What Are Key Audit Matters in an Audit Report?

An audit report on a company’s financial statements provides an opinion on whether they are presented fairly, but users of these reports have sought more insight into the audit process. In response, international standard-setters introduced Key Audit Matters (KAMs) for reports prepared under International Standards on Auditing (ISAs). Key Audit Matters are defined as the issues that, in the auditor’s professional judgment, were of most significance in the audit of the financial statements for the current period. Their purpose is to enhance the report’s value by providing greater transparency about the audit, highlighting the areas that most occupied the auditor.

The Auditor’s Determination Process

The starting point for KAMs is the collection of matters that the auditor communicates to the company’s governance body, such as the board of directors or its audit committee. From this group of communicated matters, the auditor then applies professional judgment to select the few that were of the “most significance” during the audit.

International Standard on Auditing (ISA) 701 provides a framework to guide this judgment, directing the auditor to consider three primary factors. The first is whether the matter relates to an area of higher assessed risk of material misstatement, including significant risks identified by the auditor. For instance, if a company has a high risk of its revenue being recorded in the wrong period, the audit work in that area could become a KAM.

A second consideration is the extent of significant auditor judgment related to areas of the financial statements that also involved significant management judgment. This is relevant for items involving accounting estimates that have high uncertainty. An example would be the valuation of a complex financial instrument for which there is no active market, requiring significant judgment from both management and the auditor.

The third factor is the effect on the audit of significant events or transactions that occurred during the period. A major business acquisition, the implementation of a new IT system, or a significant transaction outside the normal course of business would all fall into this category. These events often introduce new risks and complexities that demand substantial audit effort.

Communicating Key Audit Matters in the Report

Once an auditor determines which matters are KAMs, they must be communicated in a dedicated section of the audit report under the heading “Key Audit Matters.” This section clarifies that the KAMs were addressed in the context of the overall financial statement audit and that the auditor is not providing a separate opinion on these individual matters.

For each Key Audit Matter listed, the description must begin with a clear subheading that identifies the specific matter, such as “Valuation of Goodwill” or “Revenue Recognition from Long-Term Contracts.” The report must then explain why the matter was considered one of the most significant in the audit.

The communication must also include a summary of how the auditor addressed the matter, providing an overview of the audit procedures performed. For example, the auditor might describe involving valuation specialists or testing key assumptions in a financial model. The description concludes with a reference to the related disclosures in the financial statements, if any.

Common Examples of Key Audit Matters

While Key Audit Matters are specific to each company and audit, certain topics appear frequently across industries due to their inherent complexity and the judgment they require. They often relate to areas where financial reporting standards allow for management discretion or where future outcomes are highly uncertain. Common examples include:

• Valuation of goodwill and other intangible assets: After a company acquires another, it records goodwill, which must be tested for impairment annually. This process involves forecasting future cash flows and determining an appropriate discount rate, both of which require significant management judgment.
• Revenue recognition: For companies with complex and long-term contracts, determining when and how much revenue to recognize can involve significant interpretation of contract terms. The inherent risk of fraud in revenue recognition also contributes to the significant auditor attention this area receives.
• Valuation of complex financial instruments: Companies may rely on internal models to determine the fair value of derivatives or securities that are not traded in active markets. The auditor must assess the appropriateness of the model and the reasonableness of the inputs, which often requires specialized skill.
• Accounting for significant litigation or other legal provisions: Determining whether a provision is required and estimating the potential financial impact involves a high degree of uncertainty. The auditor’s work to corroborate management’s assessment often involves evaluating legal opinions and other external evidence.

Distinction from US Critical Audit Matters (CAMs)

For those familiar with U.S. public company audit reports, Key Audit Matters may sound similar to Critical Audit Matters (CAMs). CAMs are the U.S. equivalent, required in reports for public companies by the Public Company Accounting Oversight Board (PCAOB). While the spirit of both is to provide more transparency, a distinction in their definitions can affect what is reported.

A CAM is defined as a matter that was communicated to the audit committee, relates to accounts or disclosures that are material to the financial statements, and involved especially challenging, subjective, or complex auditor judgment. The key difference is that a CAM must relate to a material financial statement account or disclosure.

The definition of a KAM is broader, as it is simply a matter of most significance in the audit, selected from those communicated to governance. It does not have the explicit requirement to relate to a material account or disclosure.

This difference means a significant audit issue, such as the implementation of a new IT system that required substantial audit effort, could be a KAM but might not qualify as a CAM. The introduction of both KAMs and CAMs reflects a global trend toward more informative and transparent audit reporting.