates costs include direct compliance costs to 
auditors that will reflect changes necessary to address the 
introduction of new requirements. The Board anticipates initial and 
ongoing costs for audit firms will include costs for updating and 
maintaining methodologies and audit programs, implementation, and staff 
training. Additionally, depending on the degree of effort currently 
expended by audit firms, there may be increased costs in terms of 
incremental audit effort, including increased audit partner time, and 
potential costs for the time of specialists to review complex 
transactions.
    The increased audit effort and resulting costs may be limited as 
the standard and amendments are based on the Board's existing risk 
assessment standards and retain many existing auditing concepts and 
procedures that are common in practice today. For example, AU sec. 334 
suggests procedures for the auditor's consideration, certain of which 
have been incorporated into the standard as specific required 
procedures. To the extent that audit firms have already incorporated 
these procedures into their current practices, those firms should incur 
lower costs in updating their methodologies. As a result, costs should 
be greater where auditors are not currently performing a comprehensive 
risk-based audit or are performing only the most cursory of procedures 
under AU sec. 334. In general, audit firms that audit companies of all 
sizes were supportive of the Board's efforts to improve audit quality 
in the critical areas and did not raise concerns regarding costs or 
provide data regarding the extent of such costs for the Board's 
consideration.
    To the extent that there are increased costs for auditors as a 
result of the application of the standard and amendments, such costs 
may be passed on, in whole, or part (or not at all), to companies and 
their investors in the form of higher audit fees.\216\ The Board

[[Page 43224]]

is aware, however, that there may be increased costs for companies 
whose auditors must change their methodologies and practices to address 
the new requirements. These potential costs to companies include 
increased audit fees and costs for the additional time and expense of 
responding to auditor inquiries.
---------------------------------------------------------------------------

    \216\ It is not clear to what extent the increased auditor 
performance requirements would result in increased audit fees. The 
Board is aware of public reports that have analyzed historical and 
aggregate data on audit fees, and which suggest that audit fees 
generally have remained stable in recent years, notwithstanding the 
fact that the Board and other auditing standard-setters have issued 
new standards during that period. See, e.g., Audit Analytics Audit 
Fees and Non-Audit Fees: An Eleven Year Trend (July 2013). Because 
amendments to, and adoption of, new Board standards typically 
involve discrete parts of an audit, which is not accounted for, or 
priced, on a standard-by-standard basis, it is difficult to obtain 
data that isolates the costs of particular new audit standards, and 
that would be comparable between firms. In its reproposal, the Board 
sought data that might provide information or insight into such 
costs. As noted above, commenters did not provide data regarding the 
extent of such costs.
---------------------------------------------------------------------------

    Additionally, other costs could include costs associated with 
enhanced audit committee communications, to the extent the areas 
addressed by the standard and amendments are not already discussed. 
Company audit committees may require additional time and expense to 
participate in new audit committee communication relating to related 
party transactions and also may require expanded discussions relating 
to significant unusual transactions. While companies may need 
additional time or resources to conduct the new audit committee 
communications, the standard and amendments build on, and work in 
concert with, the approach taken in Auditing Standard No. 16. Thus, the 
new requirements in this area provide additional substance for an 
integrated meeting with the audit committee. This should not add 
significantly to the time or resources companies spend with respect to 
audit committee communications.
    The Board also considered potential unintended consequences in 
conjunction with its consideration of costs. For example, the Board 
considered whether, to the extent that potential costs stemming from 
the standard and amendments increase audit costs related to 
transactions with related parties, this could serve as a deterrent 
against their use. In such cases, any cost advantage a company may have 
from engaging in related party transactions during its normal course of 
operations could be reduced by higher audit-related costs.
    Two commenters provided their views that the reproposed standard 
and amendments could serve as a deterrent against the use of related 
party transactions. One commenter suggested that requiring auditors to 
obtain evidence supporting management's arm's-length assertion 
regarding a related party transaction had corresponding negative 
economic consequences, such as, management avoiding the use of related 
party transactions. Another commenter that stated that the increased 
audit effort will result in a pass through of marginally higher audit 
costs to companies also noted that there could be changed behavior in 
structuring transactions so that they are not related party 
transactions.
    The Board considered these comments and acknowledges that, as noted 
in the reproposal, potential costs stemming from the standard and 
amendments could increase audit costs related to transactions with 
related parties, which could conceivably serve as a deterrent against 
their use. While the Board recognizes this potential, the Board notes 
that companies are already required to disclose material related party 
transactions in their financial statements, and auditors already should 
be performing some procedures, under the existing standards, with 
respect to these transactions and related disclosures. Additionally, in 
considering these comments, the Board notes that the requirement in the 
standard for auditors to obtain evidence supporting management's arm's-
length assertion regarding a related party transaction is consistent 
with the requirement in AU sec. 334.12, as applicable financial 
reporting frameworks only permit an arm's-length assertion regarding a 
related party transaction to be included in the financial statements 
when supported by evidence.
    In general, the Board's assessment of the impact of the adoption of 
the standard and amendments relative to costs was informed by the fact 
that commenters did not raise issues regarding costs that were 
inconsistent with those described by the Board in its reproposal. 
Additionally, while some commenters noted that there would be some 
increased costs to audit firms and companies, they did not provide data 
regarding the extent of such costs. A number of commenters suggested 
that the costs of the standard and amendments were appropriate. For 
example, one commenter stated that the benefits of the reproposed 
standard and amendments would outweigh the associated costs. Another 
commenter stated that the reproposed standard and amendments benefit 
users without placing too high a burden on preparers or auditors. 
However, a few commenters indicated that the costs associated with the 
standard and amendments may be difficult to measure prior to 
implementation.
    One commenter stated that the reproposed standard and amendments 
would not require significant incremental management or auditor 
resources, but resources required could be meaningfully greater for 
companies with a significant number of related party transactions or 
significant unusual transactions. Several other commenters also 
indicated that smaller audit firms might be disproportionately impacted 
by the Board's reproposal. However, commenters in general noted that 
the standard and amendments were appropriate for, and should apply to, 
audits of companies of all types and sizes, including broker-dealers 
and EGCs. As noted above, the Board received comments from a wide 
spectrum of commenters, including firms that audit companies of various 
sizes. Further discussion of the potential impact on smaller audit 
firms and smaller companies is discussed below.
Smaller Audit Firms and Smaller Companies
    The Board recognizes that the adoption of the standard and 
amendments may impose disproportionally greater costs on smaller audit 
firms than on larger audit firms. For example, the one-time costs to 
update audit methodologies and training may represent a relatively 
larger share of audit costs for smaller audit firms compared to larger 
audit firms. Further, to the extent that a smaller audit firm has not 
already incorporated procedures suggested by AU sec. 334 into its 
current practices, such a firm would likely incur higher incremental 
costs to comply with the standard and amendments.
    As described above, the costs incurred by the auditor to comply 
with the standard and amendments may be passed on, in whole, or in part 
(or not at all), to companies and their investors in the form of 
increased audit fees. To the extent this occurs, it may particularly 
affect smaller companies that rely on related party transactions as 
part of their business model. This point also was asserted by some 
commenters on the proposal and reproposal, many of whom also noted the 
particular risks posed by related party transactions engaged in by 
smaller companies. Increasing the costs of audits for smaller companies 
could negatively impact their profitability.
    In considering this potential impact, the Board also has taken note 
of its oversight findings, which indicate that the audits of smaller 
companies are more frequently the subject of inspection findings and 
enforcement actions that involve related party transactions. 
Additionally, the Board notes that there is likely less information 
available regarding smaller companies (e.g., they have fewer brokerage 
research analysts, and less press coverage). Thus, while there is the 
potential for greater cost impact on

[[Page 43225]]

smaller companies arising from the standard and amendments, there is 
also the potential that investors in such companies would accrue 
relatively larger benefits from the standard and amendments, such as a 
lower cost of capital.
    As noted above, the Board believes that any additional audit costs 
would likely vary based on the size and complexity of the company's 
transactions in the critical areas, and would be commensurate with the 
risk of material misstatement arising out of such transactions. As 
noted in the reproposing release, a company that has extensive 
relationships and transactions with related parties or significant 
unusual transactions, or that has financial relationships and 
transactions with executive officers that give rise to risks of 
material misstatement, could anticipate a greater increase in audit-
related costs than a company without such relationships or 
transactions.\217\ Thus, the Board would not expect there to be a 
significant increase in audit fees for a company that does not have 
complex or extensive: (i) Relationships or transactions with related 
parties; (ii) significant unusual transactions; or (iii) financial 
relationships and transactions with the company's executive officers. 
In addition, to the extent that some auditors are already performing 
procedures similar to those in the standard and amendments, there would 
be a lesser impact. However, if the auditor identifies related parties 
or relationships or transactions with related parties that were 
previously undisclosed to the auditor, there would be incremental 
costs, as well as benefits, associated with the auditor's response to 
the increased risks of material misstatement.
---------------------------------------------------------------------------

    \217\ See page A4-97 of the reproposing release.
---------------------------------------------------------------------------

Other Economic Considerations
    As noted above, commenters generally supported the Board's efforts 
to promote audit quality in the areas addressed by the standard and 
amendments. However, a few expressed concerns. For example, one 
commenter acknowledged that the Board had reproposed the standard and 
amendments to obtain more information regarding economic considerations 
generally, but the commenter was nonetheless critical of the Board's 
economic analysis in its reproposal. This commenter stated that the 
Board had failed to provide adequate specifics in its reproposal 
supporting the need for the standard and stated that the reproposal did 
not adequately address potential alternatives to the proposed 
requirements, including any rationale for not choosing to converge with 
the IAASB and ASB standards, which, in that commenter's view, 
introduced unnecessary complexity and cost. This same commenter also 
asked why the Board thought it necessary to adopt new requirements 
after the issuance of Staff Audit Practice Alert No. 5.
    The Board considered the issues raised by this commenter and 
believes that the need for the standard and amendments, and the 
alternatives considered by the Board, have been fully described in the 
Board's proposals and throughout this release. The standards and 
amendments being adopted represent a targeted approach that 
appropriately responds to areas of the audit that have historically 
represented risks of material misstatement in company financial 
statements. In the Board's view, the need to improve the Board's 
existing standards addressing the critical areas, including alignment 
with the Board's risk assessment standards, cannot be adequately 
addressed through staff interpretations of existing standards. More 
specific requirements are warranted to promote heightened scrutiny in 
the critical areas. While the new auditor performance requirements will 
involve some additional effort and related costs in some cases, to 
avoid unnecessary audit efforts and costs, the Board developed the 
standard to align with existing audit procedures that the auditor 
already is required to perform as part of the auditor's risk assessment 
and requires the auditor to perform procedures that are commensurate 
with the risks of material misstatement.
    The Board also considered the comment that the Board did not set 
forth a rationale for not choosing to converge the proposed auditing 
requirements with the standards of the IAASB and the ASB. As a matter 
of practice, the Board regularly considers the work of other standard-
setters, such as the IAASB and the ASB, for insights as it develops its 
standards. In developing the standard and amendments, the Board 
considered the analogous standards of the IAASB and the ASB and 
incorporated a number of similar audit procedures and requirements that 
the Board believed were useful and appropriate.\218\
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    \218\ For example, paragraph 5 of the standard being adopted by 
the Board contains similar requirements to paragraph 13 of ISA 550 
(and paragraph 14 of AU-C 550), which require the auditor to inquire 
of management regarding: The identity of the entity's related 
parties, including changes from the prior period; the nature of the 
relationships between the entity and these related parties; and 
whether the entity entered into any transactions with these related 
parties during the period and, if so, the type and purpose of the 
transactions.
---------------------------------------------------------------------------

    The Board, however, has determined that the critical areas require 
heightened scrutiny and, thus, the standard and amendments contain 
auditing requirements that are not reflected in the analogous standards 
of the IAASB and the ASB. For example, the standard and amendments 
contain requirements for the auditor to focus heightened audit 
attention on the business purpose (or the lack thereof) of a company's 
related party transactions.\219\ Also, in view of the importance of the 
audit committee's role in the oversight of the company's financial 
reporting, the standard requires the auditor to make inquiries of the 
audit committee (or its chair) regarding the audit committee's 
understanding of the company's related parties and transactions, as 
well as regarding whether any member of the audit committee has 
concerns regarding such matters. Additionally, the other amendments 
require the auditor to perform risk assessment procedures to obtain an 
understanding of a company's financial relationships and transactions 
with its executive officers.
---------------------------------------------------------------------------

    \219\ See, e.g., paragraphs 5.d., 12.a., and 19.e. of the 
standard.
---------------------------------------------------------------------------

    Two commenters raised concerns regarding economic considerations of 
a more general nature, suggesting that the Board develop a specific 
framework for considering costs and benefits more generally. The Board 
has addressed these matters separately.\220\
---------------------------------------------------------------------------

    \220\ See, e.g., PCAOB Strategic Plan: Improving the Quality of 
the Audit for the Protection and Benefit of Investors 2013-2017 
(November 26, 2103) at 5 and 13, and PCAOB Releases Staff Guidance 
on Economic Analysis in PCAOB Standard Setting (May 15, 2014) http://pcaobus.org/News/Releases/Pages/05152014_Economic_Analysis.aspx.
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    Finally, in its reproposal, the Board specifically asked for 
comment regarding any considerations relating to efficiency, 
competition and capital formation that the Board should take into 
account with respect to the reproposed standard and amendments. Other 
than the general comments described above, the Board did not receive 
comments noting specific concerns regarding efficiency, competition and 
capital formation in response to its request.
    In summary, after considering these factors and public comments, 
the Board believes that its new requirements reflect a reasoned 
approach that considers and is intended to limit unnecessary audit 
effort and related costs.

[[Page 43226]]

Economic Considerations Pertaining to Audits of EGCs, Including 
Efficiency, Competition, and Capital Formation
    The PCAOB has been monitoring implementation of the JOBS Act in 
order to understand the characteristics of EGCs \221\ and inform the 
Board's considerations regarding whether it should recommend that the 
SEC apply the standard and amendments to audits of EGCs. To assist the 
SEC, the Board is providing the following information regarding EGCs 
that it has compiled from public sources.\222\
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    \221\ Pursuant to the JOBS Act, an EGC is defined in Section 
3(a)(80) of the Exchange Act. In general terms, an issuer qualifies 
as an EGC if it has total annual gross revenue of less than $1 
billion during its most recently completed fiscal year (and its 
first sale of common equity securities pursuant to an effective 
Securities Act of 1933 (the ``Securities Act'') registration 
statement did not occur on or before December 8, 2011). See JOBS Act 
Section 101(a), (b), and (d). Once an issuer is an EGC, the entity 
retains its EGC status until the earliest of: (i) The first year 
after it has total annual gross revenue of $1 billion or more (as 
indexed for inflation every five years by the SEC); (ii) the end of 
the fiscal year after the fifth anniversary of its first sale of 
common equity securities under an effective Securities Act 
registration statement; (iii) the date on which the company issues 
more than $1 billion in non-convertible debt during the prior three 
year period; or (iv) the date on which it is deemed to be a ``large 
accelerated filer'' under the Exchange Act (generally, an entity 
that has been public for at least one year and has an equity float 
of at least $700 million).
    \222\ To obtain data regarding EGCs, the PCAOB's Office of 
Research and Analysis has reviewed registration statements and 
Exchange Act reports filed with the SEC with filing dates between 
April 5, 2012, and November 20, 2013, for disclosures by entities 
related to their EGC status. Only those entities that have 
voluntarily disclosed their EGC status have been identified. The 
PCAOB has not validated these entities' self-identification as EGCs. 
The information presented also does not include data for entities 
that have filed confidential registration statements and have not 
subsequently made a public filing.
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Characteristics of Self-Identified EGCs
    As of November 20, 2013, based on the PCAOB's research, 1,227 SEC 
registrants had identified themselves as EGCs in SEC filings. These 
companies operate in diverse industries. The five most common Standard 
Industrial Classification (``SIC'') codes applicable to these companies 
are codes for: (i) Blank check companies; (ii) pharmaceutical 
preparations; (iii) real estate investment trusts; (iv) prepackaged 
software services; and (v) computer processing/data preparations 
services.
    The five SIC codes with the highest total assets as a percentage of 
the total assets of the population of EGCs are codes for: (i) Federally 
chartered savings institutions; (ii) real estate investment trusts; 
(iii) national commercial banks; (iv) state commercial banks; and (v) 
crude petroleum or natural gas. Total assets of EGCs in these five SIC 
codes represent approximately 35% of the total assets of the population 
of EGCs. EGCs in three of these five SIC codes (federally chartered 
savings institutions, national commercial banks, and state commercial 
banks) represent financial institutions and the total assets for these 
three SIC codes represent approximately 22% of the total assets of the 
population of EGCs.
    Approximately 19% of the EGCs identified themselves in registration 
statements and were not previously reporting under the Exchange Act as 
of November 20, 2013. Approximately 64% of the companies that have 
identified themselves as EGCs began reporting under the Exchange Act in 
2012 or later. The remaining 17% of these companies have been reporting 
under the Exchange Act since 2011 or earlier. Accordingly, a majority 
of the companies that have identified themselves as EGCs began 
reporting information under the securities laws since 2012.
    Approximately 63% of the companies that have identified themselves 
as EGCs and filed an Exchange Act filing with information on smaller 
reporting company status indicated that they were smaller reporting 
companies.\223\
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    \223\ The SEC adopted its current smaller reporting company 
rules in Smaller Reporting Company Regulatory Relief and 
Simplification, Securities Act Release No. 33-8876 (December 19, 
2007). Generally, companies qualify to be smaller reporting 
companies (``SRCs'') and, therefore, have scaled disclosure 
requirements if they have less than $75 million in public equity 
float. Companies without a calculable public equity float will 
qualify if their revenues were below $50 million in the previous 
year. Scaled disclosure requirements generally reduce the compliance 
burden of SRCs compared to other issuers. Notably, the only area in 
which SRC requirements may be more extensive than requirements for 
other issuers is with respect to the disclosure of related party 
transactions. The SEC justified this difference in treatment based 
on the importance of disclosing related party transactions, 
particularly for issuers with lower materiality thresholds.
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    Approximately 32% of the companies that have identified themselves 
as EGCs provided a management report on internal control over financial 
reporting. Of those companies that provided a report, approximately 46% 
stated in the report that the company's internal control over financial 
reporting was not effective.\224\
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    \224\ For purposes of comparison, the PCAOB compared the data 
compiled with respect to the population of companies that identified 
themselves as EGCs with companies listed in the Russell 3000 Index 
in order to compare the EGC population with the broader issuer 
population. The Russell 3000 was chosen for comparative purposes 
because it is intended to measure the performance of the largest 
3,000 U.S. companies representing approximately 98% of the 
investable U.S. equity market (as marketed on the Russell Web site). 
To contrast, approximately 95% of the companies in the Russell 3000 
Index provided a management report on internal control over 
financial reporting. Of those companies that provided a management 
report, approximately 4% stated in the report that the company's 
internal control over financial reporting was not effective.
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    Audited financial statements were available for nearly all of the 
companies that identified themselves as EGCs.\225\ For those companies 
for which audited financial statements were available and based on 
information included in the most recent audited financial statements 
filed as of November 20, 2013:
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    \225\ Audited financial statements were available for 1,216 of 
the 1,227 self-identified EGCs. Audited financial statements were 
not available for some EGCs that had filed registration statements 
that had not been declared effective by the SEC.
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     The reported assets ranged from zero to approximately 
$18.2 billion. The average and median reported assets were 
approximately $184.4 million and $0.4 million, respectively.\226\
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    \226\ As noted above, for purposes of comparison, the PCAOB 
compared the data compiled with respect to the population of 
companies that identified themselves as EGCs with companies listed 
in the Russell 3000 Index in order to compare the EGC population 
with the broader issuer population. The average and median reported 
assets of issuers in the Russell 3000 were approximately $12.2 
billion and approximately $1.6 billion, respectively. The average 
and median reported revenue from the most recent audited financial 
statements filed as of November 20, 2013 of issuers in the Russell 
3000 were approximately $4.6 billion and $725.8 million, 
respectively.
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     The reported revenue ranged from zero to approximately 
$962.9 million. The average and median reported revenue were 
approximately $59.6 million and $3 thousand, respectively.
     The average and median reported assets among companies 
that reported revenue greater than zero were approximately $359.5 
million and $68.1 million, respectively. The average and median 
reported revenue among these companies that reported revenue greater 
than zero were approximately $116.2 million and $20.7 million, 
respectively.
     Approximately 49% identified themselves as ``development 
stage entities'' in their financial statements.\227\
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    \227\ According to the Financial Accounting Standards Board 
(``FASB'') standards, development stage entities are entities 
devoting substantially all of their efforts to establishing a new 
business and for which either of the following conditions exists: 
(i) Planned principal operations have not commenced or (ii) planned 
principal operations have commenced, but there has been no 
significant revenue from operations. See FASB Accounting Standards 
Codification Subtopic 915-10, Development Stage Entities--Overall.
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     Approximately 54% had an explanatory paragraph included in 
the auditor's report describing that there is substantial doubt about 
the company's ability to continue as a going concern.\228\
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    \228\ Approximately 1% of the population of companies in the 
Russell 3000 Index have an explanatory paragraph describing that 
there is substantial doubt about the company's ability to continue 
as a going concern.

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[[Page 43227]]

     Approximately 38% were audited by firms that are annually 
inspected by the PCAOB (that is, firms that have issued auditor's 
reports for more than 100 public company audit clients in a given year) 
or are affiliates of annually inspected firms. Approximately 62% were 
audited by triennially inspected firms (that is, firms that have issued 
auditor's reports for 100 or fewer public company audit clients in a 
given year) that are not affiliates of annually inspected firms.
    The PCAOB's Office of Research and Analysis has reviewed 
registration statements and Exchange Act reports filed with the SEC 
with filing dates between April 5, 2012, and November 20, 2013, for 
related party disclosures by EGCs. An analysis of 1,103 of the most 
recent audited financial statements filed through November 20, 2013 of 
the 1,227 self-identified EGCs indicates that approximately 68% of 
these companies disclosed at least one related party relationship or 
transaction.\229\
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    \229\ A similar analysis of SEC filings for the population of 
companies in the Russell 3000 Index found that approximately 45% of 
those companies have disclosed at least one related party 
relationship or transaction.
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Economic Considerations Pertaining to Audits of EGCs, Including 
Comments Received
    The Board's analysis of the potential economic impacts on EGCs is 
based on the EGC data described above, which has been collected and 
analyzed by the Board's staff. The Board's analysis is also informed by 
the Board's oversight activities, as well as by the other 
considerations described hereinand the release more generally. 
Additionally, the Board's analysis has been informed by information 
provided by commenters. The Board's discussion of potential economic 
impacts on EGCs follows.
    Based on the data outlined above, a majority of EGCs are smaller 
public companies. EGCs also appear to be companies that are relatively 
new to the SEC reporting process. This indicates that there is less 
information available to investors regarding such companies relative to 
the broader population of public companies. It is generally 
acknowledged that investors are less informed about companies that are 
smaller and newer, suggesting there is a higher degree of information 
asymmetry for smaller and newer companies.
    Self-identified EGCs disclosed related party relationships or 
transactions at a significantly higher rate as compared to companies in 
the Russell 3000 Index. The data also suggests that EGCs are more 
likely than the population of companies in the Russell 3000 Index to 
have a management report on internal control over financial reporting 
stating that the company's internal control over financial reporting 
was not effective. The higher propensity of EGCs to engage in related 
party transactions coupled with an increased likelihood for control 
deficiencies suggests that applying the standard in audits of EGCs is 
particularly relevant.
    Given the characteristics of EGCs as newer and smaller companies, 
some might assume that EGCs would have operations that are less 
complex. However, this may not be true for many EGCs. Audits of EGCs 
appear to reflect a wide range of complexity and risk. For example, 580 
of the 1,227 companies that have identified themselves as EGCs did not 
recognize revenue in the most recently filed financial statements. 
Financial institutions represent at least 22% of the total assets of 
EGCs. Given the nature of the operations of financial institutions, 
these EGCs could engage in transactions that involve complex accounting 
and financial statement disclosure issues.
    Further, the data presented above indicates that for 54% of the 
EGCs the auditor's report on the most recent audited financial 
statements includes an explanatory paragraph describing that there is 
substantial doubt about the company's ability to continue as a going 
concern, as compared to 1% for the population of companies in the 
Russell 3000 Index.
    Thus, applying the standard and amendments to the audits of EGCs 
may be particularly pertinent because of the characteristics of EGCs 
described above (e.g., potential for higher rates of material 
weaknesses in internal control, use of related party transactions, and 
substantial doubt about the company's ability to continue as a going 
concern).
    In the reproposal, the Board specifically sought comment on the 
application of the reproposed standard and amendments to audits of 
EGCs. Commenters generally considered the requirements of the standard 
to be applicable and appropriate to companies of varying sizes and 
industries. All those who commented on the applicability of the 
standard and amendments to EGCs stated that the reproposed standard and 
amendments should be applicable to audits of EGCs. Those commenters 
provided various reasons, including that the risks regarding related 
parties, significant unusual transactions and financial relationships 
and transactions with executive officers are the same, if not greater 
at EGCs and that EGCs may enter into such matters more frequently than 
non-EGCs.
    No commenters stated that the reproposed standard and amendments 
should not apply to audits of EGCs. One commenter, however, was 
concerned that the reproposal did not contain a substantive analysis of 
the economic impacts of the proposed requirements on EGCs. This 
commenter acknowledged, however, that after the enactment of the JOBS 
Act, the Board reproposed the standard and amendments to seek comment 
and obtain additional information regarding the economic impacts on 
EGCs.
    Some commenters stated that the reproposed standard is scalable for 
application to audits of EGCs. One commenter stated that firm 
implementation costs should not differ when implementing the reproposed 
standard for audits of EGCs or other issuers; however, increased 
recurring costs may fall relatively disproportionately on EGCs. One 
commenter stated that the implementation and training costs that a firm 
would incur would not depend upon whether the reproposed standard is 
applicable to EGCs and there should be little or no additional costs to 
apply the reproposed standard to EGCs. Another commenter noted that 
although smaller companies (some of which may be EGCs) may engage in 
more related party transactions compared to other companies, which will 
result in higher audit costs, the costs are commensurate with the risks 
of material misstatement.
    Some commenters noted that regardless of the applicability to 
audits of EGCs, firms would perform the same procedures for all audits. 
One commenter suggested that it would be more costly not to apply the 
reproposed standard and amendments to audits of EGCs as this would, in 
the commenter's view, require firms to maintain two methodologies. One 
commenter stated that it would perform the same procedures for audits 
of EGCs, regardless of the applicability of the reproposed standard and 
amendments to audits of EGCs, as the cost to develop and maintain two 
separate methodologies and the related training would be cost-
prohibitive. One commenter, representing a committee, stated that the 
standard should be applicable to audits of EGCs. However, that 
commenter also noted that its committee members had a mixed response; 
some believed the standard ought to be universally applicable, as a 
``carve-out'' for EGGs would be more costly, but a minority believed 
that a carve out would be easy to implement.

[[Page 43228]]

One commenter suggested that applying different rules to financial 
statement audits performed in accordance with PCAOB standards could be 
confusing to investors and other stakeholders.
    The standard and amendments are designed to improve the auditor's 
efforts regarding a company's relationships and transactions with its 
related parties, significant unusual transactions and financial 
relationships and transactions with its executive officers. As 
previously discussed, a significant number of the Board's oversight 
findings from its inspections and enforcement programs regarding 
related party transactions involve smaller public companies, which have 
characteristics that are similar to EGCs.
    Thus, enhanced auditor consideration of the areas addressed in the 
standard and amendments may be particularly important to investors in 
EGCs given that: (i) Information asymmetry may be more pronounced at 
EGCs; (ii) there is the potential for greater reliance by EGCs on 
related party transactions; and (iii) there is a significant number of 
findings regarding related party transactions in audits of financial 
statements of smaller companies identified through PCAOB oversight 
activities.
    Improving the auditor's efforts in the areas addressed in the 
standard and amendments should promote audit quality in ways that also 
should improve financial statement accounting and disclosure, which in 
turn should improve financial reporting, reduce information asymmetry, 
and reduce the company's cost of capital. These benefits should accrue 
to all types of companies, including EGCs.
    EGCs will incur some incremental costs in connection with auditor 
compliance with the standard and amendments. As noted earlier, these 
costs may be disproportionately higher for smaller companies, including 
EGCs, relative to the broader population of public companies. The 
additional audit-related costs, as discussed above, could conceivably 
serve as a deterrent against the use of related party transactions by 
EGCs. Likewise, additional audit-related costs may deter certain EGCs 
from entering public markets, if those costs weigh heavily on their 
potential profitability. To the extent that EGCs tend to be smaller and 
newer companies, the enhanced audit performance requirements may place 
a disproportionately higher burden on them, which may impact their 
profitability and competitiveness. As noted above, however, no 
commenter stated that the reproposed standard and amendments should not 
apply to audits of EGCs and no commenter discussed the impact on 
competitiveness of EGCs.
    The standard and amendments are designed to mitigate cost impacts 
by aligning the auditor's efforts with the risk assessment standards 
and providing opportunities for a scaled approach. This allows auditors 
to integrate the audit to avoid unnecessary audit effort.
    Additionally, in its reproposal, the Board specifically asked for 
comment regarding any considerations regarding efficiency, competition 
and capital formation that the Board should take into account when 
determining whether to recommend to the SEC the application of the 
reproposed standard and amendments to audits of EGCs. No commenter 
expressed concerns regarding efficiency, competition and capital 
formation with respect to the application of the reproposed standard 
and amendments to audits of EGCs.
Recommendation
    The Board believes that the standard and amendments will advance 
investor protection and promote audit quality. In addition, more 
effective audits and more informed communications between the auditor 
and the audit committee should enhance the quality of a company's 
financial reporting.
    Additionally, the Board believes that its new requirements reflect 
a reasoned approach to considering and limiting unnecessary audit 
effort and related costs. Many commenters agreed that the reproposed 
standard and amendments would lead to improvements in audit quality, 
with many commenters stating that the requirements of the reproposed 
standard and amendments should be applicable to, and were appropriate 
for, companies of different sizes and industries.
    The JOBS Act was enacted after the Board issued its proposing 
release. Subsequently, the Board issued a reproposal, in part to 
request comment specifically on matters relating to the application of 
the standard and amendments to audits of EGCs. A variety of commenters 
noted particular risks posed by related party transactions pertinent to 
small companies, including EGCs. In addition, all those commenters who 
commented with respect to the applicability of the standard and 
amendments to EGCs stated that the standard and amendments should be 
applicable to audits of EGCs.
    Based on data available to the Board regarding EGCs, it appears 
that a wide range of entities, of differing sizes and industries, 
identify themselves as EGCs. One key difference between EGCs and the 
broader population of public companies would appear to be the length of 
time that EGCs have been subject to Exchange Act reporting 
requirements. Based on the information available to the Board, while 
there may be additional costs and potential competitive impacts on 
EGCs, there also may be additional benefits from enhanced scrutiny in 
the areas addressed by the standard and amendments. Given these 
considerations, there does not appear to be a compelling reason to 
treat audits of EGCs differently from the audits of other companies.
    For the reasons explained above, the Board believes that the 
standard and amendments are in the public interest and, after 
considering the protection of investors and the promotion of 
efficiency, competition, and capital formation, recommends that the 
standard and amendments should apply to audits of EGCs. Accordingly, 
the Board recommends that the Commission determine that it is necessary 
or appropriate in the public interest, after considering the protection 
of investors and whether the action will promote efficiency, 
competition, and capital formation, to apply the standard and 
amendments to audits of EGCs. The Board stands ready to assist the 
Commission in considering any comments the Commission receives on these 
matters during the Commission's public comment process.

III. Date of Effectiveness of the Proposed Rules and Timing for 
Commission Action

    Pursuant to Section 19(b)(2)(A)(ii) of the Exchange Act, and based 
on its determination that an extension of the period set forth in 
Section 19(b)(2)(A)(i) of the Exchange Act is appropriate in light of 
the PCAOB's request that the Commission, pursuant to Section 
103(a)(3)(C) of the Sarbanes-Oxley Act, determine that the proposed 
rules apply to audits of emerging growth companies, as defined in 
Section 3(a)(80) of the Exchange Act, the Commission has determined to 
extend to October 22, 2014 the date by which the Commission should take 
action on the proposed rules.

IV. Solicitation of Comments

    Interested persons are invited to submit written data, views and 
arguments concerning the foregoing, including whether the proposed 
rules are consistent with the requirements of Title I of the Act. 
Comments may be submitted by any of the following methods:

[[Page 43229]]

Electronic Comments

     Use the Commission's Internet comment form (http://www.sec.gov/rules/pcaob.shtml); or
     Send an email to rule-comments@sec.gov. Please include 
File Number PCAOB-2014-01 on the subject line.

Paper Comments

     Send paper comments in triplicate to Kevin M. O'Neill, 
Deputy Secretary, Securities and Exchange Commission, 100 F Street NE., 
Washington, DC 20549-1090.

All submissions should refer to File Number PCAOB-2014-01. This file 
number should be included on the subject line if email is used. To help 
the Commission process and review your comments more efficiently, 
please use only one method. The Commission will post all comments on 
the Commission's Internet Web site (http://www.sec.gov/rules/pcaob.shtml). Copies of the submission, all subsequent amendments, all 
written statements with respect to the proposed rules that are filed 
with the Commission, and all written communications relating to the 
proposed rules between the Commission and any person, other than those 
that may be withheld from the public in accordance with the provisions 
of 5 U.S.C. 552, will be available for Web site viewing and printing in 
the Commission's Public Reference Room, 100 F Street NE., Washington, 
DC 20549-1090, on official business days between the hours of 10:00 
a.m. and 3:00 p.m. Copies of such filing will also be available for 
inspection and copying at the principal office of the PCAOB. All 
comments received will be posted without charge; we do not edit 
personal identifying information from submissions. You should submit 
only information that you wish to make available publicly. All 
submissions should refer to File Number PCAOB-2014-01 and should be 
submitted on or before August 14, 2014.

    For the Commission, by the Office of the Chief Accountant, by 
delegated authority.\230\
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    \230\ 17 CFR 200.30-11(b)(2).
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Kevin M. O'Neill,
Deputy Secretary.
[FR Doc. 2014-17400 Filed 7-23-14; 8:45 am]
BILLING CODE 8011-01-P