Audit Report and CARO, 2020 - Test 2: answer key

Question 1 · 2 marks · Chapter 8: Audit Report and CARO, 2020 · medium

Scenario. M/s Sharma & Associates are the statutory auditors of Alpha Infotech Ltd., a listed technology company providing cloud-based enterprise solutions. During the year, Alpha migrated its billing and general-ledger applications to a new ERP platform. The audit team discovered that finance administrators shared privileged credentials, former employees retained active access and certain manual revenue adjustments could be posted without independent approval. The migration also changed the manner in which revenue from multi-year implementation contracts was recognised. The team assessed revenue recognition as an area of higher risk and identified substantial uncertainty in estimating variable consideration and costs to complete implementation contracts. Several large contracts contained milestone-based acceptance conditions, performance incentives and penalty clauses. Management relied on internal forecasts to calculate contract assets, but the underlying assumptions required significant judgement. The audit team involved an IT specialist and an accounting expert, performed additional procedures over contract modifications, inspected customer acceptance records and tested selected post-year-end receipts. A material error identified in the initial revenue calculations was corrected by management before finalisation of the financial statements. The auditors discussed the ERP migration, control deficiencies and contract-accounting estimates extensively with the Audit Committee. However, the engagement partner concluded that the contract-accounting estimates, rather than the corrected ERP control deficiencies, required the greatest auditor attention and were of most significance in the current-period audit. The matter was also important to investors because contract assets represented a substantial proportion of the company's reported operating performance. Management agreed to disclose the assumptions and sensitivity information in the financial statement notes but requested that the auditor use only standardised wording in the report. The engagement partner must determine the appropriate KAM selection and reporting treatment.

Which matter should be selected as a Key Audit Matter based on the facts of Alpha Infotech Ltd.?

1. The ERP migration should automatically be the only KAM because every major IT implementation requires separate reporting.
2. The corrected revenue error must be reported as a KAM because every misstatement discovered during the audit is automatically significant.
3. The contract-accounting estimates should be selected because they required significant auditor attention and were judged most significant in the current audit. (correct answer)
4. The shared administrator credentials should automatically be reported because every internal control deficiency is necessarily a KAM.

Answer: C — The contract-accounting estimates should be selected because they required significant auditor attention and were judged most significant in the current audit.

Explanation. Under SA 701, paragraphs 9 and 10, the auditor identifies matters requiring significant auditor attention from matters communicated with those charged with governance and then selects those of most significance. The contract estimates involved significant management judgement, estimation uncertainty, specialist involvement and considerable audit effort. An IT implementation or control deficiency may be relevant, but neither automatically qualifies as a KAM. Similarly, correction of a misstatement does not automatically make it a KAM.

Where it goes wrong. Assuming that every significant risk, corrected misstatement or control deficiency automatically becomes a KAM without applying the relative-significance test.

Authority. SA 701

Question 2 · 2 marks · Chapter 8: Audit Report and CARO, 2020 · hard

The engagement manager argues that the ERP migration cannot qualify as a KAM because the financial statements do not contain a separate disclosure specifically describing the new IT system. Which conclusion is most appropriate?

1. The manager is incorrect because an IT implementation may require significant auditor attention even when separate financial statement disclosure is not required. (correct answer)
2. The manager is correct because only matters separately disclosed in the notes can be considered during KAM selection.
3. The manager is correct because IT-related risks can be communicated only through the internal financial controls reporting requirement.
4. The manager is incorrect because every newly introduced accounting application must be described as a KAM irrespective of its audit impact.

Answer: A — The manager is incorrect because an IT implementation may require significant auditor attention even when separate financial statement disclosure is not required.

Explanation. SA 701, paragraph A18, recognises that implementing a new IT system or making significant changes to an existing system may require significant auditor attention, particularly when the change affects the audit strategy or a significant risk such as revenue recognition. Such a matter need not necessarily be disclosed separately in the financial statements. However, it must still satisfy paragraphs 9 and 10 before being determined to be a KAM.

Where it goes wrong. Confusing the requirement to consider a matter for KAM selection with a requirement that the matter must already appear as a separate financial statement disclosure.

Authority. SA 701

Question 3 · 2 marks · Chapter 8: Audit Report and CARO, 2020 · medium

Which information must be included when describing the contract-accounting estimates in the KAM section of Alpha Infotech Ltd.'s auditor's report?

1. Only the amount of contract assets, without mentioning the reasons for selecting the matter or the audit work performed.
2. A separate assurance statement confirming that the contract-accounting estimates are accurate and independently certified.
3. Only the management's description of estimation uncertainty, because the auditor is not permitted to discuss audit procedures performed.
4. The related financial statement disclosure, why the matter was significant and how the auditors addressed it during the audit. (correct answer)

Answer: D — The related financial statement disclosure, why the matter was significant and how the auditors addressed it during the audit.

Explanation. SA 701, paragraph 13, requires the description of each KAM to refer to related financial statement disclosures, if any, explain why the matter was considered one of most significance and describe how it was addressed in the audit. A mere repetition of the financial statement note is insufficient. The description should help users understand the auditor's focus without expressing a separate opinion or taking responsibility for management's estimates.

Where it goes wrong. Treating the KAM section as a repetition of management's accounting note or as an independent certification of a particular balance.

Authority. SA 701

Question 4 · 2 marks · Chapter 8: Audit Report and CARO, 2020 · hard

The audit partner proposes to include the statement that the contract assets are independently certified as fairly valued by the auditor. What is the most appropriate response?

1. Accept the wording because the auditor's specialist involvement permits a separate opinion on contract assets.
2. Reject the wording because a KAM description must not imply a discrete opinion on an individual financial statement element. (correct answer)
3. Accept the wording provided that management first agrees with the estimated contract asset balance.
4. Reject the entire KAM section because reporting an audit procedure or its outcome is prohibited under SA 701.

Answer: B — Reject the wording because a KAM description must not imply a discrete opinion on an individual financial statement element.

Explanation. SA 701, paragraph 11(b) and application paragraph A47, requires the auditor to clarify that KAMs were addressed in the context of the financial statements as a whole and that no separate opinion is provided on individual matters. Paragraph A51 also cautions against descriptions of audit outcomes that create the impression of a separate opinion. Specialist involvement may be mentioned, but it does not transfer or divide the auditor's overall reporting responsibility.

Where it goes wrong. Mistaking disclosure of the auditor's response and procedures for authority to issue a separate assurance conclusion on an individual account balance.

Authority. SA 701

Question 5 · 2 marks · Chapter 8: Audit Report and CARO, 2020 · medium

Scenario. M/s K. Mehta & Co. are the statutory auditors of Zenith Biopharma Ltd., a listed pharmaceutical manufacturer with operations across several Indian states. During the audit, the company became subject to an investigation by a statutory regulatory authority concerning suspected irregularities in the procurement of certain regulated ingredients. The investigating authority issued a written direction under the applicable law prohibiting public disclosure of specific information that could prejudice the investigation until the authority permits disclosure. The procurement matter required significant auditor attention. The engagement team examined transaction records, conducted discussions with the company's legal advisers and evaluated the potential financial statement implications. The matter was discussed with the Audit Committee, which acknowledged its significance but requested that nothing about the investigation appear in the auditor's report. The auditors substantiated the statutory restriction independently and concluded that public communication of the protected details was legally prohibited. Separately, the company was involved in substantial patent litigation concerning a commercially important drug. Management argued that describing the litigation as a KAM could damage ongoing settlement negotiations and weaken the company's competitive position. However, the company had already disclosed the litigation, its broad financial exposure and the relevant uncertainty in a public stock-exchange announcement and in the financial statement notes. The auditor considered the matter one of the most significant issues in the audit. The valuation of a recently acquired subsidiary also required considerable specialist involvement and extensive discussions with management, and was independently identified as a potential KAM. Management requested that the auditor omit all three matters on confidentiality grounds and merely state that the audit was conducted in accordance with SAs.

What should the auditor do with the regulatory investigation matter for which the authority has expressly prohibited public disclosure under the applicable law?

1. Communicate the full matter as a KAM because listed entities cannot omit significant matters from their auditor's reports.
2. Include the matter in an Emphasis of Matter paragraph because that paragraph overrides the statutory confidentiality restriction.
3. Exclude the protected matter from public KAM communication because paragraph 14(a) permits non-communication where law or regulation precludes disclosure. (correct answer)
4. Include the matter in the KAM section without naming the authority, because partial disclosure is compulsory under SA 701.

Answer: C — Exclude the protected matter from public KAM communication because paragraph 14(a) permits non-communication where law or regulation precludes disclosure.

Explanation. SA 701, paragraph 14(a), states that a matter otherwise determined to be a KAM need not be described in the auditor's report when law or regulation precludes public disclosure. Paragraph A52 illustrates that a legal prohibition may protect information whose public disclosure could prejudice an investigation. This is a specific legal exception, not an unrestricted confidentiality exemption. Other statutory reporting obligations remain independently applicable.

Where it goes wrong. Assuming that mandatory KAM communication for listed entities overrides an express statutory prohibition on public disclosure.

Authority. SA 701

Question 6 · 2 marks · Chapter 8: Audit Report and CARO, 2020 · hard

Management argues that disclosure of the patent litigation would damage ongoing negotiations and therefore the auditor should omit it under the extremely rare circumstances exception. What should the auditor consider?

1. Management's assertion is sufficient because commercial confidentiality automatically overrides the public interest in audit transparency.
2. The matter must be omitted whenever the finance director provides written confirmation of possible commercial damage.
3. The matter must be omitted because all litigation matters are excluded from the KAM section unless a court orders disclosure.
4. The auditor must independently assess whether adverse consequences would reasonably outweigh public interest benefits; management's assertion alone is insufficient. (correct answer)

Answer: D — The auditor must independently assess whether adverse consequences would reasonably outweigh public interest benefits; management's assertion alone is insufficient.

Explanation. SA 701, paragraph 14(b) and application paragraphs A53-A54, allow non-communication only in extremely rare circumstances when adverse consequences are reasonably expected to outweigh the public interest benefits of communication. Management's views, including concerns about commercial negotiations or competitive position, do not independently establish the exception. The auditor must evaluate the facts objectively and consider discussions with management, governance and relevant authorities.

Where it goes wrong. Treating management's commercial concerns or a written representation as automatic proof that the public interest exception applies.

Authority. SA 701

Question 7 · 2 marks · Chapter 8: Audit Report and CARO, 2020 · medium

Can the auditor invoke paragraph 14(b) to omit the patent litigation matter merely because disclosure could adversely affect settlement negotiations, when the company has already publicly disclosed information about the matter?

1. Yes, because any possible commercial disadvantage permits non-communication after management approval.
2. No, because paragraph 14(b)'s extremely rare exception does not apply where the entity has publicly disclosed information about the matter. (correct answer)
3. Yes, provided that the auditor refers to the litigation without identifying its financial statement classification.
4. No, because every matter disclosed in the financial statements must automatically be reported as a KAM.

Answer: B — No, because paragraph 14(b)'s extremely rare exception does not apply where the entity has publicly disclosed information about the matter.

Explanation. SA 701, paragraph 14(b), expressly states that its extremely rare adverse-consequences exception does not apply if the entity has publicly disclosed information about the matter. In the given case, the patent litigation has already been publicly disclosed through the company's announcement and financial statement notes. The auditor must still independently determine whether it is one of the matters of most significance under paragraphs 9 and 10.

Where it goes wrong. Overlooking the express publicly-disclosed-information restriction while applying the extremely rare exception.

Authority. SA 701

Question 8 · 2 marks · Chapter 8: Audit Report and CARO, 2020 · hard

How should the auditor describe the patent litigation and subsidiary valuation if they are determined to be KAMs?

1. Reproduce the complete legal strategy and commercially sensitive forecasts, even when unnecessary for users' understanding of the audit.
2. Use identical wording for both matters because SA 701 requires standardised language across all listed-company audit reports.
3. Describe only the financial statement balances, avoiding all references to the auditor's work and significant judgements.
4. Provide concise, balanced and entity-specific explanations of significance and audit response, avoiding unnecessary original information. (correct answer)

Answer: D — Provide concise, balanced and entity-specific explanations of significance and audit response, avoiding unnecessary original information.

Explanation. SA 701, paragraph 13 and application paragraphs A34-A36 and A46-A47, require a useful description explaining why a matter was significant and how it was addressed. The description should be concise, balanced and tailored to the entity's circumstances. The auditor should generally avoid improperly introducing original information that remains management's responsibility. A generic description or disclosure of unnecessary commercially sensitive details may fail the purpose of meaningful audit communication.

Where it goes wrong. Believing that transparency requires publishing every sensitive detail or that KAM descriptions should be identical across engagements.

Authority. SA 701

Question 9 · 2 marks · Chapter 8: Audit Report and CARO, 2020 · medium

Scenario. M/s V. Raman & Associates are the statutory auditors of Zenith Infrastructure Ltd., a listed construction company undertaking long-term infrastructure projects. During the audit, the company refused to provide access to supporting records of two significant project subsidiaries. Several third-party confirmations relating to contract balances and project advances were also unavailable. Alternative procedures did not provide sufficient appropriate evidence concerning a material portion of the consolidated project balances. The engagement partner concluded that the possible effects could be material and pervasive and determined that a disclaimer of opinion was necessary. The audit team also identified a major dispute concerning the recognition of revenue on a separate infrastructure contract. After obtaining sufficient appropriate evidence, the auditors concluded that the company had materially overstated revenue and contract assets. The identified misstatement was material but not pervasive. The engagement partner therefore decided that a qualified opinion would have been appropriate in relation to that separate issue if the evidence limitation did not independently require a disclaimer. The matter was discussed extensively with the Audit Committee. The auditors also evaluated the impairment of a specialised construction plant. Management's valuation relied on uncertain future utilisation assumptions and a highly subjective discount rate. However, the audit team concluded that, in the circumstances of this engagement, the impairment issue did not rank among the matters of most significance beyond the matters already affecting the opinion. The company requested that the auditors avoid drawing attention to any reporting issue, while the Audit Committee asked whether a KAM section would still be necessary despite the proposed disclaimer. The engagement partner must consider the interaction between SA 701 and SA 705, determine what can be communicated in the KAM section and document the professional judgements made.

Considering the proposed disclaimer of opinion because of the pervasive evidence limitation, what is the appropriate KAM reporting treatment?

1. Communicate all identified matters as KAMs because the entity is listed and paragraph 5 of SA 701 makes communication compulsory.
2. Include the matters giving rise to the disclaimer as KAMs and add a separate disclaimer paragraph below them.
3. Do not communicate KAMs under SA 701 when a disclaimer is expressed, unless such reporting is required by law or regulation. (correct answer)
4. Replace the disclaimer with a qualified opinion because KAM communication is unavailable when evidence is insufficient.

Answer: C — Do not communicate KAMs under SA 701 when a disclaimer is expressed, unless such reporting is required by law or regulation.

Explanation. SA 701, paragraph 5, specifically states that SA 705 prohibits the auditor from communicating KAMs when the auditor disclaims an opinion on the financial statements, unless such reporting is required by law or regulation. The listed-entity requirement does not automatically override this prohibition. The nature of the scope limitation and its possible pervasive effects determine the disclaimer under SA 705, not the availability of a KAM section.

Where it goes wrong. Applying the mandatory listed-entity requirement without considering the express exception for a disclaimer of opinion.

Authority. SA 701; SA 705

Question 10 · 2 marks · Chapter 8: Audit Report and CARO, 2020 · hard

Assume that the auditor issues a qualified opinion and the only matter determined to be a KAM is the matter giving rise to that qualification. What should appear in the KAM section?

1. A statement indicating that there are no other KAMs to communicate, with an appropriate reference to the Basis for Qualified Opinion section. (correct answer)
2. A detailed description of the qualification repeated under a separate KAM subheading as though it were an independent KAM.
3. A statement that KAM reporting is unnecessary for all companies receiving a qualified opinion under SA 705.
4. An Emphasis of Matter paragraph replacing the Basis for Qualified Opinion section and the KAM section.

Answer: A — A statement indicating that there are no other KAMs to communicate, with an appropriate reference to the Basis for Qualified Opinion section.

Explanation. SA 701, paragraphs 15 and 16, read with application paragraph A58, deals with matters giving rise to modified opinions. Such matters are by their nature KAMs but are reported under the applicable modified-opinion section rather than described again as individual KAMs. When no other KAM exists, the report includes a statement that there are no other KAMs to communicate, appropriately referring to the Basis for Qualified Opinion section.

Where it goes wrong. Duplicating the matter giving rise to the modified opinion in the KAM section instead of using the prescribed cross-reference and no-other-KAM statement.

Authority. SA 701

Question 11 · 2 marks · Chapter 8: Audit Report and CARO, 2020 · medium

What communication obligation does the engagement partner have regarding the determination that there are no other KAMs to communicate?

1. No communication is necessary because the report's disclaimer or qualification automatically informs the Audit Committee.
2. The engagement partner must communicate the determination that there are no KAMs to communicate, where applicable, to those charged with governance. (correct answer)
3. The determination must be communicated only to shareholders after the annual report is published.
4. Only KAMs actually included in the auditor's report are communicated; negative KAM determinations are not communicated.

Answer: B — The engagement partner must communicate the determination that there are no KAMs to communicate, where applicable, to those charged with governance.

Explanation. SA 701, paragraph 17, requires the auditor to communicate with those charged with governance both the matters determined to be KAMs and, where applicable, the auditor's determination that there are no KAMs to communicate. This obligation facilitates governance oversight and discussion of significant professional judgements. The absence of a separately described KAM does not remove the auditor's communication responsibility.

Where it goes wrong. Assuming communication with governance is required only for matters actually appearing under the KAM heading.

Authority. SA 701

Question 12 · 2 marks · Chapter 8: Audit Report and CARO, 2020 · hard

Which documentation would most suitable support the engagement partner's KAM-related judgements in this audit?

1. Only the final auditor's report and a general note that management approved the financial statements.
2. Only the Audit Committee minutes, without recording the auditor's own selection and reporting conclusions.
3. A list of every material financial statement balance, without documenting the significant auditor attention involved.
4. Matters requiring significant attention, the rationale for KAM selection or non-selection, and any decision not to communicate a KAM. (correct answer)

Answer: D — Matters requiring significant attention, the rationale for KAM selection or non-selection, and any decision not to communicate a KAM.

Explanation. SA 701, paragraph 18, requires audit documentation covering matters that required significant auditor attention and the rationale for determining whether each is a KAM. It also requires documentation, where applicable, of the rationale for determining that no KAMs exist, that only paragraph 15 matters are KAMs, or that a determined KAM should not be communicated. A final report alone does not adequately evidence these professional judgements.

Where it goes wrong. Confusing documentation of audit balances and governance minutes with documentation of the auditor's specific KAM selection decisions.

Authority. SA 701

Question 13 · 2 marks · Chapter 8: Audit Report and CARO, 2020 · medium

Scenario. A statutory auditor is appointed to audit an unlisted financial institution that is widely regarded as being of significant public interest. No law or regulation specifically requires KAM communication. Which statement correctly applies SA 701?

A statutory auditor is appointed to audit an unlisted financial institution that is widely regarded as being of significant public interest. No law or regulation specifically requires KAM communication. Which statement correctly applies SA 701?

1. SA 701 is inapplicable because only companies with equity shares listed on a recognised stock exchange can ever communicate KAMs.
2. SA 701 becomes mandatory automatically whenever an unlisted company operates in the financial services industry.
3. The auditor may decide to communicate KAMs voluntarily, and any such communication must comply with SA 701. (correct answer)
4. KAM communication is prohibited for unlisted companies unless the Ministry of Corporate Affairs separately directs it.

Answer: C — The auditor may decide to communicate KAMs voluntarily, and any such communication must comply with SA 701.

Explanation. SA 701, paragraph 5, applies to audits of complete sets of general purpose financial statements of listed entities, circumstances where the auditor otherwise decides to communicate KAMs, and circumstances where law or regulation requires such communication. Therefore, an auditor may voluntarily communicate KAMs for an unlisted entity, including an entity of significant public interest, provided the requirements of SA 701 are followed.

Where it goes wrong. Confusing mandatory applicability to listed entities with the standard's separate provision allowing voluntary or legally required KAM communication for other entities.

Authority. SA 701

Question 14 · 2 marks · Chapter 8: Audit Report and CARO, 2020 · hard

Scenario. A listed company presents the financial statements for the current year together with corresponding figures for the previous year. A matter was the principal KAM in the previous year's audit but required very little auditor attention in the current year. What should the auditor do?

A listed company presents the financial statements for the current year together with corresponding figures for the previous year. A matter was the principal KAM in the previous year's audit but required very little auditor attention in the current year. What should the auditor do?

1. Determine KAMs based on matters of most significance in the current period; the previous year's KAM need not automatically be repeated. (correct answer)
2. Repeat every previous year's KAM because comparative financial statements require identical descriptions in both audit periods.
3. Repeat previous KAMs unless management formally withdraws the related accounting estimate or financial statement disclosure.
4. Include only prior-year KAMs because the current-year auditor's opinion covers the comparative figures as well.

Answer: A — Determine KAMs based on matters of most significance in the current period; the previous year's KAM need not automatically be repeated.

Explanation. SA 701, application paragraphs A10 and A11, clarify that KAM determination is limited to matters of most significance in the current period, even when comparative financial statements are presented. The auditor is not required to update or repeat prior-period KAMs automatically, although considering whether a previous KAM remains significant may be useful. The current-period audit evidence and professional judgement determine selection.

Where it goes wrong. Assuming that comparative financial statements require automatic repetition of last year's KAMs in the current auditor's report.

Authority. SA 701

Question 15 · 2 marks · Chapter 8: Audit Report and CARO, 2020 · medium

Scenario. An auditor identifies three matters requiring significant auditor attention. Which approach is appropriate when determining which of these matters become KAMs?

An auditor identifies three matters requiring significant auditor attention. Which approach is appropriate when determining which of these matters become KAMs?

1. Select all three because paragraph 9 requires every matter involving significant auditor attention to be reported separately.
2. Select only the matter with the highest monetary amount, irrespective of its qualitative significance or audit effort.
3. Select the matter management considers most commercially important, even where the auditor's assessment differs.
4. Evaluate the matters comparatively and select those of most significance in the current-period audit using professional judgement. (correct answer)

Answer: D — Evaluate the matters comparatively and select those of most significance in the current-period audit using professional judgement.

Explanation. SA 701, paragraphs 9 and 10, establish a two-stage process: first determine matters requiring significant auditor attention and then determine which were of most significance in the current-period audit. Application paragraphs A27-A30 explain that relative importance, audit effort, complexity and governance interaction are relevant. Not every matter considered under paragraph 9 automatically becomes a KAM.

Where it goes wrong. Treating the paragraph 9 factors as an automatic reporting checklist instead of applying the additional relative-significance assessment.

Authority. SA 701

Question 16 · 2 marks · Chapter 8: Audit Report and CARO, 2020 · hard

Scenario. A statutory auditor identifies revenue recognition as a significant risk under SA 240 because of the presumed fraud risk. The company has a simple business model, automated invoicing and reliable independent evidence. The audit required no unusual procedures or significant judgement. Which conclusion is most appropriate?

A statutory auditor identifies revenue recognition as a significant risk under SA 240 because of the presumed fraud risk. The company has a simple business model, automated invoicing and reliable independent evidence. The audit required no unusual procedures or significant judgement. Which conclusion is most appropriate?

1. Revenue recognition must automatically become a KAM because SA 240 presumes a fraud risk in revenue recognition.
2. Revenue recognition should be considered, but the identified risk does not automatically make it a KAM if it did not require significant auditor attention and was not among the matters of most significance. (correct answer)
3. Revenue recognition cannot become a KAM unless management has identified the same risk in its internal risk assessment.
4. Revenue recognition must be excluded because automated controls always eliminate the possibility of a significant audit risk.

Answer: B — Revenue recognition should be considered, but the identified risk does not automatically make it a KAM if it did not require significant auditor attention and was not among the matters of most significance.

Explanation. SA 701, paragraphs 9 and 10, read with application paragraph A21, clarifies that even significant risks do not automatically become KAMs. The auditor must assess whether the matter required significant auditor attention and was of most significance in the current-period audit. A presumed fraud risk in revenue recognition is an important consideration, but its actual audit significance depends on the engagement facts and professional judgement.

Where it goes wrong. Assuming that every presumed fraud risk under SA 240 must necessarily be presented as a KAM.

Authority. SA 240; SA 701

Question 17 · 2 marks · Chapter 8: Audit Report and CARO, 2020 · medium

Scenario. During the audit of a large listed company, the engagement team initially identifies twelve possible KAMs. The engagement partner proposes reporting all twelve to demonstrate the extent of audit work. Which statement is most appropriate?

During the audit of a large listed company, the engagement team initially identifies twelve possible KAMs. The engagement partner proposes reporting all twelve to demonstrate the extent of audit work. Which statement is most appropriate?

1. The auditor must report at least twelve KAMs because every significant account requires a separate KAM description.
2. The auditor should report every matter discussed with governance, whether or not it was significant in the current-period audit.
3. The auditor should reconsider whether each matter truly meets the definition because lengthy KAM lists may contradict the concept of matters of most significance. (correct answer)
4. The auditor must report exactly five KAMs because SA 701 prescribes a maximum of five matters in every listed-company audit.

Answer: C — The auditor should reconsider whether each matter truly meets the definition because lengthy KAM lists may contradict the concept of matters of most significance.

Explanation. SA 701, application paragraph A30, makes the number of KAMs a matter of professional judgement based on the entity's size, complexity, business environment and audit circumstances. It explains that when many matters are initially identified, the auditor may need to reconsider whether each satisfies the definition. Lengthy lists may be inconsistent with the concept of KAMs being matters of most significance. No fixed numerical limit is prescribed.

Where it goes wrong. Assuming that the number of KAMs is determined by the number of material balances or by a fixed numerical limit.

Authority. SA 701

Question 18 · 2 marks · Chapter 8: Audit Report and CARO, 2020 · hard

Scenario. Which presentation is most consistent with the requirements for the KAM section in an auditor's report?

Which presentation is most consistent with the requirements for the KAM section in an auditor's report?

1. A separate section titled Key Audit Matters, with an appropriate subheading for each matter and introductory language explaining their overall audit context. (correct answer)
2. A single paragraph titled Management's Key Risks, containing the company's own risk ratings and no explanation of the auditor's role.
3. A list of account balances placed after the signature block, without identifying why each balance received significant auditor attention.
4. A separate section giving a qualified or unqualified opinion on each KAM, independent of the opinion on the financial statements.

Answer: A — A separate section titled Key Audit Matters, with an appropriate subheading for each matter and introductory language explaining their overall audit context.

Explanation. SA 701, paragraph 11, requires each KAM to be described under an appropriate subheading within a separate section titled Key Audit Matters, subject to the exceptions in paragraphs 14 and 15. The introductory language explains that KAMs were matters of most significance and were addressed in the context of the financial statements as a whole. It also confirms that no separate opinion is provided on individual matters.

Where it goes wrong. Confusing the KAM section with a management risk report or assuming that separate opinions must be issued on every KAM.

Authority. SA 701

Question 19 · 2 marks · Chapter 8: Audit Report and CARO, 2020 · medium

Scenario. An auditor uses an external valuation expert to address a complex fair-value estimate selected as a KAM. Which statement is correct regarding the description of the auditor's response?

An auditor uses an external valuation expert to address a complex fair-value estimate selected as a KAM. Which statement is correct regarding the description of the auditor's response?

1. The auditor must reproduce the expert's complete valuation report and every calculation in the auditor's report.
2. The auditor cannot mention the expert because involvement of an expert transfers responsibility for the valuation opinion.
3. The auditor may state that the expert independently certified the balance and thereby provide a separate assurance opinion on that estimate.
4. The auditor may explain the expert's involvement and relevant audit procedures, while retaining responsibility for the overall audit opinion. (correct answer)

Answer: D — The auditor may explain the expert's involvement and relevant audit procedures, while retaining responsibility for the overall audit opinion.

Explanation. SA 701, application paragraphs A46 and A49, permits the auditor to describe relevant responses, procedures and the use of an auditor's expert when explaining how a KAM was addressed. The description should be proportionate and useful, rather than reproducing detailed technical workings. Using an expert does not reduce the auditor's responsibility for the opinion on the financial statements as a whole.

Where it goes wrong. Believing that the involvement of an auditor's expert either removes the auditor's responsibility or requires the entire expert report to be reproduced.

Authority. SA 701

Question 20 · 2 marks · Chapter 8: Audit Report and CARO, 2020 · hard

Scenario. A KAM description states that the auditor tested selected samples, evaluated the assumptions and obtained corroborating evidence. The description concludes that the valuation is correct and reliable in every respect. Which reporting concern arises?

A KAM description states that the auditor tested selected samples, evaluated the assumptions and obtained corroborating evidence. The description concludes that the valuation is correct and reliable in every respect. Which reporting concern arises?

1. No concern arises because an auditor may issue a separate opinion on every KAM after describing the audit procedures.
2. The conclusion could imply a discrete opinion on the individual matter and create an inappropriate impression about the auditor's overall opinion. (correct answer)
3. The only concern is that the auditor must disclose the names of every employee who prepared the valuation.
4. The description is automatically invalid because SA 701 prohibits mentioning the outcomes of any audit procedures.

Answer: B — The conclusion could imply a discrete opinion on the individual matter and create an inappropriate impression about the auditor's overall opinion.

Explanation. SA 701, application paragraphs A47 and A51, permits an indication of the outcome of audit procedures but requires care to avoid implying a separate opinion on an individual KAM or creating doubt about the opinion on the financial statements as a whole. The description should communicate the nature of the auditor's response without presenting individual assurance conclusions that the standard does not contemplate.

Where it goes wrong. Thinking that describing an audit outcome gives the auditor authority to certify a particular balance separately from the overall financial statements.

Authority. SA 701

Question 21 · 2 marks · Chapter 8: Audit Report and CARO, 2020 · medium

Scenario. A matter has been determined to be a KAM, but management strongly opposes its communication because of possible adverse consequences. No law prohibits disclosure. Under what circumstances may the auditor decide not to communicate it?

A matter has been determined to be a KAM, but management strongly opposes its communication because of possible adverse consequences. No law prohibits disclosure. Under what circumstances may the auditor decide not to communicate it?

1. Whenever management formally requests omission and the engagement partner considers the matter commercially sensitive.
2. Whenever the Audit Committee concludes that investors are unlikely to understand the matter without additional technical explanation.
3. Only in extremely rare circumstances when adverse consequences are reasonably expected to outweigh the public interest benefits of communicating it. (correct answer)
4. Whenever the matter relates to legal proceedings, business strategy or negotiations that have not reached final settlement.

Answer: C — Only in extremely rare circumstances when adverse consequences are reasonably expected to outweigh the public interest benefits of communicating it.

Explanation. SA 701, paragraph 14(b) and application paragraphs A53-A56, provide an extremely rare exception where the auditor determines that adverse consequences to the entity or public would reasonably be expected to outweigh the public interest benefits of communication. Management's opposition or commercial concerns alone are insufficient. The auditor must independently evaluate the circumstances, consider relevant communications and may consider obtaining legal advice.

Where it goes wrong. Treating management's request or the commercial sensitivity of a matter as sufficient grounds for suppressing a KAM.

Authority. SA 701

Question 22 · 2 marks · Chapter 8: Audit Report and CARO, 2020 · hard

Scenario. A listed entity's legal adviser informs the auditor that a specific statutory provision expressly prohibits public disclosure of information about an ongoing investigation. The matter has otherwise been determined to be a KAM. Which treatment is correct?

A listed entity's legal adviser informs the auditor that a specific statutory provision expressly prohibits public disclosure of information about an ongoing investigation. The matter has otherwise been determined to be a KAM. Which treatment is correct?

1. The auditor may omit the protected matter from the public KAM section under paragraph 14(a), while considering any separate legal reporting obligations. (correct answer)
2. The auditor must describe the entire investigation because a listed company's KAM disclosures take precedence over confidentiality restrictions.
3. The auditor should report the protected details in an Other Matter paragraph because the legal restriction applies only to KAM sections.
4. The auditor should include the investigation details in an appendix available only to shareholders and omit the statutory restriction.

Answer: A — The auditor may omit the protected matter from the public KAM section under paragraph 14(a), while considering any separate legal reporting obligations.

Explanation. SA 701, paragraph 14(a), permits non-communication of a KAM where law or regulation precludes public disclosure. Application paragraph A52 recognises that legal restrictions may protect information concerning an investigation. This exception concerns public communication in the auditor's report and does not automatically eliminate other reporting or communication obligations imposed by law or regulation.

Where it goes wrong. Assuming that statutory confidentiality can be bypassed by moving protected information into another section or appendix of the auditor's report.

Authority. SA 701

Question 23 · 2 marks · Chapter 8: Audit Report and CARO, 2020 · medium

Scenario. A matter has already been determined to be a KAM. The auditor proposes to use an Emphasis of Matter paragraph instead of describing it under the KAM heading. Which statement is correct?

A matter has already been determined to be a KAM. The auditor proposes to use an Emphasis of Matter paragraph instead of describing it under the KAM heading. Which statement is correct?

1. The proposal is appropriate because an Emphasis of Matter paragraph is the preferred method for communicating all significant audit matters.
2. The proposal is appropriate when the relevant financial statement note contains sufficient details about the matter.
3. The proposal is compulsory because SA 706 replaces SA 701 whenever a matter is significant to intended users.
4. The proposal is inappropriate because an Emphasis of Matter or Other Matter paragraph cannot substitute for a required KAM description. (correct answer)

Answer: D — The proposal is inappropriate because an Emphasis of Matter or Other Matter paragraph cannot substitute for a required KAM description.

Explanation. SA 701, application paragraph A8, read with SA 706 (Revised), clarifies that Emphasis of Matter and Other Matter paragraphs are separate reporting mechanisms and are not substitutes for communicating a matter determined to be a KAM under paragraph 13. Where appropriate, the auditor may use separate reporting mechanisms alongside KAM communication, but one cannot replace the other merely for convenience.

Where it goes wrong. Confusing Emphasis of Matter reporting with KAM reporting because both may highlight matters of particular importance to financial statement users.

Authority. SA 701; SA 706

Question 24 · 2 marks · Chapter 8: Audit Report and CARO, 2020 · hard

Scenario. At the planning stage, an auditor believes that impairment of a major asset may become a KAM. When should the auditor communicate preliminary views regarding this matter to those charged with governance?

At the planning stage, an auditor believes that impairment of a major asset may become a KAM. When should the auditor communicate preliminary views regarding this matter to those charged with governance?

1. Only after the financial statements have been approved and the auditor's report has been signed.
2. The auditor may communicate preliminary views while discussing planned audit scope and timing and further discuss the matter as audit findings develop. (correct answer)
3. Only after the auditor has finally determined the KAMs, because preliminary discussion with governance is prohibited.
4. Only when management has independently classified the impairment as a significant financial statement risk.

Answer: B — The auditor may communicate preliminary views while discussing planned audit scope and timing and further discuss the matter as audit findings develop.

Explanation. SA 701, application paragraph A60, explains that preliminary views about possible KAMs may be communicated when discussing the planned scope and timing of the audit. The auditor may discuss the matters further as audit findings develop. However, the ultimate determination must be based on audit results and evidence obtained throughout the engagement, not merely the preliminary assessment made during planning.

Where it goes wrong. Assuming that governance communication can take place only after the final KAM selection or after the auditor's report is signed.

Authority. SA 701

Question 25 · 2 marks · Chapter 8: Audit Report and CARO, 2020 · medium

Scenario. During finalisation, the auditor decides that a matter communicated to the Audit Committee required significant auditor attention but was not among the matters of most significance in the audit. The engagement team also decides that no matter qualifies as a KAM. Which documentation approach is appropriate?

During finalisation, the auditor decides that a matter communicated to the Audit Committee required significant auditor attention but was not among the matters of most significance in the audit. The engagement team also decides that no matter qualifies as a KAM. Which documentation approach is appropriate?

1. Document only the final opinion and omit the assessment because the matter was not ultimately included as a KAM.
2. Document only management's explanation that the matter was insignificant, without recording the auditor's own assessment.
3. Document matters requiring significant attention and the rationale for KAM selection or non-selection, including why no KAM was identified. (correct answer)
4. Document only the financial statement note and rely on the Audit Committee minutes as complete evidence of compliance.

Answer: C — Document matters requiring significant attention and the rationale for KAM selection or non-selection, including why no KAM was identified.

Explanation. SA 701, paragraph 18(a) and (b), requires documentation of matters requiring significant auditor attention and the rationale for determining whether each was a KAM. Where applicable, the auditor must also document the rationale for determining that no KAMs exist or that only paragraph 15 matters are KAMs. The standard does not require documentation explaining why every other governance communication did not require significant auditor attention.

Where it goes wrong. Assuming that matters excluded from the final KAM section do not require documentation of the auditor's professional judgement.

Authority. SA 701