In January 2015, the new and revised Auditor Reporting standards were issued by the International Audit and Assurance Standards Board. These standards are effective for audits of financial statements for periods ending on or after December 15, 2016.
Key Audit Matters
One significant change with the Auditor Reporting standards is the new International Standard on Auditing (ISA) ISA 701, Communicating Key Audit Matters in the Independent Auditor’s Report. The ISA applies both to audits of financial statements of listed entities and in circ*mstances when the auditor otherwise decides to communicate key audit matters in the auditor’s report. This ISA also applies when the auditor is required by law or regulation to communicate key audit matters in the auditor’s report. It may therefore be relevant to different sized entities and all practitioners, including small- and medium-sized practices (SMPs).
The standard is intended to address both the auditor’s judgment as to what to communicate in the auditor’s report and the form and content of such communication. The purpose of communicating key audit matters is to enhance the communicative value of the auditor’s report by providing greater transparency about the audit that was performed. Key Audit Matters (KAM) are defined as “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.”
In determining KAM, the auditor takes into account:
(a) Areas of higher assessed risk of material misstatement, or significant risks identified in accordance with ISA 315 (Revised), Identifying and Assessing the Risks of Material Misstatement through Understanding the Entity and Its Environment;
(b) Significant auditor judgments relating to areas in the financial statements that involved significant management judgment, including accounting estimates that have been identified as having high estimation uncertainty; and
(c) The effect on the audit of significant events or transactions that occurred during the period.
The description of each KAM in the auditor’s report shall include a reference to the related disclosure(s), if any, in the financial statements and will address:
(a) Why the matter was considered to be one of most significance in the audit and, therefore, determined to be a key audit matter; and
(b) How the matter was addressed in the audit.
Approaching KAM
In drafting KAM, it is important to keep the users of the auditor’s report in mind. This includes the audience’s knowledge and understanding of auditing and accounting terms, and the objective of communicating the KAM: to communicate with report users about the audit. KAM should be relevant and succinct yet insightful.
Timely engagement and discussion with those charged with governance (TCWG) is important to the process of identifying KAM, as well as drafting KAM. This allows those charged with governance TCWG to consider how the KAM may be addressed in the disclosures in the financial statements, or elsewhere in the annual report (e.g., a discussion by TCWG in their report, regardless of whether this is prescribed by the jurisdiction).
When relevant, effective communication between the group engagement team and component auditors is important in ensuring that:
- Matters identified by the group engagement team as potential KAM are communicated to the component auditors to ensure that these are appropriately addressed, and that the necessary feedback on how the matters were addressed by the component auditors is provided to the group engagement team for inclusion in the auditor’s report.
- Component auditors highlight matters that should be communicated to TCWG of the group on a timely basis, as these matters could ultimately qualify as KAM.
ISA 220, Quality Control for an Audit of Financial Statements, establishes requirements for the engagement partner in relation to undertaking appropriate consultation on difficult or contentious matters. This includes discussing significant matters arising during the audit engagement with the engagement quality control reviewer (ECQR) for audits of financial statements of listed entities, and those other audit engagements, if any, for which the firm has determined that an EQCR is required. More rigorous quality reviews of the auditor’s report may be appropriate, particularly in the first year of implementation.
Communicating KAM is in the context of the auditor having formed an opinion on the financial statements as a whole and is intended to provide insights into the audit. Communicating KAM is not, for example, a separate opinion on individual matters or a substitute for disclosures in the financial statements that the applicable financial reporting framework requires management to make, or that are otherwise necessary to achieve fair presentation.
It is essential that the auditor’s description in the auditor’s report of how the key audit matter was addressed in the audit correlates with the work performed and is supported by the documentation in the working papers.
IAASB Auditor Reporting Implementation Working Group
The IAASB established an Auditor Reporting Implementation Working Group to promote awareness and aid understanding and support. It has performed extensive outreach across numerous jurisdictions to encourage its stakeholders adopt and support effective implementation of the standards (see previous Gateway article, “Engagement and Outreach in Support of the New Auditor’s Report”).
The Working Group has been monitoring activities globally regarding the adoption of the standards, including early adoption. The UK and the Netherlands mandated enhanced auditor’s reports ahead of the IAASB standards’ effective date. Early adoption of the standards also took place on a number of engagements in several jurisdictions, including Australia, Germany, Hong Kong, Poland, South Africa, Singapore, and Switzerland.
There are also some jurisdictions that are encouraging, or mandating, more extensive application of ISA 701, i.e., the inclusion of KAM for entities other than listed entities. For example, South Africa is requiring the communication of KAM for entities in certain industries (medical schemes, collective investment schemes, and managers of collective investment schemes, as well as for entities in the public sector) and New Zealand has extended the requirement to entities with higher public accountability. The EU 2014 Regulation, Specific Requirements Regarding Statutory Audit of Public-Interest Entities, has taken effect for June 2017 year ends and applies to audits of public interest entities. It requires a description of the most significant assessed risks of material misstatement as well as a summary of the auditor’s response to those risks and, where relevant, key observations arising from those risks and reference to the disclosure in the financial statements.
The Working Group has also explored whether there are additional reporting requirements in jurisdictions that go beyond the requirements of the ISAs. For example:
- The UK requires auditors to communicate about audit scope and materiality;
- The EU 2014 Regulation requires the disclosure of key observations, where relevant, as well as matters relating to the auditor’s appointment, the consistency of the auditor’s opinion with the report to the audit committee, and statements regarding auditor independence and the provision of non-audit services; and
- South Africa and New Zealand have requirements to communicate matters related to independence.
The IAASB have developed a number of publications to support the implementation of Auditor Reporting standards.
- Auditor Reporting—Key Audit Matters
- Auditor Reporting on Going Concern
- Slide Presentation in Support of the IAASB’s New and Revised Auditor Reporting Standards
- Auditor Reporting—Illustrative Key Audit Matters
- More Informative Auditor’s Reports—What Audit Committees and Finance Executives Need To Know
- Determining and Communicating Key Audit Matters
- The New Auditor’s Report: Questions and Answers
In 2015, the Institut der Wirtschaftsprüfer (IDW) in Germany published Analysis of Auditor Reporting on Key Audit Matters (KAM) in the UK and the Netherlands, which included a number of audit reports from the Big 4. It noted that the visual impact of the auditors’ reports varied considerably, with differences observed in content order, degree of detail presented, and table and diagram use. It also found that the range in quantity of KAMs varied quite considerably. There was also less evidence of the use of apparent “boiler plate” language than might originally have been anticipated.
In the UK, the Financial Reporting Council has published two reports on the auditor reporting status: in March 2015 Extended Auditor’s Reports – A Review of Experience, published in March 2015, covers 153 reports from the first year of adoption and Extended Auditor’s Reports – A Further Review of Experience, published in January 2016, covers 278 audit reports from the second year of adoption.
The IFAC SMP Committee’s Implementation Guidance Task Force also discussed whether further support could be developed to assist SMPs with the changes. As any auditor can elect to disclose KAM it agreed that it would be helpful if links to audit reports that include KAM could be shared. The examples are intended to guide practitioners in developing KAM, which should be relevant and tailored to the circ*mstances of each entity and engagement.
IFAC and the SMP Committee welcome additional links to other publicly available audit reports that include KAM, in particular from small- and medium-sized entities (SMEs).
Please note that this selection is limited and not intended to be globally representative:
Property Investment/ Valuations
Accounting for property transactions | 2014 | |
Valuation of property, plant and equipment at Xiamen Airport | 2016 | |
Valuation of investment properties | 2016 | |
Valuation of investment properties | 2016 | |
Valuation of investment properties and care homes | 2016 | |
Valuation of investment property | 2016 | |
Valuation of investment property | Asia Pacific Data Centre Holdings Limited (p. 51) | 2016 |
Over valuation of the property estate | 2016 | |
Valuation of investment property—development properties | 2016 | |
Valuation of the property portfolio | 2017 | |
Valuation of assets held for sale | 2014 |
Property, Plant and Equipment
Capitalization of software assets and carrying value of legacy systems Carrying value of non-current assets | 2016 | |
Capitalization and asset lives | 2017 | |
Carrying value of natural gas assets | AGL Energy Limited (p. 77) | 2016 |
Capitalization of property, plant, and equipment | 2016 | |
Assessing the carrying value of aircraft and related equipment | 2016 | |
Capitalized product development | 2016 | |
Sale of non-core assets | 2016 | |
Carrying value of property, plant, and equipment and intangible assets, including goodwill | AGL Energy Limited (p. 77) | 2016 |
Cut-off between development and production phase of mining | 2016 | |
Valuation of generation assets | 2016-17 |
Acquisitions
Accounting and related disclosures of the acquisition of Teachers Provident Society Limited | Liverpool Victoria Friendly Society Limited’s Group (p. 112) | 2016 |
Capitalization practices and asset lives for property, plant, and equipment and software intangible assets | 2014 | |
Acquisitions and disposals, specifically the disposal of Rathbone Square | 2017 | |
Acquisition of Utility Service Partners Inc | 2017 | |
Acquisition of Trustwave—purchase price allocation | 2016 | |
Acquisition of BG, specifically the judgements around the purchase price allocation | 2016 | |
Fair value estimates of assets and liabilities acquired in the Spirit business combination | 2016 | |
Acquisition accounting: new risk identified this year | 2016 | |
Acquisition accounting | 2016/17 | |
Deferred acquisition costs | 2016 | |
Acquisition accounting | 2016-17 |
Impairment
Assessment of impairment for non-current assets | 2016 | |
Impairment of property, plant, and equipment | 2015 | |
Impairment of tangible and intangible assets and adequacy of property lease provisions | 2016 | |
Impairment of non-current and current assets | 2016 | |
Store impairments | 2016/17 | |
Impairment of property, plant, and Equipment | 2014 | |
Impairment of land and stores under construction | 2014 | |
Impairment assessment of HAECO Americas and HAECO Landing Gear Services | 2016 | |
Valuation and impairment of property, plant, and equipment Assessing the carrying value of aircraft and related equipment | 2016 | |
Compensation related to accident on installation for ethylene production in subsidiary UNIPETROL RPA s.r.o. | 2015 |
Goodwill and Other Intangible Assets
Valuation of goodwill | 2014 | |
Assessment of the carrying value of goodwill in the BT Global Services line of business | 2014 | |
Goodwill impairment assessment | 2016 | |
Appropriateness of goodwill carrying value (Energy & Water) | 2016 | |
Goodwill impairment assessment of HAECO Americas | 2016 | |
Valuation of goodwill in North America | 2016 | |
Goodwill | 2016 | |
Impairment of goodwill and intangible assets | 2016 | |
Rombat and Mutlu Goodwill and Other Indefinite Life Intangibles Impairment Assessments (Group level) | 2016 | |
Impairment of goodwill | 2016 | |
Goodwill | 2016 | |
Recoverability of intangible assets in the civil aerospace business | 2016 | |
Value of goodwill | 2016 | |
Recoverable amounts of exploration and production assets, goodwill, and Upstream and Integrated Gas joint ventures and associates | 2016 | |
Asset impairment considerations in relation to the trading estate and associated goodwill | 2016 | |
Assessment of the carrying value ofgoodwill and intangible assets withindefinite life | 2016 | |
Failure to impair goodwill when required | 2016 | |
Impairment of the goodwill and intangible assets | 2016 | |
Goodwill impairment | 2016 | |
Goodwill impairment | 2016 | |
Carrying value of goodwill | 2017 | |
Goodwill impairment | 2016 | |
Goodwill impairment | 2016 | |
Carrying value of goodwill and other intangible assets | 2017 | |
Goodwill impairment review Bharti Airtel—goodwill impairment evaluation and regulatory and tax disputes | 2016 | |
Assessment of the carrying value of goodwill | 2016 | |
Valuation of goodwill | 2016 | |
Impairment of goodwill and property, plant, and equipment | 2016 |
Investments
Valuation of difficult to value investments included in financial assets held at fair value through income | Liverpool Victoria Friendly Society Limited’s Group (p. 112) | 2016 |
Valuation of investments | 2016 | |
Impairment of investments in subsidiaries (company level) | 2016 | |
Investment in bank of communications company, Ltd (BoCom) | 2016 | |
Valuation of hard to value investments | 2014 | |
Valuation of foreign associates | 2016 | |
Valuation of investments | 2016 |
Inventory
Inventory Existence | 2016 | |
Carrying value of inventories and profit recognition | 2016 | |
Estimation of oil and gas reserves, including reserves used in the calculation of depreciation, depletion, and amortization | 2016 | |
Carrying value of inventory | 2016 | |
Valuation of inventory and related provisions | 2016/17 |
Debtors
Valuation of Trade Receivables | 2016 | |
Fair value assessment of trade receivables | 2016 |
Derivatives/Financial Instruments
Valuation of complex or illiquid trading portfolio assets and liabilities, financial assets and liabilities, and derivative financial instruments held at fair value | 2014 | |
Valuation of a put option over a non-controlling interest in a subsidiary company | 2016 | |
Valuation of financial instruments held at fair value | 2016 | |
Application of hedge accounting | 2016 | |
Hedge accounting | 2016 | |
Valuation of illiquid or complex financial instruments | 2016 | |
Financial instruments Electricity hedging contract | AGL Energy Limited (p. 77) | 2016 |
Hedge accounting | 2016 | |
Valuation and existence of available-for-sale financial assets | 2016 | |
Valuation of electricity derivatives and cross currency interest rate swaps | 2016-17 |
Provisions
Regulatory and other provisions | 2014 | ||
Provisions | 2016 | ||
Assessment of provisions for taxation, litigation and claims Assessing aircraft maintenance provisions | 2016 | ||
Estimation of decommissioning and restoration provisions | 2016 | ||
Provisions and contingent liabilities | 2017 | ||
Cancellation provision and revenue deferrals | 2017 | ||
Provisions and reserves in Tesco Bank | 2014 | ||
Valuation of net outstanding claims (gross discounted central estimate, reinsurance and other recoveries, risk margins and probability of adequacy) | 2016 | ||
Provisions for the cost of conduct remediation | 2014 | ||
Industrial disease claims provision | 2016/17 | ||
Assessing aircraft maintenance provisions | 2016 | ||
Impairment of the carrying value of loans and advances to banks and to customers held at amortized cost | 2014 | ||
Impairment of loans and advances | 2016 | ||
Debt repayment and liquidity | 2016 | ||
Impairment of loans to customers | 2016 |
Pensions and Employee Entitlements
Valuation of the pension scheme obligations and unquoted investments | 2014 | |
Pension liabilities | 2016 | |
Assessment of the valuation of defined benefit pension scheme assets and liabilities | 2016 | |
Valuation of pension scheme liabilities | 2016/17 | |
Employee entitlements and post-employment benefits | 2016 | |
Defined benefit pension scheme obligations | 2016 |
Other Liabilities
Valuation of life insurance contract liabilities Valuation of non-life insurance contract liabilities | 2014 | |
The valuation of long-term insurance contract liabilities The valuation of general insurance claims liabilities | Liverpool Victoria Friendly Society Limited’s Group (p. 112) | 2016 |
Borrowings | 2016 | |
Liabilities arising from customer financing arrangements | 2016 | |
The valuation of the future redemption of IHG Rewards Club (IRC) points liability | 2016 | |
Estimating the fair value of purchased debt portfolios (PDPs) | 2016 | |
Presentation of working capital facilities | 2016 | |
Maintenance and warranty contracts | 2016 | |
Ofcom investigation contingent liability | 2016/17 | |
Policyholder liabilities | 2016 |
Litigation and Regulation
Litigation and regulatory claims | 2014 | |
Compliance with Laws and Regulations | 2016 | |
Litigation and regulatory enforcement actions Impact of the deferred prosecution agreement (DPA) | 2016 | |
Litigation and claims | 2015 | |
Accounting for legal and other contractual claims | 2016 |
Revenue
Recognition of commercial income Risk of fraud in revenue recognition | 2014 | |
Revenue Recognition | 2014 | |
Revenue Recognition | 2014 | |
Revenue recognition Recoverability of accrued revenue | 2016 | |
Recognition of fee income | 2016 | |
Revenue recognition | 2016 | |
Net Advertising Revenue (NAR) Other Review streams (Non NAR revenue) | 2016 | |
The pressure on and incentives for management to meet revenue and profit targets The basis of accounting for revenue and profit in the Civil Aerospace business The measurement of revenue and profit in the Civil Aerospace business | 2016 | |
Recognition of revenue | 2016 | |
Revenue recognition | 2016 | |
Revenue recognition relating to unrealised trading gains and losses | 2016 | |
Revenue recognition, including fraud risks and risk of management override | 2016 | |
Revenue recognition | 2016 | |
Deferred revenue associated with advance customer payments arising from stamps sold | 2016/17 | |
Recognition of revenues and profits on long-term contracts | 2016 | |
Revenue recognition | 2016 | |
Recognition and measurement - professional services and construction & fabrication revenue | 2016 | |
Property Revenue | 2016 | |
Accounting for long term commodity contracts | 2016 | |
Revenue recognition – accuracy of revenue recorded given the complexity of systems | 2017 | |
Revenue recognition | 2016 | |
Revenue recognition | 2017 | |
Revenue recognition in relation to hire and Tailor Me deposits and the provision for customer returns | 2016/17 | |
Unbilled revenue | AGL Energy Limited (p. 77) | 2016 |
Revenue recognition | 2016 | |
Revenue recognition | 2016 |
Expenses
Accounting for the hotel assessments collected as part of the revenue cycle and the allocation of expenditures related to the marketing, advertising and loyalty programmes (the System Fund) | 2016 | |
Unbilled distribution costs | AGL Energy Limited (p. 77) | 2016 |
Taxation
Recognition and measurement of potential tax exposures and tax assets | 2014 | |
Provision for uncertain tax positions | 2014 | |
Assessment of recoverability of deferred tax assets in Australia | 2016 | |
Recoverability of deferred tax assets in North America | 2016 | |
Deferred tax on unremitted earnings | 2016 | |
Deferred taxation | 2016 | |
Provisions for indirect taxes | 2016 | |
The recognition and valuation of deferred tax assets (DTA) | 2016 | |
Uncertain tax positions | 2016 | |
Deferred tax on the revaluation of the estate | 2016 | |
Indirect tax risk exposures and claims | 2016 | |
Deferred taxation assets related to assessed losses | 2016 | |
Taxation matters | 2017 | |
Deferred tax asset relating to tax losses | AGL Energy Limited (p. 77) | 2016 |
Taxation | 2016 | |
Income tax and deferred tax | 2016 | |
Taxation | 2016 | |
Assessment of provisions for taxation, litigation and claims | 2016 |
Management Override of Control
Risk of management override of internal controls | 2014 | |
Risk of management override of internal controls | 2014 | |
Risk of management override of internal controls | 2014 | |
Risk of misstatement due to management override, fraud anderror specifically around revenuerecognition | 2016 |
Financial Statement Presentation
Acquisition accounting for Sainsbury’s Bank | 2014 | |
Accounting policy of recording purchased debt portfolios (PDPs) at fair value | 2016 | |
The presentation of ‘underlyingprofit’ Disclosure of the effect on the trend in profit of items which are uneven in frequency or amount | 2016 | |
Changes in Group’s presentation currency | 2017 | |
Presentation of earnings | 2016 | |
Contract accounting | 2016 | |
The measurement and accounting for share-based payments The accounting for property leases | 2016/17 |
IT
IT systems and controls | 2014 | ||
IT access management | 2016 | ||
Data security incidents | 2016 | ||
IT systems and controls | 2017 | ||
Reliance on automated processes and controls | 2016 | ||
Portfolio and risk management system | 2016 |
Other
Supplier incentives, rebates and discounts | 2014 | |
Major contracts in BT Global Services and BT Wholesale | 2014 | |
Re-segmentation | 2014 | |
Significant one-off transactions | 2017 | |
Business combination | 2016 | |
Cut-off between development and production phase of mining | 2016 | |
Share-based payment recognition | 2016 | |
Bribery and corruption | 2016 | |
First year audit transition | 2016 | |
Migration of data to the new online gaming platform | 2016 | |
Working capital financing programs | 2016 |