The Japanese Institute ofCertified Public Accountants

Improved Transparency in Auditor Reports

Results of Trial Run of KAM Communication

The Japanese Institute of Certified Public Accounts
November 17, 2017

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Table of Contents

I.

About the Trial Run

II.

Overview of the Selected KAM

III. Feedback on the Trial Run and Expected Changes/Impacts
IV. Issues to be Addressed in Achieving the Intended Purpose ofCommunicating KAM
V.

Conclusion

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1

The Japanese Institute ofCertified Public Accountants

I. About the Trial Run

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About the Trial Run
Purpose

To identify practical issues related to the adoption of communicating KAM

Participating audit
firms

7 audit firms (including the BIG 4 firms)

Participating auditees 26 companies
Industries

Manufacturing and construction industries: 13 companies
Non-manufacturing industries: 13 companies (including 5 financial institutions)

Consolidated net sales or revenue
 Over ¥1tn
Company Over ¥500bn less than ¥1tnsize
 Over ¥100bn less than ¥500bn
 Less than ¥100bn
Financial Reporting
Framework

 J-GAAP IFRS or US-GAAP(Ref. info: No. of all listed companies*1)
12 companies
143 companies
5 companies
135 companies
4 companies
650 companies
5 companies
2,703 companies
17 companies
9 companies

3,524 companies*2
145 companies

Fiscal Year

Consolidated financial statements for fiscal years ended December 2016 to March
2017

MethodA questionnaire (multiple choice and written questions) was sent to both companies
and audit firms

Period of trial run

Late August 2017 to October 2, 2017

*1: According to eol, the database provided by PRONEXUS INC. (information gathered as of June 2017).
Information on companies that do not prepare consolidated financial statements is based on individual financial statement data.
*2: According to data provided by Internet Disclosure Co., Ltd.

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3

About the Trial Run: Questionnaire
Auditee

Auditor (Audit team) Expected changes from introduction of KAM
communication• Whether there were any difficulties• Impact on communication between
management/TCWG and the independent
auditor• Impact on disclosures• Contribution to engagement between thecompany and shareholders• Impact on the audit report from TCWG
 Time required for discussion of KAM
 Others About the selected KAM
 Feedback on selecting and drafting KAM• Difficulties when selecting KAM• Difficulties when drafting KAM• Views for including the outcome of or
observation from the auditor’s response Impact on communication with the company
 Expected additional workload forcommunicating KAM
 Others• Challenges to achieve the intended purpose• Challenges to achieve the intended purpose• Applicability, effective date and desired
preparation period• Applicability, effective date and desired
preparation period• Others• Others

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4

Parties with whom the Auditor Communicatedin the Trial Run Process
Parties with whom the auditor communicated when selecting and drafting KAM:

When selecting KAM
0

5

10

When drafting KAM
15

20

25

CEO
CEO 0

16
24

経理課長
Accounting, Section
Chief

19

社外監査役
External Kansayaku(TCWG)

Audit Committee,
Member
監査(等)委員
Other
その他

16
9
3

Full-time Kansayaku(TCWG)
常勤監査役

監査(等)委員会委員長
Audit Committee, Chair

2

Audit Committee,
Member
監査(等)委員

3
5

Other
その他

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30

24

20
5

Audit Committee
監査(等)委員会

1

25

経理部長
Accounting, General
Manager

社外監査役
External Kansayaku(TCWG)

3

20

20

監査役会
Board of Kansayaku(TCWG)

3

Full-time Kansayaku(TCWG)
常勤監査役

15

2

Accounting,
経理部員
Staff

8

監査役会
Board of Kansayaku(TCWG)

10

経理課長
Accounting, Section
Chief

16

Accounting,
経理部員
Staff

5

CFO
CFO

経理部長
Accounting, General
Manager

監査(等)委員会委員長
Audit Committee, Chair

0
CEO
CEO

CFO
CFO

Audit Committee
監査(等)委員会

30

3
2
3
5

5

The Japanese Institute ofCertified Public Accountants

II. Overview of the Selected KAM

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Process for Determining KAM and Description of KAM
in the Auditor’s Report
Narrowing down the most significant matters in
the individual audit (relative concept)
Independent Auditor’s Report
Audit issues
Audit Opinion..........

Matters that
requiresignificant
auditor attention

Key Audit Matter(KAM)

Description of each KAM

Mostsignificant
matters

Explanation about
the nature of KAM

Matters that are required
to be communicated withthose charged withgovernance (E.g. ISA 260)

Key Audit Matters
Key audit matters are those matters that, in our
professional judgment, were of most significance in our
audit of the financial statements of the current period.
These matters were addressed in the context of our auditof the financial statements as a whole, and in forming our
opinion thereon, and we do not provide a separate opinion
on these matters.

xxx (Subheading describing each KAM)
Include a reference to the related disclosure, if any, in thefinancial statements and address:• Why the mater was determined to be KAM; and• How the matter was addressed in the audit.

xxx (Subheading describing each KAM)
xxxxx

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7

Distribution of the Number of Selected KAM
Number ofcompanies

Number of KAM

Breakdown by Financial Reporting Framework
J-GAAP

US-GAAP, IFRS

1

5

4

1

2

11

7

4

3

2

2

0

4

6

3

3

5

1

1

0

6

1

0

1

Total number of KAM

68

41

27

Average number per company

2.61

2.41

3.00

(Reference Information)★ Number of KAM in UK in the 2nd year (2014/2015)(Source: UK FRC Report)
Average number per company: 3.9★ Number of KAM in Singapore in the 1st year (fiscal year ended December 2016)(Source: Joint report by ACCA, ACRA, ISCA and NTU)
Average number per company: 2.3

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8

Distribution of Selected KAM by Area
Area

Number of KAM

Impairment of assets (non-current assets other than goodwill)

18

Accounting for business combinations, and the recognition and the valuation of
goodwill

17

Provisions, asset retirement obligations and contingent liabilities

14

Revenue recognition (percentage of completion method, estimates of variableconsideration, cut-off and overstatement risk)

9

Valuation of assets (including measurement of fair value)

8

Tax calculations (including recoverability of deferred tax assets)

4

Reserves requiring specialized and complex calculations (accounting estimates)

3

Scope of consolidation

1

IT systems related to financial reporting1* Since there were 6 cases in which both “Impairment of assets (non-current assets other than goodwill)” and “Accounting forbusiness combinations, and the recognition and the valuation of goodwill” were included in a single KAM, and 1 case in which
both “Accounting for business combinations, and the recognition and the valuation of goodwill” and “Valuation of assets(including measurement of fair value” were included in a single KAM, the total sum above is 7 more than the total in the previous
slide.
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9

Summary of the Descriptions of Individual KAM
Although the style and granularity of the descriptions of KAM vary, they can be summarized and classified
into the following categories.
Why the matter was determined to be KAM

How the matter was addressed in the audit• Impact on financial statements is quantitatively
material.

• Assessment of the design and operating
effectiveness of related internal controls.

• Process for calculating numerical data iscomplex. (e.g. the assessment and estimatingprocesses)• Overview of the analytical procedures performed.

• Calculation of financial numbers requiresconsideration of management’s intent regarding
future events and elements that are significantly
subjective.
• Whether intentional or not, it contains elementsthat could easily give rise to errors in applying
accounting standards or accounting treatment.

• Overview of the substantive procedures
performed.
- Some describe procedures performed forspecific risks only, but others describe
procedures performed more comprehensively.
- Use of the work of experts. (Often describe
which areas the work of experts is used for.)- The work requested specifically to theoverseas component auditor and relevant
discussion with the component auditor

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10Views for Including the Outcome of or Observation from the
Auditor’s Response
Under the International Standards on Auditing, inclusion of the outcome of or observation from theauditor’s response is not mandatory. However, the auditor can choose to include them.
◆ Did you think inclusion of the outcome or observation ispreferable? State the reasons (replies from auditors).

◆ Results of the trial run
Outcome orobservation

Number of cases

Included16 (23.5%)

a. Yes9 (34.6%)

Not included

52 (76.5%)

b. No

17 (65.3%)

Replies

Reasons for “a. Yes”
 Without the outcome or observation, it may give the impression to the reader that the description is incomplete.
 The auditor’s observation should be included since it is useful information for users.
Reasons for “b. No”
 Inclusion of the outcome or observation could give users of financial statements the impression that KAM is aseparate opinion on an individual matter. Therefore, unless there is a compelling need, the outcome orobservation should not be included.
 For an audit issue that is routine in nature and therefore selected as KAM every year, it would not be
particularly useful for users if the description includes the outcome or observation such as “No Issues weredetected” or “We determined it is appropriate” every year.
 Even if a misstatement or deficiency of internal control identified in relation to a particular KAM is described in
the auditor’s report, users would not be able to appropriately assess these matters only from the description.
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11

Relationship between the Description of KAM andthe Disclosure of the Company (1)Total

a. Based on the information disclosed in the financial
statements, the auditor was able to describe KAM specificto the company’s audit.
b. While not disclosed in the financial statements, by using
the information publicly available from the company, theauditor was able to describe KAM specific to thecompany’s audit.
c. The auditor needs to include original information in orderto describe KAM specific to the company’s audit.
d. Other
Total:(Note: The number of replies does not match the number of
KAM, as some respondents chose multiple answers)

Breakdown by
Financial Reporting
Framework
J-GAAP

US-GAAP
IFRS

39

13

26

(54.9%)(31.7%)(86.7%)

1082(14.1%)(19.5%)(6.7%)

20

18

2(28.2%)(43.9%)(6.7%)

220(2.8%)(4.9%)

(0%)

71

41

30

(100%)(100%)(100%)

Respondents who replied “b” and “c” proceeded to the next question (next page).
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12

Relationship between the Description of KAM andthe Disclosure of the Company (2)◆ Question posed to respondents who◆ Question posed to respondents who replied “b” or “c” to thereplied “b” or “c” to the previous question:
what was the company’s reaction to thedescription of KAM?

previous question: what was the company’s reaction to
expanding the disclosures in the financial statements?
Inner circle: b. Information other than financial statements
Outer circle: c. Original information

Inner circle: b. Information other than financial statements
Outer circle: c. Original information

2

0

3

1

2

2
5

2
5

a

Positive attitudeb

Cautious attitude

c

Other

d

No reply

15
8
a

b

◆ Question posed to respondents who replied “c” to the15previous question: did it involve a sensitive matter?

a. Since KAM is a matter of the auditor’s
judgement, the company agreed to thedescription of KAM without argument.
b. We discussed changes to the descriptionof KAM with the company.
c.

Others

6

6

a Yes
b No
c Other0

d No reply
8

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13

The Japanese Institute ofCertified Public Accountants

III.

Feedback on the Trial Run andExpected Changes/Impacts

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Discussion on KAM:
Whether there were any difficulties (Replies from companies)(Question)
In the discussion with the auditor on KAM, were there any difficulties?
Breakdown by Financial Reporting Framework
Total
J-GAAP

US-GAAP
IFRS

a. No

16 (53.3%)

8 (40.0%)8 (80%)

b. Yes13 (43.3%)

11 (55.0%)

2 (20%)

No reply

1 (3.3%)1 (5.0%)0 (0%)

Details of responses “b. Yes”
 The criteria for describing KAM is not clear since it is a matter of the auditor’s professional
judgment.
 The concept that KAM is “not a separate opinion on an individual matter”.
 There was a concern that descriptions of KAM from the auditor’s perspective could make thecompany’s business risks look more serious than reality and it was difficult for the company and theauditor to seek agreement.
 Regarding the descriptions of why the matter was determined to be KAM and how the matter wasaddressed in the audit, there was a difference in opinion between the auditor and the company
regarding the qualitative expression, which required multiple discussions.
 It is likely that the discussion on to what extent non-public information should be included in KAM
takes time.
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15

Discussion on KAM:
Whether there were any difficulties (Replies from auditors)◆ Were there any difficulties in communicating with those charged with governance?
Breakdown by financial reporting
framework
Total
US-GAAPJ-GAAP
IFRS
a. No

22 (84.6%)

13 (76.5%)

9 (100%)b. Yes4 (15.4%)

4 (23.5%)

0 (0%)

b. Breakdown by types of difficulties
a. Insufficient understanding of KAM.
c. There was a tendency to keep the number of and descriptions of KAM to a minimum.

2 cases
2 cases◆ Were there any difficulties with management (e.g. CFO)?
Total
a.

Breakdown by financial reporting
framework
US-GAAPJ-GAAP
IFRS

No

19 (73.1%)

11 (64.7%)

8 (88.9%)b. Yes7 (26.9%)

6 (35.3%)

1 (11.1%)

b. Breakdown by types of difficulties
a. Insufficient understanding of KAM.
c. There was a tendency to keep the number and descriptions of KAM to a minimum.
d. Other
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1 case4 cases
2 cases16

Difficulties when Selecting KAM(Replies from auditors)◆ Were there any difficulties or questions when selecting KAM? If so, what kind of difficulties?
16

a.なし
a. No

14

b.あり
b. Yes

14
12

12
10

9

8

8

6

6
4

3

2
0

J-GAAP
US-GAAP,
IFRS
日本基準
米国基準・IFRSMain details of replies, if the respondent replied “b. Yes”.

Total
合計

 When selecting an item related to revenue recognition as KAM, the company expressed a concern that it may
give the impression on the financial statement that the company had a problem.
 When selecting an item related to revenue recognition as KAM, there is a risk of repeating the same descriptions
each year unless there are changes in the business environment.
 For a matter that has no significant impact on financial statements, but for which there was extensive
communication with those charged with governance related to the matter or it was addressed as a significant
matter in internal control audits, it is difficult to determine whether it should be selected as KAM.
 Disclosing too many items as KAM could confuse users but disclosing too few items will not achieve the intended
purpose of improving the transparency of audit reports.
 While a matter related to IT systems was a significant audit matter, it was determined not to be KAM based on
the concept that KAM is selected by relative importance.
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17

Difficulties when Drafting the Descriptions of KAM:
Identification of KAM and why the matter was determined to be KAM(Replies from auditors)◆ Were there any difficulties when drafting the identification of KAM and why the matter was determined to
be KAM?
18

a.はい
a.
Yes

16
14

b.いいえ
b.
No

16

13

12

10

10
8
6

6
4

4

3

2
0

Details of replies “a. Yes”

J-GAAP
日本基準

US-GAAP,
IFRS
米国基準・IFRS

Total
合計

 It was difficult to strike an appropriate balance between simplifying the expressions to be understandable for users
and using accurate expressions to avoid misunderstandings.
 Given that specific disclosure requirements under J-GAAP are relatively fewer than IFRS and US-GAAP, it wasdifficult to decide how much detail should be included in the descriptions of KAM. Furthermore, when describing
why the matter was determined to be KAM, it was difficult to decide to what extent technical accounting terms canbe used.
 When describing KAM, it was necessary to discuss with the company whether to include information not disclosedby the company. The difficulties arose in encouraging the company to amend and revise the company’s
disclosures before finalizing the description of KAM.
 As there were no clear criteria for the descriptions of KAM, there was a tendency to simplify the descriptions.
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18

Difficulties when Drafting the Description of KAM:
How the matter was addressed in the Audit (Replies from auditors)◆ Were there any difficulties when drafting how the matter was addressed in the audit?
18

a.はい
a.
Yes

16
14

b.いいえ
b.
No

16

13

12

10

10
8
6
4

6
4

3

2
0

J-GAAP
US-GAAP,
IFRS
Total
日本基準
米国基準・IFRS
合計
 It was very difficult to find expressions that are understandable for users, while describing the audit
procedures performed by the audit team without misunderstandings.
Details of replies “a. Yes”

 It took time to determine the appropriate expressions for industry-specific and technical terms that
could be understood by users.
 It was difficult to determine which procedures should be included, and how detailed and specific thedescriptions should be. Including procedures that are non-routine only makes the descriptions poor.
 As there were no clear criteria for the descriptions of KAM, there was a tendency to simplify thedescriptions.
 We needed to discuss whether to refer to the component auditor, and whether to identify the name of
the component auditor in KAM, considering that the group auditor should be responsible for the group
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audit opinion.

19Changes to Communications on Higher Risks(Question)
If KAM is required, do you expect any changes in communications on higher risks which impact theCompany’s financial statements? (Multiple answers allowed.)
20

19

19

18
18

17

16

会社
Company

14
12

監査人
Auditor

10
8
8

7
6

6

5
4

4
2

1

0

a

b

c

d

e

a. There will be hardly any changes.
b. Communication between management and the auditor will be improved.
c. Communication between those charged with governance and the auditor will be improved.
d. Communication between management and those charged with governance will be improved.
e. Other
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20

Impacts on Disclosures(Replies from companies)(Question)
If KAM is required, do you foresee any impacts on company disclosures, such as the annual securities reportand IR?
“a. Yes” Þ Details of expected impact
30
25

a.はい
a. Yesc.その他
c. Other

b.いいえ
b. No

 The descriptions of KAM should be based on
the information publicly available by thecompany. Therefore, improving the company’s
disclosure will be necessary to include
detailed facts and circumstances in the KAM
description.

24

20

16
15

8

10
5

2

1

2

4
0

1

0

J-GAAP
US-GAAP,
IFRS
Total
日本基準
米国基準・IFRS
合計“b. No” Þ Reasons Current disclosures are already adequate and there
will be no impact.
 Management decides which matters to be disclosed tothe third parties and the details of the disclosure bytaking into account carefully the stakeholders’interests. The descriptions in the audit report should
also be decided in the same framework.
 Unless there is a difference of opinion between thecompany and the auditor, there should be no impact
on the company’s disclosures.

 Additional disclosure through IR may benecessary, especially when the descriptions of
KAM change significantly from the previous
year.
 Investors and analysts may demand moredetailed explanations in the annual securities
reports and IR activities.
 Disclosures explaining management views on
KAM (e.g. disclosure on business risks) will
be necessary. It will encourage the filing ofannual securities reports prior to theshareholders meetings.
 Request from the audit firm to disclose moredetailed information will be increasing.

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21

Contribution to the Engagement between the Company and
its Shareholders (Replies from the companies)(Question)
If KAM is required, do you expect it to be useful for the engagement with shareholders?
a.はい
b.いいえ
c.その他
a.
Yes
c.
Other
b.
No
Reasons for “a. Yes”
17
18
 The descriptions of the audit procedures will16
help users understand that the disclosed
14
information passed the auditor’s test for12
10potential risk including fraud.
9
10
8

8

7

6
4

3

2

3

3
0

0

J-GAAP
日本基準

US-GAAP,
IFRS
米国基準・IFRS

Total
合計

Reasons for “b. No”

 Since knowledgeable analysts will understandand analyze the descriptions of KAM, it may
help the dialogue with shareholders to acertain extent. Shareholders’ questions arelikely to increase for better or for worse.
 It will help shareholders understand industryspecific risks, the company’s financial positionand performance and audits.

 Since questions from shareholders generally tend to
focus on business matters, shareholders may nothave much interest in the descriptions of KAM.

Reasons for “c. Other”

 Matters determined to be KAM are significant
enough that the company has already madesubstantive amount of disclosure on those matters,
and has already answered shareholders’ questions
on those matters at the AGM. Therefore, there will
be no major changes to the “dialogue withshareholders” as a result of KAM.

 KAM will probably be helpful for investors inunderstanding the audit. However, thecompany provides consistent explanations to
its shareholders using flexible types of
disclosures such as the integrated report.
Therefore, the effect of KAM on dialogue withshareholders is expected to be limited.

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22

Consequences on the Reports from Those Charged with
Governance (Replies from the companies)(Question)
If KAM is required, do you expect it to impact the descriptions in reports from those charged with governance?
a.はい
a.
Yes

b.いいえ
b.
No

Reasons for “a. Yes”

c.その他
c. Other Those charged with governance(TCWG) must
determine the appropriateness of the methods andresults of the audit. Since KAMs are selected frommatters communicated to TCWG, they would needto express their views on KAMs in their report.

15

16
14
12

10

10

10
8

6

5

6
4

2

4

4
2

2
0

J-GAAP
日本基準

US-GAAP,
IFRS
米国基準・IFRS

Reasons for “b. No”

Total
合計

 The annual securities report is generally filed after
the AGM. Given the importance of the AGM and thatthe report from TCWG is presented at the AGM, it ishard to imagine that the report from TCWG would
not refer to KAM.
 Improvement of the report from TCWG will also
likely be requested.

 Since the report from TCWG is prepared based on their conclusion on the appropriateness of the methods
and results of the audit, the descriptions of their report will not be affected.
 Since KAM is communicated by the auditor in the auditor’s reports, and TCWG do not assume any
statutory obligations or liabilities on it, it is unlikely that the responsibility of TCWG relating to their reportwill be affected.
 Given that KAM will be determined upon robust discussion between the auditor, the CFO and TCWG, there
will be no impact on the report from TCWG.
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23

Time Required for the Trial Run◆ Approximate number of hours requiredby companies(Unit: hours)
Average

MedianManagement (CFO)

5.41

3.00

Accounting divisions

14.73

Those charged with
GovernanceStaff for those charged
with governance
Total◆ Approximate number of hours requiredby the auditors(Unit: hours)
Average

MedianPartner

36.10

26.75

7.50

Manager

36.37

29.75

6.64

3.00

Senior staff

3.40

0

5.55

4.00

Total

75.87

59.00

32.33

18.00

Comments• As the period for the trial run was limited (approx. 1 month), we only selected matters that were clearlysignificant and that had already been subject to robust communications with management and those charged
with governance. Consequently, there were hardly any conflicts of opinion within the audit team or with thecompany.
• As the trial run was conducted for the prior year audit, there was no need to discuss the disclosures of thefinancial statements. Therefore, discussion within the audit team and with the company on the descriptions of
KAM did not go into depth comparing to those that should be necessary if communicating KAM in the current
audit.
• The time we spent on this trial run will not be useful information in considering the time required if KAM is
required.
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24Factors which could impact the Time Required◆ For auditors◆ For companies
70

63

Factors that impact the number ofhours of deliberation

60

60

Factors that impact the number ofaudit hours

53

50

41

50

40

39

40

30
30

21
20

25

23

12
8

10

19

20

17
1

3

0

0

10

1

0

4

1

0

a

ｂ

c

d

e

f

g

h

i

a

b

c

d

e

f

g

h

i

a. The number of items and contents of potential KAM

The top 3 factors that could impact:• For the companies
Þ Time spent for discussion withaudit firm
• For the audit firm
Þ Audit hours

b. The depth of regular communications between management and the auditor
c. The depth of regular communications between TCWG and the auditor
d. The auditor’s communication skills
e. The extent of differences in opinions between management and the auditorf.

Those charged with governance understanding of the audit

g. Management’s understanding of the audit
Weighted aggregation:
Sum of 1st = 3 points, 2nd = 2 points and3rd = 1 point.

h. The company’s disclosure (including statutory disclosures and voluntary IR )i.

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25

Additional Time to be Required(Replies from companies)(Question)
If KAM is required, how much additional time will be needed?
16
14
12
10
8
6
4
2
0

15
a. Hardly any difference
9b. Slightly more timec. Significantly more time5d. Others
1ab
Major comments made under “d. Others”

cd It will be between b. and c.
 It will depend on the extent of differences in opinions between management and the auditor.
 It will depend on the contents and volume of potential KAM.
 If the descriptions of KAM includes matters beyond the company’s disclosures, substantial time will be
required for discussion and communication between the auditor and the company.
 Currently, there is already sufficient communication with the auditor, and appropriate disclosures inaccordance with the accounting standards have already been made. Therefore, additional disclosures would
not be required. However, more time will be necessary for discussion with the auditor.
 We cannot expect it now.

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26

Additional Time to be Required(Replies from the auditors)(Question)
If KAM is required, how much additional time will be needed?
a. Hardly any differenceb. The additional time needed will be in proportion to the size of the engagement.
Total audit hours, including for quality control, will increase by ( )%.
c. The additional time needed will be roughly the same regardless of the size of the engagement.
Total audit hours, including for quality control, will increase by ( ) hours.
d. Others
Numbers for b. Less than 3%
3 to 5%5%Major comments

3 cases
1 case1 caseNumbers for c. Less than 50 hours
50 to 100 hours
100 to 200 hours
Don’t know

0
5
12
9

4 cases
4 cases
3 cases
1 cases Additional time will depend greatly not on the size of the engagement but on the complexity of the company
and the audit, the number of KAM, the company’s disclosure level and understanding of KAM, thecompany’s significant issues and the company’s attitude.
 Additional time will depend on the extent the auditor has already communicated to the company significant
matters in the audit.
 It will depend on the size and complexity of the engagement but it will also be affected by changes in the riskof material misstatements due to the changes in the business environment (including changes in businessperformance) and changes in audit procedures.
 The audit hours will increase depending on the number of KAM in the first year but from the second year,
there should not be such an increase .
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The Japanese Institute ofCertified Public Accountants

IV.

Issues to be Addressed in Achieving
the Intended Purpose ofCommunicating KAM

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Issues to be Addressed in Achieving theIntended Purpose (1)We asked both companies and auditors about issues related to the system and issues for eachstakeholder that need to be addressed in achieving the intended purpose.
Issues relating to the system
Replies from companies

Replies from auditors

 Promoting better understanding of the purpose of KAM
communication (e.g., KAM does not indicate a weakness ofthe company)

 Promote the user’s understanding of KAM(e.g. KAM is determined by the auditor’s judgment based on arelative significance of the matters to the individual audit, and it
is not necessarily comparable between entities)

 The disclosure system according to the Companies Act andthe Financial Instruments and Exchange Act
 Revision of the disclosure system/standards
 Clarification of the issues concerning original information(including liability issues on shareholder derivative actions) The impact on audits pursuant to the Companies Act andthe responsibility of those charged with governance (e.g.,when those charged with governance and management
have different views, the scope of “those charged withgovernance”)

 Consideration for effective introduction of KAM taking into
account Japan’s cultural background (e.g., preference forhomogeneity), consideration of the impact on corporate activities
such as IR Enhancement and improvement of the disclosure standards(including other information in the annual securities report)
 Clarification of the issues on original information
 The impact on audits pursuant to the Companies Act

 Accountability regarding KAM at AGM and IR

 Clarification of legal liabilities of those charged with governanceregarding KAM

 If an event occurring during the period is determined to be
KAM, the necessity of timely disclosure from the company

 Auditor’s responsibility if the event not described in KAM
emerges on a subsequent date

 The relationship between the PCAOB standards applied to
US SEC-registered entities and J-GAAP How to communicate KAM in the audit of the restated financial
statements
 How to communicate KAM that could impact both financial
statement audits and internal control audits

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 The
differencewith PCAOB standards

29

Issues to be Addressed in Achieving theIntended Purpose (2)Issues to be addressed by auditors
Issues for auditors
Replies from companies

Replies from auditors

 Review of the audit plan and approaches

 More robust and early communication with the company

 Commencement of communications early with theauditor, and sufficient consideration of KAM

 How to make the descriptions more user-friendly and whatlevel of descriptions is expected A deeper understanding of the company’s business Maintain the balance between standardized and companyspecific descriptions of KAM, and prevent lengthy andboilerplate descriptions and the attitude of “following what
others do”

 Consideration of the company’s disclosure, userfriendly descriptions of KAM, the audit firms’ behavior
and action to prevent inconsistencies between the levelof precision of the descriptions by the auditors andboilerplate descriptions.

 Whether consistency of the descriptions of KAM within anaudit firm is needed (the degree of details and thedescriptions to be included) Issues when there is a disagreement between thecompany and the auditor

 Improve audits of note disclosures

 Issues about information for which public disclosure is
not appropriate (e.g., pending litigation)

 Ensure sufficient discussion, human resources and audit
remuneration

 Establish rules to discourage KAM from becoming
excessively conservative, and complacent and selfserving for the auditor

 Improve efficiency of audit procedures, and issues whenthe event occurred after the period end is determined to be
KAM Improve the efficiency of the audit process;concerns that it would lead to excessive audit
procedures

 Establishment of quality control system including theengagement quality control review

 Additional burden under the already-tight audit
schedule Issues when accounting irregularity is discovered (e.g.,
litigation risk)

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30

Issues to be Addressed in Achieving theIntended Purpose (3)Issues to be addressed by companies
Issues for companies to address
Replies from companies
 A culture that fosters sharing of risk information withauditors

Replies from auditors
 Proactive consideration for disclosing information
related to selected KAM

 Foster the company’s positive attitude that KAM is agood opportunity for general investors andshareholders to understand the entity’s business Concerns that the company may ask the auditor toalign with other companies in the same industry interms of the number of KAM and the level ofdescriptions
 Early disclosure to and information sharing with auditors Sufficient communication with the auditor (including Ensuring sufficient time for discussion with the auditor
communication with persons other than the CFO
 Increase in workload, time and resources required
and accounting division staff)
regarding the request for additional disclosures in Management’s and those charged withfinancial statements and IR, and increased audit costs
governance’s understanding of audits including Reconsideration of the account-closing schedule,
KAM
enhancement of human resources and improvement of Concerns that whether those charged withthe efficiency of the account closing process
governance in all companies can conduct Extra burden for English translations
meaningful discussions on KAM
 The company’s human resources(e.g. the number of staff, impact of personnel
transfers)

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Issues to be Addressed in Achieving theIntended Purpose (4)Issues to be addressed by users
Issues on the user’s side
Replies from companies

Replies from auditors

 Appropriate understanding of the descriptions of
KAM (KAM is not an alert from the auditor),lowering unreasonable expectations for KAM,
and sufficient understanding that KAM is not a
separate opinion on individual matters

 Appropriate understanding of the descriptions of
KAM (users’ education is necessary, for example,
on the nature of KAM, to prevent unreasonable
expectations, and on the difference between theauditor’s overall opinion and the results of theauditor’s response to individual matters, etc.)

 Improve the accounting literacy of users

 Concerns of improper company comparisons bycompanies with KAM

 Concerns whether KAM will be usedappropriately. For example, users may
incorrectly use KAM for comparison between
companies.

 Acquire accounting and audit knowledge at leastnecessary to understand KAM

 Doubt on whether KAM will really be utilized andwhether it will be useful to users

 Users themselves need to consider how they will
utilize KAM to make investment decisions

 Guidance will be needed for dialogue withinvestors regarding KAM

 User groups’ analysis to promote improvementsin the description of KAM
 Concerns over superficial analysis that only
focuses on the number of KAM, the sum of items
and trends rather than the substance

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32

Applicability of KAM
Companies and auditors were asked to comment freely on the applicability, effective date, preparation
period and other points of concern.
Applicability of KAM
Replies from companies

Replies from auditors

 Given disclosure status and the timing, KAM should be applied (first)
to audits for the consolidated financial statements pursuant to the
Financial Instruments and Exchange Act. (14 replies) Given disclosure status and the timing, KAM should beapplied to audits for the consolidated financial statements
pursuant to the Financial Instruments and Exchange Act. (19replies) KAM should be applied to audits pursuant to the Financial
Instruments and Exchange Act. (4 replies) KAM should be applied to audits pursuant to the Financial
Instruments and Exchange Act and the Companies Act, and both theconsolidated and the non-consolidated financial statements.
(1 replies) KAM should be applied to audits pursuant to the Financial
Instruments and Exchange Act and the Companies Act. (3 replies) The system of requiring companies to prepare two sets of financial
statements pursuant to two laws (Financial Instruments andExchange Act and the Companies Act) should be firstly repealed.
And then, KAM should be adopted.
 If KAM were only applied to audits pursuant to the Financial
Instruments and Exchange Act, considering the relationship between
the information disclosed pursuant to the Companies Act, how tovalidate disclosed information pursuant to the Companies Act, andthe revision of the timing of submitting the annual securities report (itis common practice that it is submitted after the general meeting ofshareholders) is necessary.

 KAM should be applied to audits pursuant to the Financial
Instruments and Exchange Act. (1 replies) KAM should be applied to audits pursuant to the Financial
Instruments and Exchange Act and the Companies Act, andboth the consolidated and the non-consolidated financial
statements. (1 replies) If KAM were only applied to audits pursuant to the Financial
Instruments and Exchange Act, the date that the company
submits the annual securities report should be moved up
before the date of the general meeting of shareholders.
 If KAM were adopted under the current tight financial reportand audit schedule, which allow little or no flexibility, thebenefits of KAM may not be fully be achieved. If sufficient
preparation periods were ensured, such as through phased
adoption, it would be possible to apply KAM for all, i.e. toaudits pursuant to the Financial Instruments and Exchange
Act and the Companies Act, and to consolidated and nonconsolidated financial statements. This would make thebenefit of KAM understood by a wider range of stakeholders.

 KAM should not be applied uniformly to all listed companies but
should be firstly adopted for audits of companies with large market
caps.
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33

Preparation Period and Other Matters
Preparation period and other matters (free comments)
Replies from companies

Replies from auditors

 A deep understanding of the new requirement isessential and thus a substantial preparation period isnecessary.

 A deep understanding of the new requirement isessential and thus a substantial preparation period isnecessary.

 It is necessary to clarify how to discuss matters. Indepth discussion should be carried out.

 A reasonable preparation period is required to promoteusers’ proper understanding of the new requirement .

 Care should be taken not to further burden companies
that are engaged in legitimate and fair financial
reporting by excessive reinforcement of audit
procedures.

 A period to discuss ideal corporate disclosures isnecessary.

 We should study the implementation experience ofother countries that have already adopted KAM.

 We need to promote discussion to integrate thefinancial statements pursuant to the Financial
Instruments and Exchange Act and the financial
statements pursuant to the Companies Act.

 Issues need to be addressed as soon as possible fromthe perspective of international comparisons.

 In cases where the parent and its subsidiaries operate
in different markets, the qualitative differences (e.g.,differences in standards and in practices) need to be Care is necessary regarding the submission deadline
considered.
and the contents of the description, given that KAM willneed to be translated into English for overseas
 We need to conduct another trial run in the period priorinvestors.
to formal adoption of KAM, wherein the company andthe auditor, without disclosures, take one year to The point is whether KAM will instigate dialogue
discuss the matters so that both parties accumulate
between companies and stakeholders, and thus plain
know-how through actual preparation of KAM.
expressions easily understood by users are preferable.
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The Japanese Institute ofCertified Public Accountants

V. Conclusion

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Based on the Results of the Trial Run• Improved transparency of audits (promotes understanding of audits and accounting)Purpose andexpected benefits

Cost-effectiveness• Deeper communication between the auditor and management / those charged withgovernance relating to the impact of higher risks on financial statements• Positive impact on the companies’ public reporting and corporate governance; forexample, disclosures in annual securities reports and IR, dialogue with shareholders
and reports from those charged with governance.

• [Effects] In addition to the above, it will not change, but deepen, audit methods.
Þ Toward thinking audit• [Costs] Will not necessarily require a large amount of additional time in each case.

• Establish and promote an understanding of the purpose of KAM• Must raise awareness of each stakeholder to improve auditor reporting.
Issues to beaddressed inachieving theintended purpose(success factors)

 Continuous improvement of the environment and financial reporting regime
 Auditors ⇒ strong attitude of providing meaningful audit information to users ofauditor reports
 Companies ⇒ proactive attitude towards better disclosures and audits Users ⇒appropriate and correct use of auditor reports and financial reports
including KAM
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36

The Japanese Institute ofCertified Public Accountants

Thank you.

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