ISA 701

Communicating Key Audit Matters in the Independent Auditor's Report

1Objective and scope

ISA 701 deals with the auditor's responsibility to communicate key audit matters in the auditor's report. It is intended to address both the auditor's judgement about what to communicate and the form and content of that communication. Communicating key audit matters enhances the communicative value of the report by providing greater transparency about the audit performed: it gives users additional information to understand the matters that, in the auditor's professional judgement, were of most significance in the audit, and may help them understand the entity and the areas of significant management judgement. ISA 701 applies to audits of complete sets of general purpose financial statements of listed entities, to circumstances where law or regulation requires key audit matters, and to any audit where the auditor decides to communicate them; it also applies when ISA 705 requires them to be included alongside a modified opinion. Key audit matters are not a substitute for disclosures management is required to make, for a modified opinion, for reporting on going concern under ISA 570, or for a separate opinion on individual matters.

The objectives are to determine key audit matters and, having formed an opinion on the financial statements, communicate those matters by describing them in the auditor's report.

2Key definitions

Key audit matters (KAM)

Those matters that, in the auditor's professional judgement, 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.

Listed entity

An entity whose shares, stock or debt are quoted or listed on a recognised stock exchange, or are marketed under the regulations of a recognised stock exchange or other equivalent body (in Kenya, entities listed on the Nairobi Securities Exchange).

3Requirements

Determining key audit matters

The auditor determines, from the matters communicated with those charged with governance, those that required significant auditor attention in performing the audit, taking into account: areas of higher assessed risk of material misstatement, or significant risks identified under ISA 315; significant auditor judgements relating to areas of the financial statements that involved significant management judgement, including accounting estimates with high estimation uncertainty; and the effect on the audit of significant events or transactions that occurred during the period. From those matters, the auditor determines which were of most significance in the audit of the current period: these are the key audit matters. The filter therefore narrows in three steps, from everything communicated to those charged with governance, to what required significant attention, to what was of most significance, and typically yields a small number of matters (revenue recognition, impairment of goodwill, expected credit losses, a major acquisition, an IT migration, a material litigation).

Communicating key audit matters

Describe each key audit matter, using an appropriate subheading, in a separate section of the report headed 'Key Audit Matters', with introductory language stating that key audit matters are those matters that, in the auditor's professional judgement, were of most significance in the audit of the current period; that they were addressed in the context of the audit of the financial statements as a whole and in forming the opinion, and the auditor does not provide a separate opinion on them.
The description of each matter includes a reference to the related disclosure(s), if any, and addresses why the matter was considered to be one of most significance and therefore a key audit matter, and how the matter was addressed in the audit (the auditor's approach, procedures, the outcome or key observations, or a combination).
A matter giving rise to a modified opinion under ISA 705, or a material uncertainty related to going concern under ISA 570, is by its nature a key audit matter but is not described in the KAM section: the section refers to the Basis for Qualified (Adverse) Opinion section or the Material Uncertainty Related to Going Concern section instead.
The description must not imply that the matter has not been appropriately resolved, must not contain or imply discrete opinions on separate elements of the statements, and must not disclose original information about the entity (information not otherwise made publicly available by the entity) unless the entity discloses it or it is necessary; the auditor's description is about the audit, and the entity's disclosures are the source of information about the entity.
The order of matters is a matter of judgement (by relative importance, or the order of the items in the financial statements).

When a matter is not communicated, and when there are none

A matter determined to be a key audit matter is described unless law or regulation precludes public disclosure about the matter (a tipping-off restriction under anti-money-laundering law, a regulator's confidentiality order), or, in extremely rare circumstances, the auditor determines that the matter should not be communicated because the adverse consequences of doing so would reasonably be expected to outweigh the public interest benefits (a disclosure that would prejudice a criminal investigation or a sensitive negotiation). This exception does not apply if the entity has publicly disclosed information about the matter.
If the auditor determines there are no key audit matters, or the only ones are those referred to in the modified opinion or going concern sections, the report includes a statement to that effect in the Key Audit Matters section.
When the auditor disclaims an opinion under ISA 705, no Key Audit Matters section is included at all, because describing matters other than the one giving rise to the disclaimer would suggest the financial statements are more credible than the disclaimer implies.

4Documentation and reporting

The auditor documents the matters that required significant auditor attention and the rationale for the determination as to whether or not each of them is a key audit matter; where applicable, the rationale for the determination that there are no key audit matters, or that the only ones are those referred to in other sections; and where applicable, the rationale for not communicating a matter determined to be a key audit matter. The auditor communicates with those charged with governance the matters determined to be key audit matters or, where applicable, the determination that there are none, and the draft wording, so that they can consider the entity's own disclosures in light of the matters the auditor will describe. Key audit matters are reported in the section of that name, after the Basis for Opinion (and after the Material Uncertainty Related to Going Concern section if any) and before Other Information.

A key audit matter, in the required shape

Impairment of goodwill (refer to note 14). Why: goodwill of KES 3.2 billion arose on the acquisition of a subsidiary, the recoverable amount depends on management's five-year cash flow forecast, discount rate and terminal growth assumptions, and small changes in these assumptions would result in an impairment; the matter involved significant judgement and estimation uncertainty.

How the matter was addressed: we evaluated the composition of the cash-generating units and the allocation of goodwill; tested the arithmetic of the model; compared forecast cash flows with board-approved budgets and with historical performance; involved our valuation specialists to assess the discount rate and terminal growth rate against market data; performed sensitivity analysis on the key assumptions; and assessed the adequacy of the disclosures in note 14, including the sensitivity disclosures required by IAS 36.

5Examinable focus

What KASNEB tests

Expect 'explain the purpose of key audit matters, how they are determined and what the description of each must contain', then a scenario listing matters from the audit of a listed company (a major impairment, a revenue recognition judgement, a new IT system, an immaterial control weakness, a fraud by a junior clerk) and asking which are key audit matters and how to write one up. Know that KAM apply to listed entities, are drawn from matters communicated to those charged with governance, do not modify the opinion, are never used to disclose original information about the entity, are omitted entirely on a disclaimer, and cross-refer rather than repeat a modified opinion or a going concern uncertainty. The 'why' and 'how addressed' structure is what the marker checks.