Key Audit Matters

Key audit matters (KAMs) are additional information presented in a company's audit report. They highlight the most sensitive areas of the financial statements that may involve higher risks or complexities and require greater attention by those groups holding charge of governance (audit committees). The auditor selects such matters based upon their judgment from the various matters reported to the audit committee or other groups charged with governance. 

Such information enhances the quality of the audited financial statements for use by various internal and external stakeholders like investors, shareholders, creditors, analysts, regulators, and other interested parties. The key audit matters applicability is compulsory for listed public companies; however, some unlisted companies also follow this practice to improve their audit and financial reporting quality.

However, such insights may be falsely assumed to be the indicators of risk or potential downsides of the company by the investors. Further, the auditors need to avoid information overload while deciding what to consider for KAMs since highlighting too many significant matters can confuse the users and mislead them. Moreover, it increases the burden of the auditing team, simultaneously increasing the time taken and cost of an audit. Sometimes, the auditors fail to include precise information in this section. Also, its relevance depends upon the auditors' individual knowledge and judgment expertise.

The auditors usually follow a standard process to determine the key audit matters in the audit report, comprising of the following steps:

1. The foremost step is to identify the areas with a high risk of potential material misstatement or other discrepancies, as per SA 315.
2. Then, the auditors must make a professional judgment on these areas of crucial concern in the financial statements. These can be significant management judgments or estimates that are quite uncertain and indicate unrealistic financial reporting.
3. The next step is to gauge the impact of the substantial events or transactions between the auditing period and the present.
4. After analyzing all the above aspects, the auditor needs to select the most significant matters in the current period's financial reporting and mark them as key audit matters.

The KAMs are essential information in publicly listed companies' audit reports. Its significance can be understood through the following examples:

Example #1

Suppose ABC Ltd.'s management included a revenue recognition of the goods it sold on credit worth $27,600 in December 2023, but the payment is to be received in March 2024. Thus, it was considered an ISA 701 key audit matter since the earnings yet to be received have elevated the company's profits, which may mislead investors and creditors while assessing ABC Ltd's financial position.

Example #2

With the audit report's increasing significance among stakeholders, the International Board has updated its standard requirement for including Key Audit Matters (KAMs) in audit reports. This improvement ensures that the report is relevant and useful for the stakeholders.

KPMG Sri Lanka released a Key Audit Matters report on September 06, 2019, at the KPMG Learning Centre in Colombo. It emphasized the performance of the first year of KAM reporting in Sri Lanka. It analyzed the key audit matters, qualifications, emphasis of matter, and uncertainties related to ongoing concerns from 280 annual reports of listed companies. The major findings were the different types of KAMs reported across different sectors.

The KPMG leaders noted the need for auditing transparency during this presentation. They emphasized that while KAMs make the audit reports more useful, there is a need for more comprehensive and specific disclosures to interpret the impact of broader economic conditions on the entities. Further, a significant concern was the low number of KAMs reported by large, diversified business groups and the generalized brief narratives provided by the auditors, which failed to adequately fulfill the purpose of making these reports more transparent and useful. The report also highlighted the role of auditors in making the shareholders understand the critical issues a company faces in their audit reports through KAM inclusion.

The key audit matters bring out some of the prominent complexities of the financial reports, which require more attention from the management, stakeholders, and regulatory authorities. It is an essential part of any audit report for the following reasons:

1. Ensures Transparency: KAMs help maintain transparency in the auditing process by stating the most significant areas of a financial report that require more attention from management.
2. Improves Audit Quality: This additional insight enhances the quality of an audit report used by the public, including investors, regulators, creditors, partners, analysts, etc., for various purposes.
3. Better Accountability: It ensures greater accountability of the auditors in identifying and highlighting sensitive matters in their audit reports while providing valid reasons and suggestions.
4. Facilitates Decision Making: Such an inclusion in the audit report ensures that stakeholders, including investors, shareholders, and creditors, can make informed decisions using this information.
5. Regulatory Compliance: According to the International Standards on Auditing (ISA 701), KAMs are an inevitable part of a public limited company's audit report.
6. Fosters Communication: The auditors can discuss the critical areas of the audit and how these can be worked out with management, directors, audit committees, etc., to ensure a seamless flow of information and suggestions.

Although key audit matters, critical audit matters, and emphasis on matters are all inclusions of an audit report, they differ from one another in the following ways: