Auditors will now have to disclose the procedures used to arrive at conclusions

After a few stops and starts, a new feature of audit reports will kick in from the current fiscal. Auditors will now have to spell out ‘Key Audit Matters’ or KAM in their report to shareholders whichspecific procedures used in the audit of companies and explain how they arrived at the conclusions.

The new section will explain to the readers or users (like investors, credit rating agencies etc.) the kind of work that has been put in by the auditors to arrive at conclusions. This is expected to reflect in audit reports from Q1FY20 onwards for listed companies.

“Let’s say a company has made certain investments and there is a stress in those investments,” explains Jamil Khatri, head of audit at BSR & Co LLP. “And therefore, the auditor spent a lot of time auditing to see if they have been correctly reflected and to make sure provisioning is made appropriately on those investments.. The auditor may look at valuation reports that have been produced by the management… do some sensitivity testing around it.”

In the KAM section, the auditor will communicate all the procedures that were undertaken to arrive at the conclusions.

This will help users of financial statements, specifically investors, to take a call on the matters that are highlighted in the KAM section. Till now, an audit was almost like a black box for investors — they only had the audit report to take a call, and never knew the procedures employed by the auditor.

“The auditor will have to explain important decisions taken as part of the audit and the associated considerations and risks,” says R. Narayanaswamy, professor of finance at Indian Institute of Management, Bangalore. “These would include scope, materiality, revenue, goodwill and other intangible assets, impairment, internal controls, litigations and deferred taxes.”

Additional communication

Essentially, KAM is an additional communication mechanism for the auditors, which they can use to explain to investors the kind of assumptions that have been made, and the discussions held with the management before signing the audit report. This is expected to help investors understand what went behind the scenes between the auditor, audit committee and the management.

However, key audit matters should not be confused with a concern area that has been highlighted through an emphasis or a qualification, Khatri adds.

It’s not a substitution for a qualification in audit reports, which specifically mentions the disagreement that the auditors have with the management’s conclusions on the financial statements. It is also different from the emphasis of matter section of the audit report that draws the reader’s attention to matters that are uncertain like a result of a pending litigation that might have a significant impact on the company’s financial position.

KAM is equally an opportunity for the auditor to communicate with the investor and to the world at large.

“If implemented properly, KAM has the potential to reduce the expectations gap between auditors and investors,” adds Narayanaswamy.