Key Audit Matters: What They Are and What It Means For You

Public company financial statements will soon become more transparent with the introduction of Key Audit Matters (KAMs) as a required component of auditor reporting. Providing enhanced disclosure about areas of significant risk and judgement as contemplated by the auditor, the adoption of KAM disclosures in the auditor’s report is a significant overhaul for filers.

They will be included in auditor’s reports for all TSX-listed entities (excluding NI-81-106 filers) for years ending on or after December 31, 2020 (this year) and entities listed on other exchanges (TSX:V, CSE, NEO) for years ending on or after December 15, 2022.

Auditor KAMs must include the following:

• A description of the key audit matter and the significant risks and judgments around the matter as applied by management;
• A description of the work done by the auditor to address the risks; and
• The outcome of the work performed by the auditor and reference to the relevant areas of the financial statements.

What impacts in the market can we expect?

Originally, the impact of this new audit standard was relatively unknown. How would the markets react to the disclosure of additional information by an issuer's auditors? Would there be increased litigation? Could this impact the competitive position of Canadian companies in an already challenging North American market?

Europe adopted KAMs back in 2016, giving us an example to look to as we begin to unpack these questions and what the forthcoming changes mean for Canadian filers. In European disclosures, impairment and revenue have emerged as the most prominent KAMs. Other areas that are commonly seen are valuation of investments, going concern, income taxes, inventory, and business combinations, among other things.

Although more information will be disclosed by the auditors than in the past, it is not expected that substantial new information which will impact investor decisions will be included in the reported KAMs. Further information around certain metrics and inputs used as well as the auditor's assessment of those metrics and inputs will be included, however it is not expected to significantly impact investor decisions. Interestingly, our research indicates no noticeable increase in class action litigation resulting from the presence of this additional information becoming available to investors.

As with many of our recently adopted accounting standards, the US has also assumed the similar (though slightly different) Critical Audit Matters (CAMs) with similar implementation dates. The first CAMs for large accelerated filers were required for years ended on or after June 30, 2019 and for all other companies (aside from certain specific exceptions) are required for years ending on or after December 15, 2020, which mirrors the date for TSX-listed entities in Canada.

The requirements of CAMs in the US differ from KAMs in Canada. CAMs are required to be related to a balance or disclosure in the financial statements, while KAMs can relate to other areas that may require significant auditor attention but not directly reflected in the financial statements. For example, the implementation of a new general ledger or enterprise resource planning system may be included as a KAM but would not be considered a CAM. Aside from this difference, KAMs and CAMs are substantially the same.

In terms of the magnitude, there is no set number of KAMs expected per report. An auditor's report may not include any KAMs, although these cases are anticipated to be rare. In other industries where we have seen KAMs previously implemented, we have noted the number of KAMs to range from 2.5 to 2.9, with an average of 2.63¹.

A higher number of KAMs is not considered to be indicative of more audit issues, but rather a higher degree of complexity of the accounting and disclosures in the financial statements. By nature, some industries, like banking, will have more KAMs than others. Other entities may be outliers, even within their own industries, based on certain unique business they may undertake.

The COVID-19 factor

Since COVID-19 hit us back at the beginning of the year, we have seen an increase in KAMs, largely related to going concern matters. We anticipate that the pandemic will continue to have an impact on financial statements and auditor reporting for years to come, especially as the country navigates a second wave of COVID-19.

We are working with our clients to ensure a smooth transition to the new auditor reporting standards in anticipation of the upcoming effective dates. While KAMs certainly provide more transparency to financial statement users, we have not observed any significant legal implications or changes in prices or trading patterns linked to the adoption of KAM reporting.

Please contact me for a free consultation if you’re interested in learning more about the impact of KAMs in auditor reporting or public company reporting requirements.

Contact:

Brent Wolfe, CPA
604.637.1592
[email protected]