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Emphasis of matter paragraphs in the auditor’s report

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Emphasis of Matter paragraphs can cause headaches in the auditor's report. Which is why, as Steve Collings writes, it is important the auditor adequately documents the reasons why such a paragraph should be included.

27th Jun 2023
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Emphasis of Matter (EoM) paragraphs are dealt with in ISA (UK) 706 Emphasis of Matter Paragraphs and Other Matter Paragraphs in the Independent Auditor’s Report. Discussions with a number of file reviewers indicate there is often confusion about when an EoM paragraph is needed in an auditor’s report, and quite often an EoM paragraph is not required.

ISA (UK) 706 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.

The ‘key’ words in this definition are ‘… matter appropriately presented or disclosed in the financial statements’ and ‘… fundamental to users’ understanding of the financial statements.’ 

An EoM paragraph is used to refer to a matter which has been adequately presented or disclosed by the directors. If the auditor concludes that these matters are of such fundamental importance to users’ understanding, then an EoM paragraph is appropriate. It is always worthwhile documenting the reasons in arriving at that conclusion as well so a reviewer can understand the reasoning behind the inclusion of an EoM paragraph. 

Not every auditor’s report will include an EoM paragraph because not every matter disclosed or presented in the financial statements will be fundamental to users’ understanding of the accounts. What is, and what is not, fundamental will be a matter of professional judgement for the auditor. However, such matters may include the following (note, the list below is not exhaustive):

•    the client’s financial statements have been prepared on a basis other than the going concern basis;
•    there is an uncertainty relating to the future outcome of a material legal case or regulatory action;
•    a significant post-balance sheet event occurs between the balance sheet date and the date of the auditor’s report;
•    the entity early adopts an accounting standard (or an amendment to an accounting standard);
•    a major catastrophe has occurred that has had a significant effect on the entity’s financial position;
•    corresponding figures have been restated; and
•    the financial statements have been reissued and the auditor has provided an amended auditor’s report.

When the auditor concludes that an EoM paragraph is appropriate, ISA (UK) 706, para 9 outlines the process involved as follows:

When the auditor includes an Emphasis of Matter paragraph in the auditor’s report, the auditor shall:

a)    Include the paragraph within a separate section of the auditor’s report with an appropriate heading that includes the term “Emphasis of Matter”;

b)    Include in the paragraph a clear reference to the matter being emphasized and to where relevant disclosures that fully describe the matter can be found in the financial statements. The paragraph shall refer to only to information presented or disclosed in the financial statements; and

c)    Indicate that the auditor’s opinion is not modified in respect of the matter emphasized. 

Audit firms must keep in mind that an EoM paragraph is only used by the auditor to emphasise a point that has already been adequately disclosed or presented. It is not to be used for anything else. The EoM paragraph must also cross-refer to the relevant disclosure note in the financial statements (ISA (UK) 706, para 9(b)).

A couple of examples are best to illustrate the inappropriate use of an EoM paragraph together with why they are inappropriate:

Example – Incorrect use of an EoM paragraph (1)

The financial statements of XYZ Ltd for the year ended 31 March 2023 contain a disclosure of a material uncertainty related to going concern. The auditor is satisfied that the going concern disclosure in the financial statements is adequate.
    
The audit engagement partner considers the going concern disclosure to be fundamental to users’ understanding of the financial statements and has included the following:

‘Emphasis of Matter

We draw your attention to note 20 in the financial statements which confirms the existence of a material uncertainty related to going concern. The company’s borrowing facilities are due for renewal after the financial statements have been authorised for issue and it is currently uncertain whether the bank will renew those borrowing facilities. As stated in note 20, these events or conditions 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.’ 

Under ISA (UK) 570 Going Concern, where an entity has adequately disclosed a material uncertainty related to going concern, the auditor does not use an EoM paragraph. Instead, they must comply with ISA (UK) 570, para 22 and include the issue under a separate heading ‘Material Uncertainty Related to Going Concern’ in the auditor’s report. 

Example – Incorrect use of an EoM paragraph (2)

The audit of ABC Ltd for the year ended 31 March 2023 revealed a number of misstatements which the auditor has concluded as being immaterial both in isolation and when aggregated. The directors decided not to adjust the financial statements on the grounds that the misstatements were immaterial.

The audit engagement partner has placed the following comment on the completion section of the audit file:

‘To err on the side of caution, I deem an Emphasis of Matter paragraph to be appropriate in these circumstances. When drafting the auditor’s report, I suggest we refer to there being a number of unadjusted misstatements which are immaterial in isolation and in the aggregate and confirm that our opinion is not modified in respect of these misstatements.’ 

There are some flawed points to the partner’s logic in concluding that an EoM paragraph is needed in this situation:

•    An EoM paragraph can only be used when a matter has been adequately disclosed in the financial statements as the paragraph must cross-refer the user to the relevant disclosure note.
•    In this situation, there is no disclosure note that can be cross-referred to as the company will not have made any disclosures concerning immaterial misstatements that remain uncorrected.
•    There is no need to include an EoM paragraph in the auditor’s report in respect of immaterial misstatements because the mere fact they are immaterial means they do not warrant the attention of the shareholders.
•    There would be no need to confirm that the audit opinion is not modified in respect of the immaterial misstatement as an auditor’s opinion would never be modified (qualified) for misstatements that are immaterial in isolation and in the aggregate. 

On the flip side, there may be situations when an EoM paragraph is justified as can be seen in the following example:

Example – Post-balance sheet event

The audit of the financial statements of DEF Ltd for the year ended 31 March 2023 has drawn to a close and the auditor’s report is being drafted. During the audit, the audit senior discovered that one of the client’s bonded warehouses had suffered a fire that had destroyed a large amount of stock. The fire occurred in mid-April 2023 and so the inventory has not been written down to estimated selling price less costs to complete and sell as the event is a non-adjusting post-balance sheet event. The auditor has concluded that adequate disclosure has been made in the financial statements concerning this event and that the event is fundamental to the users’ understanding of the accounts.

In this situation, an EoM paragraph would be appropriate and may be drafted as follows:

Emphasis of Matter

We draw attention to note 34 of the financial statements, which describes the effects of a fire at the premises of a third party warehouse provider. Our opinion is not modified in respect of this matter. 

Placement of the EoM paragraph in the auditor’s report

ISA (UK) 706, para A16 states that the placement of an EoM paragraph will depend on the nature of the information to be communicated and the auditor’s judgement as to the relative significance of such information to intended users compared to other elements required under ISA (UK) 700 Forming an Opinion and Reporting on Financial Statements.

In practice, it is common to include an EoM paragraph immediately after the Opinion paragraph. 

Conclusion

EoM paragraphs seem to present a number of issues when it comes to the auditor’s report. In some cases a reviewer may challenge the inclusion of an EoM paragraph and hence this is why it is important that the auditor adequately documents the reasons as to why such a paragraph should be included in the auditor’s report.

More importantly, an EoM paragraph cannot be used as a substitute for a modified audit opinion as that is not what such a paragraph is intended to be. In any case, the auditor must always confirm that an EoM paragraph does not modify the opinion in respect of the matter being emphasised.

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