PCAOB reissues proposed standards for related party accounting

Reissued standards will help auditors differentiate between dubious transactions and legitimate mechanisms for financing or asset sales.  

The Public Company Accounting Oversight Board this week reissued proposed standards calling for greater auditor focus on related party transactions and significant financial relationships of executive officers with their employers, but left unanswered whether certain smaller companies will be exempted from the requirements.

The standards, originally proposed in February 2012, were reproposed at an open meeting of the PCAOB in Washington D.C. on May 7, along with amendments made in response to public comments the board had received. If adopted as amended, the standards would strengthen audit procedures for evaluating the identification, accounting, and disclosure by a client company of its relationships and transactions with related parties.

Related party transactions, and significant transactions that are outside the normal course of business, have contributed to many financial reporting frauds over the decades. The PCAOB’s reproposed standards address ‘a skein of financial reporting failures in this area that have resulted in significant investor losses as well as the loss of jobs at affected companies,’ according to a statement by PCAOB Chairman James R. Doty at the meeting.

One provision in the original proposal that elicited several negative public comments would also require the auditor to look at a company’s financial relationships and transactions with executive officers as part of its material misstatement risk assessment. While that requirement has been retained, the PCAOB clarified that auditors are not required ‘to make any determination regarding the reasonableness of, or any recommendations regarding, compensation arrangements,’ according to a statement from the Board.

The Society of Corporate Secretaries and Governance Professionals (SCSGP) had expressed concerns regarding the original proposal that the standards would cause auditors to increasingly become ‘enmeshed in the minutiae of a company’s daily transactions rather than remaining focused on the larger, macro-view of the company’s financial statements’, which would increase the cost of the audit.

Darla Stuckey, senior vice president for policy and advocacy at SCSGP, said they had not yet looked at the revised standards. ‘I’m sure we will comment. We’re looking at it and evaluating them.’

Concerns about the economic impact of implementing the proposed standards, particularly on smaller companies, remain unanswered. The JOBS Act, passed last year to reduce the regulatory and accounting burden on smaller companies going public, specifically exempted those companies defined as Emerging Growth Companies from new audit standards unless the SEC determines otherwise. The PCAOB, in releasing the proposal, specifically asked for public comment on the potential economic impact of the new standards on those emerging growth companies.

High profile cases of financial reporting fraud, such as at Enron and Tyco, were cited by the PCAOB when developing the standards. ‘The number and magnitude of these cases demonstrate that heightened auditor scrutiny is warranted, and the reproposed standard and amendments will focus auditors on providing a more consistent examination of these areas,’ Doty said in a statement released after the meeting.

Comments on the standards are due to the PCAOB by July 8, 2013. The standards currently proposed would go into effect for fiscal years beginning on or after Dec 15, 2013.

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