The Public Company Accounting Oversight Board is preparing to publish a revised proposed auditing standard regarding how auditors are expected to scrutinize transactions with related parties or other unusual transactions that seem to fall outside the normal course of business.

“Related parties” can include individuals or business entities that are somehow closely tied to the company or senior management within the company. Transactions with such parties, especially when they are unusual for the company, carry an increased risk for misstatement or fraud, yet the PCAOB says it sees through its inspections that auditors too often fail to adequately consider that risk. PCAOB Chairman James Doty says related parties have played key roles in some of the biggest financial failures of the past several years, most recently with a string of problems with emerging companies.

The board first proposed a new standard for related parties and significant unusual transactions in February 2012. It instructed auditors on how to evaluate a company's identification of and accounting for relationships and transactions between the company and its related parties. It also addressed how auditors should identify and evaluate a company's accounting and disclosure of its significant unusual transactions, and it directed auditors to get a good understanding of a company's financial relationships and transactions with executive officers so auditors can sufficiently identify risks of material misstatement.

The 2012 proposal also directed auditors to get a better understanding of executive compensation plans and consider the incentives executives might have under certain performance-based awards to game business results. Preparers and auditors raised concerns regarding the requirements to dig deeper into executive compensation contracts, worried it established requirements that were too broad and would have a chilling effect on performance-based awards. Investor advocates were generally supportive of the proposal.

“The proposal describes basic tools that good auditors have used for years to identify financial reporting risks,” said Doty in a recent speech. “For example, it requires auditors to understand management's compensation as a way to understand management's motivations.” He said the board received “useful comment” on the proposal, and he anticipates the board's newly revised proposal will “likely be the final version.”