Last October, with relatively little fanfare, new PCAOB Auditing Standard No. 18 expanded Audit Committee oversight responsibilities. (See this Doug’s Note.) AS 18, which became effective for fiscal years beginning on or after December 15, 2014, focuses on three categories of transactions and relationships that, in the PCAOB’s view, provide increased risk of material financial misstatements due to fraud, conflict of interest or mistake. As a result, Audit Committees must become knowledgeable about such matters in order to effectively respond to the auditors and carry out their oversight function.

A quick synopsis of AS 18’s three categories of focus…

Related-Party Transactions. AS 18 requires auditors to perform certain procedures to understand related-party transactions, which include inquiring of the Audit Committee or its chairperson as to the Committee’s understanding of such matters and whether any concerns exist among Committee members. The auditors also must evaluate whether the company has properly identified its related parties and its relationships and transactions with them. Finally, the auditor must communicate to the Audit Committee its evaluation of the company’s identification of, accounting for and disclosure of such transactions and relationships.

Significant Unusual Transactions. Auditors now must perform certain procedures to identify significant unusual transactions and understand and evaluate their business purpose. They then must communicate that understanding to the Audit Committee.

Executive Officer Relationships and Transactions. Auditors must perform certain procedures designed to uncover incentives or pressures for the company to attain a financial result because of executive officer compensation and incentives. Auditors will need to review employment and compensation agreements, review regulatory filings related to such matters and perhaps question the chairperson of the Compensation Committee and any compensation consultants about the company’s executive officer compensation structure. Auditors may also be expected to request and review any reports by compensation consultants that address incentive awards and structures.

Governance action steps…

Companies should consider whether:

• the Audit Committee charter should be updated to reflect the enhancements provided by AS 18,
• the related-persons transaction policy’s pre-approval requirement carve outs should be modified,
• the Audit Committee should set aside time to become more familiar with impacted transactions and relationships in order to better communicate with the auditors and provide the necessary assurances;
• existing relationships and transactions can withstand the enhanced auditor scrutiny and whether any modifications or additional documentation are needed in order for the Audit Committee to provide the requisite assurances; and
• it is necessary to modify past practices regarding communications among the Audit Committee, Compensation Committee and compensation consultants in order to satisfy AS 18.

Above all, be sure the Audit Committee is not surprised by any of these developments as this year’s audit process unfolds.