ISA 701 — Communicating Key Audit Matters in the Independent Auditor's Report: Complete Guide

Key Takeaways

ISA 701 introduced the concept of Key Audit Matters (KAM) — those matters that, in the auditor's professional judgment, were of most significance in the audit of the current period's financial statements.
The standard is mandatory for listed entities. It also applies when law or regulation requires KAM disclosure or when the auditor voluntarily decides to communicate KAM.
The determination follows a funnel process: all matters communicated to TCWG → those requiring significant auditor attention → those of most significance.
Three considerations guide the determination: (1) areas of higher assessed risk or significant risks, (2) significant auditor judgments in areas with significant management judgment, and (3) the effect of significant events or transactions.
Each KAM must describe why the matter was most significant, how it was addressed in the audit, and include a reference to related disclosures.
KAM descriptions must be entity-specific and audit-specific — boilerplate defeats the purpose of the standard.
When the auditor expresses a disclaimer of opinion, KAM must not be communicated (unless required by law).

What is ISA 701?

ISA 701, titled "Communicating Key Audit Matters in the Independent Auditor's Report," was introduced in 2015 as part of the IAASB's auditor reporting reforms. It responded to widespread calls from investors and other stakeholders for a more informative auditor's report — one that goes beyond a binary pass/fail opinion and provides insight into the audit itself.

Before ISA 701, auditor's reports for different entities were largely indistinguishable: the same boilerplate text with only the opinion varying. KAM provides a window into what the auditor focused on, what was complex or risky, and how the auditor responded — making the report entity-specific and decision-useful.

The KAM Determination Process

Step 1: Matters communicated with those charged with governance

The starting pool for KAM is all matters communicated with those charged with governance under ISA 260 (Revised). This includes significant findings from the audit, significant difficulties encountered, and other matters arising from the audit that the auditor considers significant.

Step 2: Matters requiring significant auditor attention

From this pool, the auditor identifies matters that required significant auditor attention. ISA 701.9 requires three specific considerations:

Areas of higher assessed risk or significant risks (ISA 315). These are, by definition, areas requiring more attention — and often involve complex or unusual transactions, fraud risks, or areas of significant estimation uncertainty.

Significant auditor judgments relating to areas involving significant management judgment, including accounting estimates with high estimation uncertainty. When management had to exercise significant judgment, the auditor typically also had to exercise significant judgment in evaluating that work.

The effect on the audit of significant events or transactions during the period. Mergers, disposals, restructurings, regulatory changes, or other events that fundamentally affected the audit approach.

Step 3: Matters of most significance

From the matters requiring significant attention, the auditor determines which were of most significance — the KAM. This is a further filtering step that ensures only the truly important matters are communicated, avoiding information overload.

Communicating KAM in the Report

Structure

KAM are presented in a dedicated section headed "Key Audit Matters" with introductory language explaining that KAM are matters of most significance in the current period's audit. Each KAM uses an appropriate subheading and includes:

Why the matter is a KAM. Why it was considered one of most significance — referencing the specific circumstances, the risks involved, the complexity, or the judgments required.

How the matter was addressed. A description of the audit response — the procedures performed, the key findings, or the outcome of the procedures.

Reference to disclosures. A cross-reference to the related note(s) in the financial statements.

What good KAM descriptions look like

Good KAM descriptions are entity-specific, concise, balanced, and avoid highly technical auditing jargon. They help users understand what the auditor focused on and why, without providing a separate opinion on individual matters or replacing disclosures that management should make.

Avoid boilerplate — regulators are watching

Regulators across Europe have consistently criticised KAM descriptions that are generic, boilerplate, or recycled year after year without meaningful change. The AFM (Netherlands), FRC (UK), and H3C (France) all examine whether KAM descriptions are truly entity-specific and audit-specific. Common deficiencies include: describing the same KAM in identical language for different entities within the same industry; failing to explain why a specific matter was most significant for this entity; and describing audit responses in vague terms ("we evaluated," "we tested") without explaining the nature or extent of the procedures.

Relationship with Other Reporting Standards

KAM and ISA 705 (Modified opinions)

When the auditor modifies the opinion, the matter giving rise to the modification is described in the "Basis for..." section — not as a KAM. However, the auditor may still communicate other KAM alongside a qualified or adverse opinion. When the auditor disclaims an opinion, no KAM are communicated (unless required by law).

KAM and ISA 706 (Emphasis of Matter / Other Matter)

A matter cannot be both a KAM and an Emphasis of Matter paragraph. If a matter has been determined as a KAM, the KAM description under ISA 701 takes precedence. If the matter does not meet the KAM threshold but warrants emphasis, ISA 706 applies.

KAM and ISA 570 (Going Concern)

If a material uncertainty related to going concern exists, it is reported in a dedicated section under ISA 570 — not as a KAM. However, a "close call" going concern situation (where no material uncertainty exists after evaluation) may be a KAM.

Common Examples of KAM in Practice

Based on academic research and regulatory reviews, the most frequently reported KAM categories include:

Impairment of goodwill and intangible assets
Revenue recognition (particularly for complex revenue arrangements)
Valuation of financial instruments
Provisions and contingent liabilities
Business combinations
Tax provisions and uncertain tax positions
Going concern (close call situations)
IT systems and controls (for complex IT environments)

The specific KAM for any given audit depend entirely on the entity and the audit — the above is a list of commonly seen categories, not a prescribed list.

ISA 701 in Your Jurisdiction

Netherlands. COS 701 follows ISA 701. KAM disclosure is mandatory for OOBs (organisations of public interest) and is increasingly used voluntarily for other entities. The AFM's thematic reviews of KAM quality have consistently pushed for more specificity and less boilerplate, particularly around revenue recognition KAM and impairment KAM.

Germany. IDW PS 401 adapts ISA 701. For PIEs in Germany, KAM requirements are supplemented by the EU Audit Regulation's requirement to describe the most significant assessed risks of material misstatement (besonders wichtige Prüfungssachverhalte). The WPK has examined consistency between KAM descriptions and the detailed Prüfungsbericht.

United Kingdom. ISA (UK) 701 extends KAM requirements beyond listed entities — requiring KAM for all entities that report under the UK Corporate Governance Code and certain other PIEs. The FRC's annual reviews of audit quality have been influential in setting expectations for KAM quality.

France. The French justification des appréciations (justification of assessments) predates ISA 701 and applies to all statutory audits, not just listed entities. NEP 701 has been aligned with ISA 701 for listed entities, but the broader French requirement means that even SME audits include entity-specific justifications.

Frequently Asked Questions

How many KAM should there be?

ISA 701 does not prescribe a number. It explicitly states that "lengthy lists of key audit matters may be contrary to the notion of such matters being those of most significance." In practice, most listed entity audits report between two and five KAM. The number depends on the complexity of the entity and the audit.

Must KAM change from year to year?

Not necessarily. If the same matter continues to be of most significance year after year (e.g., goodwill impairment for an entity with significant goodwill), it may remain a KAM. However, the description should be updated to reflect the current year's circumstances and audit response — recycling identical text from prior years is a deficiency.

Can KAM reveal original information about the entity?

The auditor should not provide original information about the entity that management has not already disclosed. KAM descriptions are intended to provide transparency about the audit — not to disclose information that management should be disclosing in the financial statements.

Is there a KAM for every significant risk?

Not necessarily. Significant risks are one consideration in determining KAM, but not every significant risk will be a KAM — the auditor applies the "most significance" filter. Conversely, a matter that is not a significant risk could still be a KAM if it required significant auditor attention for other reasons.

ISA 701 — Communicating Key Audit Matters: Complete Guide