CA Amogh Dongshanwar
With the introduction of new Standard on Auditing – SA 701 by Institute of Chartered Accountants of India (ICAI), the members of the ICAI have been entrusted with the new responsibility along with opining on the financial statements, to communicate the key audit matters (KAM) in the auditor’s report. Standard has left it to the professional judgement of the auditor, as to what is to be communicated as a Key audit matter making it more important for the auditors to understand what exactly constitutes a KAM.
In simple words, Key audit matters 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. The significant matters are communicated to those charged with governance (TCWG) by auditors on quarterly/six monthly basis in the audit committee meetings during limited reviews. However, most significant matters out of those matters can be Key audit matter. The need to communicate Key audit matter has aroused to get rid of the uninteresting audit report format. The inclusion of Key audit matter will make the audit report more interesting, transparent and will capture the attention of the readers of the financial statements towards the matters that were significantly important in the professional judgement of the statutory auditor of the company.
The applicability of New SA 701, Communicating Key Audit Matters (KAM) in the Independent Auditor’s Report is attracted when all the following conditions are satisfied–
1. Company is required to be listed on any stock exchange in India.
2. Financial statements of such listed companies on which opinion is required to be given, to be general purpose financial statements.
3. Such financial statements to be an annual financial statement.
4. If Key audit matters are required to be communicated by law or regulation in the auditor’s report.
The KAM is also applicable in the circumstances when the statutory auditor otherwise decides based on his professional judgement to communicate key audit matters in the auditor’s report of any other company not fulfilling the abovementioned conditions. It is important to note that the key audit matter is not applicable to the limited review report by statutory auditor on quarterly and six-monthly results. Also, KAM is not required to be given in case of the auditor’s report on special purpose financial statements.
This New SA 701, Communicating Key Audit Matters in the Independent Auditor’s Report, is effective for annual audits of financial statements for periods beginning on or after April 1, 2018. The first auditor’s report to contain Key audit matters would be for the annual financial statements for the year ending on March 31, 2019. Earlier, the said standard was effective for audits of financial statements for periods beginning on or after April 1, 2017. The Council of ICAI has made a partial modification of the decision earlier taken by it and has decided that the effective date of SA 701 along with few other revised auditing standards, be deferred by one year. Consequently, the said Standards shall now be applicable for audits of financial statements for periods beginning on or after April 1, 2018 instead of April 1, 2017.
The determination of key audit matter requires diligent application of professional judgement by the auditor. The auditor presents few matters in front of the members of the audit committee (TCWG) on a quarterly/six monthly basis. As prescribed by the standard itself, Key audit matters are to be selected from the matters communicated/presented to audit committee throughout the current audit year. The auditor shall determine/select, out of all the matters communicated during the year, those matters that required significant auditor attention in performing the current year audit. The determination of KAM to be limited to significant matter of the current year audit even when the auditor’s opinion refers to comparative numbers presented in the financial statements. Further, this SA does not require the auditor to update the KAM included in prior period auditor’s report in the current period auditor’s report unless the matter is continuing in the current period as well and determined as key matter again in the current year. Following are some matters that usually requires significant audit attention –
a. The significant risk areas i.e. area in which the auditor assesses higher risk at audit planning stage.
b. The matters which poses challenge to auditor in forming an opinion of financial statements.
c. Areas where significant management as well as auditor’s judgment is involved for example specialised areas of accounting and auditing where auditor’s expert is used.
d. Areas which includes related party transactions and other complex transactions.
e. Areas where audit partner concludes to consult with others on significant technical matter and areas where significant matter arises on review by internal quality control reviewer.
f. Significant event or transactions that occurred during the year and had impacted the auditor’s overall audit strategy.
Auditor needs to develop preliminary view on matters that are likely to be significant which would require significant attention and eventually be determined as KAM at planning stage. These potential KAM’s to be communicated and be discussed with audit committee and TCWG in advance.
Determination of KAM is a matter of professional judgement. However, standard has clearly guided on few matters not to be KAM. Accordingly, communicating KAM in the auditor’s report is not –
a. A substitute for disclosure in the financial statement as per the applicable GAAP.
b. A substitute for modified opinion by the auditor.
c. A separate opinion on individual matters.
d. A substitute for reporting as per SA 570, when material uncertainty relating to the events or conditions that may cast significant doubt on entity’s ability as a going concern.
Auditor shall describe each key audit matter under a separate sub heading under heading “Key Audit Matters”. The descriptions for each Key audit matter shall be given in every case unless law or regulation prohibits for public disclosure of the matter and in some very rare cases where auditor believes that the matter should not be communicated due to its adverse consequences. In the Key audit matter, the auditor shall also refer the relevant disclosures made in the financial statement. Also, auditor needs to state as to why that matter has been determined as a key and how the matters has been dealt with during course of the audit. However, SA 705 (Revised) prohibits the auditor from communicating key audit matters when the auditor disclaims an opinion on the financial statements, unless such reporting is required by law or regulation.
Auditor needs to document following in relation to KAM –
a. Matters that required significant auditor attention and rationale for auditor’s determination about key audit matter from the all the matters that required significant auditor attention.
b. Where applicable, the rational for auditor’s determination that there are no other KAM’s other than those included as part of basis for qualified/adverse opinion para.
c. Where applicable, the rationale behind not communicating the matter which was determined as a key audit matter.