An emphasis-of-matter paragraph points the reader to something already disclosed in the financial statements that is fundamental to understanding them. An other-matter paragraph covers something not presented or disclosed in the statements that is relevant to understanding the audit, the auditor's responsibilities, or the auditor's report. Both are governed by AU-C 706, which is effective for audits of periods ending on or after December 15, 2021. Neither changes the opinion.
The AU-C 706 standards page summarizes the section. This guide is about drafting: the elements each paragraph needs, which examples the standard gives, and the sections that force one into the report.
When can the auditor add an emphasis-of-matter paragraph?
Paragraph .08 allows an emphasis-of-matter paragraph when the auditor considers it necessary to draw attention to a matter appropriately presented or disclosed in the financial statements that is of such importance that it is fundamental to users' understanding. Two conditions apply:
- the auditor would not be required to modify the opinion under AU-C 705 because of the matter; and
- when AU-C 701 applies, the matter has not been determined to be a key audit matter.
Application material A4 gives four examples of circumstances where one may be necessary:
- uncertainty about the future outcome of unusually important litigation or regulatory action;
- a significant subsequent event between the balance sheet date and the report date;
- a major catastrophe that has had, or continues to have, a significant effect on financial position or results; and
- significant transactions with related parties.
A5 sets the boundary: the paragraph refers only to what is presented or disclosed in the statements. Adding information beyond the disclosure "may raise questions about the appropriateness of such presentation or disclosure."
What must an emphasis-of-matter paragraph contain?
Paragraph .09 sets three requirements. The paragraph must:
- sit in a separate section of the report with an appropriate heading (and when key audit matters are communicated, the heading must include "Emphasis of Matter");
- clearly reference the matter and where the relevant disclosures that fully describe it can be found in the statements; and
- state that the auditor's opinion is not modified with respect to the matter.
The standard's own litigation example reads as follows in outline: under the heading "Emphasis of Matter," "As discussed in Note X to the financial statements, ABC Company is a defendant in a lawsuit [brief description consistent with the note]. Our opinion is not modified with respect to this matter."
A6 allows extra context in the heading, such as "Emphasis of Matter, Subsequent Event," to distinguish it from individual KAMs. Placement is a judgment call (A14). With a KAM section, the paragraph may sit directly before or after it.
When is an other-matter paragraph appropriate?
Paragraph .10 applies to a matter other than those presented or disclosed in the statements that is relevant to users' understanding of the audit, the auditor's responsibilities, or the report. The heading is "Other Matter" or another appropriate heading (paragraph .11).
The standard's examples:
- Scope limitation where withdrawal is not possible (A9). When the auditor cannot withdraw from the engagement even though a management-imposed scope limitation could have a pervasive effect, an other-matter paragraph may explain why withdrawal is not possible.
- Responsibilities or report content required or permitted by law, regulation or generally accepted practice (A10). Multiple matters under one "Other Matter" section can take subheadings.
- More than one set of statements (A12). An entity prepares GAAP statements and another general purpose framework set, and the auditor reports on both. The paragraph states that the other set exists and that a report was issued on it.
- Updated report on a prior period with a different opinion (Illustration 3 in Exhibit A). The prior-period report expressed an adverse opinion, and the updated report expresses a different one.
A13 limits the content. The paragraph reflects that the matter is not required to be presented in the statements. It excludes anything the auditor is prohibited from providing by law, regulation or ethical standards on confidentiality, and anything management is required to provide. A11 adds that an other-matter paragraph does not address additional reporting responsibilities beyond GAAS or reporting on additional specified procedures.
Which AU-C sections make a paragraph mandatory?
Paragraph .04 and Exhibits B and C list the sections that require one. For emphasis of matter:
- AU-C 560, paragraph .16c (management revises the financial statements after facts are discovered and the opinion on the revised statements differs from the one previously expressed, which can be disclosed in either kind of paragraph);
- AU-C 708, paragraphs .08 to .09 and .11 to .13 (consistency: a material change in accounting principle, a change in reporting entity, a material investee change under the equity method, or restatement to correct a material misstatement in previously issued statements); and
- AU-C 800, paragraphs .19 and .21 (special purpose frameworks).
For other matter, the list includes AU-C 560 .16c (same circumstance), AU-C 700 (paragraphs .55 to .56 and .58 to .59), AU-C 703 for ERISA plans, AU-C 800 .20, AU-C 806 .13 and AU-C 905 .07. When one of these applies, the form requirements in AU-C 706 still apply (paragraph .04).
For example, a company changes inventory costing from FIFO to average cost with a material effect, and the change is preferable and properly disclosed. AU-C 708 .08 requires an emphasis-of-matter paragraph describing the change and referring to the disclosure. See the changes in accounting principle guide for the accounting side.
How do these paragraphs relate to going concern and KAMs?
If substantial doubt about going concern remains after considering management's plans, AU-C 570 requires a separate section headed "Substantial Doubt About the Entity's Ability to Continue as a Going Concern" (A2). An emphasis-of-matter paragraph is not a substitute for it (A7). If the doubt is alleviated by management's plans and the disclosure is adequate, the auditor may use an emphasis-of-matter paragraph referring to management's disclosures (A2). See the AU-C 570 going concern guide.
Where AU-C 701 applies, an emphasis paragraph is not a substitute for describing an individual KAM (A1). See key audit matters under AU-C 701. Illustration 2 in Exhibit A shows a report with all three: a KAM section, an emphasis-of-matter paragraph (a post-year-end fire disclosed in the statements), and an other-matter paragraph.
Who must be told before the report goes out?
Paragraph .12: if the auditor expects to include either paragraph, the auditor communicates with those charged with governance about the expectation and the wording. A16 says this lets them understand what will be highlighted and ask for clarification. If the same other-matter paragraph recurs every year, the auditor may decide that repeating the communication is unnecessary.
Frequently asked questions
Can we put an emphasis paragraph on a matter that is not in the notes?
No. Paragraph .09b says the paragraph refers only to information presented or disclosed in the financial statements. A matter outside the notes belongs in an other-matter paragraph or needs a disclosure first.
Does an emphasis-of-matter paragraph affect the opinion?
No. Paragraph .09c requires a statement that the opinion is not modified with respect to the matter, and A7 says the paragraph is not a substitute for a modified opinion when one is required. See types of audit opinions.
How many can a report carry?
The standard sets no limit. Each must meet the "fundamental to users' understanding" or "relevant to users' understanding" test.
Sources
- AICPA, AU-C Section 706, Emphasis-of-Matter Paragraphs and Other-Matter Paragraphs in the Independent Auditor's Report (paragraphs .01 to .12, A1 to A16, Exhibits A to C): https://www.aicpa-cima.com/resources/landing/aicpa-professional-standards
- AICPA, AU-C Section 708, Consistency of Financial Statements (paragraphs .08 to .09 requiring an emphasis-of-matter paragraph): https://www.aicpa-cima.com/resources/landing/aicpa-professional-standards
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