SA-701 -“Communicating Key Audit Matters in the Independent Auditor’s Report”- A way forward to auditor’s reporting
Why SA 701?
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.
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.
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 the audit of unlisted entities in situations where law or regulation requires communication of key audit matters in the audit report.
In short, the applicability of New SA 701, Communicating Key Audit Matters (KAM) in the Independent Auditor’s Report is attracted when all the following conditions are satisfied–
1. Company is required to be listed on any stock exchange in India.
2. Financial statements of such listed companies on which opinion is required to be given, to be general purpose financial statements.
3. Such financial statements to be an annual financial statement.
4. If Key audit matters are required to be communicated by law or regulation in the auditor’s report.
Determination of Key Audit Matters
The determination of key audit matter requires diligent application of professional judgement by the auditor. The auditor presents few matters in front of the members of the audit committee (TCWG) on a quarterly/six monthly basis.
The auditor shall determine/select, out of all the matters communicated during the year, those matters that required significant auditor attention in performing the current year audit. The determination of KAM to be limited to a significant matter of the current year audit even when the auditor’s opinion refers to comparative numbers presented in the financial statements.
Further, this SA does not require the auditor to update the KAM included in prior period auditor’s report in the current period auditor’s report unless the matter is continuing in the current period as well and determined as key matter again in the current year. Following are some matters that usually requires significant audit attention –
a. The significant risk areas i.e. area in which the auditor assesses higher risk at audit planning stage.
b. The matters which poses challenge to auditor in forming an opinion of financial statements.
c. Areas where significant management as well as auditor’s judgment is involved for example specialised areas of accounting and auditing where auditor’s expert is used.
d. Areas which includes related party transactions and other complex transactions.
e. Areas where audit partner concludes to consult with others on significant technical matter and areas where significant matter arises on review by internal quality control reviewer.
f. Significant event or transactions that occurred during the year and had impacted the auditor’s overall audit strategy.
What is not a Key audit matter?
Determination of KAM is a matter of professional judgement. However, standard has clearly guided on few matters not to be KAM. Accordingly, communicating KAM in the auditor’s report is not –
a. A substitute for disclosure in the financial statement as per the applicable GAAP.
b. A substitute for modified opinion by the auditor.
c. A separate opinion on individual matters.
d. A substitute for reporting as per SA 570, when material uncertainty relating to the events or conditions that may cast significant doubt on the entity’s ability as a going concern.
How to communicate KAM in the Auditor’s Report
The auditor shall describe each key audit matter under a separate subheading under heading “Key Audit Matters”. The descriptions for each Key audit matter shall be given in every case unless law or regulation prohibits public disclosure of the matter and in some very rare cases where the auditor believes that the matter should not be communicated due to its adverse consequences. In the Key audit matter, the auditor shall also refer to the relevant disclosures made in the financial statement. Also, the auditor needs to state as to why that matter has been determined as a key and how the matters have been dealt with during the course of the audit. However, SA 705 (Revised) prohibits the auditor from communicating key audit matters when the auditor disclaims an opinion on the financial statements unless such reporting is required by law or regulation.