Key Audit Matters Under AU-C 701: Determining and Communicating Them When Engaged To

AU-C 701, Communicating Key Audit Matters in the Independent Auditor's Report, does not require any audit report to include key audit matters (KAMs). Paragraph .01 says the section addresses the auditor's responsibility to communicate KAMs "when the auditor is engaged to do so" and that it "does not require the communication of key audit matters." If the engagement letter does not call for KAMs, there is no KAM section. If it does, AU-C 701 sets the process and the report wording. It is effective for audits of periods ending on or after December 15, 2021.

KAMs under AU-C 701 are different from the PCAOB's critical audit matters, which are mandatory in most issuer audits. See critical audit matters under AS 3101 for that definition.

What is a key audit matter?

Paragraph .07 defines KAMs as those matters that, in the auditor's professional judgment, were of most significance in the audit of the current period's financial statements. KAMs are selected from matters communicated with those charged with governance.

The purpose, per paragraph .02, is greater transparency about the audit performed. Paragraph .03 says communicating KAMs is not a substitute for disclosures management must make, for a modified opinion under AU-C 705, for reporting under AU-C 570 when substantial doubt remains, or a separate opinion on individual matters.

How do you get from the audit file to the KAMs?

The standard works as a two-step funnel.

Step 1: matters that required significant auditor attention (paragraph .08). Starting from the matters communicated with governance, the auditor determines which required significant attention. The auditor must take into account:

• areas of higher assessed risk of material misstatement, or significant risks identified under AU-C 315;
• significant auditor judgments relating to areas involving significant management judgment, including accounting estimates subject to a high degree of uncertainty; and
• the effect on the audit of significant events or transactions during the period.

Application material A15 says these considerations are required but do not mean every related matter is a KAM. A matter that meets more than one of them is more likely to be one.

Step 2: matters of most significance (paragraph .09). From the first group, the auditor determines which were of most significance and are therefore KAMs. Paragraph A29 adds a check: the more matters initially determined to be KAMs, the more the auditor needs to reconsider whether each meets the definition, because long lists are contrary to the idea of "most significance."

Two points from the application material:

• Determination is limited to the current period, even when comparative statements are presented (A8). Prior-period KAMs need not be updated (A9).
• The auditor may form a preliminary view at planning, but the final determination rests on the results of the audit and the evidence obtained throughout it (A14).

What goes in the report?

Paragraph .10 requires a separate section headed "Key Audit Matters," with a subheading for each matter. The introduction states that KAMs are matters communicated with governance that were of most significance in the current period audit, and that they were addressed in the context of the audit as a whole, with no separate opinion on them.

Under paragraph .12, each description refers to the related financial statement disclosures, if any, and addresses:

• why the matter was one of most significance and therefore a KAM; and
• how the matter was addressed in the audit.

The adequacy of the description is a matter of professional judgment (A34). The aim is a succinct, balanced explanation in language that avoids highly technical auditing terms. The auditor seeks to avoid giving original information about the entity, meaning information management has not made public (A35). Where original information is necessary, management may expand its own disclosures instead (A36).

How do KAMs interact with AU-C 705 and AU-C 570?

Paragraph .11 says a matter must not be communicated as a KAM when the auditor would have to modify the opinion under AU-C 705 because of it. Paragraph .14 goes further for two cases. Matters that give rise to a qualified opinion, or to substantial doubt about going concern, are by their nature KAMs, but they are not described in the KAM section. They are reported in the "Basis for Qualified Opinion" or "Going Concern" section, and the KAM section refers to them.

AU-C 705 paragraph .30 also prohibits a KAM section altogether when the auditor expresses an adverse opinion or disclaims an opinion. Paragraph .04 of AU-C 701 repeats that, unless law or regulation requires the reporting.

A KAM is not an emphasis-of-matter paragraph. Application material A6 says that when AU-C 701 applies, an emphasis or other-matter paragraph is not a substitute for including a matter that meets the KAM definition. See AU-C 706 emphasis and other-matter paragraphs.

When is there no KAM section content?

Paragraph .15 requires the "Key Audit Matters" heading with a statement when there are no KAMs to communicate, or when the only KAMs are those handled under paragraph .14. A56 lists three situations: the auditor determines there are no KAMs, a KAM is withheld under paragraph .13 and no other KAMs exist, or the only KAMs are the qualified-opinion or going-concern matters. A57 illustrates the wording: "We have determined that there are no [other] key audit matters to communicate in our report."

Paragraph .13 allows a KAM to be left out of the report in only two cases: law or regulation precludes disclosure, or, in extremely rare circumstances, the adverse consequences of communicating would reasonably be expected to outweigh the public interest benefits. The second does not apply if the information about the matter is available outside the entity.

What must be communicated to governance, and what documented?

Paragraph .16 requires the auditor to communicate to those charged with governance either the matters determined to be KAMs, or the determination that there are none. A58 notes the auditor may share preliminary views when discussing the planned scope and timing, and A59 notes that a draft of the report may help the discussion. The same conversation lets governance consider whether to enhance their disclosures. See AU-C 260 communications.

Paragraph .17 requires the file to include:

• the matters that required significant auditor attention under paragraph .08, and the rationale for deciding whether each is a KAM;
• where applicable, the rationale for concluding there are no KAMs, or that the only ones are those in paragraph .14; and
• where applicable, the rationale for not communicating a matter determined to be a KAM.

Paragraph A63 clarifies that the standard does not require documenting why other matters communicated with governance did not require significant attention.

Worked example: a small manufacturer

A privately held manufacturer asks for KAMs in its engagement letter. The matters discussed with governance:

Two KAMs, each with a subheading, a reference to the inventory note, why it mattered and how it was addressed. The cutoff row is documented as a paragraph .08 matter with the rationale for the .09 decision, which is what paragraph .17(a) requires.

Frequently asked questions

Do we need KAMs on a standard private company audit?

No. Without an engagement to communicate them, AU-C 701 does not apply.

Can the engagement partner skip the governance discussion?

No. Paragraph .16 requires the communication, and engagement partner review of the report under AU-C 220 covers the KAM descriptions where they apply (A60).

Is "no KAMs" an acceptable result?

Yes, A56 calls it rare, and the report must still carry the heading and statement.

Sources

• AICPA, AU-C Section 701, Communicating Key Audit Matters in the Independent Auditor's Report (paragraphs .01 to .17, A8 to A63): https://www.aicpa-cima.com/resources/landing/aicpa-professional-standards
• AICPA, AU-C Section 705, Modifications to the Opinion in the Independent Auditor's Report (paragraph .30, no KAM section for adverse opinions or disclaimers): https://www.aicpa-cima.com/resources/landing/aicpa-professional-standards
• PCAOB, AS 3101 (comparison to the mandatory critical audit matter requirement): https://pcaobus.org/oversight/standards/auditing-standards/details/AS3101

CORAA prepares ready-to-review audit files for US CPA firms from client books; you review and sign. See /us.

AU-C references are to AICPA Professional Standards, paraphrased here; read the standard itself before relying on a requirement. This page is guidance, not professional advice. Report an error