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Overview

Upon completion of this lesson, candidates should be able to:

Understand how to identify and assess the risks of material misstatement involving related party
relationships and transactions under PCAOB auditing standards.

Understand how to respond to the assessed risks of material misstatement involving related party
relationships and transactions and to evaluate their financial statement effects under PCAOB
auditing standards.

Know the auditor's responsibilities for communicating with an entity's audit committee about
related party relationships and transactions under PCAOB auditing standards.

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Study Guide

1. Related Parties
2. Introduction and Overview
1. Until 2014, the PCAOB guidance with respect to related-party issues was a now-superseded
AICPA Statement on Auditing Standards adopted by the PCAOB on a temporary basis in 2003.
The PCAOB updated its guidance on related-party relationships and transactions by
incorporating the PCAOB's risk assessment standards issued in 2010.
2. Objective—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.”
3. Risk Assessment —The auditor should identify and assess the risks of material misstatement at
the financial statement and assertion levels, including the risks of material misstatement
associated with related parties and transactions with related parties.
4. Response to Risk Assessment—The auditor should design and implement audit responses
addressing the assessed risks of material misstatement, including the risks of material
misstatement associated with related parties and transactions with related parties.

Note
If management makes an assertion that transactions with related parties were conducted on
terms equivalent to those prevailing in arm's-length transactions, the auditor should
determine whether evidence obtained supports or refutes such assertions. Such an assertion
may result in a qualified or adverse opinion, since it may be impossible for management to
determine what the terms would have been had the parties not been related.

3. Perform Risk Assessment Procedures—The auditor should perform procedures to obtain an

understanding of the nature of the relationships between the company and its related parties,
including the terms and business purposes of transactions with related parties.
1. The auditor should obtain an understanding of the company's process for
1. Identifying related parties and transactions with related parties;
2. Authorizing and approving transactions with related parties; and
3. Accounting for and disclosing relationships and transactions with related parties in the
financial statements.
2. The auditor should make appropriate inquiries of management, others who may be
knowledgeable about related-party issues, and the audit committee (or chair).
1. Inquire of management about the following:
1. The names of the company's related parties, the nature of the relationships, and
any changes from the prior period;
2. Background information about the related parties, including location, industry,
size, etc.;
3. The transactions involving related parties during the period, including the terms
and business purposes of those transactions; and

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4. Any related-party transactions that were not authorized according to the

company's established policies (including any exceptions that were granted and
the reasons).
2. Inquire of others who may have knowledge of the matters identified above. These may
include internal auditors, in-house legal counsel, the chief compliance/ethics officer, and
the human resources director.
3. Inquire of the audit committee (or its chair) about the audit committee's understanding
of the company's relationships, significant related-party transactions, and whether any
member of the audit committee has any concerns about related-party issues.
3. Communication—The auditor should communicate relevant information about related-party
issues to engagement team members (and, when using the work of other auditors, the auditor
should communicate relevant information about related-party issues to those other auditors).
4. Response to Risk Assessment —The auditor should respond appropriately to the assessed risks of
material misstatement associated with related parties and transactions with related parties.
1. For any related-party transactions that are required to be disclosed or that are determined to
be a significant risk, the auditor should do the following:
1. Read the underlying documents for consistency with explanations from inquiries and
other audit evidence about the business purpose;
2. Determine whether the transaction has been authorized and approved in accordance
with the company's established policies and whether any exceptions to the company's
established policies were granted;
3. Evaluate the financial capability of the related parties with respect to significant
responsibilities (relevant information might include the audited financial statements of
the related parties, reports of regulatory agencies, financial publications, and income tax
returns if available); and
4. Perform other procedures as necessary regarding the assessed risks of material
misstatement.
2. Intercompany Accounts —The auditor should address the risks of material misstatement
regarding the company's intercompany accounts.
5. Evaluation of Financial Statement Treatment —The auditor should evaluate whether the company
has properly identified its related parties and transactions with related parties.
1. The auditor should read the minutes of board meetings and evaluate any significant unusual
transactions, including transactions with executives.
2. If the auditor believes that previously undisclosed related-party relationships or transactions
may exist, the auditor should perform procedures (beyond inquiry of management) to
determine whether those relationships or transactions do exist.
3. If the auditor determines that previously undisclosed related-party relationships or
transactions exist, the auditor should do the following:
1. Inquire of management about the possible existence of other transactions with the
related party previously undisclosed;
2. Evaluate why the matter was previously undisclosed to the auditor;
3. Communicate relevant information to other members of the audit team;

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4. Consider the need to perform additional procedures to identify other relationships or

transactions previously undisclosed;
5. Perform the procedures identified above for transactions with related parties required to
be disclosed or determined to be a significant risk; and
6. Reconsider the auditor's risk assessment: (1) Evaluate the implications to the auditor's
assessment of internal control; (2) reassess the risk of material misstatement and
perform additional procedures as necessary; and (3) evaluate the implications for the
audit if the auditor believes the undisclosed matter indicates that fraud or an illegal act
may be involved.
4. Communications with the Audit Committee
1. In general, the auditor should communicate the auditor's evaluation of the company's
identification and financial reporting of related-party relationships and transactions.
2. The auditor should also communicate other significant matters associated with related-
party relationships and transactions, such as the following:
1. Related-party relationships or transactions with parties that were previously
undisclosed to the auditor
2. Significant related-party transactions that have not been authorized in accordance
with the company's established policies or for which exceptions to the company's
established policies were made
3. Related-party transactions identified by the auditor that appear to lack an
appropriate business purpose
4. Management's assertion included in the financial statements that the terms of a
related-party transaction were equivalent to that of an arm's-length transaction
(and the evidence obtained by the auditor that is consistent or inconsistent with
that assertion)
5. Indicators of Related Parties and Transactions Undisclosed to the Auditor
The PCAOB provides examples of information (and sources of information) that may indicate to
the auditor that related parties or related-party transactions previously undisclosed to the
auditor might exist.
1. Examples of information that may indicate that related parties or transactions with
related parties previously undisclosed to the auditor might exist
1. Purchasing or selling at significantly different than market prices
2. Sales transactions that have unusual terms (e.g., “bill and hold” transactions) or
engaging in transactions that lack economic substance
3. Borrowing or lending at significantly different than normal terms
4. Advancing funds that are used to pay for an otherwise uncollectible receivable
5. Guarantees outside the normal course of business
2. Examples of sources of information that may indicate that related parties or transactions
with related parties previously undisclosed to the auditor might exist:
1. Filings with the SEC and other regulatory agencies
2. Confirmation responses and lawyer letters
3. Internal reports (e.g., reports prepared by the entity's internal auditors and records
from the company's whistleblower program)
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4. Shareholder registers identifying major shareholders

5. Contracts and other agreements with management or others involving significant
unusual transactions

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Notes

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Flashcards

1
1. How the company identifies related
PCAOB auditing standards parties and transactions with
require the auditor to obtain related parties
an understanding of the 2. How the company authorizes and
approves transactions with related
company's processes for three parties
specific matters regarding 3. How the company accounts for and
related party issues. What are discloses relationships and
transactions with related parties in
they? the financial statements.

2
PCAOB auditing standards
suggest that the auditor
should make certain inquiries
Internal auditors
of others (in addition to In-house legal counsel
management or the audit Chief compliance or ethics officer
committee). Identify some Director of human resources

examples of such others to

whom inquiry should be
made.
3
Names of the related parties,
PCAOB auditing standards nature of the relationships, and
require the auditor to make changes from the prior period
Background information about
certain inquiries of related parties, including location,
management about related- industry, size, and so on
party issues. What are those Transactions involving related
parties, including terms and
specific matters about which business purposes
the auditor should inquire of Any related-party transactions not
management? authorized according to the
company's established policies

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4
Purchasing or selling at
significantly different than market
What are some examples of prices
information that may indicate Sales transactions that have
unusual terms or transactions that
that related parties or
lack economic substance
transactions with related Borrowing or lending at
parties previously undisclosed significantly different than normal
terms
to the auditor might exist?
Guarantees outside the normal
course of business

5
PCAOB auditing standards
suggest that the auditor
The audit committee's understanding of
should make certain inquiries the company's relationships, significant
of the company's audit related-party transactions, and whether
any member of the audit committee has
committee (or its chair) about any concerns about related-party issues
related-party issues. What
matters should the auditor
inquire about?
6
Read the underlying documents for
consistency with other audit
evidence about the business
purpose.
Determine whether the transaction
What should the auditor do has been authorized and approved
when a related-party in accordance with established
transaction is determined to policies and whether any
exceptions to established policies
be a significant risk? were granted.
Evaluate the financial capability of
the related parties with respect to
significant responsibilities.
Perform other procedures as
necessary.

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7
The auditor's objective is "to obtain
What is the auditor's objective sufficient appropriate audit evidence to
in connection with the PCAOB determine whether related parties and
auditing standard entitled relationships and transactions with
related parties have been properly
Related Parties? identified, accounted for, and disclosed
in the financial statements."

8
Filings with the SEC and other
regulatory agencies
What are some sources of Confirmations and lawyer letters
information that may indicate Internal reports (e.g., by the
internal auditors or from a
that related parties or
whistleblower program)
transactions with related Shareholder registers identifying
parties previously undisclosed major shareholders
Contracts and other agreements
to the auditor might exist?
involving significant unusual
transactions

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Knowledge Checks

Question 1 (PQ9018)

Under PCAOB auditing standards, the auditor should identify and assess the risks of material
misstatement associated with related parties and transactions with related parties.
True
False

Question 2 (PQ9024)

An auditor of a public company has no responsibility to evaluate the financial capability of the related
parties with respect to their significant responsibilities whether or not the transactions are required to be
disclosed.
True
False

Question 3 (PQ9022)

Under PCAOB auditing standards, the auditor is prohibited from making inquiries of company personnel
other than those directly involved in the company's financial reporting function.
True
False

Question 4 (PQ9021)

If management of an issuer makes an assertion that transactions with related parties were conducted on
terms equivalent to those prevailing in arm's-length transactions, the auditor's report may include a
qualified or adverse opinion if evidence cannot be obtained to support management's assertion.
True
False

Question 5 (PQ9027)

If the auditor identifies previously undisclosed related-party relationships or transactions, the auditor
should reassess the risk of material misstatement and perform additional procedures considered
necessary.
True
False

Question 6 (PQ9025)

If the auditor of a public company believes that previously undisclosed related-party relationships or
transactions may exist, the auditor's responsibility is limited to expressing a qualified audit opinion.
True
False

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Question 7 (PQ9026)

When the auditor identifies related-party relationships or transactions with parties that were previously
undisclosed to the auditor, the matter should be communicated to the company's audit committee.
True
False

Question 8 (PQ9020)

If management of an issuer makes an assertion that transactions with related parties were conducted on
terms equivalent to those prevailing in arm's-length transactions, the auditor's report should include a
disclaimer of opinion on the company's financial statements.
True
False

Question 9 (PQ9023)

Among other matters, the auditor of a public company should inquire of management as to whether there
were any related-party transactions that were exceptions to the company's established policies for
approving such transactions.
True
False

Question 10 (PQ9019)

Under PCAOB auditing standards, the auditor should design and implement audit responses addressing
the risks of material misstatement associated with related parties and transactions with related parties.
True
False

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Slides

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