Most manufacturing companies have an established procedure to deal with the return of defective goods. A company I worked for used a form with ‘Product Improvement Opportunity’ emblazoned at the top. As well as making me smile, it was a reminder that today’s problems can indeed be tomorrow’s opportunities.
I was reminded of this recently when looking at key audit matters (KAMs). These are a relatively recent development, and I think it is fair to say that implementation has been underwhelming.
Sustainability is bolted on here and there in the accounts like a series of afterthoughts
KAMs became mandatory with ISA 701 in 2016, and were intended to improve transparency about how an audit was conducted. ISA 701 required an auditor to disclose areas of significant risk and/or judgment and explain how they had addressed those issues.
The principle was sound in my view, but the downside is that KAMs can become just another piece of boilerplate, as are most statements of accounting policies. It is so easy to leave contentious things out, especially with subjective judgments.
I have occasionally found KAMs interesting. My all-time favourite was a company that had a very sophisticated way of accounting for long-term contracts that included ‘significant manual intervention’, which translates as ‘we just made a lot of it up’.
Integral vs incidental
Almost every set of accounts now includes copious references to climate-related matters. A few companies do this well, with sustainability being woven into the narrative in a relatively seamless way. I think that these companies are also more likely to be the ones that take climate risks seriously.
Most companies, though, do it very badly, with sustainability bolted on here and there in what looks like a series of afterthoughts. It is always tempting to conclude that this reflects the way the company is managed.
Many companies now describe climate change as one of the biggest risks they face. These risks can be short term, such as increasingly extreme weather; or longer term, such as proposed legislation or the need to switch to sustainable raw materials.
I fail to understand how a major risk can fail the entrance exam for KAM inclusion
The risks can also be positive as new markets are created. This, one might think, is the very thing that KAMs were created for: a requirement for the auditor to discuss how material risks were assessed.
Unfortunately, the reality is less impressive. I have seen only a handful of companies that address climate-related risks in the KAMs. I fail to understand how a major risk can fail the entrance exam for KAM inclusion. Even when companies do discuss specific climate-related risks, they may end up burying the discussion in the sustainability report or, even worse, the voluntary and unaudited CDP submission.
Glaring omissions
It’s the same problem that we have today with accounting policies and risk statements. Key topics are omitted, even when they are obvious to all sentient observers, presumably because management finds it all a little embarrassing.
I think this is a missed opportunity for the audit profession. Financial accounting was historically backward-looking, with a focus on the year just ended. There is huge pressure on companies now to include more forward-looking information, especially on environmental issues. This requires a new approach with a focus on how the company’s business will evolve as we all strive to get to a more sustainable world.
As the International Sustainability Standards Board (ISSB) edges towards developing ‘decision-useful’ sustainability standards, the question of who will assure these standards remains open. KAMs are in theory written by the auditor, not by management. Ambitious auditors have a tailor-made opportunity to demonstrate they are on top of environmental issues and, by implication, ideally placed to provide ISSB assurance. It mystifies me that so few are seizing the moment.
