We often come across the term Key Audit Matters in the auditors’ report segment of the audited financial statements of public companies.
“Key Audit Matters” is defined by the International Standard of Auditing as those matters that, in the auditor’s professional judgment, are the most significant in the audit of the financial statements of the current period.
Furthermore, Key Audit Matters are usually selected from matters that were communicated to those charged with governance such as audit committee members of a public company during the audit.
In this article, we will highlight the key factors that the auditor applies in determining Key Audit Matters. Do take note that there are circumstances where the auditor may apply other considerations such as the importance of the matter to the user of the financial statements, deviation of accounting application from industry practice, nature, or materiality (which could be either quantitative or qualitative), and control deficiency.
Determining Key Audit Matters
The starting point for determining Key Audit Matters is understanding the term “most significant”. This term is regarding areas of audit where there is higher complexity and requires significant management judgment where will, in turn, require a similar level of involvement from the auditor due to the complexity and significant judgment that will be required to audit such areas.
The auditors usually have a list of matters they have identified during the audit’s final stages, which consists of the above significant areas. Thereafter, from such a list the auditors decide the matters which require to be brought to the attention of those charged with governance.
Then from the list of matters communicated to those charged with governance, the auditors will identify matters that required significant auditors’ attention when they carried out the audit.
The auditors’ strategy may also play a part in determining Key Audit Matters such as the allocation of resources by the auditor to address a particular matter and whether or not the engagement of auditors’ experts is required.
The criteria to determine matters requiring significant auditors’ attention include areas with a higher risk of material misstatements or when a significant risk was identified, areas where the significant judgment was applied by the auditor such as auditing accounting estimates that are subject to a high degree of uncertainty and significant events or transactions that occurred during the audit period.
To illustrate, company A acquired a subsidiary during the accounting period and had performed an internal assessment to estimate the purchase price allocation of the acquired subsidiary. This is an example of a significant transaction.
Purchase price allocations are normally subject to a high degree of uncertainty as the management needs to determine the fair value of the assets and liabilities and determine the goodwill of the acquired subsidiary. This involves the use of many significant estimates.
The auditor will have to exercise significant judgment when auditing the purchase price allocation by the management. Due to the significant estimates involved, there is also a higher risk of misstatements.
The above is just an illustration of how a Key Audit Matter will be required, not all criteria need to be present concurrently for a Key Audit Matter to be identified.
Communicating Key Audit Matters
In communicating the Key Audit Matters, the auditor needs to describe each Key Audit Matter on its own under a separate section in the auditors’ report. The introduction paragraph shall always be:
“Key Audit Matters are those matters that, in the auditors’ professional judgment, were of most significances in the audit of the financial statements of the current period and these matters were addressed in the context of the audit of the financial statements as a whole, and informing the auditor’s opinion thereon, and the auditor does not provide a separate opinion on these matters.”
The auditor shall also explain the reason for including each Key Audit Matter in terms of why this matter was considered most significant in the audit and what audit procedures were performed to address each matter.
For instance, the auditor has identified fair value measurement of investment property as a Key Audit Matter. The auditor will need to explain that in auditing this matter, the auditor has applied significant judgment to the estimate of fair value made by either the management or the management’s external specialist such as property valuers.
Lastly, the auditor will have to describe in detail the audit procedures performed to audit the fair value such as enquiring the management’s expert on the valuation method, key assumption applied, and check the independence and competency of the expert.
There are circumstances where communication of Key Audit Matters may be exempted such as local laws or regulations forbid the disclosure of such matters to the public or when the consequences of disclosing such matter outweigh the interests of the public. Such exemption should always be applied with extreme care by the auditor.
Other Information on Key Audit Matters
The auditor is not required to provide an update to Key Audit Matters highlighted in the auditors’ report in the previous accounting period. However, the auditor will need to reassess the matters determined to be a Key Audit Matter in the prior accounting period to determine if they could still be a Key Audit Matter in the current accounting period.
Key Audit Matters is a requirement by auditing standards to enable the auditor to inform the user of the financial statements where they have spent most time auditing and where the auditor had applied significant judgment.
This allows the users of the financial statements to grasp the importance of certain balances or transactions disclosed in the financial statements and helps the users to determine whether they are satisfied with the work performed by the auditor.
Key Audit Matters does not in itself form an opinion on particular account balances or transactions but is part and parcel of the audit work performed and evidence obtained to support the audit opinion. It does not indicate there is an issue or discrepancy in the account balances and should not be misunderstood as such.