(a)    Key audit matters (‘KAM’) are the matters which, in the auditor’s judgement, were of most significance in the audit of the financial statements. They were introduced by ISA 701 Communicating Key Audit Matters in the Independent Auditor’s Report, to enhance the auditor’s report issued in respect of listed entities by providing more relevant information to the users of those reports.

Benefits

The principal reason for the disclosure of KAM in the auditor’s report was to provide increased transparency in response to requests from users of the financial statements for more information in relation to significant judgements made by both management and the auditor. This should lead to increased focus on the uncertainties created by judgement in the reporting process and help to improve users’ understanding of the financial statements. This in turn will serve to increase confidence in the audit process and the perception of audit quality.

The audit expectation gap is the difference between the actual role of the external auditor and the role which the public believes the auditor performs. In this context, the inclusion of KAM within the auditor’s report represents an important step in the process of informing and educating the public about the auditor’s role in evaluating areas of high risk, judgements and significant events or transactions which occurred during the period. Furthermore, auditors are expected to discuss how they addressed KAM during the course of the audit and the provision of detail in relation to the procedures performed will also go some way to provide greater transparency on how the audit is performed.

Difficulties

The determination of which audit matters to report as ‘key’ is subjective and requires auditor judgement. As a result, this may reduce the consistency and comparability of auditor reporting. In order to assist with this, ISA 701 provides a decision making framework to help auditors determine which matters are KAM. This should help reduce ambiguity and promote consistency across audits.

The inclusion of KAM in the auditor’s report may lead to a significant increase in the volume of detail contained in the report thereby obscuring which of the matters are of the greatest significance. This increase in volume may deter users from reading the auditor’s report in full and therefore undermine its role in closing the audit expectation gap. There are also concerns that the lack of specific guidance may lead to standardised ‘boilerplate’ disclosures which add little value to the auditor’s report.

(b)    There are a number of issues to consider in critically appraising the auditor’s report extract which has been drafted by the audit senior. These include the following:

Key audit matters (KAM)

The section should include an introductory paragraph explaining the concept of KAM in order for users of the auditor’s report to understand its importance and significance. The introduction should also clearly state that the auditor is not forming a separate opinion on the items identified as KAM.

Valuation of financial instruments

This is an area of significant audit judgement with a high risk of material misstatement, hence inclusion as KAM is appropriate although the disclosure should explain the factors which led the auditor to determine the matter was a KAM. It would also aid user understanding further if the auditor’s report quantified the size and significance of the issue and explained its impact on the nature and extent of the audit effort.

The auditor should describe how the KAM was addressed in the audit, and although this is a matter for auditor judgement, the auditor may describe aspects of the auditor’s response or approach, provide a brief overview of the procedures performed and an indication of the outcome of the procedures. Based on the current wording, the users of the auditor’s report would have no clear indication of how the auditor has gathered evidence over this key area.

There are also several issues in relation to the detailed drafting of the paragraph. The report should not refer to the Group’s finance director by name and should not imply criticism of him as result of his inexperience. The use of the word ‘guesswork’ is inappropriate and undermines the credibility of the audit and financial reporting process.

Customer liquidation

The amount owed by the customer of $287,253 is material to the loss before tax at 13·1% and to assets at 2%. The ‘except for’ qualification on the grounds of material misstatement is therefore appropriate. However, the details of the material misstatement should not be included in the KAM section at all but should be given in the basis for qualified opinion paragraph. This should also be clearly cross referenced within the opinion paragraph itself. Furthermore, the wording of the report currently references reducing the profit before tax when it should refer to increasing the loss before tax.

Opinion paragraph

This is incorrectly positioned and incorrectly titled. It should be at the start of the auditor’s report and should simply be titled ‘Qualified Opinion’. The opinion paragraph should be clearly cross referenced to the ‘Basis for Qualified Opinion’ paragraph which should be placed immediately below the opinion paragraph and should clearly describe the issue which has given rise to a qualified opinion. As above, the ‘except for’ qualification on the grounds of materiality is appropriate.

Going concern – Emphasis of matter

Following ISA 570 Going Concern, the use of an emphasis of matter paragraph to refer to uncertainties in relation to going concern disclosures in the financial statements is no longer appropriate. The auditor’s report should now include a specific section headed ‘Material Uncertainty Related to Going Concern’ immediately after the basis for opinion paragraph and before the KAM section. The material uncertainty related to going concern should be cross referenced clearly to the disclosure note where the directors have given details of the uncertainty. If the matter has not been adequately disclosed by the directors in the financial statements, the auditor should give full details of the uncertainties in relation to going concern and the audit opinion should be qualified ‘except for’ the material misstatement in relation to this lack of disclosure.