November 1st, 2018
By Associate Professor Dr. Zaini Ahmad, C.A (M), ACTIM and Associate Professor Johari Mohd Alwi, C.A (M), ACTIM
Effective 2017, the audited financial statements of public listed companies (PLCs) for financial period ending on or after 15 December 2016 should include an enhanced format of the independent auditors’ report. The most obvious change in the enhanced format of auditor’s report is the inclusion of Key Audit Matters (KAMs). KAMs are information with respect to areas the auditor spent the most effort on in the audit of the financial statements of the current period. In KAMs, the auditor shall explain the most risky and judgmental areas of audit and describe the audit approaches in those areas. Thus, KAMs reflect an in-depth discussion between the auditor as well as the management and directors on those areas. This new requirement will thus give essential information that is most relevant to the users of financial statements.
The inclusion of KAMs in the auditor’s report is a result of the market demands for more expansive disclosure in the auditor’s report. In other words, there have been demands by the stakeholders for the auditor to improve transparency and clarity of auditor’s report. For many years, the stakeholders who have been relying on the information in the financial statements have been asking the auditor to give more details about the audit process. Effectively, more contextual information about the audit is needed in the auditor’s report. The incremental information provided in KAMs may help the stakeholders in differentiating the degree of “cleanliness” among companies with “clean” auditor’s reports.
The principal justification for KAMs is to produce useful information for the stakeholders (ISA 701). Through KAMs, the stakeholders will get more insight on areas where the auditor spent the most effort on. These areas are often difficult and complex in the financial statements because they involve the use of extensive judgement by the directors. Understanding these critical areas should help the stakeholders to better understand the financial statements. Thus, with this new requirement, it could enhance the communicative value of the auditor’s report by providing greater transparency about the audit performed (ISA 701).
The Chief Executive Officer of the Malaysian Institute of Accountants, Dr Nurmazilah Mahzan had commented that KAMs will make it easier for the stakeholders to navigate their way around PLCs’ annual reports, thus providing the stakeholders with more clarity (Surendran, 2017). KAMs can also assist the stakeholders to further engage with the company’s management and those charged with governance about related audit matters. The stakeholders can further question the management and the auditor regarding KAMs. For instance, assuming there are KAMs with respect to an acquisition of a business during the year. Then, the stakeholder can raise the following questions to the management:
- What was the intention of the acquisition?
- On what basis was the purchase price accepted?
Further possible questions can also be asked to the auditor:
- How did the auditor obtain comfort that the valuation of intangible assets was appropriate?
- Was an external expert engaged for the valuation process?
(Questions are adopted from Malaysian Institute of Accountants (2017))
The ambiguity or uncertainty faced by the stakeholders which are expressed in the questions raised above will be answered by the management and those charged with governance in order to facilitate the stakeholders in making informed decisions.
Besides producing useful information for the stakeholders, highlighting KAMs has given rise to a number of other benefits that are even more valuable (The Association of Chartered Certified Accountants, 2018). The benefits are discussed as follows:
Improve corporate governance
KAMs require the auditor to discuss with the audit committee on the most important audit issue. This will enhance communication between the auditor and the audit committee. The communication will potentially result in increased attention to disclosures of matters in the financial statements. Thus, the disclosure of KAMs has been seen to increase transparency about the audit and indirectly improve corporate governance.
Improve auditor’s professional skepticism
Due to the requirement to disclose KAMs, the auditor will be more alert in performing audit. The auditor is required to explain complex matters which require careful judgment and to explain the audit approach to these matters. It renews auditor’s focus on matters to be communicated. Thus, there is a high tendency for the auditor to enhance professional scepticism, which is an important contributor to audit quality.
Improve audit quality
More work should be carried out on issues raised in KAMs. Thus, this could allow the auditor to spend more time on bigger issue. For the stakeholders, KAMs give a sense that it is extremely important for them to understand those issues raised, thus triggering them to probe necessary questions.
Improve financial reporting
ISA 701 Paragraph A37 stated that the management or those charged with governance may decide to include new or enhanced disclosure in the financial statements or elsewhere in the annual report relating to KAMs in light of the fact that the matter will be communicated in the auditor’s report. Such new or enhanced disclosures, for example, may be included to provide more robust information about the sensitivity of key assumptions used in accounting estimates or the entity’s rationale for a particular accounting practice or policy when acceptable alternatives exist under the applicable financial reporting framework. In this manner, KAMs have resulted in better financial reporting.
Increase confidence of the users of financial statements
The inclusion of KAMs in the auditor’s report may have a positive impact on the users’ perception. Likely, the users’ confidence in relying on the information presented in the audited financial statements may have increased.
Although the benefits of KAMs are noticeable, the issues perhaps could relate to the use of appropriate language in describing KAMs. The auditor should limit the use of highly technical language to ensure descriptions of the issues are understandable to the intended users of financial statements. The auditor should bear in mind that most users of financial statements do not necessarily have an in-depth understanding of auditing and accounting.
It is important to note that KAMs are not “new conclusions” or “new opinions” given by the auditor. The auditor is still opining on the true and fair view of the financial statements and that has not changed. There is also a need to understand that KAMs do not portray the auditor as concluding or giving mini opinions on the financial statements. KAMs should not be viewed as a disclosure to highlight that something is wrong with the entity being audited. KAMs are also not a substitute for disclosures in the financial statements and should not be construed as a substitute for the auditor in expressing a modified opinion. Furthermore, KAMs are not to replace reporting for a “going concern” and clearly, not a separate opinion on the financial statements. It should be noted that disclosure of KAMs neither indicates a change of the auditor’s underlying responsibilities nor a change of the responsibilities of the management and those charged with governance for the preparation and proper presentation of financial statements.
KAMs are required in circumstances where the auditor issue an unmodified opinion as well as modified opinion. Nevertheless, if the auditor’s report expresses “disclaimer opinion”, then KAMs are not required to be disclosed. Likewise, for a listed entity with very limited operations, the auditor may determine that there are no matters that require significant auditor’s attention, thus, KAMs are not required to be disclosed in the auditor’s report.
As a conclusion, KAMs are an additional section included in the auditor’s report with respect to significant judgment or uncertainties that are under the auditor’s attention. The matters highlighted could give more information to the users of financial statements to assist them in making informed decisions. The benefits discussed above justify the need for the inclusion of KAMs in the auditors’ report.
ISA 701: Communicating Key Audit Matters in the Independent Auditor’s Report, Issued April 2015, updated July 2018.
Surendran, S. (2017). More clarity with ‘Key Audit Matters’. The Edge Financial Daily. Retrieved from http://www.theedgemarkets.com/article/more-clarity-%E2%80%98key-audit-matters%E2%80%99
Malaysian Institute of Accountants. (2017). The Enhanced Auditor’s Report: Questions and Answers. Retrieved from https://www.mia.org.my/v2/downloads/ppt/auditing/publications/2017/05/17/The%20Enhanced%20Auditors'%20Report%20-%20Questions%20and%20Answers%20(English).pdf
The Association of Chartered Certified Accountants,” Key Audit Matters: unlocking the secrets of the audit”, March 2018