Key Audit Matter, professionally known as SA 701, is no more a newly introduced standard for any auditor. The auditor has been given the onerous responsibility as well as individual decision to incorporate it in the audit report. Incorporated as those of the most significant in the audit of financial statements from the year reports of 2018-2019 onwards, its significance and identity has been very well understood by the auditor as well as the involved stakeholders.

Time has arrived to see how it has been used in audit reports and does it occupy the value as the most important matter in case of all listed companies where its usage has been made regulatory.

True to our preamble, let us study the financial statements of three of the biggest private sectors listed companies who have been in the news virtually every now and then. Those corporates are as under:

1. Tata Consultancy Services Ltd.

2. Maruti Suzuki India Ltd.

3. Tata Motors Ltd.

The main reason for choosing them is based upon their international exposure, operation among a large number of countries, millions of clienteles or all types of stakeholders and most importantly, in the financial news regularly for whatever reasons.

My paper depends upon the observations of auditors opinion in the balance sheet of standalone companies as on 31st March, 2019 under the head “Key Audit Matters” though it is realistic to expect its discussion in the audit committee during the course of its meeting which is normally 4 times a year and with the compulsory attendance of one independent auditor or more as the case may be. My discussion will have the format of the issue to be discussed, auditor’s treatment and my observation, if any to describe the issues involved, if need be.

One can look at web address given below for a detailed study:

Key audit matter (KAM)

The company engages in fixed-price development contracts where revenue is recognized using the per centage of completion computed as per the input method based on management’s estimate of contract costs. The auditor identified revenue-recognition of fixed price development contracts as the key audit matter in view of the inherent risk involved around the revenue involved.

How did the auditor audit the information?

Audit procedures undertaken by the auditor:

  • After understanding the systems, processes and controls implemented by management for recording and verifying the revenue in the main contract as well as associated contract, and the unearned revenue, the auditor involved the services of IT specialist who could understand and verify the information.

In continuation of KAM (2):

Due to involvement of high- tech systems, controls and estimates of future cost to completion of the contracts actually undertaken as well as left over which constitutes the work in process, the company had to ensure critical estimates of the amounts of revenue earned, revenue yet to earn etc., which have been reflected in the books of the company.

Audit procedures undertaken by the auditor:

The auditor had to undertake typical text book definition of identifying the sample of usage of tech systems, controls and estimates of the actual revenue earned and verifying with the amounts that should have occurred, verifications of systems and controls which restrained unauthorized usage of them for revenue earning, comparison of those calculated by the company and the ones actually approved by the clients at various levels of management and at various stages of completion of the contracts. These activities were obligated in terms of accounting standards prescribed by regulatory authorities.

Now coming to the crux of the issues involved in above complex

Adoption of Ind AS 115 – Revenue from contracts with customers.

The company adopted the above standard Ind AS 115 popularly known as revenue from contracts whose transition turned out to be complex and tedious. The standard establishes how much and when the revenue is earned. This involves making critical judgements relating to distinct performance obligations, and determine its appropriate usage and measure the revenue recognized for this performance. This standard requires regulatory disclosure about revenue earned and period over the left- over period up to which the other obligations of the contracts would be finalized. The company used Ind AS 115 to meet the requirements not to restate the details of comparative periods.

 My observations

Though the auditor quoted Ind AS 115 to calculate the work involved, usage of time, controls which enabled the proper authority to use the timing as well as calculate the left-over time to complete the task, how will we verify the audit procedure used by the auditor?

Let us have a deep understanding of the above standard.

Quoting from Taxmann’s Illustrated guide to Indian Accounting Standards(Ind AS) by Mr. B.D. Chatterjee, chapter 41, page 823, input methods which has been quoted by the auditor , recognize revenue on the basis of entity’s efforts or inputs to the satisfaction of a performance obligations (for example, resources consumed, labor hours expended, costs incurred, time lapsed or machine hours used). It is left to the auditor to verify the revenue information either by sampling methods or rerun the exercise for a short duration to verify the same.

It is time for us to look at the Key Audit Matter referred by the auditor in his Balance Sheet as on 31.03.2019 for Maruti Suzuki Limited.

Let us base our observations on the basis of web address given below about the same company.

I have reproduced the standard 115 from the financial statement auditor’s opinion page as under:

“Revenue Recognition in terms of Ind AS 115

“Revenue from Contracts with Customers” “This is a newly applicable Accounting Standard on Revenue which prescribes five steps revenue recognition model which involves identifying the contract with the customer, identifying the separate performance obligations in the contract, determining the transaction price, allocating the transaction price to the separate performance obligations and recognizing revenue over the period of time / at a point in time depending upon how the entity satisfies its performance obligations.”

Let us summarize the way auditor has replied to this standard.

“Our audit procedures included considering the appropriateness of the Company’s revenue recognition accounting policies and assessing compliance with the policies in terms of the applicable accounting standards.

 Evaluated the design of internal controls relating to implementation of the new revenue accounting standard.

Selected a sample of contracts, and tested the operating effectiveness of the internal control, relating to identification of the distinct performance obligations and satisfaction of performance obligations.

 We performed following substantive procedures over revenue recognition with specific focus on whether there is single performance obligation or multiple performance obligations in the contract and whether the performance obligation is being satisfied over the period of time or at a point in time:

  • Read, analyzed and identified the distinct performance obligations in these contracts.
  • Compared these performance obligations with that identified and recorded by the Company.
  • Considered the terms of the contracts to verify the transaction price used to allocate to separate performance obligations.
  • Checked whether the performance obligation is being satisfied over the period of time or at a point in time.
  • Performed analytical procedures for reasonableness of revenues disclosed.”

My observations

Maruti Suzuki Limited is one of the most advanced auto manufacturers with a couple of plants over a few states/countries.

 Producing automotive products, it employs diverse labor, some of the most advanced machinery, and is very conscious of expenditure incurred and engages the most productive plants to produce and earn substantial revenue.

It is heartening to know the text book style of auditing techniques engaged by the auditor to verify or give his observations on application of Ind AS 115. All of us are aware that analytical procedures could be from bench marking industrial standards of other manufacturers or the company’s history of decades of manufacturing cars and other automotive products.

Now that we have looked closely the key audit matter pertaining to two of India’s leading giant industries, let us look at the financial statements of one of the oldest manufacturers, now world’s giant car/truck or other automotive products, namely, Tata Motors Limited.

Over to the financial statements of above company as on 31st March 2019.

Now to the web site for details:

Key Audit Matter

A. Impairment testing of long-life property, plant and equipment and intangible assets of passenger vehicles cash generating unit:

Details of matter discussed

“The Company has identified passenger vehicle segment as a separate cash generating unit (”CGU”).

The history of losses in the passenger vehicle business led the Company to perform an impairment assessment as at 31 March 2019.

The annual impairment testing of passenger vehicle CGU involves significant judgments and estimates in assessing the recoverable value.

 The recoverable value is considered to be the higher of the Company’s assessment of the value in use (VIU) and fair value less cost of disposal (FVLCD).

There is a risk over the Company’s assessment and measurement of impairment due to:

– VIU: uncertainties involved in forecasting of cash flows, including key assumptions such as future sales volumes, prices, margins, overheads, growth rates and weighted average cost of capital.

– FVLCD: uncertainties involved in identifying appropriate comparable companies, estimating their market multiple and estimating the depreciated replacement cost of fixed assets”

The above matter does not require much discussion since the replacement of old models of passenger cars with the new ones was a known historical fact in the life of the company.

Yes, a challenging audit engagement for the auditor and how did the auditor meet his challenges?

“Identification: Obtained an understanding of Company’s evaluation of identification of passenger vehicles segment as a cash generating unit;

– Controls: Tested management review controls on the assumptions including underlying cash flow forecasts and impact of macro-economic factors on the forecasts.

Tested management’s review of the discounted cash flow calculations performed to support the impairment assessment including benchmarking of key assumptions (discount rates, growth rate) and assessment of sensitivities;

– Completeness and accuracy of the VIU model:

Obtained valuation computation performed by the Company for its impairment assessment and agreed with the mathematical accuracy of the VIU by recalculating the cash flow build up;

– Cash flow forecast assumptions: Involved independent valuation specialists to assist in the evaluation of the assumptions (discount rate which included comparing the weighted average cost of capital with sector averages for the relevant markets in which the CGU operates and long-term growth rate) and challenged the key assumptions and judgments within the build- up of the cash flow forecast (such as future sales volumes and prices, margins, overheads etc.) and methodologies used by the Company and its experts;

– Sensitivity analysis: Assessed the sensitivity of the outcome of impairment assessment to changes in key assumptions such as volumes and margins;

– FVLCD assumptions: Compared the market multiple used in the FVLCD to comparative companies and to market data sources with the assistance of specialists.”

Description of Key Audit Matter B.

Capitalization of product development cost

“Product development costs incurred on new vehicle platforms, engines, transaxles and new vehicles are recognized as intangible assets only when technical feasibility has been established, the Company has committed technical and commercial resources to complete the development and use the intangible asset and it is probable that the asset will generate future economic benefits.

The costs capitalized during the year include the cost of technical know-how expenses, materials, direct labor, inspecting and testing charges, designing cost, software expenses and directly attributable overhead expenditure incurred up to the date the intangible asset is available for use including interest capitalized.”

B. Application of Ind AS 38 “Intangible Assets” is required to undertake the required audit technique.

The auditor in his opinion gave the information that his audit techniques included

Testing the Company’s design and implementation and operating effectiveness of controls around initiation of capitalization of the product development cost including:

– management review controls over calculations of the future economic benefit of the projects;

– observed management’s validation of relevant data elements and benchmarking the assumptions;

– evaluating management’s assessment of whether costs recorded meet the capitalization criteria;

– observed management’s assessment of sensitivity of the impact of the changes in key assumptions;

The auditor further elaborated the usage of

“Test of details: On selected sample of amounts capitalized, we tested:

– costs incurred towards projects;

– inspected the technical team’s approvals for initiation of capitalization;

– reviewed the central cost allocation for the year and determined costs capitalized are ”directly attributable” including the interest capitalized.”

Particularly, Tata Motors Limited in its new dimension of working in various countries and absorption of new companies and their world class models faced lot of technical challenges in their accounting field also like application of GAAP/IFRS standards alone or a combination of both.

One can easily see through the excellent work undertaken by the auditors to challenge the assumptions or the activities undertaken in their manufacturing activities with the application of Ind AS, a technically advanced IFRS version incorporating impairment values which were more of historical under GAAP standards, inherited since time immemorial.


SA 701 – Key Audit Matter, newly introduced in consonance with the introduction abroad, has given an advantageous position to an auditor an opportunity to draw the attention of all stakeholders of financial statements to look for one of the most important audit matters which is separately given in his opinion. But this can’t be covered any were as routine audit objection. This article clearly draws the actual state of affairs, directly quoted from the reports for unambiguous understanding, both the Key Audit Matter and the audit techniques used by the auditor to verify or confirm the existence of the steps taken by the company to face the challenges. Unlike the normal operations in manufacturing or high technique companies, the auditors face unusual accounting/auditing challenges so far unheard in our country but history has made us among the most unchallenged emerging country which faces the world boldly. Yes, so are our auditors. Key Audit Matter is a small window in that direction.

I request those auditors who actually use KAM in their audit reports to narrate their experiences for a writer like myself/professionals like you to appreciate.

Attempts have been made to give valid credit to auditors in this essay by quoting the web site which contain their opinions.

Author Bio

Qualification: Post Graduate
Company: subramanian natarajan cpa firm
Location: NEW DELHI, Delhi, India
Member Since: 09 May 2017 | Total Posts: 231
A banker with 27 years of experience, a CPA from USA with specialization in US taxation, individual, partnership, S corporation or LLC taxation etc View Full Profile

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