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Corporate governance in financial reporting plays a significant role in ensuring that the financial statements prepared by a company’s management are transparent, accountable, and imbued with integrity. Effective corporate governance in financial reporting enhances investor confidence by ensuring that financial reports are credible, accurately reflect a company’s financial position and performance, and comply with accounting and auditing standards and regulatory requirements.
Corporate governance in financial reporting also mandates that financial statements undergo examination by an independent auditor, and that proper disclosures of Key Audit Matters (KAMs) are included in the auditor’s report, as required by Philippine Standards on Auditing (PSA) 701. PSA 701 applies to audits of complete sets of general-purpose financial statements of publicly listed entities, as well as circumstances where the auditor elects to communicate key audit matters in the auditor’s report.
KAMs refer to the most significant matters that, in the auditor’s professional judgment, were of utmost significance in the audit of the financial statements of the current period. These are matters that demanded significant auditor attention and should be communicated with those charged with governance.
The purpose of communicating KAMs in the auditor’s report is to enhance the communicative value of the auditor’s report by providing increased transparency about the audit performed and assisting intended users in better understanding the financial statements. KAMs aim to improve the informative value of the auditor’s report, alongside audit quality, by increasing the auditor’s accountability and leverage over management.
KAMs provide a roadmap that influences how users navigate through financial statements by directing their access to and increasing their attention on matters highlighted by the auditor.
When determining KAMs, the auditor needs to consider the following:
- Areas of higher and significant risks of material misstatements.
- The effect on the audit of significant events or transactions that occurred during the reporting period.
- Significant auditor judgments relating to areas in the financial statements that involved significant management judgment, including accounting estimates that have been identified as having high estimation uncertainty.
Once the auditor has determined which matters will be regarded as KAMs, the auditor must ensure that each matter is appropriately described in the auditor’s report.
- Describe each key audit matter.
- List the information in a separate section of the auditor’s report under the heading "Key Audit Matters."
- Include a concise description as to why the matter was deemed most significant and how the matter was addressed in the audit.
The disclosures of KAMs in the auditor’s report:
- Enhance Transparency and Accountability by providing investors and stakeholders with greater insight into the audit process and areas of complexity in financial reporting, thereby improving the credibility of financial statements by explaining areas of high risk.
- Improve Communication Between Auditors and Stakeholders by helping users and readers of the financial statements understand the key areas auditors focused on.
- Promote Audit Quality and Professional Skepticism by ensuring that significant issues receive proper attention.
- Support Informed Decision-Making by helping investors and other stakeholders make more informed decisions by understanding complex areas of the financial statements.
- Align with Global Best Practices, ensuring consistency in audit reporting globally.
The disclosures of KAMs vary by industry and company, but some common disclosures include:
- Revenue Recognition – Complexity in recognizing revenue, especially for long-term contracts or multiple performance obligations.
- Impairment of Goodwill and Intangible Assets – Subjectivity in assessing impairment, requiring significant management judgment.
- Valuation of Financial Instruments – Challenges in fair value estimation, particularly for instruments with no available fair value.
- Provisions and Contingent Liabilities – Uncertainty in legal disputes, regulatory penalties, or environmental liabilities.
- Allowance for Expected Credit Losses (ECL) – Judgment in estimating credit losses on financial assets, especially for banks.
- Business Combinations – Challenges in determining fair value of acquired assets and liabilities.
- Going Concern Assumptions – Evaluating management’s assessment of an entity’s ability to continue as a going concern.
By fostering trust and confidence in the audit process, KAMs contribute to the overall integrity and financial stability of the capital market.
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Wilfredo A. Baltazar, Chief Inspector, Quality Assurance Review Office
