Auditing

Global Audit Board Rules on Related Parties

A new rule from the International Auditing and Assurance Board focuses on the risks of fraud posed by a company's relationships.
Alan RappeportJuly 16, 2008

The International Auditing and Assurance Board has released a new standard that clarifies how auditors should treat “related parties,” which unscrupulous companies — Enron, for example — have used to distort earnings or cloak items from financial statements.

The new rule is part of the board’s ongoing “clarity” project in which it is revising many of its standards so they have more universal application. In some countries, financial reporting rules don’t specify what to do about related parties, noted board chairman John Kellas.

Related parties can be a company’s controlled entities, shareholders, or management, all of which carry the potential for fraud. Kellas called the revised standard a “recognition that fraud remains one of the areas of greatest challenge for auditors.”

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The standard is not about procedures but rather focuses on having auditors look at where the risks of material misstatements associated with related parties might rest and how to respond to them, according to Kellas. The standard also is intended to clarify the auditor’s responsibilities in situations where a financial reporting framework does not have any related-party requirements.

“This is more consistent with modern auditing and the general standards on assessing and responding to risks of misstatement,” Kellas told CFO.com.

The new standard provides clearer objectives for auditors regarding related-party relationships, outlines what related-party transactions an audit should cover, and makes clear that understanding these relationships is crucial to understanding a firm’s financial results. It also pushes auditors to take care to inspect transactions “outside the normal course of business,” anything that suggests hidden relationships, and newly established relationships.

Kellas said the revised standard has “significant differences” from the previous one. He also noted that the American Institute of Certified Public Accountants, which sets auditing standards for private companies in the United States, is working to align its standards with those of the IAASB. And he said the Public Company Accounting Oversight Board is watching international developments as it revises its related-party standards. The three regulators are working slowly to harmonize their standards, Kellas said.

Other standards that have been revised by the IAASB, which is overseen by the International Federation of Accountants, include those dealing with the auditor’s responsibility to consider fraud, accounting estimates, and fair-value measurements.

So far more than 100 countries have either adopted the IAASB’s rules or based local rules on them.