The five W’s and the H – who, what, when, where, why, how

Alongside the changes to the auditor’s report mandated by Canadian Auditing Standards (CAS) 700 Forming an Opinion and Reporting on Financial Statements, among others (discussed in a previous Spark article), the new CAS 701 Communicating Key Audit Matters (KAM) in the Independent Auditor’s Report is the one you really want to pay attention to.

CAS 701 is effective for audits of financial statements for periods ending on or after December 15, 2018 and is asking your auditor to determine and include key audit matters (KAM) in their auditor’s report. The KAM are to be included when the auditor decides to communicate KAM or is required by law or regulation to communicate KAM, however, currently there are no laws or regulations that require such KAM communication. The Key Audit Matters section will be included in the auditor’s report after the Material Uncertainty Related to Going Concern section if present, otherwise after the Basis for Opinion.

The communication of the KAM in the auditor’s report is designed to enhance transparency of the audit. In determining the KAM to communicate your auditor will consider:

• areas of high and/or significant risk of material misstatement;
• areas in the financial statements that require significant management as well as auditor judgment (e.g. accounting estimates); and
• audit impact of significant events or transactions during the period.

The auditor will now have to determine which of the key audit matters included in the communication to Those Charged With Governance (TCWG) are to be included in the auditor’s report to the financial statements. Even if the auditor decides that there are no KAM to be included in the auditor’s report, a statement under the Key Audit Matter header is still required to state that there are no KAM to communicate. In addition, the KAM communicated are to relate only to the current period even if the auditor’s opinion refers to multiple periods.

While the KAM are expected to be entity-specific as well as specific to the audit that was performed, there is flexibility relating to how much entity-specific information is included. The structure of a KAM is required to be presented in the following pattern:

• issue – why was the mater considered to be most significant;
• audit response – how was the matter addressed in the audit; and
• note disclosure – reference to the related financial statement note.

In addition, the auditor’s audit file is required to contain detailed documentation discussing why KAM were determined to be KAM and why others were not, as well as why no KAM were included, if that is the case.

Going concern and KAM

As noted in the previous article on the new audit report, the going concern related wording is going to be headed by Material Uncertainty Related to Going Concern (MURGC) going forward. CAS 701, as well as the revised CAS 570 Going Concern, states that a going concern issue is by nature a KAM, and indicates that if a MURGC section is included in the auditor’s report a reference shall be included from the KAM section to the MURGC instead of describing the going concern issue in the KAM. The impact of the new standard relates to scenarios where the auditor performs work on a possible going concern issue but concludes that no material uncertainty exists, and no MURGC is thus presented in the auditor’s report. In this case, the auditor may determine that a KAM relating to the work performed and conclusions reached around the going concern basis is warranted.

Sample KAM ¹

Goodwill

Under IFRSs, the Company is required to annually test the amount of goodwill for impairment. This annual impairment test was significant to our audit because the balance of $XX as of December 31, 20X1 is material to the financial statements and management’s assessment process is complex and highly judgmental and is based on assumptions, specifically [describe significant assumptions], which are affected by expected future market or economic conditions, particularly those in [name of country or geographic area] and cause a high degree of estimation uncertainty.

Our audit procedures included, among others, using the work of a valuation expert to assist us in evaluating the methodologies, assumptions and data used by the Company, in particular those assumptions relating to the forecasted revenue growth and profit margins for [name of business line]. We also focused on the adequacy of the Company’s disclosures about those significant assumptions to which the outcome of the impairment test is most sensitive, that is, those that have the most significant effect on the determination of the recoverable amount of goodwill and cause the high degree of estimation uncertainty.

The Company’s disclosures about goodwill are included in Note X, which specifically explains that small changes in the significant assumptions used could give rise to an impairment of the goodwill balance in the future.

¹Reproduced from the May 2017 A&A alert by CPA Canada