KAM will increase transparency in the audit and the financial statements insofar that it will inform users about the areas in the financial statements that are subject to the highest level of management judgment and require significant auditor attention. Users can thereby better understand the risks and sensitivities relating to the reported numbers. However, it is important for users to understand that KAM do not represent concerns that the auditor wishes to highlight, but are a summary of the most significant aspects dealt with during the audit.
KAM will not change the manner in which numbers are reported. However, in some cases, companies may provide enhanced disclosures in their financial statements relating to matters that are reported as KAM.
The UK, the Netherlands, Australia and other countries have already seen reporting using the new format. The reaction of the stakeholders in these countries has been quite positive. Under KAM, auditors have reported on areas such as impairment, going concern, loss provisions, related party transactions, revenue recognition and income taxes, depending on the nature of the entity’s business environment. This has assisted users to better engage with companies in these areas.
Successful implementation of KAM is a shared responsibility between the management, the audit committee and auditors. Management and audit committees would need to engage with their auditors and agree on the matters to be reported as KAM. This would, in turn, result in senior management and audit committees enhancing their focus on financial reporting complexities, judgments and disclosures relating to such KAM. Board of directors, management and others responsible for preparing financial statements will also need to consider the implications of such enhanced communication on various users of financial statements. For example, management may need to proactively communicate with investors to assure them that KAM are different from ‘emphasis of matters’, which have historically been viewed as a tool for auditors to highlight uncertainties relating to the reported numbers. Similarly, management should be prepared to engage with investors to address questions around the assumptions made and judgment exercised in these areas and related sensitivities to the reported numbers.
The interactions between the auditor and the audit committee are a key element for enhancing the quality of financial reporting, as well as the quality of the audit. Reporting of KAM requires a candid two-way dialogue between the auditor and the audit committee about the risks of misreporting and how these risks have been addressed. To that extent, KAM reporting is likely to improve overall audit quality. Further, the enhanced communication in the audit report will provide the users with a basis to engage further with the management about important matters relating to the financial statements. Overall, if implemented correctly, KAM reporting can assist in building a greater trust in the financial statements and the audit process.