This electronic announcement reminds institutions of the longstanding requirement to disclose all related party transactions in audited financial statements and explains how institutions can comply with these requirements given recent guidance provided by the American Institute of Certified Public Accountants (AICPA) to auditors. It also describes the actions the Department will take concerning the disclosure of related party transactions identified by the auditor as unaudited and not covered by the auditor’s opinion on the financial statements. This information is intended primarily for staff that provide financial information for an institution’s annual audit.
Regulatory Requirements to Disclose Related Party Transactions
The U.S. Department of Education’s (Department) regulations require institutions to disclose all relationships and transactions with related parties, which are defined under the Generally Accepted Accounting Principles (GAAP) Accounting Standards Codification (ASC) Topic 850, “Related Party Disclosures.” The regulations also require institutions to disclose when there are no relationships or transactions with related parties.
Since July 1, 1997, the regulations have required that an institution’s disclosure of related party relationships and transactions in its audited financial statements not only meet the requirements of GAAP, but also the Department’s requirements to disclose all related party relationships and transactions.
On October 31, 2023, the Department published new regulatory requirements concerning the related party transactions requirements [88 FR 74568]. These new regulations went into effect on July 1, 2024. The new regulations do not change the requirements for reporting these transactions which have been in place since 1997. Instead, the new regulations require institutions to include specific information on related party disclosures to clearly identify the related party being disclosed that had previously only been identified as possible information to include in the disclosure.
Additionally, the new regulations require institutions to provide an affirmative disclosure that an institution had no related party relationships and transactions to disclose, which had also been the Department’s practice prior to the implementation of the new regulations. This requirement applies to financial statements submitted to the Department on or after July 1, 2024, irrespective of when the fiscal year begins or ends (see FAQ FR-Q4).
The Department requires this information in audited financial statements because we are not only a reasonable user but also a primary user of audited financial statements because of the significance of the level of funding provided to students enrolled at participating institutions, without which institutions may cease to be financially viable. Therefore, the Department’s views should be carefully considered in making disclosure decisions.
The Department’s related party transactions disclosure requirement must be audited under the regulations. In abiding by this requirement, institutions determine what will be disclosed in their financial statements and are responsible for the information provided. The AICPA published guidance for auditors on disclosure alternatives and the auditing implications for each alternative. However, the only alternative identified by the AICPA that would meet the Department’s regulations is where the entire related party disclosure is audited. We explain this in more detail below.
Auditor Guidance
The AICPA guidance issued to auditors on the audit and reporting implications of the Department’s requirement for the disclosure of related party relationships and transactions required by 34 C.F.R. 668.23(d)(1). It also provides auditor reporting considerations relative to the related party disclosures. (Technical Question and Answer Section 6960.13)
In that guidance, the AICPA stated:
Paragraph .10 of AU-C Section 320, Materiality in Planning and Performing an Audit, states that when establishing the overall audit strategy, the auditor should determine materiality for the financial statements as a whole. It goes on to state that if, in the specific circumstances of the entity, one or more particular classes of transactions, account balances, or disclosures exist for which there is a substantial likelihood that misstatements of lesser amounts than materiality for the financial statements as a whole would influence the judgment made by a reasonable user based on the financial statements, the auditor also should determine the materiality level or levels to be applied to those particular classes of transactions, account balances, or disclosures.
Paragraph .A13 of AU-C section 320 acknowledges that certain factors may indicate the existence of one or more particular classes of transactions, account balances, or disclosures for which there is a substantial likelihood that misstatements of lesser amounts than materiality for the financial statements as a whole would influence the judgment made by a reasonable user based on the financial statements. Among the factors cited are whether law, regulation, or the applicable financial reporting framework affect users’ expectations regarding the measurement or disclosure of certain items (for example, related party transactions). Thus, the auditor may consider establishing a lower materiality for the additional disclosures required by the Department if there is a substantial likelihood or a reasonable expectation that a misstatement smaller than the materiality for the financial statements as a whole would be considered material to the users of the financial statements (for example, the Department).
The AICPA guidance disclosure alternative that would meet the disclosure requirements in the Department’s regulations is where the related party disclosure addresses both GAAP and the Department’s requirements and the entire disclosure is covered by the auditor’s opinion.
With regard to the disclosure alternative acceptable to the Department, the AICPA provides the following guidance –
Paragraph .61 of AU-C section 700, Forming an Opinion and Reporting on Financial Statements, states that information that is not required by the applicable financial reporting framework but is nevertheless presented as part of the basic financial statements should be covered by the auditor's opinion if it cannot be clearly differentiated. Thus, if an institution includes the additional related party disclosures required by the Department and does not clearly differentiate them from the related party disclosures required by GAAP, the disclosures are covered by the auditor's opinion.
The other audit possibility offered by the AICPA would result in some of the related party disclosure being “unaudited” or “not covered by the auditor’s report.” This would not be acceptable to the Department and the Department would reject the institution’s financial statements submission in this circumstance.
Institutional Compliance with Related Party Disclosure Requirements
The Department has heard from some institutions who have expressed concerns about their ability to comply with the Department’s new regulations for related party transactions. The Department would like to clarify that an institution is responsible for disclosing all related party transactions of which it is aware.
Institutions are required to have an adequate system of internal controls under the administrative capability standards at 34 C.F.R. 668.16(c). An effective system of internal controls increases the likelihood that an entity will achieve its objectives which would include compliance with the Department’s related party relationship and transaction disclosure requirement.
Given these requirements, the Department expects an institution to have a system of internal controls that is adequate to provide reasonable assurance about an institution’s compliance with the Department’s regulations, including the existence of related party relationships and transactions, as well as being able to identify the related parties. The institution’s internal controls must be sufficiently rigorous to provide for reasonable assurance that, when an institution’s financial statements include that it has disclosed all of its related party transactions or that it has no related party transactions, the disclosure is complete and accurate.
For the past 27 years, the Department has relied on institutions to ensure that the related party disclosure in their audited financial statements met the requirement that an institution include all related party transactions and at a level of detail that would enable the Department to readily identify the related party. During this period, to the Department’s knowledge it has not received a financial statements audit where a portion of the required disclosure of all related parties was identified as unaudited and not covered by the auditor’s opinion.
For financial statements submitted to the Department on or after July 1, 2024, if the Department determines that an institution’s audited financial statements are submitted by an institution with an unaudited related party disclosure not covered by the auditor’s opinion, the financial statements will be rejected by the Department and the institution may be subject to administrative action under 34 C.F.R. 668.171(i) or the past performance provisions at 34 C.F.R. 668.174(a)(3).
Contact Information
For questions concerning disclosure of related party transactions, please contact the Department’s Financial Analysis division at FSAFinancialAnalysisDivision@ed.gov.