What are 'Key Audit Matters'?
'Key' is that, that is vital, essential, paramount and crucial to study and examine an issue to facilitate to take a right call on the issue. 'Key' is also a piece of metal cut into a special shape that is used for opening or closing a lock that is more often than not, used by known and for the intended persons.
Then, what's audit? Audit is to give a report giving an opinion on the financial statements on 'the 'true and fair view' for a specified a period to the members of an entity. Then, what is 'true and fair view'? 'True' is factually correct while 'fair' is based on reasonable estimates built on proper appraisals and assessments on given circumstances? To understand, it is better to compare with living figures that essentially depend on book figures. Mother is 'true' since the child is born out of her womb that is visually 'seen'. But, what about 'father' that's tested by environments? - It is a fair' call. Today, when there is surrogate mother, how far is it true even for a mother - a call may be required! Coming to the book figures, most of the items are contractual payments based on agreed contacts that are by and large nothing but true. But, what about estimates based on judgments? –the possible out outcome of disputed cases, provisions for income tax, cases pending in appeals at different levels etc. Are they not fair view taken? That is all about 'true and fair' view.
Then, what are 'matters'? Are there different from 'material'? Matter can be material or otherwise but, if it is relevant or staple for an issue, the auditors may have to consider for KAM for reason obvious. That is the cause for 'birth' of KAMs to take a 'berth' in the Audit Report so that the members have an easy 'breath'.
Present formats of Audit Report:
To properly appreciate the necessity for the KAMs in the present day ever changing environments, it is but ideal to know the present formats. The present formats of the audit reports are primarily guided by the relevant SAs: SA 700 'Forming an Opinion and Reporting on Financial Statements'; SA 705 'Modifications to the Opinion in the Independent Auditor's Report' and SA '706 'Emphasis of Matter Paragraphs and Matter of Emphasis, Other Matters (if applicable).
The above standards inter-alia give the formats covering Report on the Financial Statements, Management's Responsibility for the Financial Statements, Auditor's Responsibility, Opinion ,Basis of opinion for Qualification(if applicable) and Report on Other Legal and Regulatory Requirements.
Report on Other Legal and Regulatory Requirements:
Regarding Other Legal and Regulatory Requirements mentioned in the SA format it inter-alia covers:
• Requirements of Section 143 of the Companies Act 2013 - the new Act has added among other things 143 (3) (i) on IFC and 143 (12) on fraud. In respect of IFC, the ICICI Guidance Note on IFC even suggests for a separate addendum, if required. Fraud that is noticed during audit is handled in CARO. But, now, even if it is sense, it is coming under the notch of main report.
• The Requirements of the other Acts like Banking Act, Insurance Act etc.,
• Besides, Companies (Auditor's Report) Order, 2016 is part and parcel of companies as applicable (refer Para 2).
Apart from the increased responsibility of the auditors, the global aspirations expect much more improved reporting in the light of increased need.
Now, let us see -Why Change the Auditor's Report Now?
Today, world is a globalized economy. It is reduced to a global village. When there is cold in America, we may have to sneeze it here. What happens in Japan when Sun rises, it has a huge impact in the market in India as a follow suit. Internet connects in various forms reduce the information reach within reach at the same time. The world is moving towards International Standards either through adoption or convergence. In the scenario, people across the globe invest in other parts of the world. A day will come, people may settle on other planets who may also invest in entities spread across sphere. Besides shareholders, stake holders are also from different parts of the sphere. They cannot afford direct call on the entities since spread across and hence, the auditors are call of the time. The present format centers on opinion and wherever modified opinions are involved they gave the basis for qualified Opinion/ Matter of Emphasis.
Therefore, foundation for the future of global auditor reporting and improved auditor communications is the root cause for the emergence of KAMS. Though audit opinion is valued, there is increased expectation- let be more informative. In other words, users want more relevant and useful information about the entity and the financial statement audit
The answer is to provide a space for Key Audit Matters (KAM) in Audit Report. As has been spelt out earlier in the article, Key is vital inputs that matter much for the Shareholders & Stakeholders spread across the Globe. These key matters other than what is spelt out in the Opinion & Matter of Emphasis may be highly relevant for the intended users of financial statements so that they can take them up with the management and those charged with governance. Key figuratively is highly helpful to open up to understand matters that in the auditor's professional judgment, were of most significance in the audit though not qualified
Though some nations have already moved into KAM regime, India has after a careful thought to sail neatly, the effective date has been suitably postponed as detailed hereunder for reason obvious.
Revised Effective Date/ Applicability of following Standards on Auditing –
- SA 700 (Revised), 'Forming an Opinion and Reporting on Financial Statements'
- SA 701, 'Communicating Key Audit Matters in the Independent Auditor's Report'
- SA 705 (Revised), 'Modifications to the Opinion in the Independent Auditor's Report'
- SA 706 (Revised), 'Emphasis of Matter Paragraphs and Other Matter Paragraphs in the Independent Auditor's Report'
- Is deferred by one year and consequently the said Standards shall now be effective/applicable for audits of financial statements for periods beginning on or after April 1, 2018 (instead of audits of financial statements for periods beginning on or after April 1, 2017 as was earlier decided and referred to above.
What Are Key Audit Matters - KAM?
KAMs are defined as those matters that, in the auditor's professional judgment, were of most significance in the audit of the financial statements of the current period. SA does not require the auditor to update key audit matters included in the prior period's auditor's report. KAMs are selected from matters communicated with Those Charged with Governance (TCWG).
In which Auditor's Reports, a KAM Section is relevant and to be included?
KAMs are required to be communicated in the auditor's report for audits of financial statements of listed entities in accordance with new SA 701 unless
• Law or regulation may require KAM for audits of entities other than listed entities (e.g., 'public interest entities', or public sector entities)
• Circumstances when the auditor otherwise decides to communicate key audit matters in the auditor's report.(Para 5)
Is KAM suo- motu to be included in the Auditor's Report?
Auditor is required to include each KAM unless
• Law or regulation precludes disclosure In extremely rare circumstances, the auditor determines that the matter should not be communicated
• Adverse consequences of communicating the KAM would reasonably be expected to outweigh the public interest benefits of such communication
• KAM is prohibited for a disclaimer of opinion, but required for a qualified or adverse opinion.( Para 5)
• In certain limited circumstances, there may be no KAM to be communicated e.g., for a listed entity that has very limited operations (Para A59)
What are baby/ Initial Steps to be taken in Determining KAM?
- Matters that were communicated with TCWG
- Matters that required significant auditor attention
To go about to determine KAMS of the particular entity, the auditor will have to ipso- facto always consider
- Areas of higher assessed risks of material misstatements or significant risks (i.e., risks requiring special audit consideration)
- Significant auditor judgments relating to areas of significant management judgment (e.g., complex accounting estimates on disputed matters)
- Effect on the audit of significant events or transactions
How to go about in determination of Matters of Most Significance in the Audit – KAM
The same should flow from Matters that required significant auditor attention that is handled in earlier paragraph so as to fix the Matters of most significance in the audit. It requires auditors ingenious/ creative judgment which inter alia comprise the following factors
- KAM are determined by the auditor's consideration of the (Para. 13(a))
- Nature and extent of communication with TCWG
- Importance to intended users' understanding of the f/s
- Nature and extent of audit effort needed to address
- Nature of the underlying accounting policy, its complexity or subjectivity
- Nature and materiality, quantitatively or qualitatively, of corrected and accumulated uncorrected misstatements due to fraud or error (if any)
- Severity of any control deficiencies identified relevant to the matter (if any)
- Nature and severity of difficulties in applying audit procedures, evaluating the results of those procedures, and obtaining relevant and reliable evidence
What Is Included in the Description Part of KAM In audit report?
For an easy understanding of the shareholders/stakeholders, it is but necessary; descriptions of KAMS and how they are addressed at appointed place in the audit report are to be clearly spelt without any ambiguity so that members understand the utility.
- The description always includes
- Why the matter was considered to be a KAM
- How the matter was addressed in the audit
- Reference to the related disclosure(s), if any
- The description of how the matter was addressed in the audit may include
- Aspects of the auditor's response or approach
- Brief overview of procedures performed
- Indication of the outcome of the auditor's procedures
- Key observations with respect to the matter
Cares to be taken in Describing KAM:
- KAM should be entity-specific and avoid standardized or overly technical language
- Description of a KAM should not imply that the matter has not been appropriately resolved by the auditor in forming the opinion on the financial statements
- Contain or imply discrete opinions on separate elements of the financial statements (a 'piecemeal opinion')
KAM – Relationship to Emphasis of Matter (EOM) and Other Matter (OM) Paragraphs and Modified Opinions:
The following are to be taken note of while outlining KAM
- Concepts of EOM and OM paragraphs are retained.
- EOM and OM paragraphs cannot be used as a substitute for communicating a matter determined to be a KAM.
- Modified opinions are KAM by their nature but are described in the Basis for Opinion section.
What are the documentation requirements for KAM?
- As per SA 701, auditors are required as a matter of fact to document the professional judgments made about
- Why a matter that required significant auditor attention is or is not a KAM
- If there are no KAM, the rationale why
- Why a matter determined to be a KAM is not communicated
- No requirement to document the rationale as to why matters that are communicated to TCWG were not matters that required significant auditor attention. (Para 18)
Improved Auditor Reporting on Going Concern:
As per the revised SAS 700 to706 on the auditor's report, there is an enhanced focus more on GC
- Explicit description of the respective responsibilities of management and the auditor in all auditors' reports.
- Separate GC section required when material uncertainty exists, with a heading 'Material Uncertainty Related to Going Concern'( SA 570 Para 22)
- New requirement to challenge adequacy of disclosures for GC 'close calls
Interaction between KAM and GC:
- Matters relating to GC, including 'close calls', may be determined to be KAM and communicated in the auditor's report in accordance with new SA 701
- When a material uncertainty related to GC exists, it is by nature a KAM, but is reported separately in the 'Material Uncertainty Related to Going Concern' section of the auditor's report.( SA 570 Para 22)
Other Changes to the Auditor's Report:
- Auditor's opinion required to be presented first
- Required Basis for Opinion section for unmodified opinions.
- Statement about independence and other ethical responsibilities.
- Enhanced description of auditor responsibilities and key features of the audit
- Required identification section when TCWG are separate from management. (Para 32 & A 39)
Auditor Reporting and Law or Regulation:
New and revised Auditor Reporting standards continue to allow for
- Reference to the SAs in the auditor's report when law or regulation in a jurisdiction specify the layout or wording of the auditor's report, provided that certain requirements are met
- Any other reporting responsibilities (ORR) prescribed by law or regulation in addition to those required by the SAs, reported either
- In a separate section in the auditor's report; or
- If addressing the same topics required by SAs, in the same section, provided the auditor's report clearly differentiates the ORR from the reporting required by the SAs
In key audit matter portion of the audit report, the auditor has to select KAMs by professional judgment, that were of most significance n the audit of the financial statements of the current period. KAMs are by and large selected from matters communicated with Those Charged with Governance (TCWG). For each area of KAM- risk factors involved are dealt with and there after auditors response with regard to that is highlighted.
Auditing community has to cater to the needs of international community spread across the globe especially when the world is in the fast tract, thanks to internet penetration as well due to the adoption/ convergence of International financial standards by most of the countries across the globe and the rest is in the fast tract into IFRS regime. Auditing community is in the most piquant situation, why? In an enviable position, since his opinion has a phenomenal reach across the globe as against judiciary whose judgments are appealable; as well applicable only to the restricted jurisdiction. Judicial decisions, more often than not, drag but, auditors have to deliver their reports spot on within a stipulated time. The call of the time is to KAM for reason obvious as copiously dealt with earlier in the article.
'Let us arise, awake and stop not till our goal is reached' KAM is the answer.