This significant change in rule will make audit reports more effective

Implementation of KAMs in true spirit will certainly strengthen the faith on Chartered Accountants and also add value to the organization having strong foundation of transparency and corporate governance.

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The dimension of KAMs will enable more dialogue to take place between the auditors and the management, board of directors, audit committee and members of the company.
By Sandesh Rajapkar & Bhavin Kapadia

Following the financial calamities around the globe after the 2008 crisis, many questions have been raised about the role of watchdogs. In particular, they criticized that the statutory auditor's report is 'boilerplate language' with standardized contents which is not effective for the stakeholders to understand the financial risks involved. Discussions on key issues between an auditor and a company's management (including its audit committee and independent directors) happen behind closed doors and the conclusions remains with the auditors as part of audit working papers.

Currently, the auditor is not required to report issues wherein he receives satisfactory explanation from the company management, despite the fact that these explanations may be material to the understanding of the financial statements and the audit report.


One significant change is the new Standard on Auditing 701, Communicating Key Audit Matters in the Independent Auditor's Report. This new reporting requirement does not expand the scope of the auditor, however, this new reporting requirement is expected to add transparency and increase communicative value of an auditor's report. The Institute of Chartered Accountants of India has made this mandatory for audit of general purpose financial statement for period beginning on or after April 1, 2018 for listed entities. Certain countries had adopted this new reporting requirement since year 2015 and there was overall a good feedback. In United States, it will be implemented in year 2019 and will also be termed as "critical audit matters".

The sequence and format of audit report is also being changed:
  1. Placement of "Auditor's opinion paragraph" is at the beginning of the Auditor's Report
  2. Separate paragraph for going concern assumptions
  3. Instead of reproducing auditors responsibility, the report can provide the link to the relevant authority which prescribes the same

Gist of Key Audit Matters (KAMs) section in the Auditor's Report
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  1. KAM are those matters that were of most significance in the audit of financial statements of the current period.
  2. KAMs are selected out of matters communicated with the client
  3. While selecting the KAMs following aspects can be considered:
  • Areas of high risk
  • Areas involving management judgement,
  • Significant events or transactions that occurred during the period.
The descriptions of the matter/s should supplement, and not reiterate or disagree, what has been disclosed in the financials.

Will KAMs meet expectations of users of financial statements?
Certainly new reporting requirement will give additional information to users in regard to the key risks involved in the audit of financial statement of listed companies and how these matters were addressed during the course of audit.

Investors expects frequent updates about the company's key financial issues which will assist them in their investment life cycle. Such KAMs reported will generally be available in public domain when the annual report of the listed company is published and circulated to the members of the company (Quarterly limited review reports issued by the auditors will not contain such KAMs).

In case of unlisted entities, KAM reporting is not required unless it is considered for the purpose of consolidated financial statement of listed entity.
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Is there any litmus test for what to report under KAMs?
There is no such benchmark and materiality levels to identify the matters to be reported under KAMs. Financial risks involved and its degree may differ within the industry players and also based on the size of the company.

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Identification of KAMs is a subjective and predominantly based on auditors judgement. Tabulated below is the summary of reportable KAMs based on the nature of industry.

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Other matters which may be covered under KAMs
  • Impairment of assets
  • Disputed taxes
  • Goodwill impairment
  • Frauds

Benefits of KAM (to audit committee)
Audit committees should expect the auditors to communicate with them early and adequately, about the KAMs that are likely to be included in the auditor's report. This increased engagement and discussions around how those matters will be described in the auditor's report and how they complement the financial statement disclosures, can provide new perspectives for audit committees and auditors. This could have indirect benefits for audit quality and the quality of the disclosures in financial statements.

Conclude
Globally measures are being taken to improve the confidence and cement the trust on the Chartered Accountants. The dimension of KAMs will enable more dialogue to take place between the auditors and the management, board of directors, audit committee and members of the company. Implementation of KAMs in true spirit will certainly strengthen the faith on Chartered Accountants and also add value to the organization having strong foundation of transparency and corporate governance.

CA Sandesh Rajapkar, is Senior Qualified Associate and CA Bhavin Kapadia, Audit Manager at N. A. Shah Associates LLP
(Disclaimer: The opinions expressed in this column are that of the writer. The facts and opinions expressed here do not reflect the views of www.economictimes.com.)
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