consistent with the existing description in paragraph 71.g. of Auditing
Standard No. 12. The amendments to AU sec. 316.66 also state that
significant unusual transactions may be used to engage in fraudulent
financial reporting or conceal misappropriation of assets.
    Conforming Amendments: The amendments regarding significant unusual
transactions also make conforming changes to introduce a uniform
description of ``significant unusual transaction'' throughout the
Board's standards. Specifically, the amendments align the terminology
in: (i) Paragraph 14 of Auditing Standard No. 5, An Audit of Internal
Control Over Financial Reporting That Is Integrated with An Audit of
Financial Statements; (ii) paragraph 12 of Auditing Standard No. 9,
Audit Planning; (iii) paragraph 13 of Auditing Standard No. 12; (iv)
paragraph 15.c. of Auditing Standard No. 13; (v), paragraph .85.A.2 of
AU sec. 316; and (vi) AU sec. 722.55.B1.
    In general, the description of a significant unusual transaction
included in the amendments permits the auditor flexibility in applying
the description to different companies of different sizes and in
different industries. The description of a significant unusual
transaction is designed so that the auditor determines whether a
transaction is a significant unusual transaction based on the specific
facts

and circumstances of the company under audit.
    A significant unusual transaction does not necessarily need to
occur infrequently. Whether a transaction constitutes a significant
unusual transaction should be based upon the specific facts and
circumstances. The timing or frequency of transactions is only one
element to be considered in determining whether a transaction is a
significant unusual transaction.

Enhancing Requirements for Identifying Significant Unusual Transactions

    Existing requirements relating to the auditor's consideration of
fraud in a financial statement audit recognize that during an 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.\107\ The risk assessment standards also anticipate that
the auditor might come across 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. For example,
paragraph 71.g. of Auditing Standard No. 12 states that one factor that
should be evaluated for the auditor's determination of which risks are
significant risks is whether the risk involves significant transactions
outside the normal course of business or that otherwise appear to be
unusual due to their timing, size, or nature.
---------------------------------------------------------------------------

    \107\ See AU secs. 316.66-.67.
---------------------------------------------------------------------------

    The amendments include changes to existing standards that require
the performance of procedures as part of the auditor's risk assessment
process to identify significant unusual transactions. As discussed
below, these procedures include: (i) Inquiring of management and
others; (ii) understanding controls relating to significant unusual
transactions; and (iii) taking into account other information obtained
during the audit.
    Inquiring of Management and Others (Paragraphs 56-57 of Auditing
Standard No. 12): The amendments regarding significant unusual
transactions build on existing requirements in Auditing Standard No. 12
that require the auditor to make inquiries of management and others
within the company about the risks of material misstatement.\108\
Specifically, the amendments regarding significant unusual transactions
revise paragraph 56.a. of Auditing Standard No. 12 to require the
auditor to inquire of company management regarding 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.
The amendments regarding significant unusual transactions also revise
paragraphs 56.b. and 56.c. of Auditing Standard No. 12 to require the
auditor to inquire of the audit committee and internal audit personnel
(if applicable), respectively, regarding whether the company has
entered into any significant unusual transactions.
---------------------------------------------------------------------------

    \108\ See paragraphs 56 and 57 of Auditing Standard No. 12.
---------------------------------------------------------------------------

    The amendments regarding significant unusual transactions also
amend paragraph 57 of Auditing Standard No. 12, which currently
requires that the auditor inquire of others within the company about
their views regarding fraud risks and includes the example of employees
involved in initiating, recording, or processing complex or unusual
transactions. The amendments add significant unusual transactions as an
example of a complex or unusual transaction to paragraph 57 of Auditing
Standard No. 12.
    Inquiring of management and others within the company regarding the
existence of significant unusual transactions as part of the auditor's
risk assessment procedures is an important step--but not the only
step--in the auditor's identification of significant unusual
transactions. The auditor might determine that there are significant
unusual transactions despite management's assertion that there are no
significant unusual transactions (e.g., through other procedures
performed during the audit, such as reading minutes of the board of
directors meetings and performing journal entry testing).
    Understanding Controls Relating to Significant Unusual Transactions
(Paragraph 73A of Auditing Standard No. 12): Auditing Standard No. 12
requires that the auditor obtain a sufficient understanding of each
component of internal control over financial reporting to: (i) Identify
the types of potential misstatements; (ii) assess the factors that
affect the risks of material misstatement; and (iii) design further
audit procedures.\109\
---------------------------------------------------------------------------

    \109\ See paragraph 18 of Auditing Standard No. 12.
---------------------------------------------------------------------------

    The amendments regarding significant unusual transactions build on
the risk assessment standards by adding paragraph 73A to Auditing
Standard No. 12. That paragraph requires the auditor to obtain an
understanding of the controls 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 through 40, 72, and 73 of
Auditing Standard No. 12.
    Taking into Account Other Information Obtained During the Audit (AU
sec. 316.66): The amendments regarding significant unusual transactions
add a note to AU sec. 316.66 stating that the auditor's identification
of significant unusual transactions should take into account
information obtained from: (i) The risk assessment procedures required
by Auditing Standard No. 12 (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 (ii) other procedures
performed during the audit (e.g., reading minutes of the board of
directors meetings and performing journal entry testing).
    Examples of those procedures include:
     Reading minutes of meetings of the board of directors and
its committees; \110\
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    \110\ See AU sec. 560.12.c. and AU sec. 722.18.a.
---------------------------------------------------------------------------

     Reading periodic and current reports, and other relevant
company filings with the SEC and other regulatory agencies; \111\
---------------------------------------------------------------------------

    \111\ See paragraph 11 of Auditing Standard No. 12, which
requires the auditor to consider reading public information about
the company relevant to the evaluation of the likelihood of material
financial statement misstatements as part of obtaining an
understanding of the company.
---------------------------------------------------------------------------

     Inspecting confirmation responses and responses to
inquiries of the company's lawyers; \112\
---------------------------------------------------------------------------

    \112\ See paragraph .06 of AU sec. 337.
---------------------------------------------------------------------------

     Obtaining an understanding of the company's selection and
application of accounting principles, including related disclosures
(e.g., reading accounting policy manuals and technical memoranda
prepared by or for management); \113\
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    \113\ See paragraph 7.c. of Auditing Standard No. 12.
---------------------------------------------------------------------------

     Performing analytical procedures during the audit; \114\
and
---------------------------------------------------------------------------

    \114\ See paragraphs 46 through 48 of Auditing Standard No. 12.
---------------------------------------------------------------------------

     Performing journal entry testing, including inquiring of
individuals involved in the financial reporting process about
inappropriate or unusual activity relating to the processing of journal
entries and other adjustments as required by existing standards.\115\
---------------------------------------------------------------------------

    \115\ See AU secs. 316.58 through 62.

---------------------------------------------------------------------------

    Also, the auditor might identify significant unusual transactions
when examining information gathered during the audit. For example, an
auditor might identify a significant unusual transaction by scanning a
population of invoices for unusual items when determining a sample of
items to be tested. By doing so, the auditor might identify an unusual
item in terms of dollar amount, the date on which the item was shipped
(e.g., on a Sunday when the shipping department is closed), or an
unusually high concentration of transactions during a given time
period.
    Appendix A to the standard includes 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. These examples could
also be helpful in identifying significant unusual transactions.
    The amendments add a second note to AU sec. 316.66 that states that
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.
    Also, the amendments to AU sec. 560 require that during the
``subsequent period'' the auditor inquire regarding whether the company
has entered into any significant unusual transactions. This could
inform the auditor's identification of a company's significant unusual
transactions.
    Improving the auditor's identification of significant unusual
transactions also can inform the auditor's evaluation of whether the
company has properly identified its related parties and relationships
and transactions with related parties, as a significant unusual
transaction might also be a related party transaction previously
undisclosed to the auditor.

Revising and Adding to the Examples of Fraud Risk Factors

    The amendments regarding significant unusual transactions also
revise certain examples of fraud risk factors contained in AU sec. 316.
For example, AU sec. 316.85A.2 notes that significant related party
transactions not in the ordinary course of business or with related
entities not audited or audited by another firm can provide
opportunities to engage in fraudulent financial reporting. The
amendments regarding significant unusual transactions separate that
existing example into two distinct examples, namely: (i) Related party
transactions that are also significant unusual transactions (e.g., a
significant related party transaction outside the normal course of
business); and (ii) significant transactions with related parties whose
financial statements are not audited or are audited by another firm.
The amendments also add contractual arrangements lacking a business
purpose as an example of a fraud risk factor.

Discussion of the Comments Received on the Reproposed Amendments
Regarding Identifying Significant Unusual Transactions

    The Board considered all comments received, including the following
significant comments:
    Identifying Significant Unusual Transactions Is the Auditor's
Responsibility: One commenter noted that the reproposed procedures for
identifying significant unusual transactions (performing inquiries,
understanding controls, and taking other information into account) are
performed as part of the auditor's risk assessment process rather than
to enable the auditor to perform an initial identification of
significant unusual transactions--which, in that commenter's view, is
the role of management. That commenter suggested clarifying that
management is responsible for identifying the company's significant
unusual transactions, consistent with the changes regarding a company's
related parties. Another commenter stated that, as the size and
complexity of a company increases, the likelihood of an auditor being
able to identify significant unusual transactions diminishes
proportionately.
    The Board considered these comments, noting that the determination
of whether a transaction is a significant unusual transaction is the
responsibility of the auditor. The auditor takes management's responses
to inquiries and other procedures into account when identifying
significant unusual transactions. However, the information provided by
management is not the sole consideration. The auditor's procedures for
identifying significant unusual transactions are performed as part of
the auditor's risk assessment, and the auditor's procedures should be
sufficient to identify risks of material misstatement of the financial
statements, based on the size and complexity of the company.
    Clarifying the Phrase ``Infrequent or Significant Unusual
Transactions'' in the Amendments to AU sec. 722: AU sec. 722.55
contains examples of situations about which the auditor would
ordinarily inquire of management when conducting a review of interim
financial information. A few commenters suggested revisions to clarify
the reproposed amendment to the tenth bullet of AU sec. 722.55, which
as reproposed stated ``the occurrence of infrequent or significant
unusual transactions.'' In response to comments, the Board revised the
tenth bullet into two separate items: one bullet relating to the
occurrence of infrequent transactions and the other relating to the
occurrence of significant unusual transactions.
    The Board is adopting the amendments regarding the identification
of significant unusual transactions substantially as reproposed, except
for the revision to AU sec. 722 discussed above.
Evaluating Significant Unusual Transactions

Discussion of the Amendments Regarding Evaluating Significant Unusual
Transactions

    The amendments regarding the evaluation of significant unusual
transactions address the following areas: (i) evaluating the business
purpose (or the lack thereof) of significant unusual transactions; (ii)
evaluating the accounting and disclosure of significant unusual
transactions; and (iii) other matters regarding significant unusual
transactions.

Evaluating the Business Purpose (or the Lack Thereof) of Significant
Unusual Transactions

    The amendments regarding significant unusual transactions
strengthen the auditor's evaluation of whether the business purpose (or
the lack thereof) for significant unusual transactions indicates that
those transactions were entered into to engage in fraud.
    Existing AU sec. 316.66 requires that once an auditor becomes aware
of significant unusual transactions, the auditor should gain an
understanding of the business rationale for such transactions and
whether that rationale (or the lack thereof) suggests that the
transaction may have been entered into to engage in fraudulent
financial reporting or to conceal the misappropriation of assets.
Existing AU sec. 316.67 identifies several matters that the auditor
should consider in understanding the business rationale for those
transactions.
    The amendments build on the existing requirements in AU secs.
316.66-.67 and include additional

procedures to more specifically focus the auditor's attention on
critically evaluating whether the business purpose (or the lack
thereof) for significant unusual transactions indicates that such
transactions may have been entered into to engage in fraudulent
financial reporting or to conceal the misappropriation of assets.
    Those improvements are accomplished through: (i) revisions to AU
sec. 316.66; (ii) adding AU sec. 316.66A; and (iii) revisions to AU
sec. 316.67. Each of those amendments is discussed in further detail
below.
    Revisions to AU sec. 316.66: Because a company might use a
significant unusual transaction to engage in fraudulent financial
reporting or to obscure the company's financial position or operating
results, existing standards require the auditor to perform procedures
to evaluate significant unusual transactions identified by the auditor
and discuss the auditor's evaluation of such transactions with the
audit committee.\116\ The amendments to AU sec. 316.66 are intended to
improve the auditor's evaluation of significant unusual transactions,
including the auditor's evaluation of the business purpose (or the lack
thereof), and whether the transactions have been appropriately
accounted for and adequately disclosed in the company's financial
statements, by requiring the auditor to perform specific procedures to
evaluate significant unusual transactions. Improving the auditor's
evaluation of significant unusual transactions should also result in a
more meaningful exchange of information between the auditor and the
audit committee.
---------------------------------------------------------------------------

    \116\ See AU secs. 316.66-.67 and paragraph 13.d. of Auditing
Standard No. 16.
---------------------------------------------------------------------------

    Adding AU sec. 316.66A: The amendments regarding evaluating
significant unusual transactions add a new paragraph to AU sec. 316,
paragraph AU sec. 316.66A, which requires that the auditor 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 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; and
    d. Performing other procedures as necessary depending on the
identified and assessed risks of material misstatement.
    A footnote to item c. of the amendments to AU sec. 316.66A also
states that 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.
    Item d. of the amendments to AU sec. 316.66A provides an
opportunity for the auditor to scale the audit by supplementing the
basic required procedures with more in-depth procedures commensurate
with the auditor's evaluation of the company's facts and circumstances.
Those procedures should: (i) Address the assessed risks of material
misstatement; (ii) provide an understanding of the business purpose (or
the lack thereof) that is sufficient to evaluate whether the
transaction was entered into to commit fraudulent financial reporting
or misappropriate assets; and (iii) provide the auditor with sufficient
audit evidence to evaluate whether the financial statement accounting
and disclosure requirements have been met.
    Examples of other procedures that might be appropriate, depending
on the nature of the significant unusual transaction and the risks of
material misstatement of the financial statements, include:
     Inquiring directly of the other party regarding the
business purpose of the transaction;
     Reading public information regarding the transaction and
the parties to the transaction, if available;
     Reading the financial statements or other relevant
financial information obtained from other parties involved in the
transaction, if available, to understand how the other party accounted
for the transaction;
     Evaluating the transferability and value of collateral
provided by the other party, if any;
     Confirming the terms of the transaction with other parties
with knowledge of the transaction (e.g., banks, guarantors, agents, or
attorneys), if any; and
     Confirming whether there are any side agreements or other
arrangements (either written or oral) with the other party.
    The amendments regarding significant unusual transactions were
designed to establish basic procedures for the auditor to identify and
evaluate significant unusual transactions and allow the auditor to
assess risks and respond to risks based on the facts and circumstances,
including the size and complexity of the company and the assessed
significance of the identified risks of material misstatement in the
financial statements.
    Significant unusual transactions, like all transactions, are
subject to the requirements contained in AU sec. 411.06, which requires
that the auditor consider whether the substance of a transaction
differs materially from its form when evaluating whether the financial
statements have been presented fairly in accordance with the applicable
financial reporting framework. That evaluation encompasses an
understanding of the ``business sense'' of material transactions, which
was referred to in footnote 6 of AU sec. 334.
    Existing standards require that the auditor design and perform
audit procedures in a manner that addresses the assessed risks of
material misstatement for each relevant assertion of each significant
account and disclosure.\117\ This includes designing and performing
audit procedures in a manner that addresses the assessed risks of
material misstatement associated with significant unusual transactions.
The procedures contained in AU sec. 316.66A work in conjunction with
the procedures that the auditor performs during the audit to address
the relevant assertions associated with each significant unusual
transaction.
---------------------------------------------------------------------------

    \117\ See also paragraph 8 of Auditing Standard No. 13.
---------------------------------------------------------------------------

    Revisions to AU sec. 316.67: The amendments regarding significant
unusual transactions also require the auditor to evaluate certain
matters when evaluating whether the business purpose (or the lack
thereof) of a significant unusual transaction suggests that the
transaction may have been entered into to engage in fraudulent
financial reporting or to conceal the misappropriation of assets. The
amendments incorporate the list of matters currently in AU sec. 316.67
and add the following matters:
     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; \118\ and
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    \118\ See Section II.C. of Securities Act Release No. 33-8056,
Commission Statement about Management's Discussion and Analysis of
Financial Condition and Results of Operations (January 22, 2002),
http://www.sec.gov/rules/other/33-8056.htm.
---------------------------------------------------------------------------

     The transaction enables the company to achieve certain
financial targets.
    These additional matters are intended to improve the auditor's
evaluation of the business purpose (or the lack thereof) for
significant unusual transactions, including whether they may have been
entered into to engage in fraudulent financial reporting or to conceal
the misappropriation of assets. For example, considering whether a
transaction enables the company to achieve certain financial targets is
an important consideration when evaluating whether that transaction has
been entered into to engage in fraudulent financial reporting or to
conceal the misappropriation of assets. These additional matters also
represent areas that may be relevant to the auditor's evaluation of
whether the financial statements contain the information regarding the
significant unusual transaction essential for a fair presentation in
conformity with the applicable financial reporting framework.
    Including these additional matters in the auditor's evaluation of a
significant unusual transaction can also assist the auditor in the
identification of related parties or relationships or transactions with
related parties previously undisclosed to the auditor because it
focuses the auditor on the substance of the relationship or
transaction. For example, relationships such as those with entities
managed by former officers, interlocking directors/ownership,
significant customers and suppliers, competitors, strategic alliances
or partnerships, or collaborative arrangements could represent matters
that involve related parties or relationships or transactions with
related parties previously undisclosed to the auditor. Further, a
related party could be involved in a significant unusual transaction
either directly or indirectly, through the use of an intermediary whose
involvement in the transaction appears to serve no apparent business
purpose.
    A footnote to AU sec. 316.67 references the requirement, contained
in paragraph 16 of the standard, that the auditor 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.
Evaluating the Accounting and Disclosure of Significant Unusual
Transactions
    The amendments add a new paragraph to AU sec. 316, paragraph .67A,
to require the auditor to evaluate whether significant unusual
transactions that the auditor has identified have been properly
accounted for and disclosed in the financial statements. AU sec.
316.67A further states that this includes evaluating whether the
financial statements contain the information regarding significant
unusual transactions essential for a fair presentation in conformity
with the applicable financial reporting framework. A footnote directs
the auditor to paragraphs 30 and 31 of Auditing Standard No. 14, which
address the auditor's evaluation of the presentation of the financial
statements, including the disclosures.
    A note to AU sec. 316.67A states that, in evaluating whether the
financial statements contain the information regarding significant
unusual transactions essential for a fair presentation in accordance
with the financial reporting framework, the auditor considers
management's disclosure regarding significant unusual transactions in
other parts of the company's SEC filing containing the audited
financial statements in accordance with AU sec. 550, Other Information
in Documents Containing Audited Financial Statements.
Other Matters Regarding Significant Unusual Transactions
    The amendments regarding significant unusual transactions also make
a number of other related amendments, including adding a new paragraph,
paragraph 11A, to Auditing Standard No. 13 and making a conforming
amendment to Auditing Standard No. 16.
    The new paragraph 11A to Auditing Standard No. 13 reminds auditors
that significant unusual transactions can affect the risks of material
misstatement due to error or fraud, and that 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
the reproposed amendments to AU secs. 316.66-.67A regarding significant
unusual transactions.
    The amendments regarding significant unusual transactions also
amend the auditor communication requirements in Auditing Standard No.
16. The amendments revise paragraph 13.d. of Auditing Standard No. 16
to refer to the ``business purpose (or the lack thereof)'' instead of
the ``business rationale'' of a significant unusual transaction. In the
Board's view improving the auditor's identification and evaluation of
significant unusual transactions should enhance the quality of the
auditor's discussions with the audit committee.
Discussion of the Comments Received on the Reproposed Amendments
Regarding Evaluating Significant Unusual Transactions
    The Board considered all comments received, including the following
significant comments:
    Clarifying the Auditor's Evaluation of Identified Significant
Unusual Transactions: One commenter suggested several clarifying
revisions to the factors in AU sec. 316.67 that are relevant to the
auditor's evaluation of whether the business purpose (or the lack
thereof) of a significant unusual transaction indicates that the
transaction may have been entered into to engage in fraud. For example,
that commenter suggested revising the fourth bullet to state ``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.'' The Board considered these
suggestions and agrees that emphasizing that a related party might be
involved in a significant unusual transaction in place of the company
is an important clarification, and has revised AU sec. 316.67,
accordingly.
    Understanding Economic Substance Versus Commercial Substance: One
commenter stated that reproposed AU sec. 316.67 did not distinguish
``commercial substance'' (a term used in connection with accounting for
nonmonetary transactions) from ``economic substance'' (a doctrine
governing all transactions). That commenter suggested revising this
factor in AU 316.67 so that ``commercial substance'' is understood to
only refer to nonmonetary transactions. The Board considered this
comment, noting that the auditor's evaluation does not impose

accounting requirements on the auditor as the standard and amendments
follow a ``framework neutral'' approach.
    Understanding ``Financial Targets'': A few commenters suggested
improving the auditor's evaluation of whether a significant unusual
transaction enables the company to achieve certain financial targets
pursuant to AU sec. 316.67, by including required procedures to obtain
an understanding of the company's financial targets. The Board
considered these comments noting that the auditor's understanding of a
company's financial targets is already informed by information obtained
during the auditor's risk assessment process.\119\ The procedures to
obtain an understanding of the company's financial relationships and
transactions with its executive officers required by the other
amendments to Auditing Standard No. 12 further inform the auditor's
understanding. The information obtained from such procedures informs
the auditor's evaluation of whether a company's significant unusual
transaction enables the company to achieve certain financial targets.
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    \119\ See paragraphs 16 and 17 of Auditing Standard No. 12.
---------------------------------------------------------------------------

    The Board is adopting the amendments regarding the evaluation of
significant unusual transactions substantially as reproposed, except
for the revisions discussed above to AU sec. 316.67 and the addition of
a reference to paragraph 30 of Auditing Standard No. 14 in footnote 25B
of AU sec. 316.67A.
Other Amendments to PCAOB Auditing Standards
    The Board is also adopting other amendments to PCAOB auditing
standards, including: (i) Amendments regarding a company's financial
relationships and transactions with its executive officers; (ii) other
new requirements that complement the standard and amendments; and (iii)
amendments that conform other auditing standards to the standard and
amendments being adopted by the Board, including conforming amendments
that revise the references to the Board's superseded auditing standard,
AU sec. 334.
    After considering the comments received, the Board is adopting the
other amendments substantially as reproposed. The Board is, however,
making a number of minor clarifications in response to comments. These
include:
     Clarifying the Auditor's Inquiries of Management (AU sec.
560): The amendments to paragraph 12 of AU sec. 560 include revisions
to clarify that the auditor should inquire regarding both whether there
have been any changes in the company's related parties and whether
there have been any significant new related party transactions; and
     Revising the First Illustrative Letter in AU sec. 722 (AU
sec. 722): The amendments to AU sec. 722 include revisions to clarify
that the auditor should obtain a representation from management that
management has provided ``all financial records and related data,
including the names of all related parties and all relationship and
transactions with related parties'' whether the auditor is using the
first illustrative letter or the second illustrative letter contained
in AU sec. 722.
    The following sections describe the other amendments being adopted
by the Board and existing requirements, as well as discuss the
significant comments received and Board responses, including revisions
made, where applicable. The sections are organized by the following
areas:
     Auditing Standard No. 12, Identifying and Assessing Risks
of Material Misstatement
     AU sec. 315, Communications Between Predecessor and
Successor Auditors
     AU sec. 316, Consideration of Fraud in a Financial
Statement Audit
     AU sec. 333, Management Representations
     AU sec. 560, Subsequent Events
     AU sec. 722, Interim Financial Information
Auditing Standard No. 12, Identifying and Assessing Risks of Material
Misstatement
Discussion of the Amendments to Auditing Standard Auditing Standard No.
12
    In some circumstances, a company's financial relationships and
transactions with its executive officers can create risks of material
misstatement that relate pervasively to the financial statements. The
other amendments to Auditing Standard No. 12 require the auditor to
perform specific procedures to obtain an understanding of a company's
financial relationships and transactions with its executive officers as
part of the auditor's risk assessment.
    As described in the following sections, the other amendments to
Auditing Standard No. 12: (i) Add a new paragraph, paragraph 10A, to
Auditing Standard No. 12; (ii) revise paragraph 11 of Auditing Standard
No. 12; and (iii) make a related conforming amendment to the risk
assessment standards.
    Paragraph 10A of Auditing Standard No. 12: The other amendments add
paragraph 10A to Auditing Standard No. 12 to require the auditor to
perform procedures to obtain an understanding of the company's
financial relationships and transactions with its executive officers.
Paragraph 10A states that those procedures should be designed to
identify risks of material misstatement and should include, but not be
limited to: (i) Reading the employment and compensation contracts
between the company and its executive officers; and (ii) reading the
proxy statements and other relevant company filings with the SEC and
other regulatory agencies that relate to the company's financial
relationships and transactions with its executive officers. The other
amendments are intended to assist the auditor in identifying and
assessing risks associated with a company's financial relationships and
transactions with its executive officers. The other amendments
anticipate that the additional procedures to be performed would
contribute to the auditor's consideration of fraud in a financial
statement audit pursuant to AU sec. 316, which recognizes certain
incentives and pressures on management to commit fraud as examples of
fraud risk factors.\120\
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    \120\ See AU sec. 316.85, which provides examples of fraud risk
factors that could result in incentives and pressures to commit
fraud, including available information that indicates that
management's or the board of directors' personal financial situation
is threatened by the entity's financial performance arising from:
(i) Significant financial interests in the entity; (ii) significant
portions of their compensation (e.g., bonuses, stock options, and
earn-out arrangements) being contingent upon achieving aggressive
targets for stock price, operating results, financial position, or
cash flow; or (iii) personal guarantees of debts of the entity.
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    Performing procedures to obtain an understanding of a company's
financial relationships and transactions with its executive officers
assists the auditor in understanding whether those relationships and
transactions affect the risks of material misstatement.\121\ For

example, the auditor could consider whether the company's internal
control over financial reporting is designed and operating to address
the risk that management might seek accounting results solely to boost
certain executive officers' compensation. This understanding could also
assist the auditor in determining areas where management bias might
occur (for example, certain accounting estimates, including fair value
measurements).
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    \121\ For example, a May 2010 academic study that examined SEC
accounting and auditing enforcement releases 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. 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. See M. Beasley, J. Carcello,
D. Hermanson, and T. 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.
---------------------------------------------------------------------------

    Reading proxy statements and other relevant company filings with
the SEC that are available to the auditor can provide the auditor with
relevant information regarding a company's financial relationships and
transactions with its executive officers that informs the auditor's
understanding of the company. In addition, the risk assessment
standards require that the auditor consider reading public information
about the company, for example, SEC filings.\122\
---------------------------------------------------------------------------

    \122\ See paragraph 11 of Auditing Standard No. 12.
---------------------------------------------------------------------------

    The information obtained regarding a company's financial
relationships and transactions with its executive officers, in
conjunction with other information obtained during the risk assessment
process (e.g., information about company performance measures),\123\
could be used to identify account balances that are likely to be
affected and that could have a significant effect on the financial
statements. That information could be used by the auditor to identify
and assess risks of material misstatement due to fraud and to design
appropriate audit responses. In addition, obtaining an understanding of
a company's financial relationships and transactions with its executive
officers could identify information that indicates the existence of
related party relationships or transactions previously undisclosed to
the auditor.
---------------------------------------------------------------------------

    \123\ See paragraphs 16 and 17 of Auditing Standard No. 12.
---------------------------------------------------------------------------

    The amendments to paragraph 10A are not intended to call into
question the policies and procedures of the company with respect to its
compensation arrangements with executive officers, but rather to assist
the auditor in identifying and assessing risks of material misstatement
associated with those financial relationships and transactions. Such
risks could include unrecognized compensation, self-dealing or other
conflicts of interest, or possible illegal acts. If present, these
conditions may call into question the integrity of management's
representations or represent violations of the company's established
policies and procedures. In addition, these procedures could identify
potential instances of management override of internal controls that
could inform the auditor whether others in the company are willing to
challenge management or whether management might be dominating others
in the company.
    The purpose of the procedures in paragraph 10A is to further the
auditor's risk assessment rather than to require the auditor to
determine the appropriateness of a company's compensation agreements
with its executive officers. The amendments would not require the
auditor to assess the appropriateness of the compensation of executive
officers. The procedures performed are intended to occur in the context
of the auditor's process for assessing the risks of material
misstatement of the company's financial statements.
    The other amendments do not change the existing requirement in
paragraph 10 of Auditing Standard No. 12 to consider obtaining an
understanding of compensation arrangements with senior management. The
population for the procedures required by paragraph 10A of the other
amendments is the list of ``executive officers,'' as defined in SEC
Rule 3b-7 or included on Schedule A of Form BD,\124\ while the existing
requirement in paragraph 11 of Auditing Standard No. 12 continues to
apply to what may be a larger population of a company's management.
---------------------------------------------------------------------------

    \124\ See Exchange Act Rule 3b-7, 17 CFR 240.3b-7, and Schedule
A of Form BD. See generally Item 401(b) of Regulation S-K, 17 CFR
229.401(b).
---------------------------------------------------------------------------

    The term ``senior management'' is not a defined term in Auditing
Standard No. 12. For certain companies or brokers or dealers, senior
management might be the same population as its executive officers.
Further, the individuals the company considers to be its ``senior
management'' may differ among issuers and among broker-dealers. The
existing standard anticipates that a company's or broker's or dealer's
facts and circumstances may affect the composition of its ``senior
management.'' The auditor could: (i) Gain an understanding of the
compensation arrangements with a larger group of ``senior management''
under Auditing Standard No. 12 in order to obtain an understanding of
the company and then (ii) perform the procedures under the other
reproposed amendments regarding the financial arrangements with a
smaller group of ``executive officers.''
    The other amendments do not require the auditor to evaluate the
company's identification of its ``executive officers,'' for SEC filing
and other regulatory purposes. In the Board's view, the SEC rules cited
in the amendments provide a definition of the term ``executive
officers'' that provides sufficient direction to auditors.\125\
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    \125\ See Item 401(b) of Regulation S-K, 17 CFR 229.401(b). For
a discussion of ``executive officer'' for foreign private issuers,
see the discussion in this section titled ``Identifying the
Executive Officers of Foreign Private Issuers.''
---------------------------------------------------------------------------

    Amendments to Paragraph 11: The other amendments also include other
changes designed to strengthen the auditor's consideration of the risks
of material misstatement associated with financial relationships and
transactions with its executive officers.
    For example, the amendments to Auditing Standard No. 12 amend
paragraph 11 of Auditing Standard No. 12 to require the auditor to
consider making inquiries regarding the structuring of the company's
compensation for executive officers to 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.
    An auditor performing this inquiry could take into account other
available audit evidence, such as disclosures in SEC filings that: (i)
describe the company's compensation policies and practices that present
material risks to the company \126\ and (ii) disclose fees paid to
compensation consultants, in certain circumstances.\127\ An auditor
performing this inquiry could inquire of the audit committee, or its
chair, regarding its views on executive officer compensation at the
same time the auditor makes inquiries regarding how the audit committee
exercises oversight of the company's assessment of fraud risks and the
establishment of controls to address fraud risks as required by
paragraph 56.b.(4) of Auditing Standard No. 12.
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    \126\ See Securities Act Release No. 33-9089, Proxy Disclosure
Enhancements (December 16, 2009), http://www.sec.gov/rules/final/2009/33-9089.pdf.
    \127\ See Item 407(e)(3)(iii) of Regulation S-K.
---------------------------------------------------------------------------

    In addition, the amendments to paragraph 11 of Auditing Standard
No. 12 also require the auditor to consider performing procedures to
obtain an understanding of established policies and procedures
regarding the authorization and approval of executive officer expense
reimbursements.

    Based on the auditor's assessment of risk, the auditor might
determine that additional procedures are necessary. For example, the
auditor might read available reports from the internal audit function
that contain an evaluation of the expense report process. In other
cases, the auditor might determine that it is necessary to inspect
executive officer expense reimbursement documentation for unusual
items.
    Conforming Amendment to the Risk Assessment Standards: The other
amendments include a conforming amendment to Auditing Standard No. 12.
The change aligns Auditing Standard No. 12 with the requirement in
paragraph 3 of the standard, which states that the procedures in
paragraphs 4 through 9 of the standard are performed in conjunction
with the risk assessment procedures required by Auditing Standard No.
12. That amendment removes the note to the final bullet of paragraph 10
of Auditing Standard No. 12.

Discussion of the Comments Received on the Reproposed Amendments to
Auditing Standard No. 12

    The Board considered all comments received, including the following
significant comments:
    Revisions Included in Paragraph 10A of the Reproposed Amendments:
Commenters who commented on the revisions included in paragraph 10A of
the reproposed amendments to Auditing Standard No. 12 generally were
supportive of the revisions to the reproposed amendments. Some
commenters stated that it is sufficiently clear that the auditor: (i)
should obtain an understanding of the company's financial relationships
and transactions with its executive officers as part of the auditor's
risk assessment; and (ii) is not required to assess the appropriateness
of executive officer compensation. One commenter stated that the
reproposed amendments addressed their concerns regarding the proposed
amendments. Another commenter recommended including additional language
stating that the amendments are not intended to call into question the
policies and procedures of the company. The Board considered these
comments and believes that the revisions contained in the reproposed
amendments sufficiently acknowledge that the auditor is not required to
assess the appropriateness or reasonableness of compensation
arrangements with executive officers.
    Alternatives to Reading Each Compensation Arrangement: One
commenter expressed their support for the auditor to obtain an
understanding of compensation arrangements with the company's executive
officers. That commenter suggested including further clarification to
these amendments, including, for example, considering whether such an
understanding could be achieved by the auditor assessing the company's
internal control over such arrangements as opposed to reading each
compensation arrangement. The Board considered this comment, but noted
that the purpose of these procedures is to obtain information regarding
individuals who perform specific functions at the company, as part of
the auditor's risk assessment. Relying on a company's process may not
provide the information necessary for the auditor to identify
incentives and pressures that may result in risks of material
misstatement. Further, reading the documents underlying the financial
relationships and transactions with a company's executive officers
could identify information that indicates that related parties or
relationships or transactions with related parties previously
undisclosed to the auditor might exist and also informs the auditor's
evaluation of whether a significant unusual transaction enables the
company to achieve financial targets as part of the auditors evaluation
pursuant to AU sec. 316.67.
    Identifying the ``Executive Officers'' of Foreign Private Issuers:
One commenter expressed concern that the auditor would need to
determine which individuals fall within the definition of ``executive
officers'' if foreign private issuers do not identify ``executive
officers'' in their filings with the SEC. The Board considered this
comment and determined not to make revisions.
    The auditor's risk assessment procedures with respect to a
company's financial relationships and transactions with its executive
officers begins with the company's identification of its executive
officers. These procedures do not require the auditor to evaluate the
company's identification of its executive officers for SEC filing or
other regulatory purposes. The company's identification of its
executive officers is generally available from its SEC filings or other
company information.
    For example, foreign private issuers might identify their executive
officers in their SEC filings:
     Some foreign private issuers currently disclose their
``executive officers'' in their filings with the SEC (e.g., some
foreign private issuers simply disclose ``executive officers'' in Form
20-F, and some foreign private issuers voluntarily file their annual
report on Form 10-K and disclose their executive officers).
     Some home country filing requirements require a foreign
company to determine executive officers using a similar definition to
Rule 3b-7. For example, in Canada, National Instrument 51-102,
Continuous Disclosure Obligations states that ``executive officer
means, for a reporting issuer, an individual who is (a) a chair, vice-
chair or president; (b) a vice-president in charge of a principal
business unit, division or function including sales, finance or
production; or (c) performing a policy-making function in respect of
the issuer.'' Canadian foreign private issuers are also required to
disclose such individuals in annual information filings with the SEC.
    Further, the individuals comprising a company's ``[d]irectors and
senior management'' determined pursuant to item F. of the General
Instructions to Form 20-F would include, among others, those
individuals who, on the basis of title or policy making function,
qualify as ``executive officers'' under Rule 3b-7.
    In addition, foreign private issuers might identify their executive
officers for a number of other reasons, for example:
     If more than 50% of a foreign company's voting securities
are held by U.S residents, the company must determine its eligibility
to be a ``foreign private issuer'' by considering, among other things,
whether the majority of its ``executive officers'' or directors are
U.S. citizens or residents.\128\
---------------------------------------------------------------------------

    \128\ ``Foreign private issuer'' is defined in Rule 405 of
Regulation C under the Securities Act of 1933 and Rule 3b-4(c) under
the Exchange Act.
---------------------------------------------------------------------------

     A foreign private issuer listed on the New York Stock
Exchange (``NYSE'') would need to identify its executive officers for
purposes of complying with Section 303A.12(b), Certification
Requirements of the NYSE Listed Company Manual, which requires that
each listed company chief executive officer must promptly notify the
NYSE in writing after any executive officer of the listed company
becomes aware of any non-compliance with any applicable provisions of
Section 303A of the NYSE Listed Company Manual.
    Although the Board did not revise the amendments to Auditing
Standard No. 12 for this comment, the Board's consideration of this
comment did prompt a change to the amendments to AU sec. 316.81A to
include a reference to Item 16F of Form 20-F to remind auditors of
foreign private issuers of their responsibilities.
    Performing Procedures Relating to Individuals Outside of the
Company's Executive Officers: Some commenters

suggested that the auditor's procedures should not be limited to
``executive officers,'' because compensation arrangements with persons
outside the definition of ``executive officers'' (e.g., the most highly
compensated individuals, or individuals holding a material block of
stock options that are in a position to influence the company) also
might create incentives and pressures that could create risks of
material misstatement.
    The Board considered these comments, noting that the intent of the
amendments was to sharpen the auditor's focus on a company's financial
relationships and transactions with individuals that could pose
increased risks of material misstatement because of the ability of
those individuals to have direct involvement in the company's financial
reporting. However, the amendments do not change the existing
requirement that the auditor consider obtaining an understanding of the
compensation arrangements with what may be a larger group of
individuals, a company's senior management. The Board agrees that
financial relationships with individuals outside of a company's
executive officers also may warrant the auditor's attention. However,
obtaining an understanding of the compensation arrangements with
individuals outside of management should be based upon the company's
facts and circumstances.
    Expanding the Examples of Executive Officer Compensation: One
commenter suggested including in the amendments a discussion of the
basic components of many of today's executive compensation plans and
requiring the auditor to read and understand each of the documents
underlying those common components. The Board considered this comment
but did not make changes, noting that the requirement to obtain an
understanding of the company's financial relationships and transactions
with its executive officers is intended to provide an overarching
requirement for the auditor that can be applied to all companies as
part of the auditor's risk assessment procedures and apply to companies
of different size and complexity. Additionally, the Board notes that
the auditor might have an overall understanding of the issues pertinent
to compensation arrangements with the company's executive officers due
to the existing responsibility under Auditing Standard No. 12 to
consider obtaining an understanding of the compensation arrangements
with the company's senior management.
    The Board is adopting the amendments to Auditing Standard No. 12 as
reproposed.
AU sec. 315, Communications Between Predecessor and Successor Auditors
Discussion of the Amendments to AU sec. 315
    The Board is adopting amendments to AU sec. 315, Communications
Between Predecessor and Successor Auditors. AU sec. 315 provides
guidance on communications between predecessor and successor auditors
when a change of auditors is in process or has taken place, but does
not specifically address a company's relationships or transactions with
its related parties or its significant unusual transactions. AU sec.
334 notes that determining the existence of relationships with related
parties requires the application of audit procedures that may include
inquiring of predecessor auditors concerning their knowledge of
existing relationships and the extent of management involvement in
material transactions.\129\
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    \129\ See AU sec. 334.07.g. and AU secs. 9334.12-.13.
---------------------------------------------------------------------------

    The amendments to AU sec. 315 require the auditor to make inquiries
regarding the predecessor auditor's understanding of the company's
relationships and transactions with related parties and significant
unusual transactions. The amendments also include within the successor
auditor's review of the predecessor auditor's working papers any
documentation regarding relationships and transactions with related
parties and significant unusual transactions.
    Inquiring of a predecessor auditor regarding the company's
relationships and transactions with related parties and significant
unusual transactions can assist the successor auditor in determining
whether to accept the engagement. Such inquiries also can benefit the
successor auditor in obtaining an understanding of the company's
relationships and transactions with its related parties and in
identifying significant unusual transactions.
    After considering all comments received, the Board is adopting the
amendments to AU sec. 315 as reproposed.
AU sec. 316, Consideration of Fraud in a Financial Statement Audit
Discussion of the Amendments to AU sec. 316
    The amendments to AU sec. 316 expand the discussion in the standard
regarding certain audit requirements contained in Section 10A of the
Exchange Act. The amendments emphasize the auditor's responsibility to
investigate and disclose possible fraud to management, the audit
committee and, upon the satisfaction of certain conditions, the SEC,
consistent with the auditor's responsibility under Section 10A of the
Exchange Act.
    Improving the auditor's identification and evaluation of
significant unusual transactions could lead to more instances of
auditors becoming aware of indications that fraud or another illegal
act has or may have occurred.
    In addition, the other amendments to AU sec. 316 also add a new
example of a fraud risk factor, the exertion of dominant influence by
or over a related party.
    The Board's consideration of the comments received regarding the
amendments to paragraph 10A of Auditing Standard No. 12, regarding the
audits of foreign private issuers, prompted a change to the amendments
to AU sec. 316.81A. Specifically, to assist auditors of foreign private
issuers with their responsibility when there is a change in a
registrant's certifying accountants, a reference to Item 16F of Form
20-F in the amendments to AU sec. 316.81A has been included.
    After considering all comments received, the Board is adopting the
amendments to AU sec. 316 as reproposed, except for adding a reference
to Item 16F of Form 20-F to AU sec. 316.81A.
AU sec. 333, Management Representations

Discussion of the Amendments to AU sec. 333

    The amendments to AU sec. 333 require that the auditor obtain
certain written representations each interim period regarding a
company's relationships and transactions with its related parties. AU
sec. 333 currently requires auditors to obtain written representations
from management for the periods covered by the auditor's report. That
standard addresses representations covering financial statements;
completeness of information; recognition, measurement, and disclosure;
and subsequent events. Additionally, AU sec. 333 currently requires the
auditor to obtain a representation regarding the recognition,
measurement, and disclosure of related party transactions.
    The amendments to AU sec. 333.06 require that the auditor obtain
written representations from management indicating that management has
disclosed to the auditor the names of all of the company's related
parties and all relationships and transactions with related parties.
The standard also amends AU sec. 333.06 to require the

auditor to obtain a written representation from management that there
are no side agreements or other arrangements (either written or oral)
undisclosed to the auditor.
    Side agreements or other arrangements (either written or oral)
undisclosed to the auditor could represent a risk of material
misstatement of the financial statements for both related party and
significant unusual transactions. For example, the lack of an arm's-
length relationship in related party transactions can raise questions
about whether all transaction terms have been disclosed to the auditor.
Similarly, significant unusual transactions occurring close to the end
of the period that pose difficult substance over form questions also
could involve side agreements or other arrangements undisclosed to the
auditor. The existence of implicit or informal understandings (either
written or oral) could have a significant impact on the financial
accounting and disclosure of relationships and transactions with
related parties and significant unusual transactions.
    In addition, the amendments to AU sec. 333 require that the auditor
obtain written representations from management in situations in which
the financial statements include an assertion by management that
transactions with related parties were conducted on terms equivalent to
those prevailing in an arm's-length transaction. This requirement
complements the auditor's evaluation, required by paragraph 18 of the
standard, when management has asserted that a transaction with a
related party was conducted on terms equivalent to those prevailing in
an arm's-length transaction.
    After considering all comments received, the Board is adopting the
amendments to AU sec. 333 as reproposed.
AU sec. 560, Subsequent Events

Discussion of the Amendments to AU sec. 560

    AU sec. 560 currently requires the auditor to perform auditing
procedures with respect to the period after the balance-sheet date for
the purpose of ascertaining the occurrence of subsequent events that
may require adjustment or disclosure essential to a fair presentation
of the financial statements in conformity with generally accepted
accounting principles.\130\ AU sec. 560 currently does not require the
auditor to inquire regarding the company's relationships and
transactions with its related parties and its significant unusual
transactions.
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    \130\ See AU sec. 560.12.
---------------------------------------------------------------------------

    The amendments to AU sec. 560.12 require that during the
``subsequent period'' the auditor inquire regarding related party
transactions and significant unusual transactions. Events or
transactions that occur subsequent to the balance sheet date, but prior
to the issuance of the financial statements, may have a material effect
on the financial statements. Making specific inquiries during the
``subsequent period'' regarding a company's relationships and
transactions with its related parties and its significant unusual
transactions can benefit the auditor's identification of matters that
might require disclosure in the financial statements.

Discussion of the Comments Received on the Reproposed Amendments to AU
sec. 560

    The Board considered all comments received, including the following
significant comment:
    Clarifying the Auditor's Inquiries of Management: One commenter
recommended revising the inquiry in item v. of the reproposed
amendments to AU sec. 560.12 to clarify that there are two separate
inquiries. The Board considered this comment and in the interest of
clarity, revised the reproposed amendments to place each inquiry into a
separate bullet.
    The Board is adopting the amendments to AU sec. 560 substantially
as reproposed, with the clarifying change noted above.
AU sec. 722, Interim Financial Information

Discussion of Amendments to Auditing Standard No. 12

    AU sec. 722 currently requires the auditor to inquire of management
that has responsibility for financial and accounting matters concerning
unusual or complex matters that might have an effect on the interim
financial information. Generally, the amendments to AU sec. 722 require
that the auditor obtain certain written representations each interim
period regarding a company's relationships and transactions with its
related parties. The other amendments revise AU sec. 722 to be
consistent with the amendments to AU sec. 333 that require the auditor
to obtain written representations each interim period regarding the
company's related parties and the absence of side agreements or other
arrangements.

Discussion of the Comments Received on the Reproposed Amendments to AU
sec. 722

    The Board considered all comments received, including the following
significant comment:
    Revising the First Illustrative Letter in AU sec. 722: One
commenter recommended that a change that had been made in the
reproposal to expand item 2.a. of the second illustrative letter of AU
sec. 722 should also be made to the corresponding item in the first
illustrative representation letter. That commenter recommended that
item 2.a. in the first illustrative letter be revised to state that
management has made available to the auditor ``all financial records
and related data, including the names of all related parties and all
relationships and transactions with related parties.'' The Board
considered this comment and made the revisions suggested by the
commenter so that the letters were consistent.
    The Board is adopting the amendments to AU sec. 722 substantially
as reproposed, with the clarification discussed above.
Audits of Brokers and Dealers
    Section 982 of the Dodd-Frank Wall Street Reform and Consumer
Protection Act \131\ provided the Board with oversight authority with
respect to audits of brokers and dealers that are registered with the
SEC. On July 30, 2013, the SEC adopted amendments to SEC Rule 17a-5
under the Exchange Act to require, among other things, that audits of
brokers' and dealers' financial statements be performed in accordance
with the standards of the PCAOB for fiscal years ending on or after
June 1, 2014.\132\
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    \131\ Public Law 111-203, 124 Stat. 1376 (July 21, 2010).
    \132\ See Rule 17a-5, 17 CFR 240.17a-5 SEC, Broker-Dealer
Reports, Exchange Act Release No. 34-70073, (July 30, 2013), 78
Federal Register 51910 (August 21, 2013), http://www.sec.gov/rules/final/2013/34-70073.pdf.
---------------------------------------------------------------------------

    In its reproposal, the Board solicited comment regarding whether
there were specific issues relating to audits of brokers and dealers of
which the Board should be aware. Commenters did not provide examples of
specific audit issues, but did provide views on the applicability of
the standard and amendments to audits of brokers and dealers. For
example, many commenters stated that the reproposed standard and
amendments should apply to audits of brokers and dealers and provided
various rationales. Some commenters noted that the financial reporting
risks that the reproposal is designed to target also exist at these
entities and in some

cases more prevalently. Other commenters noted that the scalability of
the standard and amendments allow the auditor to focus on the specifics
of the company, making the standard and amendments appropriate for
audits of brokers and dealers.
    Further, at the May 17, 2012 SAG meeting, the point was raised that
a robust auditing standard on related parties was important for both
regulators of brokers and dealers and for users of their financial
statements. Several scenarios were discussed by which related party
transactions might be improperly used by brokers and dealers, including
scenarios where the brokers and dealers could use related party
transactions to: (i) Overpay for goods and services and disguise
capital withdrawals; (ii) avoid the imposition of higher capital
requirements and capital charges; (iii) structure a broker's or
dealer's business model to appear smaller; and (iv) transfer customer
assets to parties that are not approved custodians.
    Additionally, the results of the Board's oversight activities
regarding audits of brokers and dealers have identified deficiencies
regarding the auditor's efforts in the area of related parties,
suggesting that this is an area warranting heightened scrutiny.\133\
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    \133\ See The Report on the Progress of the Interim Inspection
Program Related to Audits of Brokers and Dealers (August 20, 2012)
and the Second Report on the Progress of the Interim Inspection
Program Related to Audits of Brokers and Dealers (August 19, 2013).
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    The standard and amendments, if approved by the SEC, will be
applicable to all audits performed pursuant to PCAOB standards,
including audits of brokers and dealers.
Effective Date
    The Board determined that the standard and amendments will be
effective, subject to approval by the SEC, for audits of financial
statements for fiscal years beginning on or after December 15, 2014,
including reviews of interim financial information within those fiscal
years.
    In determining the effective date, the Board considered the
comments received. Many commenters noted that the effective date in the
reproposing release was reasonable, if the final standard and
amendments were approved three to four months prior to the effective
date contemplated in the reproposing release. Those commenters
generally indicated that this would have allowed sufficient time for
firms to incorporate the new requirements into their methodologies,
guidance, audit programs, and staff training. Given the date of the
adoption of the standard and amendments, the Board determined that the
standard and amendments should be applicable, subject to SEC approval,
to audits of financial statements for fiscal years beginning on or
after December 15, 2014.
    One commenter recommended that the amendments to AU sec. 722 become
effective in the first interim period following the first annual period
that the standard and amendments are effective. The Board considered
this comment but noted that the amendments to AU sec. 722, which
encompass inquiries of and representations from management, are
designed to complement the standard and amendments. Performing those
procedures for reviews of interim financial information during the
first year of implementation (the fiscal year beginning on or after
December 15, 2014) can inform the auditor's efforts in these critical
areas for the audit performed during the first year of implementation.

2. Comparison of the Objective and Key Requirements of the Proposed
Rules With the Analogous Standards of the International Auditing and
Assurance Standards Board and the Auditing Standards Board of the
American Institute of Certified Public Accountants

Introduction
    This comparison, which was prepared for informational purposes
only, compares certain significant differences between the objective
and certain key requirements of the standard and amendments with the
analogous standards of the IAASB and the ASB of the AICPA.
    This comparison is not a summary of, or a substitute for, the
standard or the amendments. This comparison may not represent the views
of the IAASB or the ASB regarding the interpretations of their
standards.
    The analogous standards of the IAASB discussed in this comparison
include:
     International Standard on Auditing 550, Related Parties
(``ISA 550'');
     International Standard on Auditing 210, Agreeing the Terms
of Audit Engagements (``ISA 210'');
     International Standard on Auditing 240, The Auditor's
Responsibilities Relating to Fraud in an Audit of Financial Statements
(``ISA 240'');
     International Standard on Auditing 315, Identifying and
Assessing the Risks of Material Misstatement through Understanding the
Entity and Its Environment (``ISA 315'');
     International Standard on Auditing 510, Initial Audit
Engagements-Opening Balances (``ISA 510'');
     International Standard on Auditing 560, Subsequent Events
(``ISA 560'');
     International Standard on Auditing 580, Written
Representations (``ISA 580'');
     International Standard on Auditing 600, Special
Considerations--Audits of Group Financial Statements (Including the
Work of Component Auditors) (``ISA 600''); and
     International Standard on Review Engagements 2410, Review
of Interim Financial Information Performed by the Independent Auditor
of the Entity, (``ISRE 2410'').
    The analogous standards of the ASB discussed in this comparison
include:
     AU-C Section 550, Related Parties (``AU-C Section 550'');
     AU-C Section 210, Terms of Engagement (``AU-C Section
210'');
     AU-C Section 240, Consideration of Fraud in a Financial
Statement Audit (``AU-C Section 240'');
     AU-C Section 315, Understanding the Entity and Its
Environment and Assessing the Risks of Material Misstatement (``AU-C
Section 315'');
     AU-C Section 510, Opening Balances--Initial Audit
Engagements, Including Reaudit Engagements (``AU-C Section 510'');
     AU-C Section 560, Subsequent Events and Subsequently
Discovered Facts (``AU-C Section 560'');
     AU-C Section 580, Written Representations (``AU-C Section
580'');
     AU-C Section 600, Special Considerations--Audits of Group
Financial Statements (Including the Work of Component Auditors) (``AU-C
Section 600''); and
     AU-C Section 930, Interim Financial Information (``AU-C
Section 930'').\134\
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    \134\ These AU-C sections are contained in Statement on Auditing
Standards No. 122, Statement on Auditing Standards: Clarification
and Recodification (``SAS No. 122''). In October 2011, the ASB
adopted SAS No. 122, which contains 39 clarified SASs with ``AU-C''
section numbers for each clarified SAS. The ``AU-C'' is a temporary
identifier to avoid confusion with references to existing ``AU''
sections in AICPA Professional Standards.
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    This comparison is organized in the following sections: The
auditing standard; the amendments regarding significant unusual
transactions; and the other amendments to PCAOB auditing
standards.\135\ This comparison does not

cover the application and explanatory material in the analogous
standards of the IAASB or ASB.\136\
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    \135\ This comparison does not cover the requirements contained
in the risk assessment standards. Appendix 11 of PCAOB Release No.
2010-004, Auditing Standards Related to Auditor's Assessment of and
Response to Risk and Related Amendments to PCAOB Standards, contains
a comparison of the objectives and requirements of those standards
with the analogous standards of the IAASB and the ASB.
    \136\ Paragraph A59 of International Standard on Auditing 200,
Overall Objectives of the Independent Auditor and the Conduct of an
Audit in Accordance with International Standards on Auditing, states
that the Application and Other Explanatory Material section of the
ISAs ``does not in itself impose a requirement,'' but ``is relevant
to the proper application of the requirements of an ISA.'' Paragraph
A63 of AU-C Section 200, Overall Objectives of the Independent
Auditor and the Conduct of an Audit in Accordance with Generally
Accepted Auditing Standards, states that although application and
other explanatory material ``does not in itself impose a
requirement, it is relevant to the proper application of the
requirements of an AU-C section.''
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Auditing Standard, Related Parties
Introduction (Paragraph 1 of the Standard)
PCAOB
    The standard refers auditors to the requirements of the SEC 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. The standard does not
include a definition for an arm's-length transaction.
IAASB
    Paragraph 10(b) of ISA 550 defines a related party as a party that
is either:
    i. A related party as defined in the applicable financial reporting
framework; or
    ii. Where the applicable financial reporting framework establishes
minimal or no related party requirements:
    a. A person or other entity that has control or significant
influence, directly or indirectly through one or more intermediaries,
over the reporting entity;
    b. Another entity over which the reporting entity has control or
significant influence, directly or indirectly through one or more
intermediaries; or
    c. Another entity that is under common control with the reporting
entity through having:
    (i) Common controlling ownership;
    (ii) Owners who are close family members; or
    (iii) Common key management.
    However, entities that are under common control by a state (that
is, a national, regional or local government) are not considered
related unless they engage in significant transactions or share
resources to a significant extent with one another.
    ISA 550 also defines an arm's-length transaction as a transaction
conducted on such terms and conditions as between a willing buyer and a
willing seller who are unrelated and are acting independently of each
other and pursuing their own best interests.
ASB
    AU-C Section 550 defines a related party as that term is defined in
generally accepted accounting principles. AU-C Section 550 also
contains a definition of arm's-length transaction that is similar to
the definition in ISA 550.
    Objective (Paragraph 2 of the Standard)
PCAOB
    Paragraph 2 of the standard states that the auditor's objective is
to obtain sufficient appropriate audit evidence to determine whether
related parties and relationships and transactions with related parties
have been properly identified, accounted for, and disclosed in the
financial statements.
IAASB
    Paragraph 9 of ISA 550 states that the objectives of the auditor
are:
    (a) Irrespective of whether the applicable financial reporting
framework establishes related party requirements to obtain an
understanding of related party relationships and transactions
sufficient to be able:
    i. To recognize fraud risk factors, if any, arising from related
party relationships and transactions that are relevant to the
identification and assessment of the risks of material misstatement due
to fraud; and
    ii. To conclude, based on the audit evidence obtained, whether the
financial statements, insofar as they are affected by those
relationships and transactions:
    a. Achieve fair presentation (for fair presentation frameworks); or
    b. Are not misleading (for compliance frameworks); and
    (b) In addition, where the applicable financial reporting framework
establishes related party requirements, to obtain sufficient
appropriate audit evidence about whether related party relationships
and transactions have been appropriately identified, accounted for and
disclosed in the financial statements in accordance with the framework.
ASB
    Paragraph 9 of AU-C Section 550 contains a similar objective to the
objective in ISA 550 for fair presentation frameworks.
Performing Risk Assessment Procedures To Obtain an Understanding of the
Company's Relationships and Transactions With Its Related Parties
(Paragraphs 3-9 of the Standard)
PCAOB
    Paragraph 3 of the standard requires that the auditor 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. Paragraph 3 of the standard states that
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).
    A note to paragraph 3 of the standard states that 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.
    Another note to paragraph 3 of the standard states that performing
the risk assessment procedures described in paragraphs 4-9 of the
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.
IAASB
    Paragraph 11 of ISA 550 states that as part of the risk assessment
procedures and related activities required by ISA 315 and ISA 240, the
auditor shall perform the audit procedures and related activities set
out in paragraphs 12-17 of ISA 550 to obtain information relevant to
identifying the risks of material misstatement associated with related
party relationships and transactions.

ASB
    AU-C Section 550 contains similar requirements to those in ISA 550.

Obtaining an Understanding of the Company's Process (Paragraph 4 of the
Standard)

PCAOB
    Paragraph 4 of the standard requires that in conjunction with
obtaining an understanding of internal control over financial
reporting, the auditor obtain an understanding of the company's process
for:
    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.
IAASB
    Paragraph 14 of ISA 550 requires that the auditor shall inquire of
management and others within the entity, and perform other risk
assessment procedures considered appropriate, to obtain an
understanding of the controls, if any, that management has established
to:
    a. Identify, account for, and disclose related party relationships
and transactions in accordance with the applicable financial reporting
framework;
    b. Authorize and approve significant transactions and arrangements
with related parties; and
    c. Authorize and approve significant transactions and arrangements
outside the normal course of business.
ASB
    Paragraph 15 of AU-C Section 550 contains similar requirements to
those in ISA 550.

Performing Inquiries (Paragraphs 5-7 of the Standard)

PCAOB
    Paragraph 5 of the standard requires the auditor to inquire of
management regarding:
    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.
    Paragraph 6 of the standard requires the auditor to inquire of
others within the company regarding their knowledge of the matters in
paragraph 5 of the standard. Paragraph 6 also requires the auditor to
identify others within the company to whom inquiries should be
directed, and determine the extent of such inquires, by considering
whether such individuals are likely to have knowledge regarding:
    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.
    Paragraph 7 of the standard requires the auditor to inquire of the
audit committee, or its chair, regarding:
    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.
IAASB
    Paragraph 13 of ISA 550 requires the auditor to inquire of
management regarding:
    a. The identity of the entity's related parties, including changes
from the prior period;
    b. The nature of the relationships between the entity and these
related parties; and
    c. Whether the entity entered into any transactions with these
related parties during the period and, if so, the type and purpose of
the transactions.
ASB
    Paragraph 14 of AU-C Section 550 contains similar requirements to
those in ISA 550.
Identifying and Assessing Risks of Material Misstatement (Paragraph 10
of the Standard)
PCAOB
    Paragraph 10 of the standard aligns with the existing requirements
for the auditor to identify and assess the risks of material
misstatement at the financial statement level and the assertion level.
Paragraph 10 states that 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 or relationships or transactions with related parties.
Paragraph 59 of Auditing Standard No. 12 requires that the auditor
identify which risks are significant risks. Further, paragraph 71 of
Auditing Standard No. 12 provides factors that the auditor should
evaluate in determining which risks are significant risks. Those
factors include: (i) whether the risk involves significant transactions
with related parties; (ii) whether the risk involves significant
transactions that are outside the normal course of business; and (iii)
whether the risk is a fraud risk. The amendments regarding significant
unusual transactions revise paragraph .85A.2 of AU sec. 316,
Consideration of Fraud in a Financial Statement Audit, to state that a
related party transaction that is also a significant unusual
transaction (e.g., a significant related party transaction outside the
normal course of business) is an example of a fraud risk factor.
    A note to paragraph 10 of the standard states that, 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 the standard and
from performing the risk assessment procedures required by Auditing
Standard No. 12.
IAASB and ASB
    Paragraph 18 of ISA 550 and paragraph 19 of AU-C Section 550
require that the auditor identify and assess the risks of material
misstatement associated with related party relationships and
transactions and determine whether any of those risks are

significant risks. ISA 550 and AU-C Section 550 require the auditor to
treat identified significant related party transactions outside the
normal course of business as giving rise to significant risks.
Responding to the Risks of Material Misstatement (Paragraphs 11-13 of
the Standard)
PCAOB
    Paragraph 11 of the standard aligns with existing requirements that
the auditor design and implement audit responses that address the
identified and assessed risks of material misstatement. Paragraph 11 of
the standard states that 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.
    A note to paragraph 11 of the standard states that the auditor
should look to the requirements of AU secs. 316.66-.67A for related
party transactions that are also significant unusual transactions (for
example, significant related party transactions outside the normal
course of business). That note further states that 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 or conceal misappropriation of assets.
IAASB
    Paragraph 20 of ISA 550 requires that the auditor designs and
performs further audit procedures to obtain sufficient appropriate
audit evidence about the assessed risks of material misstatement
associated with related party relationships and transactions. These
audit procedures shall include those required by paragraphs 21-24 of
ISA 550.
ASB
    Paragraph 21 of AU-C Section 550 contains similar requirements to
those in ISA 550.
Transactions With Related Parties Required to Be Disclosed in the
Financial Statements or Determined to Be a Significant Risk (Paragraph
12 of the Standard)
PCAOB
    Paragraph 12 of the standard requires that 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;
    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; and
    e. Perform other procedures as necessary to address the identified
and assessed risks of material misstatement.
    A note to paragraph 12 of the standard states that 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.
IAASB
    Paragraph 23 of ISA 550 requires that for identified significant
related party transactions outside the entity's normal course of
business, the auditor shall:
    a. Inspect the underlying contracts or agreements, if any, and
evaluate whether:
    i. The business rationale (or lack thereof) of the transactions
suggests that they may have been entered into to engage in fraudulent
financial reporting or to conceal misappropriation of assets;
    ii. The terms of the transactions are consistent with management's
explanations; and
    iii. The transactions have been appropriately accounted for and
disclosed in accordance with the applicable financial reporting
framework; and
    b. Obtain audit evidence that the transactions have been
appropriately authorized and approved.
ASB
    Paragraph 24 of AU-C Section 550 contains similar requirements to
those in ISA 550.
Evaluating Whether the Company Has Properly Identified Its Related
Parties and Relationships and Transactions With Related Parties
(Paragraphs 14-16 of the Standard)
PCAOB
    Paragraph 14 of the standard requires that the auditor 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 information gathered
during the audit. Paragraph 14 requires that as part of that
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.
    A note to paragraph 14 of the standard states that 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 related parties previously
undisclosed to the auditor might exist.
    Other PCAOB auditing standards might impose requirements relating
to the sources of information that could indicate that related parties
or relationships or transactions with related parties previously
undisclosed to the auditor might exist (e.g., reading confirmation
responses and responses to inquiries of the company's lawyers).\137\
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    \137\ See, e.g., AU sec. 330, The Confirmation Process, and AU
sec. 337, Inquiry of a Client's Lawyer Concerning Litigation,
Claims, and Assessments.
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    Paragraph 15 of the standard requires that 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.
Paragraph 15 also states that those

procedures should extend beyond inquiry of management.
    Paragraph 16 of the standard describes the procedures that the
auditor is required to perform if the auditor determines that a related
party or relationship or transaction with a related party previously
undisclosed to the auditor exists. Paragraph 16 of the standard
requires that the auditor:
    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;
    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 the 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;
    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; and
    (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.
IAASB and ASB
    Paragraph 15 of ISA 550 requires the auditor to remain alert,
during the audit, when inspecting records or documents, for
arrangements or other information that may indicate the existence of
related party relationships or transactions that management has not
previously identified or disclosed to the auditor. Paragraph 15 of ISA
550 further requires that, in particular, the auditor inspect the
following for indications of the existence of related party
relationships or transactions that management has not previously
identified or disclosed to the auditor:
    (a) Bank and legal confirmations obtained as part of the auditor's
procedures;
    (b) Minutes of meetings of shareholders and of those charged with
governance; and
    (c) Such other records and documents as the auditor considers
necessary in the circumstances of the entity.
    Paragraph 21 of ISA 550 requires that if the auditor identifies
arrangements or information that suggests the existence of related
party relationships or transactions that management has not previously
identified or disclosed to the auditor, the auditor shall determine
whether the underlying circumstances confirm the existence of those
relationships and transactions.
    Paragraph 22 of ISA 550 requires that if the auditor identifies
related parties or significant related party transactions that
management has not previously identified or disclosed to the auditor,
the auditor shall:
    a. Promptly communicate the relevant information to the other
members of the engagement team;
    b. Where the applicable financial reporting framework establishes
related party requirements;
    (i) Request management to identify all transactions with the newly
identified related parties for the auditor's further evaluation;
    (ii) Inquire as to why the entity's controls over related party
relationships and transactions failed to enable the identification or
disclosure of the related party relationships or transactions;
    c. Perform appropriate substantive audit procedures relating to
such newly identified related parties or significant related party
transactions;
    d. Reconsider the risk that other related parties or significant
related party transactions may exist that management has not previously
identified or disclosed to the auditor and perform additional audit
procedures as necessary; and
    e. If the nondisclosure by management appears intentional (and
therefore indicative of a risk of material misstatement due to fraud),
evaluate the implications for the audit.
ASB
    AU-C Section 550 contains similar requirements to those in ISA 550.
Evaluating Financial Statement Accounting and Disclosures (Paragraphs
17-18 of the Standard)
PCAOB
    Paragraph 17 of the standard aligns with the existing requirement
that the auditor evaluate whether related party transactions have been
properly accounted for and disclosed in the financial statements.
Paragraph 17 states that 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.
IAASB
    Paragraph 25 of ISA 550 requires that in forming an opinion on the
financial statements, the auditor shall evaluate:
    a. Whether the identified related party relationships and
transactions have been appropriately accounted for and disclosed in
accordance with the applicable financial reporting framework; and
    b. Whether the effects of the related party relationships and
transactions:
    (i) Prevent the financial statements from achieving fair
presentation (for fair presentation frameworks); or
    (ii) Cause the financial statements to be misleading (for
compliance frameworks).
ASB
    Paragraph 26 of AU-C Section 550 contains similar requirements to
the requirements in ISA 550 for fair presentation frameworks.
Assertions That Transactions With Related Parties Were Conducted on
Terms Equivalent to Those Prevailing in Arm's-Length Transactions
(Paragraph 18 of the Standard)
PCAOB
    Paragraph 18 of the standard requires that 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.
    A note to paragraph 18 of the standard further states that a
preface to a statement such as ``management believes that'' or ``it is
the company's belief that'' does not change the auditor's
responsibilities.
IAASB
    Paragraph 24 of ISA 550 states that if management has made an
assertion in the financial statements to the effect that a related
party transaction was conducted on terms equivalent to those prevailing
in an arm's length transaction, the auditor shall obtain sufficient
appropriate audit evidence about the assertion.
ASB
    Paragraph 25 of AU-C Section 550 contains similar requirements to
those in ISA 550.
Communications With the Audit Committee (Paragraph 19 of the Standard)
PCAOB
    Paragraph 19 of the standard requires that the auditor 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. Paragraph 19 of the standard
also requires that the auditor communicate other significant matters
arising from the audit regarding the company's relationships and
transactions with related parties including, but not limited to:
    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.
IAASB
    Paragraph 27 of ISA 550 requires that the auditor communicate with
those charged with governance significant matters arising during the
audit in connection with the entity's related parties.
ASB
    Paragraph 27 of AU-C Section 550 contains similar requirements to
those in ISA 550.
Amendments to Certain PCAOB Auditing Standards Regarding Significant
Unusual Transactions
Identifying Significant Unusual Transactions
PCAOB
    The amendments to paragraph 56.a. of Auditing Standard No. 12
require the auditor to inquire of management regarding 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 involve related
parties. The amendments regarding significant unusual transactions to
paragraph 56.b. of Auditing Standard No. 12 require that the auditor
inquire of the audit committee or equivalent, or its chair, regarding
whether the company has entered into any significant unusual
transactions. The amendments regarding significant unusual transactions
to paragraph 56.c. of Auditing Standard No. 12 require similar
inquiries of internal audit personnel.
    A note to AU sec. 316.66 states that 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.
    That note refers the auditor to paragraphs 14-16 of Auditing
Standard No. 18. That note further states that Appendix A of the
standard includes examples of such information and examples of sources
of such information.
IAASB and ASB
    ISA 315, ISA 550, AU-C Section 315, and AU-C Section 550 do not
contain similar requirements for the auditor to those in the PCAOB's
amendments described above.
Evaluating Significant Unusual Transactions
PCAOB
    The amendments regarding significant unusual transactions add
paragraph .66A to AU sec. 316. That paragraph requires the auditor to
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. AU sec. 316.66A requires
that those procedures include the following:
    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 appropriately
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; and
    d. Performing other procedures as necessary depending on the
identified and assessed risks of material misstatement.
    The amendments to AU sec. 316.67 require that the auditor 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.
The amendments require that, in making that evaluation, the auditor
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;
     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.
    Further, the amendments add paragraph 11A to Auditing Standard No.
13. That paragraph requires that 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.
    The amendments to AU sec. 316.67A require that the auditor evaluate
whether significant unusual transactions identified by the auditor have
been properly accounted for and disclosed in the financial statements.
IAASB
    Paragraph 16 of ISA 550 requires that if the auditor identifies
significant transactions outside the entity's normal course of business
when performing the audit procedures required by paragraph 15 or
through other audit procedures, the auditor shall inquire of management
about:
    (a) The nature of these transactions; and
    (b) Whether related parties could be involved.
    Paragraph 32(c) of ISA 240 requires the auditor to evaluate whether
the business rationale (or the lack thereof) of a significant
transaction outside the normal course of business suggests that the
transaction may have been entered into to engage in fraudulent
financial reporting or to conceal misappropriation of assets. Paragraph
23 of ISA 550 requires the auditor to perform certain procedures for
identified significant related party transactions outside the entity's
normal course of business.
ASB
    AU-C Section 550 and AU-C Section 240 contain similar requirements
to those in ISA 550 and ISA 240.
Other Amendments to PCAOB Auditing Standards
Auditing Standard No. 12, Identifying and Assessing Risks of Material
Misstatement
PCAOB
    The other amendments to paragraph 10A of Auditing Standard No. 12
require that to assist in obtaining information for identifying and
assessing risks of material misstatement of the financial statements
associated with a company's 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 SEC and other regulatory agencies
that relate to the company's financial relationships and transactions
with its executive officers. The other amendments to Auditing Standard
No. 12 also include a definition of executive officer that aligns with
definitions used in SEC filings.
    In addition, the other amendments amend paragraph 11 of Auditing
Standard No. 12 to require the auditor to consider:
     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
     Obtaining an understanding of the company's established
policies and procedures regarding the authorization and approval of
executive officer expense reimbursements.
IAASB and ASB
    ISA 315 and AU-C Section 315 do not contain similar requirements
for the auditor to those in the PCAOB's amendments described above.
AU sec. 315, Communications Between Predecessor and Successor Auditors
PCAOB
    The other amendments to other PCAOB Auditing Standards amend AU
sec. 315, Communications Between Predecessor and Successor Auditors, to
require the auditor to inquire of the predecessor auditor regarding the
predecessor auditor's understanding of the nature of the company's
relationships and transactions with related parties and significant
unusual transactions. The other amendments also require the successor
auditor to review documentation regarding related parties and
significant unusual transactions.
IAASB and ASB
    Neither ISA 210 and ISA 510, nor AU-C Section 210 and AU-C Section
510 contain similar requirements to those in the PCAOB's amendments
described above.
AU sec. 316, Consideration of Fraud in a Financial Statement Audit
PCAOB
    The other amendments to AU sec. 316.81A describe the auditor's
responsibility, under certain conditions, to disclose possible fraud to
the SEC 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 on Form
8-K 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 (the ``Exchange Act'') relating to
an illegal act that the auditor concludes has a material effect on the
financial statements.
IAASB and ASB
    ISA 240 and AU-C Section 240 do not inform the auditor of certain
obligations under Section 10A of the Exchange Act, which is applicable
to auditors of U.S. public companies registered with the PCAOB.

AU sec. 333, Management Representations
PCAOB
    The other amendments to AU sec. 333, Management Representations,
require that the auditor obtain written representations from management
that there are no side agreements or other arrangements (either written
or oral) undisclosed to the auditor. The other amendments to AU sec.
333 also require the auditor to obtain written representation from
management 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.
IAASB and ASB
    Neither ISA 580 and ISRE 2410, nor AU-C Section 580, and AU-C
Section 930 contain similar requirements to those in the PCAOB's
amendments described above.
AU sec. 560, Subsequent Events
PCAOB
    The other amendments amend paragraph .12 of AU sec. 560, Subsequent
Events, to require that during the ``subsequent period'' the auditor
inquire of and discuss with officers and other executives having
responsibility for financial and accounting matters (limited where
appropriate to major locations) as to:
     Whether there have been any changes in the company's
related parties;
     Whether there have been any significant new related party
transactions; and
     Whether the company has entered into any significant
unusual transactions.
IAASB and ASB
    ISA 560 and AU-C Section 560 do not contain similar requirements to
those in the PCAOB's amendments described above.
AU sec. 722, Interim Financial Information
PCAOB
    The other amendments to AU sec. 722, Interim Financial Information,
require that the auditor obtain written representations from management
that there are no side agreements or other arrangements (either written
or oral) undisclosed to the auditor. The other amendments to AU sec.
722 also require the auditor to obtain written representations from
management when management has made an assertion that a transaction
with a related party was conducted on terms equivalent to those
prevailing in arm's-length transactions.
IAASB
    ISA 550 and ISRE 2410 do not contain similar requirements to those
in the PCAOB's amendments described above.
ASB
    AU-C Section 550 and AU-C Section 930 do not contain similar
requirements to those in the PCAOB's amendments described above.

D. Economic Considerations, Including for Audits of Emerging Growth
Companies

    This discussion describes the Board's approach in adopting the
standard and amendments as well as the Board's consideration of the
economic impacts of the standard and amendments, including economic
considerations pertinent to audits of EGCs.\138\ Additionally, this
discussion summarizes the views of commenters with respect to the
economic impacts of the standard and amendments.
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    \138\ Section 3(a)(80) of the Exchange Act defines the term
``emerging growth company.''
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Introduction and Statutory Background
    The Board is adopting the standard and amendments pursuant to its
authority under the Act.\139\ The standard and amendments must be
approved by the Commission before they are effective. Pursuant to
Section 107(b)(3) of the Act, the Commission shall approve a proposed
standard if it finds that the standard is ``consistent with the
requirements of [the] Act and the securities laws, or is necessary or
appropriate in the public interest or for the protection of
investors.''
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    \139\ Public Law 107-204. Pursuant to Section 101 of the Act,
the mission of the Board 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. Section 103 of the Act authorizes the Board to adopt
auditing standards for use in public company audits ``as required by
this Act or the rules of the [U.S. Securities and Exchange]
Commission, or as may be necessary or appropriate in the public
interest or for the protection of investors.'' In addition, Section
982 of the Dodd-Frank Wall Street Reform and Consumer Protection Act
(the ``Dodd-Frank Act'') expanded the authority of the PCAOB to
oversee the audits of registered brokers and dealers, as defined in
the Exchange Act. See Public Law 111-203.
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    In the Board's view, the adoption of the standard and amendments is
in the public interest and contributes to investor protection by
establishing specific auditor performance requirements designed to
heighten the auditor's attention to areas associated with risks of
fraudulent financial reporting and that may also involve risks of
error. New required audit procedures are intended to improve the
auditor's identification, understanding, and evaluation of transactions
in the critical areas, which can pose difficult measurement,
recognition, and disclosure issues due to factors such as transaction
structure, complexity, and/or relationship to company financial
targets. Additionally, the standard and amendments establish audit
committee communication requirements designed to promote and enhance
communications and understanding between the auditor and the audit
committee.
    The auditor's heightened scrutiny of transactions in the critical
areas, and the enhanced understanding of such transactions both by the
auditor and the audit committee, should improve the quality of the
audit and also may result in improvements in companies' accounting and
disclosures in these areas. Additionally, the new requirements are
aligned with the Board's risk assessment standards \140\ and reflect a
cohesive audit approach that should improve the auditor's risk-based
consideration of the critical areas, as well as provide opportunities
for efficient implementation.
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    \140\ In 2010, the Board adopted eight auditing standards to
establish a framework for the auditor's assessment of and response
to the risks of material misstatement in an audit (the ``risk
assessment standards''), which reflect the Board's view of the
auditor's fundamental approach to the audit. The risk assessment
standards 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 Act was amended by Section 104 of the Jumpstart Our Business
Startups Act JOBS Act \141\ to provide that any additional rules
adopted by the Board subsequent to April 5, 2012, do not apply to the
audits of EGCs unless the SEC ``determines that the application of such
additional requirements is necessary or appropriate in the public
interest, after considering the protection of investors and whether the
action will promote efficiency, competition, and capital formation.''
\142\ As a result, if the standard and amendments are approved by the
SEC, they will be subject to a separate determination by the SEC
regarding their applicability to audits of EGCs.
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    \141\ Public Law 112-106 (April 5, 2012).
    \142\ See Section 103(a)(3)(C) of the Act, as added by Section
104 of the JOBS Act.
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