Discussion of the Amendments Regarding Identifying Significant Unusual Transactions The amendments regarding identifying significant unusual transactions: (i) align the description of significant unusual transactions in the Board's auditing standards; (ii) enhance the requirements for identifying a company's significant unusual transactions; and (iii) revise and add to the examples of fraud risk factors described in AU sec. 316. Aligning the Descriptions of Significant Unusual Transactions
Amendments to AU sec. 316.66: The amendments regarding significant unusual transactions revise AU sec. 316.66 to describe significant unusual transactions as significant transactions that are outside the normal course of business for the company or that otherwise appear to be unusual due to their timing, size, or nature. This description is 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
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A. Identifying Significant Unusual Transactions A4-48 B. Evaluating Significant Unusual Transactions A4-54
"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.50/ 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.
The amendments include changes to existing standards that require the performance of procedures as part of the auditor's risk assessment process to identify
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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.51/ 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.
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).
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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.52/
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. 316.6653/ 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;54/
Reading periodic and current reports, and other relevant company filings with the SEC and other regulatory agencies;55/
52/
See paragraph 18 of Auditing Standard No. 12. 53/
Section B. of Appendix 2 contains the amendments to AU sec. 316.66. 54/
See AU sec. 560.12.c. and AU sec. 722.18.a. 55/
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
Inspecting confirmation responses and responses to inquiries of the company's lawyers;56/
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);57/
Performing analytical procedures during the audit;58/ and
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.59/
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.
As described in section II.F. of this Appendix, 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 likelihood of material financial statement misstatements as part of obtaining an understanding of the company.
56/
See paragraph .06 of AU sec. 337. 57/
See paragraph 7.c. of Auditing Standard No. 12. 58/
See paragraphs 46 through 48 of Auditing Standard No. 12. 59/
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, as discussed in Section IV.E. of this Appendix, 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.
B. Evaluating Significant Unusual Transactions (Section B. of the Reproposed