I support the release of the proposed standard dealing with
related parties that would supersede AU 334, as well as the proposed
amendments to AU 316, Consideration of Fraud in a Financial
Statement Audit, to strengthen the auditor's evaluation of
significant unusual transactions, and the amendments to PCAOB
standards that would address the auditor's consideration of a
company's financial relationships and transactions with its
executive officers. Taken together, these new standards further
elucidate and strengthen the Board's risk assessment standards set
forth in Auditing Standards 8 through 15.
Related party transactions, significant and unusual transactions,
and transactions between a company and its executive officers may or
may not overlap, but together they encompass types of relationships
and transactions that may be especially vulnerable to fraud or
material misstatement of financial statements. Indeed, an
examination of the major financial frauds and financial statement
restatements in recent years, both in the U.S. and abroad, reveals
that one or more of the relationships or types of transactions
addressed by these proposals have been present in many of these
cases. The PCAOB's own inspection results have shown that some
auditors have not given adequate consideration to the risks of
material misstatement from related party transactions. Our
inspection results have also revealed deficiencies in some auditors'
consideration and understanding of off-balance sheet structures
which can also be a source of material misstatement.
These facts suggest two things to me: 1) that the types of
relationships and transactions addressed by the Board's proposals
deserve special scrutiny by auditors and 2) that audit committees
should be informed in detail of the work performed by auditors in
these areas so that they can fully understand their meaning and
implications. These new standards should both clarify for auditors
those areas that the Board believes require special attention and
should insure that audit committees are better informed about them.
With respect to related parties, auditors should ascertain from
management information about the identity, background, nature of the
relationship, types of transactions and business reasons for the
transactions as well as whether they were authorized in accordance
with company policy. These rules are designed to give the auditor an
understanding of the economic substance and business rationale for
the transaction, an understanding that should make abuses easier to
spot.
The amendments to AU 316 will require auditors to perform
specific procedures to identify significant unusual transactions, to
understand and evaluate the business purpose of such transactions
and to evaluate whether they have been appropriately accounted for
and adequately disclosed. Additionally, other amendments will
require auditors to perform procedures to obtain an understanding of
the company's financial relationships and transactions with its
executives, to obtain representations from management that there are
no other arrangements, whether oral or written, concerning such
relationships and transactions that have not been disclosed. The
amendments will also emphasize the auditor's existing
responsibilities to communicate possible fraud to management, the
audit committee and under certain circumstances the U.S. Securities
and Exchange Commission.
Together, the proposed changes should provide clearer guidance
about the types of investigative and analytic steps that auditors
need to undertake in connection with types of relationships and
transactions that experience has shown are particularly subject to
abuse. If they operate as intended they may improve the analytical
rigor with which auditors approach such matters and the
understanding of audit committees of such transactions. If, as
hoped, this is the case, investors will be the beneficiaries.
I want to acknowledge and express my appreciation for the
dedicated of the Office of the Chief Auditor and the General Counsel
on the proposals and specifically Greg Scates, Brian Degano, Nick
Grillo, Bob Burns and Nina Mojiri-Azad. We look forward to receiving
comments on these proposals.