In January 2015, the new and revised Auditor Reporting standards were issued by the International Audit and Assurance Standards Board. These standards are effective for audits of financial statements for periods ending on or after December 15, 2016.

Key Audit Matters

One significant change with the Auditor Reporting standards is the new International Standard on Auditing (ISA) ISA 701, Communicating Key Audit Matters in the Independent Auditor’s Report. The ISA applies both to audits of financial statements of listed entities and in circumstances when the auditor otherwise decides to communicate key audit matters in the auditor’s report. This ISA also applies when the auditor is required by law or regulation to communicate key audit matters in the auditor’s report. It may therefore be relevant to different sized entities and all practitioners, including small- and medium-sized practices (SMPs).

The standard is intended to address both the auditor’s judgment as to what to communicate in the auditor’s report and the form and content of such communication. The purpose of communicating key audit matters is to enhance the communicative value of the auditor’s report by providing greater transparency about the audit that was performed. Key Audit Matters (KAM) are defined 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. Key audit matters are selected from matters communicated with those charged with governance.”

In determining KAM, the auditor takes into account:

(a)   Areas of higher assessed risk of material misstatement, or significant risks identified in accordance with ISA 315 (Revised), Identifying and Assessing the Risks of Material Misstatement through Understanding the Entity and Its Environment;

(b)   Significant auditor judgments relating to areas in the financial statements that involved significant management judgment, including accounting estimates that have been identified as having high estimation uncertainty; and

(c)   The effect on the audit of significant events or transactions that occurred during the period.

The description of each KAM in the auditor’s report shall include a reference to the related disclosure(s), if any, in the financial statements and will address:

(a)   Why the matter was considered to be one of most significance in the audit and, therefore, determined to be a key audit matter; and

(b)   How the matter was addressed in the audit.

Approaching KAM

In drafting KAM, it is important to keep the users of the auditor’s report in mind. This includes the audience’s knowledge and understanding of auditing and accounting terms, and the objective of communicating the KAM: to communicate with report users about the audit. KAM should be relevant and succinct yet insightful.

Timely engagement and discussion with those charged with governance (TCWG) is important to the process of identifying KAM, as well as drafting KAM. This allows those charged with governance TCWG to consider how the KAM may be addressed in the disclosures in the financial statements, or elsewhere in the annual report (e.g., a discussion by TCWG in their report, regardless of whether this is prescribed by the jurisdiction).

When relevant, effective communication between the group engagement team and component auditors is important in ensuring that:

  • Matters identified by the group engagement team as potential KAM are communicated to the component auditors to ensure that these are appropriately addressed, and that the necessary feedback on how the matters were addressed by the component auditors is provided to the group engagement team for inclusion in the auditor’s report.
  • Component auditors highlight matters that should be communicated to TCWG of the group on a timely basis, as these matters could ultimately qualify as KAM.

ISA 220, Quality Control for an Audit of Financial Statements, establishes requirements for the engagement partner in relation to undertaking appropriate consultation on difficult or contentious matters. This includes discussing significant matters arising during the audit engagement with the engagement quality control reviewer (ECQR) for audits of financial statements of listed entities, and those other audit engagements, if any, for which the firm has determined that an EQCR is required. More rigorous quality reviews of the auditor’s report may be appropriate, particularly in the first year of implementation.

Communicating KAM is in the context of the auditor having formed an opinion on the financial statements as a whole and is intended to provide insights into the audit. Communicating KAM is not, for example, a separate opinion on individual matters or a substitute for disclosures in the financial statements that the applicable financial reporting framework requires management to make, or that are otherwise necessary to achieve fair presentation.

It is essential that the auditor’s description in the auditor’s report of how the key audit matter was addressed in the audit correlates with the work performed and is supported by the documentation in the working papers.

IAASB Auditor Reporting Implementation Working Group

The IAASB established an Auditor Reporting Implementation Working Group to promote awareness and aid understanding and support. It has performed extensive outreach across numerous jurisdictions to encourage its stakeholders adopt and support effective implementation of the standards (see previous Gateway article, “Engagement and Outreach in Support of the New Auditor’s Report”).

The Working Group has been monitoring activities globally regarding the adoption of the standards, including early adoption. The UK and the Netherlands mandated enhanced auditor’s reports ahead of the IAASB standards’ effective date. Early adoption of the standards also took place on a number of engagements in several jurisdictions, including Australia, Germany, Hong Kong, Poland, South Africa, Singapore, and Switzerland.

There are also some jurisdictions that are encouraging, or mandating, more extensive application of ISA 701, i.e., the inclusion of KAM for entities other than listed entities. For example, South Africa is requiring the communication of KAM for entities in certain industries (medical schemes, collective investment schemes, and managers of collective investment schemes, as well as for entities in the public sector) and New Zealand has extended the requirement to entities with higher public accountability. The EU 2014 Regulation, Specific Requirements Regarding Statutory Audit of Public-Interest Entities, has taken effect for June 2017 year ends and applies to audits of public interest entities. It requires a description of the most significant assessed risks of material misstatement as well as a summary of the auditor’s response to those risks and, where relevant, key observations arising from those risks and reference to the disclosure in the financial statements.

The Working Group has also explored whether there are additional reporting requirements in jurisdictions that go beyond the requirements of the ISAs. For example:

  • The UK requires auditors to communicate about audit scope and materiality;
  • The EU 2014 Regulation requires the disclosure of key observations, where relevant, as well as matters relating to the auditor’s appointment, the consistency of the auditor’s opinion with the report to the audit committee, and statements regarding auditor independence and the provision of non-audit services; and
  • South Africa and New Zealand have requirements to communicate matters related to independence.

The IAASB have developed a number of publications to support the implementation of Auditor Reporting standards.

In 2015, the Institut der Wirtschaftsprüfer (IDW) in Germany published Analysis of Auditor Reporting on Key Audit Matters (KAM) in the UK and the Netherlands, which included a number of audit reports from the Big 4. It noted that the visual impact of the auditors’ reports varied considerably, with differences observed in content order, degree of detail presented, and table and diagram use. It also found that the range in quantity of KAMs varied quite considerably. There was also less evidence of the use of apparent “boiler plate” language than might originally have been anticipated.

In the UK, the Financial Reporting Council has published two reports on the auditor reporting status:  in March 2015 Extended Auditor’s Reports – A Review of Experience, published in March 2015, covers 153 reports from the first year of adoption and Extended Auditor’s Reports – A Further Review of Experience, published in January 2016, covers 278 audit reports from the second year of adoption.

The IFAC SMP Committee’s Implementation Guidance Task Force also discussed whether further support could be developed to assist SMPs with the changes. As any auditor can elect to disclose KAM it agreed that it would be helpful if links to audit reports that include KAM could be shared. The examples are intended to guide practitioners in developing KAM, which should be relevant and tailored to the circumstances of each entity and engagement.

IFAC and the SMP Committee welcome additional links to other publicly available audit reports that include KAM, in particular from small- and medium-sized entities (SMEs). 

Dawn McGeachy

Principal, Colby McGeachy Professional Corporation

Dawn McGeachy is a licensed public accountant, and is the accounting and assurance partner in the firm Colby McGeachy Professional Corporation, an independent member firm of Porter Hétu International, where she also serves on the National Standards Committee. She has over 30 years of public practice and audit-related experience. Dawn has served on both the Public Accountants Council of Ontario for a three-year term, as well as the Public Accounting Licensing Board for the Certified General Accountants Association of Ontario.

Christopher Arnold

Director

Christopher Arnold is a Director at the International Federation of Accountants (IFAC). He leads activities on contributing to and promoting the development, adoption and implementation of high-quality international standards, including the Member Compliance Program, Intellectual Property and Translations. Christopher is also responsible for IFAC’s SME (small- and medium-sized entities), SMP (small- and medium-sized practices) and research initiatives, which include developing thought leadership, public policy and advocacy. He was previously an Audit Manager for Deloitte and qualified as a professional accountant in a mid-tier accountancy practice in London (now called PKF-Littlejohn LLP). Christopher started his career as a Small Business Policy Adviser at the Association of Chartered Certified Accountants (ACCA).