CA Bhagyashri B. Kadganchi
SA-701 -“Communicating Key Audit Matters in the Independent Auditor’s Report”- A way forward to auditor’s reporting
With the purpose of enhancing the communicative value of auditors report by offering better transparency about audit and to provide additional information to the users of financial statements in assisting them to understand those matters which are of critical importance in auditors professional judgement, SA 701 is introduced.
SA 701 is applicable for audits of financial statements for periods beginning on or after April 01,2018 for audits of complete sets of general purpose financial statements of listed entities. It casts a new reporting requirement on auditors of listed entities to communicate the key audit matters in their audit reports. This Standard is also applicable in audit of unlisted entities in situations where law or regulation requires communication of key audit matters in the audit report.
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. Key audit matters are selected from matters communicated with those charged with governance.
Identification/ Determination of Key Audit Matters
While determining the key audit matters which are to be reported in the auditors report, the auditor will
have to follow filter approach as mentioned below.
Understanding of Key Audit Matters
Areas of significant auditor attention often relate to areas of complexity and significant management judgment in the financial statements, and therefore often involve difficult or complex auditor judgments. In turn, this often affects the auditor’s overall audit strategy, the allocation of resources and extent of audit effort in relation to such matters. These effects may include, for example, the extent of involvement of senior personnel on the audit engagement or the involvement of an auditor’s expert or individuals with expertise in a specialized area of accounting or auditing, whether engaged or employed by the firm to address these areas.
Accordingly, matters that pose challenges to the auditor in obtaining sufficient appropriate audit evidence or pose challenges to the auditor in forming an opinion on the financial statements may be particularly relevant in the auditor’s determination of key audit matters.
These considerations focus on the nature of matters communicated with those charged with governance that are often linked to the matters disclosed in the financial statements, and are intended to reflect areas of the audit of the financial statements that may be of particular interest to intended users.
Further, the users of the financial statements have also highlighted their interest in accounting estimates that have been identified as having high estimation uncertainty in accordance with SA 540 that may have not been determined to be significant risks. Among other things, such estimates are highly dependent on management judgment and are often the most complex areas of the financial statements, and may require the involvement of both a management’s expert and an auditor’s expert. Users have also highlighted that accounting policies that have a significant effect on the financial statements (and significant changes to those policies) are relevant to their understanding of the financial statements, especially in circumstances where an entity’s practices are not consistent with others in its industry.
The ideal key audit matters need to refer and leverage relevant disclosures in the financial statements in explaining why the auditor considered that matter to be one of most significance and how the matter was addressed in the audit.
It can also be said that the key audit matters better describes what an audit is and what an auditor does by providing an insight into the audit process for the matters which are most significant and peculiar in auditing the financial statements of the entity.
Description of Key Audit Matters
Auditor is required to report in his report a further description of each of key audit matter by stating
-Why the matter was considered to be one of the most significance in the audit
-How the matter was addressed in the audit
-Reference to the related disclosures
Communication of Key Audit Matters
A separate section with title “Key audit matters” is to be included in the auditor’s report. In this section the language should clearly cover the following:
SA 701 prescribes no threshold on number of key audit matters that needs to be communicated by auditor.
Placement of Key Audit Matters
Generally, Key audit matters section is required to be placed after the Basis for opinion paragraph and before the Management responsibility paragraph.
In case, ‘Material uncertainty relating to going concern’ section is required as per revised SA 570, then KAM section is placed after that section.
When a Key Audit Matters section is presented in the auditor’s report, an Emphasis of Matter paragraph may be presented either directly before or after the Key Audit Matters section, based on the auditor’s judgment as to the relative significance of the information included in the Emphasis of Matter paragraph.
Situation when there is no key audit matter to communicate
There could be situations where there are no key audit matters to be communicated. The determination of KAM involves making a judgement about relative importance of matters that required significant auditor attention. In those circumstances where auditor determines that there are no KAM for communication, this needs to be communicated to those charged with governance and also to include in the auditor’s report.
“We have determined that there are no key audit matters to communicate in our report.”
Interplay between qualified/adverse opinion and KAM
Communicating key audit matters in the auditor’s report is not a substitute for expressing a modified opinion when required by the circumstances of a specific audit in accordance with SA 705.
Accordingly if the auditor determines one or more key audit matters in addition to the matter which is giving rise to the qualified or adverse opinion, the auditor can still communicate those matter(s) as KAM.
Interplay between EOM and KAM
When SA 701 applies, the use of Emphasis of Matter paragraphs is not a substitute for a description of individual key audit matters. In other words, when a matter has been determined to be a key audit matter, the auditor is required to include the matter in the auditor’s report in accordance with SA 701. The auditor should not use an Emphasis of matter paragraph or Other matter paragraph to highlight the matter instead of the requirements in SA 701 and Emphasis of matter paragraph or an Other matter paragraph cannot be used as a substitute for reporting the matter as a key audit matter.
Disclaimer of opinion and communication of KAM
When an auditor disclaims his overall opinion on financial statements, he is prohibited from communicating key audit matters, unless such reporting is required by law or regulation.
Potential examples of Key Audit Matters
1. Certain complex areas relating to revenue recognition
2. Provisions and contingencies
3. Taxation matters (multiple tax jurisdictions, uncertain tax positions, deferred tax assets)
4. Assessment of impairment
5. Put arrangements over non-controlling interests
6. IT systems and controls
Benefits for the stakeholders from revised reporting
1. Greater transparency
2. Increased communication between auditors and Those Charged With Governance
3. Increased usefulness of disclosures in financial statements
4. Better and clear information on significant areas
5. Meaningful information for decision making and increased confidence
6. Lenders can be made aware about how the company is managed
An auditor should include in his audit documentation
1. Matters which required his significant attention as KAM & basis/ rationale for determination whether such matter is a KAM.
2. The rationale for the auditor’s determination that there are no key audit matters to communicate in the auditor’s report (Wherever applicable).
3. A written representation from management as to why public disclosure about a matter determined to be a KAM is not appropriate.
Auditors are not required to document why other matters communicated with those charged with governance were not matters that required significant auditor attention.