[Federal Register Volume 79, Number 142 (Thursday, July 24, 2014)]
[Notices]
[Pages 43163-43229]
[FR Doc No: 2014-17400]

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

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

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

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

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

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.)

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

(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

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).
---------------------------------------------------------------------------

    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.
---------------------------------------------------------------------------

    \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

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.
---------------------------------------------------------------------------

    \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\
---------------------------------------------------------------------------

    \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.
---------------------------------------------------------------------------

    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\

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.
---------------------------------------------------------------------------

    \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.
---------------------------------------------------------------------------

    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.
---------------------------------------------------------------------------

    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.
---------------------------------------------------------------------------

    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

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

to the standard and amendments.\58\ Some of the more significant of
these include:
---------------------------------------------------------------------------

    \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.
---------------------------------------------------------------------------

     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.
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    \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.
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     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

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.
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    \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.
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    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

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.
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    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\
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    \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.
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    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