Key audit matters: Unlocking secrets of the external audit

Davidzo Paradzai
The International Auditing and Assurance Standards Board (IAASB), which is the global regulator of accounting practices, finalised its process of revising auditor reporting standards in 2015.

This resulted in the promulgation of a set of new and revised auditor reporting standards on auditor reporting, which became effective for audits of financial statements for periods ending on or after 15 December 2016.

Out of these changes made by the IAASB, the most prominent new standard that came out was the requirement for auditors to report Key Audit Matters (KAMs).

The changes to the auditor’s report aim to give users of financial statements more insight into the audit process to improve transparency and enhance the nature of communication between stakeholders and auditors.

In light of the new and revised standards, regulators in Zimbabwe for example the PAAB, RBZ, ZSE and ZIMRA as well as investors are expected to now have a thorough understanding of how the auditors would have reached their opinion on the fair presentation of audited financial statements.

KAMs are those matters that, in the auditor’s professional judgement, require significant auditor attention in performing the audit.

KAMs are selected from matters communicated with those charged with governance and are determined by considering areas of high risk, significant auditor judgements and their effect on the audit of significant events or transactions.

However, it is key to note that KAMs do not indicate that the financial statements are misstated but communicate to the public those areas which required significant auditor attention during the performance of the audit.

The reporting of KAMs in the auditors’ report is a response to calls from stakeholders for more detail about the audit process and greater transparency and clarity of the audit report.

Providing better information for investors and encouraging improvements throughout the financial reporting chain is also another important aspect of KAMs.

The Chartered Accountants Academy (CAA) conducted a survey on common KAMS reported in audits of financial Institutions.

The financial services industry was selected for our survey as it plays a central role in contributing to financial stability, and therefore, attracts need for market confidence in the quality of external audits of banks’ financial statements, and communication to stakeholders.

As part of our research, we randomly selected a sample of six annual reports for financial institutions for the financial year ended 31 December 2017.

We inspected the auditors’ reports in the financial statements of the six selected financial institutions with a view of identifying the most common KAMs that were featuring in these reports.

From our sample we noted that an average of four KAMs were reported in each report.

Moreover, for all auditors’ reports in the sample, auditors disclosed the engagement partners name and their PAAB practicing certificate number for ease of reference in the event of any queries in line with the requirements of ISA 701.

Outlined below are some of the (KAM)s as noted in the auditors reports of selected financial institutions for the year ended 31 December 2017.

In this report we only included KAMs that would have been reported in at least more than three auditor’s reports for us to consider it to be commonly reported by auditors.

Completeness and accuracy of interest Income

The completeness and accuracy of interest income was noted as a key audit focus area by auditors of financial institutions due to interest computations, which are highly automated.

Computations of interest are complex accompanied by large volumes of transactions, therefore there is need to evaluate general and application controls on the automation of the interest income calculations and therefore, appropriate to be noted as a KAM.

Existence of loans and advances

Loans are significant in the financial industry and comprise a large volume of balances of varying magnitude.

For a certain group financial institution, 48.36 percent of the group’s total assets comprised loans and advances amounting to $204 333 927, which provides evidence of the significance of loan receivables on the balance sheets of banks.

Based on the KAMs reported, most auditors reported investing a significant amount of audit effort to independently verify the existence of these loan receivable balances.

Auditors performed procedures which included testing internal controls over the credit granting process and monitoring and assessing whether controls are or were effective.

Also as part of the procedures performed by auditors they confirmed the loan balances with customers and review of security for selected loans and advances to determine whether the security adequately covered the outstanding loan balance.

Impairment of loans and advances

In all the audits reports, impairment of loans and advances was identified as a Key Audit matter.

Financial institutions are exposed to credit risk on their portfolio of loans and advances largely influenced by the current macro-economic environment in Zimbabwe, which is characterised by increase in non-performing loans, low liquidity and business performance constraints. Significant judgement is exercised by management in assessing the impairment in these loan balances.

We expect this issue to be still prominent in the December 2018 year end audits due to the introduction of International Financial Reporting Standards (IFRS 9) effective 1 January 2018, which is bringing further onerous financial reporting requirements on the impairment of loan receivable balances.

Accounting treatment and disclosure of treasury bills

Banking institutions in Zimbabwe carry a material portfolio of Treasury Bills on their statement of financial position. The valuation and measurement of treasury bills was identified by most auditors in the audit reports sampled as a complex area that required significant audit attention.

The absence of an active open market with sufficient trades of Treasury bills makes fair value determination and comparability subjective and heighted the risk that the determination of fair value for treasury bills may not be accurate as it is subject to significant judgement and therefore noted as a key audit matter within the industry.

It is appropriate to recognise this as a KAM because auditors have to review management’s recognition and classification criteria relative to the requirements of IFRS and guidance issued by regulatory bodies

Susceptibility of suspense accounts to fraud

Most banking institutions operate suspense accounts, a feature in their day to day operations and a high-risk area given the nature of banking operations and their general susceptibility to fraudulent transactions.

The matter was reported as KAM in the auditors reports as it required significant auditors’ attention given that the high volume of transactions that are recorded in suspense accounts pending authorisations or clearance with other financial institutions.

Additionally, suspense accounts are, by their nature susceptible to fraud, especially in the current macro-economic environment characterised by financial pressure being experienced by employees.

This made up a significant area of most audits since auditors would have to focus on outstanding matters and long outstanding items, tracing significant transactions to supporting documents and inspecting for subsequent clearance.

Valuation of properties

The valuation of properties was noted as a KAM in most of the audit reports sampled.

This again was in line with our expectations as building societies hold properties which are accounted for as investment property and owner — occupied property.

The valuation of properties is of a subjective nature due to the use of judgment, estimates and assumptions in determining fair values and resulted in additional auditor attention in this area and noted by auditors of building societies as a (KAM).

Valuation of properties has become complex in Zimbabwe because the evaluation of reasonability of assumptions used by management is complex and may not be in line with IFRS, coupled with the three-tier pricing structure often used in Zimbabwe.

It is interesting to note that auditors have embraced communicating KAMs with 31 December 2017 marking two cycles of reporting on KAMs.

A further analysis or survey that may need to be made is to determine whether the reporting of KAMs has met the expectations of users of financial statements or more still needs to be done.

Currently, the intention of reporting on key audit matters is to provide users of financial statements with more insight into the audit and how the auditor responded or responds to the matters identified as KAMs. Therefore, this enhances the nature of communication between stakeholders and auditors.

The article was written by Davidzo Paradzai, a lecturer at Chartered Accountants Academy, a local education institution specialising in the provision of tuition to student-chartered accountants. Feedback Email/Phone number: [email protected]/  +263(0242)702532-5

 

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  • Fu Mags

    Quite insightful Davidzo, thank you