key audit matters v2

8/16/2019 Key Audit Matters v2

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Communicating Key Audit Matters:

Introduction:

The basic premise based on which an audit report, for the general purpose financial statements,

was drafted by an independent auditor was to communicate the financial well-being of an entity. An

auditor’s report is matter of an opinion and not a certification. SA 700 ‘Forming an Opinion and

Reporting on Financial Statement’ deals with the auditor’s responsibility to form an opinion on the

financial statements. It also deals with the form and content of the auditor’s report issued as a

result of an audit of financial statements.

Over a period of time, the expectation of the users of the financial statements have increased. The

topic of auditor reporting had been on the IAASB (International Auditing and Assurance Standards

Board). The comment letters received by IAASB indicates greater disclosure by the Auditor on the

professional judgements, conclusion and appropriateness on Going Concern of entities especially

when there lies a material uncertainty. IAASB, thereafter, issued ISA 701 ‘Communicating Key

Audit Matters in the Independent Auditor’s Report’ for financial statements. On the similar lines

ICAI proposes to issue SA 701.Standard will be applicable for audit of financial statements

on or after 1st April 2017.

What are Key Audit Matters?

In the words of Sir David Tweedie, the former Chairman of the IAASB and National Technical

Partner of KPMG, suggested that investors should learn through the report: (i) what kept the

auditor awake at night, (ii) what arguments the auditor had with CFO, (iii) what the big estimates

are, (iv) what the contentious accounting policies are, and (v) what the going concern assumptions

are?

From the above quote, one can infer that KAM are those issues which would have affected the

Auditor’s opinion on the financial statements. These matters are of that significance, the accounting

treatment, presentation or disclosure, management’s judgement, etc., were indeed so material to

the financial statements that it could have influenced the auditor’s opinion on the financialstatements. Are all the audit matters, are so relevant to be reported to the users of the financial

statements? The standard has given the following steps to determine, which of the matters may

have to be reported:

1.Step 1: Have a population of all the audit matters.

2.Step 2: These matters should have been communicating with those charged with governance.

3.Step 3: Select those audit matters which are :

A.The nature of the underlying accounting policy relating to the matter or the complexity or

subjectivity involved in management’s selection of an appropriate policy compared to other

entities within its industry


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B.Any corrected or any uncorrected misstatements due to fraud or error

C.Instances where auditor had to rely upon an export to or a professional with specialized

knowledge or skill to apply audit procedures

D.Severity any control deficiencies identified relevant to the matter

E.Significant risk identified as per SA 315, or

F.Areas of higher assessed risk of material misstatement;

G.Accounting estimates that involved significant management judgement which could have a

degree of high estimation uncertainty;

H.Effect on the audit of significant events or transactions that occurred during the period.

What should be reported as Key Audit Matter?

a.Brief description of the audit issue;

b.Audit procedure applied;

c.Outcome of the audit procedure or Key observations;

d.Audit Conclusion on the KAM.

Refer sample KAM reported in Companies incorporated in Europe.

Consequent amendment to other SA, to align with SA 701 (Proposed)

a.What is a significant matter to be reported is to the judgement of the auditor. However, one of

the indicators are that those matters which are reported to those charged with governanceunder SA 260. The proposed SA 260 (Revised) requires auditors to communicate to those

charged with governance about the significant issues which would be classified as KAM and

subsequently reported in the Audit Report.

e.SA 705 (Revised) caters to the scenarios where the auditor concludes that there is a material

misstatement relating to the appropriateness or adequacy of disclosures in the financial

statements and thereby leading to qualification, adverse or disclaimer of opinion. Qualification

or rendering an adverse opinion is no substitute of disclosure of KAM. Further, where theauditor disclaims to given any opinion on the financial statement, KAM paragraph need not be

provided.

f. Proposed SA 706 (Revised) establishes mechanisms for auditors to include additional

paragraphs in the Audit Report by use of ‘Emphasis of Matter paragraphs and Other Matter

paragraphs’. These paragraphs are presented independent of KAM section. There may be a

matter that is no determined to be a KAM in accordance with SA 701 (Proposed), but which, in

the auditor’s judgement, is fundamental to user’s understanding of the financial statements

(e.g., a subsequent event). If the auditor considers it necessary to draw users’ attention to such


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a matter, the matter is included in an Emphasis of Matter paragraph in the auditor’s report in

accordance with SA 706 (Revised).

g.Proposed SA 260 (Revised) requires the auditor to communicate with those charged with

governance about the significant risks identified by the auditor and how the auditor plans to

address areas of higher assessed risks of material misstatement.

a.Consequent Revision of SA 570:

Sl.

No.Scenario Proposed SA 570 Requirement

1 Use of Going Concern Basis

of Accounting is Inappropriate

Para 21- Adverse Opinion to be rendered

2 Use of Going Concern Basis of Accounting is appropriate, but a material uncertainty exists:

2a Adequate disclosure is made

in financial statements

a)Para 22 - Unmodified Opinion to be rendered.

b)Audit Report shall include a separate section “Material

Uncertainty Related to Going Concern”

c)Draw attention to the note in the financials and the events /

conditions that leads to this disclosure.

2b Adequate disclosure is not

made in financial statements

a)Para 23 - Qualified Opinion or Adverse Opinion, as

appropriate.

b)Basis of Qualified / Adverse Opinion - Auditor to state that a

material uncertainty exists that may cast significant doubt on

entity’s ability to continue as a going concern and that the

financial statements do not adequately disclose this matter.

3 Management Unwilling to

make or extend its

Assessment of going concern

Para 24 - Auditor shall consider the implications on the Auditor’s

Report and report accordingly.

Where should the KAM be presented in the Audit Report?

Standard mandates that the KAM paragraph should be in ‘close proximity’ to the auditor’s

opinion. The paragraph has to be clearly titled as Key Audit Matter. The position of the

issue in the previous year (comparative period) also needs to be reported.

Challenges faced by Auditors


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1.Behavioural / Relationship with the Management and Audit Committee: The

Management of the Company and Audit Committee would have to be communicated

about the changes in the auditor’s responsibility and the KAM that would be disclosed.

2.Where to draw the line? - Carving audit matters from those communicated to thosecharged with governance would surely be a challenge to many of the auditors. It is the

professional judgement of the auditor to determine which audit issue needs to be

reported. The application paragraph (A59) also indicates it would be ‘rare’ for the

auditor of listed entity would not determine at least one key audit matter from the

matters communicated with those charged with governance to be reported. And, in

certain limited circumstances (where entity has very limited operations) the auditor may

determine that there are no key audit matters to be reported. This would indicate, that

the auditors of the listed entities are obliged to remain at least one issue as KAM

(unless they are so contained due to client’s limited operations).

3.Language used in the paragraph should not be indicative of the fact that the issue has

not been appropriately resolved or should not contain any opinion on material assertion

which is contrary to the opinion given on the overall financial statements.

4.To ensure that the auditor does not let out any sensitive or trade information relating tothe client in the audit report.

5.Ensure that there are no law or regulation precluding public disclosures about the

matter, or

Examples of Key Audit Matters reported by Auditors for various entities …

Carclo Plc (y.e. 31st March 2015)

“In arriving at our audit opinion above on the financial statements the risk of material misstatement

that had the greatest effect on our audit was as follows:Carrying value of patent and

development costs. Refer to pages 38 to 39 (Audit Committee Report), pages 66 to 67 and 69

(accounting policy) and pages 81 and 95 (financial disclosures).

The Risk:The group has conducted a significant level of technology development activity within the CIT

Technology business and continues to undertake development activity in the Diagnostics Solutions business

areas. Patent and development costs are capitalised if they meet the criteria as laid down in the relevant

accounting standard. These include, among others, an assessment of the future out-turn of the development


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activity, for example, the technical feasibility and how the patents and development costs will generate

probable future economic benefits. Once these criteria are met the eligible patent and development costs are

required to be capitalised. There is judgement involved in both determining when the criteria are met and in

identifying the relevant costs to be capitalised, which include accurately capturing time and cost information

for the development activity.

Patents and development costs capitalised are tested for impairment in accordance with the relevantaccounting standard. The group applies judgement in determining realisable value by assessing the potential

future economic returns from the technology. These valuations have inherent uncertainties.

Our response:Our audit procedures included, among others,

• As part of our assessment of costs capitalised during the year we challenged the group and third

party assessments of technical feasibility and how the patents and development costs will generate

probable future economic benefit.

• We considered the group’s cash flow forecasts and correspondence. We assessed theappropriateness of key inputs, such as the value and timing of sales by reference toour knowledge of

the group’s business, our experience of the industry, and consideration of publicly available

information, such as customer press releases. We performed sensitivity analysis on the valuations

and range of assumptions used by the group. We compared the group’s discount rate assumptions

to externally derived data as well as our own assessments.

• We have agreed a sample of the specific development costs that have been capitalised to supporting

documentation.

• We have also considered the adequacy of the group’s disclosures in respect of patents and

development costs and impairment. “

Rolls Royce Holdings Plc (31 December 2014)

Bribery and corruption Refer to page 147 (Note 23 to the Financial Statements – Contingent liabilities)

and pages 69 to 71 (Audit Committee report – Financial reporting)

The risk – A large part of the Group’s business is characterised by competition for individually significantcontracts with customers, which are often directly or indirectly associated with governments, and the award

of individually significant contracts to suppliers. The procurement processes associated with these activities

are highly susceptible to the risk of corruption. In addition the Group operates in a number of territories

where the use of commercial intermediaries is either required by the government or is normal practice. In

December 2013, the Group announced that it had been informed by the Serious Fraud Office in the UK that

it had commenced a formal investigation into bribery and corruption in overseas markets. The Group is

cooperating with the Serious Fraud Office and other agencies, including the US Department of Justice.

Breaches of laws and regulations in this area can lead to fines, penalties, criminal prosecution, commercial

litigation and restrictions on future business.

Our response – We evaluated and tested the Group’s policies, procedures and controls over the selection

and renewal of intermediaries, contracting arrangements, ongoing management, payments and responses to


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suspected breaches of policy. We sought to identify and tested payments made to intermediaries during the

year, made enquiries of appropriate personnel and evaluated the tone set by the Board and the Executive

Leadership Team and the Group’s approach to managing this risk. Having enquired of management, the

Audit Committee and the Board as to whether the Group is in compliance with laws and regulations relating

to bribery and corruption, we made written enquiries of the Group’s legal advisers to corroborate the results

of those enquiries and maintained a high level of vigilance to possible indications of significant non-

compliance with laws and regulations relating to bribery and corruption whilst carrying out our other audit

procedures. We discussed the areas of potential or suspected breaches of law, including the ongoing

investigation, with the Audit Committee and the Board as well as the Group’s legal advisers and assessed

related documentation. We assessed whether the disclosure in note 23 to the Financial Statements of the

Group’s exposure to the financial effects of potential or suspected breaches of law or regulation complies

with accounting standards and in particular whether it is the case that the investigation remains at too early a

stage to assess the consequences (if any), including in particular the size of any possible fines.

Our findings – We found that disclosure to be proportionate (2013 audit finding: proportionate).

key audit matters v2

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