Audit: Emphasis of Matter in going concern
Steve Collings explains how Emphasis of Matter paragraphs should be used in the auditor’s report and clarifies the requirement to report on material uncertainties related to going concern.
The use of Emphasis of Matter (EoM) paragraphs in the auditor’s report is often flagged during file reviews and the reviews of financial statements as these paragraphs are often used incorrectly.
The use of EoM paragraphs in auditors’ reports is likely to increase over the coming months given the pandemic. It is therefore useful to revisit the technical provisions to ensure EoM paragraphs are used correctly.
ISA (UK) 706 Emphasis of Matter Paragraphs and Other Matter Paragraphs in the Independent Auditor’s Report defines an ‘Emphasis of Matter paragraph’ as:
“A paragraph included in the auditor’s report that refers to a matter appropriately presented or disclosed in the financial statements that, in the auditor’s judgment, is of such importance that it is fundamental to users’ understanding of the financial statements.”
An EoM paragraph is used in the auditor’s report to make reference to a matter that is already presented or disclosed in the financial statements. The auditor can only emphasise something which is already there. ISA (UK) 706, para A5 provides four examples of circumstances where the auditor may consider it necessary to use an EoM paragraph as follows:
- An uncertainty relating to the future outcome of exceptional litigation or regulatory action.
- A significant subsequent event that occurs between the date of the financial statements and the date of the auditor’s report.
- Early application (where permitted) of a new accounting standard that has a material effect on the financial statements.
- A major catastrophe that has had, or continues to have, a significant effect on the entity’s financial position.
Objective of the EoM paragraph
The objective of an EoM paragraph is outlined in ISA (UK) 706, para 6. This paragraph states that the objective of the auditor, having formed an opinion on the financial statements, is to draw users’ attention, when in the auditor’s judgement it is necessary to do so, to:
- a matter which is appropriately presented or disclosed which is of such importance that it is fundamental to users’ understanding of the financial statements; or
- as appropriate, any other matter that is relevant to users’ understanding of the audit, the auditor’s responsibilities or the auditor’s report (note: this is usually through the use of an ‘Other Matter’ paragraph).
An EoM paragraph is never used as a substitute to modify the auditor’s opinion in any way and the EoM paragraph itself must clearly state this (see Example 2 below). If a material matter is not adequately presented or disclosed (or not disclosed at all) the auditor will modify the opinion.
Example one: Non-disclosure of a material post balance sheet event
Cory’s Construction Ltd has a year end of 30 June 2020. On 6 July 2020 one of its employees suffered a serious life-changing injury due to alleged negligence on the part of the company. The family of the employee have brought a legal claim against the business and are claiming significant damages from the company. The company is going to defend the claim as it does not believe it was negligent.
The finance director has refused to include any disclosures in the financial statements relating to this incident. In the auditor’s opinion, the company should provide a non-adjusting events disclosure which makes reference to the nature of the event and an estimate of its financial effect (where possible) or a statement that such an estimate cannot be made.
In this situation if the finance director refuses to make the required disclosures in the financial statements, the auditor will qualify the audit opinion. They will not include an EoM paragraph because there is nothing to emphasise and an EoM paragraph must not be used as a substitute for a modified audit opinion.
If, on the other hand, the finance director does make adequate disclosure, then the auditor will use an EoM paragraph if they judge the matter to be of such importance that it is fundamental to users’ understanding of the accounts.
It is important that the auditor appreciates that an EoM paragraph is only used to draw users’ attention to a matter already presented or disclosed in the accounts which is of such importance and fundamental to users’ understanding of the financial statements.
This is a high hurdle and so just because something has been adequately disclosed in the financial statements (for example, a post balance sheet event) it does not automatically mean that the auditor uses an EoM paragraph in their report. The post balance sheet event may be material but the auditor may judge it not to be of such importance and fundamental to the users’ understanding of the accounts.
When the auditor is planning to include an EoM paragraph in their report, they should document the reasons why they feel the matter is of such importance and fundamental to users’ understanding of the accounts.
It is expected that due to Covid-19, EoM paragraphs will be used more widely in auditors’ reports and they should only be used in justifiable circumstances.
Content and placement
When the auditor concludes that an EoM paragraph is appropriate, the paragraph must cross-refer to the relevant disclosure in the financial statements and must also clearly state that the auditor’s opinion is not modified in respect of the matter.
It is common practice to include the EoM paragraph after the Opinion paragraph although ISA (UK) 706 states that the placement depends on the nature of the information communicated, and the auditor’s judgement as to the relative significance of such information to intended users compared to other elements required to be reported in accordance with ISA (UK) 700 Forming an Opinion and Reporting on Financial Statements.
Example two: EoM paragraph
Ratchford Retailers Ltd is a clothing retailer operating from three stores with a year-end of 31 March 2020. The company’s stores were forced to close due to lockdown restrictions and on 7 April 2020 one of its stores suffered a fire, which is believed to have been started deliberately causing a significant amount of damage.
The finance director has included a non-adjusting events disclosure in the financial statements and the auditor has concluded that this disclosure is adequate and complies with the requirements of FRS 102, para 32.10. The auditor has also concluded that the matter is fundamental to the users’ understanding of the financial statements and has included the following EoM paragraph underneath the Opinion paragraph in the auditor’s report:
We have audited the financial statements …
Emphasis of matter
We draw your attention to Note 25 which describes the effects of a fire at one of the company’s stores. Our opinion is not modified in respect of this matter.
EoM paragraphs and going concern
EoM paragraphs are not used to refer to disclosures the entity makes in respect of material uncertainties relating to going concern. Again, in a Covid-19 environment it is likely that many entities will be making disclosures in respect of material uncertainties related to going concern. Where the auditor judges that such disclosures are adequate, the auditor uses a ‘Material Uncertainty Related to Going Concern’ (MURGC) paragraph (ISA (UK) 570 Going Concern, paragraph 22). This acts in a similar way to an EoM paragraph but is only used by the auditor to highlight a disclosure in respect of a material uncertainty in respect of going concern.
The MURGC paragraph is usually placed underneath the Basis for Opinion paragraph and must also cross-refer to the relevant disclosure in the financial statements and confirm the auditor’s opinion is not modified in respect of the matter.
Example 3 – MURGC paragraph
Basis for opinion
We conducted our audit in accordance …
Material Uncertainty Related to Going Concern
We draw your attention to Note 29 which indicates that the effects of the Covid-19 pandemic have had an adverse effect on the company’s operations and cash flow. As stated in Note 29, these events or conditions, along with other matters as set forth in Note 29 indicate that a material uncertainty exists that may cast significant doubt on the company’s ability to continue as a going concern. Our opinion is not modified in respect of this matter.
EoM and MURGC paragraphs are expected to be used more widely in auditors’ reports over the coming months as the effects of the pandemic continue to wreak havoc. It is therefore advisable for auditors to document the reasons why an EoM paragraph is appropriate in the circumstances to ensure they are only used when the matter presented or disclosed is fundamental to users’ understanding of the accounts.
In addition, auditors should also ensure they do not use an EoM paragraph to make reference to material uncertainties relating to going concern disclosures.