Understanding Standard on Auditing (SA) 706 (Revised): Emphasis of Matter Paragraphs and Other Matter Paragraphs in the Independent Auditor’s Report
> Introduction
The auditing landscape has seen significant evolution over the years, aiming to enhance the clarity, transparency, and reliability of financial statements. One crucial aspect of this evolution is the Standard on Auditing (SA) 706 (Revised), which pertains to the inclusion of Emphasis of Matter (EOM) paragraphs and Other Matter (OM) paragraphs in an independent auditor’s report. These paragraphs serve to highlight significant aspects that are critical to the users’ understanding of the financial statements and the auditor’s report. This article delves into the various facets of SA 706 (Revised), elucidating its scope, objectives, requirements, and practical implications, thus providing a comprehensive understanding of its importance in auditing.
> Scope of SA 706
SA 706 (Revised) is particularly concerned with situations where additional communication in the auditor’s report is necessary for the users’ comprehension of the financial statements. The standard identifies two primary scenarios: the inclusion of Emphasis of Matter paragraphs and Other Matter paragraphs.
- Emphasis of Matter Paragraphs
Emphasis of Matter paragraphs are incorporated in the auditor’s report to draw attention to matters that are already presented or disclosed in the financial statements. These matters are of such significance that they are fundamental to users’ understanding of the financial statements. The inclusion of such paragraphs ensures that important information is not overlooked and is given the attention it deserves.
- Other Matter Paragraphs
Other Matter paragraphs, on the other hand, refer to issues that are not presented or disclosed in the financial statements but are relevant to the users’ understanding of the audit, the auditor’s responsibilities, or the auditor’s report. These paragraphs provide additional context and clarity, ensuring that users have a holistic understanding of the financial reporting and auditing process.
Effective Date
The revised SA 706 came into effect for audits of financial statements for periods beginning on or after April 1, 2018. This effective date signifies the period from which auditors are required to comply with the revised standards, ensuring that the auditing practices align with the latest guidelines and provide the necessary clarity and transparency in their reports.
> Objective
The primary objective of SA 706 (Revised) is to ensure that auditors, having formed an opinion on the financial statements, communicate additional information that is critical to users’ understanding. This communication is facilitated through the inclusion of Emphasis of Matter and Other Matter paragraphs in the auditor’s report.
- Emphasis of Matter Paragraphs
Emphasis of Matter paragraphs are included to highlight matters that are fundamental to users’ understanding of the financial statements. These matters are already presented or disclosed in the financial statements, and their significance warrants special attention. By emphasizing these matters, auditors ensure that users are aware of their importance and can consider them appropriately in their analysis and decision-making processes.
- Other Matter Paragraphs
Other Matter paragraphs provide additional information relevant to users’ understanding of the audit, the auditor’s responsibilities, or the auditor’s report. These paragraphs are included when there are matters that, although not presented or disclosed in the financial statements, are necessary for a comprehensive understanding of the financial reporting and auditing context.
> Definitions
Understanding the definitions provided in SA 706 (Revised) is crucial for comprehending its application and implications.
- Emphasis of Matter Paragraph
An Emphasis of Matter paragraph refers to a paragraph included in the auditor’s report that draws attention to a matter appropriately presented or disclosed in the financial statements. In the auditor’s judgment, this matter is fundamental to users’ understanding of the financial statements.
- Other Matter Paragraph
An Other Matter paragraph refers to a paragraph included in the auditor’s report that draws attention to a matter other than those presented or disclosed in the financial statements. This matter, in the auditor’s judgment, is relevant to users’ understanding of the audit, the auditor’s responsibilities, or the auditor’s report.
> Requirements
The requirements outlined in SA 706 (Revised) guide auditors on when and how to include Emphasis of Matter and Other Matter paragraphs in their reports.
- Emphasis of Matter Paragraphs
When an auditor decides to include an Emphasis of Matter paragraph, the following requirements must be met:
– The paragraph should refer to the information presented or disclosed in the financial statements.
– It should indicate that the auditor’s opinion is not modified with respect to the matter emphasized.
– The paragraph should be included immediately after the opinion paragraph in the auditor’s report.
– The heading “Emphasis of Matter” should be used to distinguish this paragraph from other content in the report.
– The auditor should communicate with those charged with governance regarding the inclusion of the Emphasis of Matter paragraph and the wording used.
- Other Matter Paragraphs
For Other Matter paragraphs, the requirements are as follows:
– The paragraph should draw attention to a matter not presented or disclosed in the financial statements but is relevant to the users’ understanding of the audit, auditor’s responsibilities, or the auditor’s report.
– The inclusion of such a paragraph should not be prohibited by law or regulation. – The matter should not have been determined to be a key audit matter under SA 701.
– The heading “Other Matter” should be used to distinguish this paragraph from other content in the report.
– The auditor should communicate with those charged with governance regarding the inclusion of the Other Matter paragraph and the wording used.
> Communication with Those Charged with Governance
Effective communication with those charged with governance is an essential aspect of the audit process. Before including an Emphasis of Matter or Other Matter paragraph in the auditor’s report, the auditor should discuss the proposed inclusion and the wording of such paragraphs with those charged with governance. This communication ensures that there is a mutual understanding of the significance of the matters being emphasized and the rationale behind their inclusion in the auditor’s report.
> Application and Other Explanatory Material
SA 706 (Revised) provides detailed application guidance and explanatory material to assist auditors in the practical implementation of the standard. This guidance includes examples and scenarios where Emphasis of Matter and Other Matter paragraphs might be necessary, the relationship between these paragraphs and key audit matters, and the appropriate placement of such paragraphs in the auditor’s report.
> Emphasis of Matter and Key Audit Matters
There is a distinction between Emphasis of Matter paragraphs and key audit matters as outlined in SA 701. While key audit matters are those that, in the auditor’s professional judgment, were of most significance in the audit of the financial statements, Emphasis of Matter paragraphs highlight matters that are already presented or disclosed in the financial statements but are fundamental to users’ understanding. The application material provides guidance on how to distinguish between these two types of matters and appropriately communicate them in the auditor’s report.
> Circumstances Requiring Emphasis of Matter Paragraphs
The application guidance includes various circumstances where an Emphasis of Matter paragraph might be necessary. For example, if there is a significant uncertainty relating to the outcome of a litigation case that is appropriately disclosed in the financial statements, the auditor may decide to include an Emphasis of Matter paragraph to draw attention to this uncertainty.
> Placement of Emphasis of Matter and Other Matter Paragraphs
The standard also provides guidance on the placement of Emphasis of Matter and Other Matter paragraphs in the auditor’s report. Typically, these paragraphs are included immediately after the opinion paragraph to ensure that they are prominent and clearly distinguished from other content in the report.
> Illustrative Examples
To facilitate a better understanding of the application of SA 706 (Revised), the standard includes illustrative examples of auditor’s reports that incorporate Emphasis of Matter and Other Matter paragraphs. These examples serve as practical references for auditors, helping them to understand how to appropriately apply the requirements of the standard in different scenarios.
- Example of Emphasis of Matter Paragraph
Emphasis of Matter (EOM) paragraphs are included in an auditor’s report to draw attention to matters already presented or disclosed in the financial statements. These matters are fundamental to the users’ understanding of the financial statements. Below are a few illustrative examples of EOM paragraphs to provide clarity on how and when they can be appropriately included in an auditor’s report.
- Example 1: Significant Uncertainty Relating to Going Concern
In this scenario, the financial statements disclose a significant uncertainty regarding the entity’s ability to continue as a going concern.
Emphasis of Matter
We draw attention to Note X in the financial statements, which describes the significant uncertainty the company faces regarding its ability to continue as a going concern. As stated in Note X, the company incurred a net loss of $Y during the year ended December 31, 20XX and, as of that date, the company’s current liabilities exceeded its current assets by $Z. These conditions, along with other matters as set forth in Note X, indicate the existence of a material uncertainty that may cast significant doubt about the company’s ability to continue as a going concern. Our opinion is not modified in respect of this matter.
- Example 2: Litigation and Legal Claims
The financial statements include disclosure about a significant litigation that could have a substantial impact on the company’s financial position.
Emphasis of Matter
We draw attention to Note Y in the financial statements, which describes the company’s exposure to significant litigation. The company is currently involved in legal proceedings with potential claims amounting to $X. The outcome of these legal proceedings is uncertain and could significantly affect the company’s financial position. Our opinion is not modified in respect of this matter.
- Example 3: Early Adoption of an Accounting Standard
The financial statements disclose that the company has early adopted a new accounting standard that significantly affects the financial statements.
Emphasis of Matter
We draw attention to Note Z in the financial statements, which explains that the company has early adopted IFRS 15, Revenue from Contracts with Customers, with a date of initial application of January 1, 20XX. As a result, the company has changed its accounting policy for revenue recognition as detailed in Note Z. Our opinion is not modified in respect of this matter.
- Example 4: Catastrophic Event
The financial statements disclose the impact of a catastrophic event that occurred during the year and significantly affected the company’s operations.
Emphasis of Matter
We draw attention to Note W in the financial statements, which describes the effects of the recent natural disaster that significantly affected the company’s operations and financial performance. As stated in Note W, the disaster caused substantial damage to the company’s facilities and disrupted its operations for several months. Our opinion is not modified in respect of this matter.
- Example 5: Change in Accounting Policy
The financial statements include disclosure about a change in accounting policy that has a material effect on the financial statements.
Emphasis of Matter
We draw attention to Note V in the financial statements, which describes the change in accounting policy for inventory valuation from the weighted average cost method to the FIFO method. As stated in Note V, this change in accounting policy is to provide a more relevant and reliable presentation of the company’s financial position and performance. Our opinion is not modified in respect of this matter.
- Explanation of the Examples
In each of the above examples, the auditor includes an Emphasis of Matter paragraph to highlight a specific disclosure in the financial statements that is crucial for the users’ understanding. The key elements of an EOM paragraph include:
1. Reference to the Note: The paragraph refers to the specific note in the financial statements where the matter is disclosed.
2. Description of the Matter: A brief description of the matter is provided, explaining why it is significant.
3. Unmodified Opinion: The paragraph clarifies that the auditor’s opinion is not modified in respect of the emphasized matter.
- Example of Other Matter Paragraph
Other Matter (OM) paragraphs are included in an auditor’s report to draw attention to matters that are not presented or disclosed in the financial statements but are relevant to the users’ understanding of the audit, the auditor’s responsibilities, or the auditor’s report. Below are several illustrative examples of OM paragraphs to provide clarity on how and when they can be appropriately included in an auditor’s report.
- Example 1: Restriction on Distribution or Use of the Auditor’s Report
In this scenario, the auditor wants to communicate that the use of the auditor’s report is restricted.
Other Matter
This auditor’s report is intended solely for the information and use of the board of directors and management of ABC Company and is not intended to be and should not be used by anyone other than these specified parties.
- Example 2: Reporting on Supplementary Information
The auditor’s report includes information about the auditor’s responsibility for supplementary information presented with the financial statements.
Other Matter
Our audit was conducted for the purpose of forming an opinion on the financial statements as a whole. The supplementary information included in Schedule A is presented for purposes of additional analysis and is not a required part of the financial statements. Such information has been subjected to the auditing procedures applied in the audit of the financial statements and, in our opinion, is fairly stated in all material respects in relation to the financial statements as a whole.
- Example 3: Comparative Information – Predecessor Auditor’s Report
The auditor’s report includes a reference to a predecessor auditor’s report on the financial statements of the prior period.
Other Matter
The financial statements of ABC Company for the year ended March 31, 20XX, were audited by another auditor who expressed an unmodified opinion on those statements on March 31, 20XX.
- Example 4: Inconsistency in Other Information
The auditor’s report addresses an inconsistency identified in other information that accompanies the financial statements.
Other Matter
We obtained other information comprised of the annual report, which includes the financial statements and our auditor’s report thereon. We have identified a material inconsistency between the information presented in the Director’s Report and the financial statements, as described in Note X. Our opinion on the financial statements is not modified with respect to this matter.
- Example 5: Explanation of the Auditor’s Responsibility for the Audit of Internal Control Over Financial Reporting
The auditor includes an OM paragraph to explain their responsibility regarding the audit of internal control over financial reporting.
Other Matter
Our audit was conducted for the purpose of forming an opinion on the financial statements taken as a whole. We have not audited the internal control over financial reporting and accordingly, we do not express an opinion on the effectiveness of the company’s internal control over financial reporting.
- Explanation of the Examples
In each of the above examples, the auditor includes an Other Matter paragraph to provide additional information that is relevant to the users’ understanding of the audit, the auditor’s responsibilities, or the auditor’s report. The key elements of an OM paragraph include:
1. Description of the Matter: A brief description of the matter that is being brought to the users’ attention.
2. Explanation of the Relevance: A clear explanation of why the matter is relevant to the users’ understanding of the audit or the auditor’s report.
> Conclusion
SA 706 (Revised) is a pivotal standard in the field of auditing, designed to enhance the transparency and communicative value of auditor’s reports. By including Emphasis of Matter and Other Matter paragraphs, auditors can provide essential context and highlight significant issues, ensuring that users of financial statements have a clear and comprehensive understanding of the financial and auditing landscape.
The effective implementation of SA 706 (Revised) requires auditors to exercise professional judgment, communicate effectively with those charged with governance, and adhere to the detailed guidance provided in the standard. Through these efforts, auditors can uphold the integrity of financial reporting and contribute to the trust and confidence that users place in audited financial statements.
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Disclaimer:
This article provides general information existing at the time of preparation and author takes no responsibility to update it with the subsequent changes in the law. The article is intended as a news update and author neither assumes nor accepts any responsibility for any loss arising to any person acting or refraining from acting as a result of any material contained in this article. It is recommended that professional advice be taken based on specific facts and circumstances. This article does not substitute the need to refer to the original pronouncement.
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