Any entity’s financial health and growth trajectory can be determined from its financial statements. While financial experts and auditors may easily understand the ins and outs of a company just by looking at its audited financial statements, not all stakeholders are well versed with the minute details and significance of a ratio or percentage. This is where the auditor’s report plays a crucial role–it serves as the primary connection between an entity’s stakeholders and auditor(s). The usual audit report is definitely important, but most stakeholders and readers believe that a more informative auditor’s report will go a long way to gain better insights and provide for a more objective decision-making process.

In the ever-dynamic global market, where investor sentiment fluctuates by the second, it is of utmost importance that all stakeholders of a company understand the meaning and implications of the auditor’s report. To address the dichotomy between what is communicated by the audited statements and what is understood by the readers and stakeholders, the ICAI released a new Standard on Accounting (SA 701) in 2016, applicable to audits of financial statements starting on or after April 1, 2018. This SA means to provide auditors a framework for what they should include in their report, and the way they should convey the information. It is mandatory to abide by this SA for the audit of listed entities, but it is also applicable for the audit of non-listed entities.

The aim of introducing this SA is to enhance transparency of the audit procedure and to deem the report as an advisory tool for the intended users and decision makers. It is important to note that this SA does not alter the scope of an independent audit. Rather, it is an additional professional insight into the company’s financial health.

Key audit matters (KAMs) are the most important issues or items of the financial statements, in the auditor’s objective and professional opinion. Highlighting the KAMs can assist the company officers and stakeholders to identify the most urgent issues to be taken care of after the audit. This makes it a dual directional measure – to look at and learn from the past in order to improve the future of the company. In a nutshell, it is the auditor’s description of the key areas of focus of the audit, and the procedures used during the audit.

Other than providing transparency to the audit process, the introduction of the KAMs will allow decision makers to identify important areas of improvement in terms of financial statements. It will also help stakeholders better understand and judge the audited financial statements.

It is also important to note that KAMs will differ across industries: real estate companies depend more on permissions and lease contracts, while manufacturing entities rely on a steady flow of inputs and outputs (purchase orders and inventory). The most commonly identified KAMs may deal with goodwill valuation, complex revenue calculations, and valuation of long-term assets, financial instruments, or significant tax issues.

Considering the growth of companies both in size and numbers, it is no surprise that audit and bookkeeping requirements are also becoming increasingly stringent. Tax avoidance agreements, special trade agreements have also added to the complex nature of financial reporting. These complexities in turn have made the audit process more complex too, and an auditor’s perspective of the risks and challenges the business poses is a much more important factor in driving investors’ decisions than just the binary version of the financial statements.

In an extension of gauging the financial strength of the entity, the auditor’s report, complete with the KAM will also serve as a tool to understand what auditors actually do and the processes they follow when analyzing a company’s books.

A plausible problem in this approach is to acknowledge when an issue is not a KAM. A huge but straightforward merger may not be a risk or a KAM, just because its transaction value is large. Similarly, a multi-layered tax calculation need not be a KAM if the applicable audit standards and process are simple to follow.

Another landmine to auditors to steer clear of is using jargon-rich language in their report. The basic aim of the KAMs approach is to make the report more accessible and understandable. Relying on technical terms will defeat the whole purpose of making the report transparent and inclusive.

In a nutshell, the KAMs approach is key to unlocking the secrets of audit and improving the financial reporting chain. It relies on identifying areas, which involve the most risk and require the most judgment from the auditor. The new approach may promote better financial reporting across businesses, increased compliance with the standards of good practice, and better information for investors and other stakeholders of a going concern.