Impact of PCAOB AS No. 18 on Auditing Practices
The Public Company Accounting Oversight Board (PCAOB) has raised the bar for auditors with the publication of a new auditing standard, AS-18. This standard aims to increase scrutiny on three critical areas: relationships and transactions with related parties, significant transactions outside the normal course of business, and financial relationships and transactions with executive officers. These areas, collectively referred to as 'the critical areas,' are subject to increased audit scrutiny due to their potential for material misstatement in financial statements.
The auditor's primary objective is to obtain sufficient appropriate audit evidence to conclude if all significant relationships and transactions with related parties and executive officers, and unusual transactions, have been properly identified, accounted for, and disclosed in the audited financial statements. To achieve this, the auditor needs to understand the company's process, perform inquiries, communicate with the audit engagement team, and other auditors.
The auditor also needs to determine what constitutes 'sufficient appropriate audit evidence' as required by the standard and interpreted by the PCAOB. This involves conducting adequate audit procedures and ensuring they are sufficiently documented. Risk assessment procedures required by AS-12 are also essential for the critical areas.
The auditor is expected to identify all significant relationships and transactions with related parties and executive officers, and unusual transactions. The relevant U.S. GAAP definition of related parties can be found in the Financial Accounting Standards Board (FASB) Accounting Standards Codification® (ASC), specifically in ASC 850-10-20. According to this definition, related parties include affiliates, entities with significant investments, trusts managed by or under the trusteeship of management, principal owners, management, and parties that can significantly influence the management or operating policies of the entity.
The auditor needs to ensure that all identified relationships and transactions are adequately disclosed. Additional procedures are required when related party transactions exist, including testing the accuracy and completeness of the relationships and transactions. Missteps in understanding and applying the definition of related parties can lead to violations of U.S. GAAP and potential legal actions.
The PCAOB views the auditor's efforts for these three critical areas as complementary, as working in one area can easily relate to one or both of the other areas. The auditor needs to assess the risk taken on by the client and its impact on Risk Management Methodology (RMM).
The increased expectations posed by AS-18, combined with the PCAOB's tendency to focus on recently issued standards in their inspections, has audit firms laser-focused on related party transactions. The auditor's understanding of AS-18 is crucial in meeting the requirements of the standard.
The AS-18 auditing standard issued by the PCAOB on February 8, 2016, primarily affects public accounting firms registered with the PCAOB and the public companies they audit. It establishes requirements on audit procedures for related parties and significant unusual transactions, thus impacting auditors and those companies subject to PCAOB inspections and standards compliance. The PCAOB has provided examples and sources of information that may be gathered by the auditor to indicate that related party relationships or transactions exist in Appendix A to Appendix 1 of AS-18.
In conclusion, AS-18 sets a new standard for auditors, increasing the focus on related parties and unusual transactions. Compliance with this standard is essential for maintaining the integrity and accuracy of financial statements.
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