The most significant enhancement in auditor reporting in recent history, at the heart of the call from investors and other users of audited financial statements for more entity-specific and relevant information, is the reporting of key audit matters. By Ciara Reintjes The new International Standard on Auditing (ISA) 701, Communicating Key Audit Matters in the Independent Auditor’s Report, is part of the suite of much-anticipated ISAs known as Reporting on Audited Financial Statements – New and Revised Auditor Reporting Standards and Related Conforming Amendments (the new and revised auditor reporting standards) issued by the International Auditing and Assurance Standards Board (IAASB) in January 2015. The overall objective of the new and revised auditor reporting standards is to enhance the value and relevance of the auditor’s report.
ISA 701 defines key audit matters (KAM) 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. KAM are selected from matters communicated with those charged with governance. ISA 701 is mandatory for audits of complete sets of general-purpose financial statements of listed entities, with voluntarily application allowed for entities other than listed entities. This ISA also applies when the auditor is required by law or regulation to communicate KAM in the auditor’s report. In South Africa, certain regulators may therefore require the communication of KAM in the auditor’s report. Auditors of public interest entities and public sector entities may also be required to communicate KAM.
|DIAGRAM A STANDARDS AFFECTED BY KEY ENHANCEMENTS TO THE AUDITOR’S REPORT|
|DIAGRAM B DETERMINING KAM|
|DIAGRAM C DETERMINING THOSE MATTERS THAT REQUIRED SIGNIFICANT AUDITOR|
ATTENTION HOW KAM ARE DETERMINED ISA 701 includes a ‘judgment-based decision-making framework’ to assist auditors in determining which matters should be communicated as KAM. This framework may be illustrated as follows:
a) Matters communicated with those charged with governance The introduction of KAM is not intended to alter the scope of the audit. KAM are determined from those matters that the auditor has communicated with those charged with governance (TCWG) in the normal course of the audit. ISA 260 (Revised), Communication with Those Charged with Governance, and other ISAs set out requirements for the auditor to communicate significant findings from the audit with TCWG, for example significant difficulties encountered during the audit, communications regarding related party transactions, limitations on the group audit and consultations on difficult or contentious matters.
b) Those matters that required significant auditor attention in performing the audit Indications that a matter may be a matter that required significant auditor attention in performing the audit are:
- The matter posed challenges to the auditor in obtaining sufficient appropriate audit evidence
- The matter posed challenges to the auditor in forming an opinion
- The matter involved difficult or complex auditor judgments of areas of complexity and significant management judgment in the financial statements, resulting in the auditor’s overall audit strategy, resource allocation and extent of audit effort being affected
An auditor determines which matters, from those that have been communicated with TCWG, required significant auditor attention in performing the audit by taking into account the following:
i) Areas of higher assessed risk of material misstatement, or significant risks The auditor identifies and assesses risks of material misstatement of the financial statements and plans and performs audit procedures in response to assessed risks in the normal course of an audit. ISA 315 (Revised), Identifying and Assessing the Risks of Material Misstatement through Understanding the Entity and Its Environment, defines significant risk as an identified and assessed risk of material misstatement that, in the auditor’s judgment, requires special audit consideration. Significant risks or areas of higher assessed risks may often be areas that require significant auditor attention.
ii) Areas in the financial statements that involved significant management judgment The auditor takes into account areas of significant management judgment and therefore significant auditor judgment, including accounting estimates having high estimation uncertainty (for example depending on the circumstances of a specific entity, impairment of goodwill or the fair value of a particular financial instrument). Complex estimates may require the involvement of both a management’s expert and an auditor’s expert. The auditor also considers accounting policies and practices that are not consistent with others in the entity’s industry.
iii) Significant events or transactions that occurred during the period The effect on the audit of significant events and transactions during the period may require significant auditor attention. Significant events and transactions may include significant transactions with related parties, significant transactions outside the normal course of business and unusual transactions. Significant economic, accounting, regulatory, industry, or other developments that affected management’s assumptions or judgments may also result in a matter requiring significant auditor attention.
c) Those matters of most significance in the audit of the financial statements of the current period The final step in determining KAM is selecting from (b) above, those current-period matters that were of most significance in conducting the audit. This is a matter of professional judgment and may be affected by the size and complexity of the entity, the nature of its business and environment, and the facts and circumstances of the audit engagement (that is, entity-specific or audit-specific factors may influence the auditor’s judgment). ISA 701 provides guidance on factors that the auditor may consider in determining ‘most significance’, including:
- The nature and extent of communication with TCWG, as more in-depth, frequent or robust interaction may occur on more difficult or complex matters
- The importance of the matter to users’ understanding, in particular its materiality
- The nature of the underlying accounting policy or the complexity or subjectivity of management’s selection of an accounting policy compared to other entities in the industry
- The nature and materiality, quantitatively or qualitatively, of corrected and accumulated uncorrected misstatements due to fraud or error related to the matter
- The nature and extent of audit effort needed to address the matter, including the extent of specialised skill or knowledge needed and the nature of consultations required outside the engagement team
- The nature and severity of difficulties in applying audit procedures, evaluating the results of those procedures, and obtaining relevant and reliable evidence on which to base the auditor’s opinion, in particular as the auditor’s judgments become more subjective
- The severity of any control deficiencies identified relevant to the matter
- Whether the matter involved a number of separate, but related, auditing considerations
HOW KAM ARE COMMUNICATED KAM are described in a separate section of the auditor’s report, under the heading ‘Key audit matters’, using appropriate subheadings for each KAM. The introductory language must state (ISA 701.11):
- KAM are those matters that, in the auditor’s professional judgment, were of most significance in the audit of the financial statements of the current period, and
- These matters were addressed in the context of the audit of the financial statements as a whole, and in forming the auditor’s opinion thereon, and the auditor does not provide a separate opinion on these matters
The description of each KAM must include (ISA 701.13):
- Why the matter was considered to be one of the most significant in the audit and therefore a KAM, that is, the factors considered
- A reference to any related disclosures in the financial statements to enhance intended users’ understanding of how management has addressed the matter in preparing the financial statements, and
- How the matter was addressed in the audit, for example descriptions of the auditor’s approach, a brief overview of procedures, outcome and key observations, or a combination of these
There are two circumstances under which a matter determined to be KAM is not required to be communicated in the auditor’s report:
- Where law or regulation precludes public disclosure about the matter, or
- In extremely rare circumstances, where the auditor determines that the adverse consequences of the disclosure would reasonably be expected to outweigh the public interest benefit of the communication
Matters giving rise to a modified opinion or a material uncertainty regarding going concern are by their nature KAM. However, ISA 701 states that these matters will not be described as KAM as these matters are included in their own sections in the auditor’s report in accordance with ISA 705 (Revised), Modification to the Opinion in the Independent Auditor’s Report and ISA 570 (Revised), Going Concern, respectively. The auditor should take care that the language used in the description of KAM:
- Is entity-specific and audit-specific
- Does not imply that any audit issues were not resolved or that there is a discrete opinion on separate elements of the financial statements
- Leads to succinct and balanced descriptions, with a limited use of highly technical audit terms
- Is not standardised or generic. Boilerplate language should be avoided
EFFECTIVE DATE OF THE NEW AND REVISED AUDITOR REPORTING STANDARDS The new and revised standards will be effective for audits of financial statements for periods ending on or after 15 December 2016. Registered auditors are reminded that the Committee for Auditing Standards (CFAS) of the Independent Regulatory Board for Auditors (the IRBA) will still be following due process in terms of recommending the new and revised auditor reporting standards to the IRBA board at its May 2015 meeting, for approval to adopt, issue and prescribe for use by registered auditors.
IMPLEMENTATION SUPPORT Auditors that are required to disclose KAM have several resources at their disposal:
- The IAASB has published a number of non-authoritative documents and intends to publish further materials aimed at promoting awareness, understanding and effective implementation of the auditor reporting standards. These documents may be found at www.iaasb.org/auditor-reporting. The IAASB intends to issue a limited number of illustrative KAM examples and listings and extracts of illustrative reports, among others.
- The CFAS has commenced a project to revise South African Auditing Practice Statement (SAAPS) 3, Illustrative Reports.
- Awareness programmes and campaigns are being planned by the JSE, SAICA, the IRBA, the Institute of Directors and others. These will be directed at specific stakeholders.
KAM are determined from the auditor’s perspective – ‘through the eyes of the auditor’. The judgment-based decision-making framework in the new ISA 701 is designed for the auditor to select a smaller number of matters from the matters communicated with TCWG. The number of matters may be further reduced by selecting those matters that required significant auditor attention in performing the audit, and thereafter selecting those matters that were of most significance in the audit, which are the KAM. The disclosure of entity-specific and audit-specific KAM is intended to increase confidence in the audit and the financial statements, as users will have more relevant information, and communication between various stakeholders will be enhanced. The value of the audit and the auditor report and audit quality will improve. The public interest will be served.
Links from https://www.ifac.org/auditing-assurance/new-auditors-report:
- IAASB, International Standards on Auditing (ISAs), Reporting on Audited Financial Statements – New and Revised Auditor Reporting Standards and Related Conforming Amendments, January 2015.
- IAASB, At a Glance: New and Revised Auditor Reporting Standards and Related Conforming Amendments, January 2015.
- IAASB’s Auditor Reporting Implementation Working Group, Auditor Reporting – Key Audit Matters, January 2015.
- IAASB, The New Auditor’s Report: Greater Transparency into the Financial Statement Audit, January 2015.
Author: Ciara Reintjes CA(SA) and Registered Auditor is Senior Professional Manager: Standards at the IRBA