Emphasis of matter and other matter paragraphs: ISA 706

Sometimes an auditor is satisfied with the financial statements but wants the reader to look at something. A fire has destroyed a factory. A court case is still open. Last year’s statements were audited by someone else. None of these changes the opinion. All of them are worth a sentence in the report.

International Standard on Auditing (ISA) 706 gives the auditor two tools for this, the emphasis of matter paragraph and the other matter paragraph, and it says when each is allowed. The difference is simple to state and easy to get wrong: an emphasis of matter paragraph points to something in the financial statements, and an other matter paragraph points to something that is not.

This topic covers both, the ISAs that require them and how they fit with key audit matters and modified opinions.

What these paragraphs are for

The purpose of both paragraphs is to give additional communication in the auditor’s report where the auditor wants to draw users’ attention to a particular matter. They do not modify the audit opinion.

If a matter is a key audit matter under ISA 701, it goes in the key audit matters section and not in an emphasis of matter paragraph.

Emphasis of matter paragraphs

An emphasis of matter paragraph draws the reader’s attention to a matter presented or disclosed in the financial statements that is fundamental to an understanding of them.

The opinion is not modified. The paragraph can therefore be used only where the auditor has obtained sufficient appropriate evidence that the matter is not materially misstated. If it is materially misstated, a modified opinion is needed. The matter is properly presented or disclosed, but the auditor wants users to notice it.

Position

• When a key audit matters section is included, the paragraph goes directly before or directly after it, depending on the auditor’s judgement of its relative significance.
• When there are no key audit matters, it goes immediately after the Basis for Opinion paragraph.

Requirements

1. Use the heading “Emphasis of Matter”, or another appropriate heading.
2. Include a clear reference to the matter and to where the relevant disclosures that fully describe it are in the statements.
3. Say that the opinion is not modified in respect of the matter.

Circumstances

ISA 706 gives these examples:

• an uncertainty relating to the future outcome of exceptional litigation or regulatory action;
• a significant subsequent event between the date of the statements and the date of the report;
• early adoption of a new IFRS that has a pervasive effect on the statements; and
• a major catastrophe that has had, or continues to have, a significant effect on the entity’s financial position.

The illustrative wording from ISA 706 reads: “We draw attention to Note X to the financial statements which describes the effects of a fire in the Company’s production facilities. Our opinion is not modified in respect of this matter.”

ISAs that require an emphasis of matter paragraph

• ISA 210. Where the framework prescribed by law would be unacceptable but for the fact that law or regulation prescribes it.
• ISA 560. In two circumstances relating to a later report issued because of subsequent events.

Other matter paragraphs

An other matter paragraph is used when the auditor considers it necessary to communicate a matter other than those in the financial statements that, in the auditor’s judgement, is relevant to users’ understanding of the audit, the auditor’s responsibilities or the auditor’s report.

Position

• The illustrative report in ISA 706 puts the paragraph immediately after the key audit matters section.
• If it concerns other reporting responsibilities, it may go in the Report on Other Legal and Regulatory Requirements section.
• If it is relevant to all the auditor’s responsibilities or to users’ understanding of the whole report, it can be a separate section after both parts of the report.

Circumstances

• The auditor cannot resign even though the possible effect of a limitation of scope imposed by management is pervasive. This should be rare.
• Local law or custom allows the auditor to elaborate on his responsibilities in the report.
• The prior year statements were audited by a previous auditor, or not audited, so this is the current auditor’s first audit.

The ISA 706 example reads: “The financial statements of ABC Company for the year ended December 31, 20X5, were audited by another auditor who expressed an unmodified opinion on those statements on March 31, 20X6.”

ISAs that require an other matter paragraph

Fitting the paragraphs together

The syllabus adds that ISA 706 was revised to reflect that matters needing emphasis as fundamental to users’ understanding may now be determined to be key audit matters. The auditor may show their importance by listing them first or by adding detail. Because key audit matters always concern matters in the statements, other matter paragraphs and key audit matters do not overlap.

The rules in more depth

Why an emphasis of matter paragraph is not a modification

The opinion is the same as it would be without the paragraph. The paragraph exists to point at something, not to qualify the opinion. If the matter were misstated, there would be a qualified or adverse opinion and not an emphasis.

The test between emphasis and key audit matter

Ask whether the matter took significant auditor attention. If it did, it is a KAM and is explained with why and how. If it did not, but it is fundamental to understanding, it is an emphasis of matter. A listed company’s fire after the year end may be both important and heavily audited, so it would be a KAM.

For a small unlisted company with no KAM section, the same fire would be an emphasis of matter.

Other matter for the audit and the report

An other matter paragraph helps the reader understand the audit, for instance, who audited last year. It does not tell the reader anything about the entity’s finances.

Worked example: choosing the right tool

Decide what the auditor should do in each case. Assume the opinion is otherwise unmodified and the entity is unlisted, so there is no KAM section.

1. A fire after the year end destroyed a warehouse and is fully described in Note 18. A significant subsequent event, properly disclosed: an emphasis of matter paragraph referring to Note 18, saying the opinion is not modified.
2. The outcome of a large court case against the company is uncertain, and the note describes it. Exceptional litigation, properly disclosed: an emphasis of matter paragraph.
3. Last year’s statements were audited by another firm, which gave an unmodified opinion. A matter not in the statements: an other matter paragraph stating that fact, the type of opinion and the date of that report.
4. Last year’s statements were not audited. An other matter paragraph saying so. The auditor still performs procedures on opening balances under ISA 510.
5. The company has early adopted a new IFRS with a pervasive effect, and discloses it fully. An emphasis of matter paragraph.
6. The company has net current liabilities, a material uncertainty exists and the note is adequate. The separate Material Uncertainty Related to Going Concern section, not an emphasis of matter paragraph.
7. Inventory is overstated by a material amount and management refuses to adjust. A modified opinion. An emphasis of matter paragraph cannot be used for a misstated matter.
8. Management amends and reissues the statements after the report date. The new report includes an emphasis of matter or other matter paragraph referring to the note on the amendment and to the earlier report.

How to score full marks

• Ask where the matter is. In the statements points to emphasis of matter. Outside them points to other matter.
• Check that it is not misstated. A misstated matter calls for a modified opinion.
• Check that it is not a KAM. If it is, use the KAM section.
• Give the three requirements for an emphasis paragraph: heading, reference to the note, statement that the opinion is not modified.
• Give the position. Next to the KAM section, or after the Basis for Opinion if there are no KAMs.
• Quote the ISA wording where the question gives a scenario.

Common mistakes in the exam

• Saying that an emphasis of matter paragraph modifies the opinion.
• Using an emphasis of matter paragraph for a matter that is misstated.
• Using an emphasis of matter paragraph for a going concern material uncertainty.
• Using an other matter paragraph for something that is in the financial statements.
• Forgetting to say that the opinion is not modified in respect of the matter.
• Forgetting the reference to the note.

Quick revision

• Neither paragraph modifies the opinion.
• Emphasis of matter: in the statements, fundamental, properly disclosed, not a KAM. Heading, note reference, not modified.
• Examples: litigation, subsequent event, early adoption of an IFRS, catastrophe.
• Other matter: not in the statements, relevant to the audit or report. Examples: predecessor auditor, unaudited prior year, inability to resign.
• ISA 560 and ISA 710 require these paragraphs in set cases.
• Going concern uncertainty has its own section.

Practice questions

These are original questions written in the style of the Institute of Chartered Accountants of Nigeria (ICAN) exam. Try each one before you open the answer. Full model answers follow the written questions.

Recall check: multiple choice

The real ICAN paper has no multiple-choice section. These questions are for quick recall. The written questions that follow are closer to the exam.

Written questions

Model answers

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