A1-M7-Emphasis-of-Matter, Other-Matter, and Explanatory Paragraphs

Client: Nonissuer Paragraph Type: Emphasis-of-Matter Location Relative to Opinion Paragraph: After

(1). Going concern: (2). Material justified change in accounting principle. (3). Material misstatement in prior financial statements is corrected. (4). Special purpose framework. (5). Change in audit opinion.

Client: Issuer Paragraph Type: Explanatory. Location Relative to Opinion Paragraph: Before.

(1). Special purpose framework. (2). Change in audit opinion. Prior Financial statements audited by prior auditor and prior auditor's report is not presented: introductory paragraph modified.

For a particular entity's financial statements to be presented fairly in conformity with the applicable financial reporting framework, it is required that the principle selected: (1). The principles selected must be appropriate in the circumstances for the particular entity.

(2). The principles selected must present information in the FS that is classified and summarized in a reasonable manner. (3). The principles selected must reflect transactions in a manner that present the FS within a range of acceptable limits.

An emphasis-of-matter paragraph is Required in the following circumstances: (1). The auditor concludes that there is substantial doubt about the entity's ability to continue as a going concern for a reasonable period of time.

(2). To describe a justified change in accounting principle that has a material effect on the entity's financial statements.

Report Requirements. when an other-matter paragraph is included in the auditor's report, the auditor should: (1). place the other-matter paragraph immediately after the opinion paragraph and after any emphasis-of-matter paragraph;

(2). use the heading "other-matter" or other appropriate heading; and (3). describe the matter being emphasized and the location of relevant disclosures about the matter in the financial statements.

Client: Issuer. Paragraph Type: Explanatory. Location Relative to Opinion Paragraph: After. (1). Going concern. (2). Material justified change in accounting principle.

(3). Material misstatement in prior financial statements is corrected. (4). Restrict use of report. Prior Financial statements audited by prior auditor and prior auditor's report is not presented: introductory paragraph modified.

When evaluating the acceptability of an accounting change, the auditor should consider whether (Justified): (1). The newly adopted accounting principle is in accordance with the applicable financial reporting framework; (2). The method of accounting for the change is acceptable;

(3). The disclosures related to the accounting change are appropriate and adequate; and (4). The entity has justified that the alternative accounting principle is preferable.

Report Requirements. When an emphasis-of-matter paragraph is included in the auditor's report, the auditor should: (1). place the emphasis-of-matter paragraph immediately after the opinion paragraph; (2). use the heading "emphasis-of-matter" or other appropriate heading;

(3). describe the matter being emphasized and the location of relevant disclosures about the matter in the financial statements; and (4). indicate that the auditor's opinion is not modified with respect to the matter emphasized.

An other-matter paragraph is Required in the following circumstances: (2)

(4). Current period financial statements are audited and presented in comparative form with compiled or reviewed financial statements for the prior period, or in comparative form with prior period financial statements that were not audited, reviewed or complied.

An emphasis-of-matter paragraph is Required in the following circumstances: (3). Subsequently discovered facts lead to a change in audit opinion (the auditor may use an emphasis-of-matter or other-matter paragraph, as appropriate).

(4). The financial statements are prepared in accordance with applicable special purpose framework (other than regulatory basis financial statements intended for general use).

An other-matter paragraph is Required in the following circumstances: (3)

(5). Prior to the audit report date, the auditor identifies a material inconsistency in other information that is included in a document containing audited financial statements that requires revision of the other information and management refuses to make the revision.

Client: Issuer. Paragraph Type: Explanatory. Location Relative to Opinion Paragraph: After. (5).Comparative financial statements where the current year is audited and prior period is not audited.

(6). Material inconsistency in other information. (7). Report on supplementary information within auditor's report. (8). Refer to required supplementary information. (9). Report on compliance included in auditor's report.

An other-matter paragraph is Required in the following circumstances: (6).When the auditor chooses to report on supplementary information presented with the financial statements in the auditor's report, rather than in a separate report.

(7). To refer to required supplementary information that a designated accounting standard setter requires to accompany an entity's basic financial statements.

An other-matter paragraph is Required in the following circumstances: (8). A report on compliance is included in the auditor's report on the financial statements.

(9). To restrict the use of the auditor's report when special purpose financial statements are prepared in accordance with a contractual or regulatory basis of accounting (except when regulatory basis financial statements are intended for general use).

The auditor's standard report implies that the auditor is satisfied that the comparability of F/S between periods has not been materiality affected by changes in accounting principles, and that such principles have been consistently applied between or among periods because either

(a) no change in accounting principles has occurred, or (b) there has been a change in accounting principles or in the method of their application, but the effect of the change on the comparability of the F/S is not material.

An other-matter paragraph is Required in the following circumstances: (1). Anytime the auditor includes an alert in the audit report that restricts the use of the auditor's report. (2). Subsequently discovered facts lead to a change in audit opinion

(the auditor may use an emphasis-of-matter or other-matter paragraph, as appropriate). (3). The financial statements of the prior period were audited by a predecessor auditor and the predecessor's audit report is not reissued.

An unjustified accounting change may cause the auditor to issue a qualified or adverse opinion.

A material weakness must be reported to management and those charged with governance, but would not disclosed in an emphasis-of-matter paragraph added to an otherwise unmodified opinion.

The auditor may issue an unmodified opinion when a material departure from GAAP exists.

Although the situation is unusual, if a departure from GAAP is justified, the auditor may issue an unmodified opinion with an emphasis-of-matter paragraph.

If the auditor is unable to form an opinion on a new client's opening inventory balances, the auditor will issue an opinion on the closing balance sheet only

And will issue a disclaimer of opinion on the statements of income , retained earnings and cash flows.

If, after considering identified conditions and events and management's plans, the auditor concludes that substantial doubt about the entity's ability to continue as a going concern

For a reasonable period of time remains, the auditor report should include an emphasis-of-matter paragraph to reflect that conclusion.

Details concerning the results of audit procedures [such as the results of confirmation of receivables]

Generally do not appear in the footnotes.

The auditor will normally Not add an emphasis-of-matter paragraph for uncertainties that are appropriately accounted for.

However, if a question indicates that the uncertainty (such as the lawsuit) is "unusually important" then an emphasis-of-mater paragraph may be added.

A lack of consistency that has a material effect must be disclosed in an emphasis-of-matter paragraph.

If all the acceptability criteria for the account change are met, the auditor may issue an unmodified opinion.

When evaluating the acceptability of an accounting change, the auditor should consider whether (Justified): If the auditor is satisfied that all four criteria are met, the auditor should include an emphasis-of-matter (explanatory) paragraph in the auditors' report.

If any of the criteria are not met, the auditor should evaluate whether the accounting change results in a material misstatement and modify the auditor's opinion accordingly.

The emphasis-of-matter (explanatory) paragraph should be included in the auditor's report in the period of the change in accounting principle and all subsequent periods, until the new accounting principle is applied to all periods presented.

If the change in accounting principle is accounted for by retroactive restatement, the emphasis-of-matter (explanatory) paragraph is only needed in the period of the change.

The auditor should issue an "unmodified opinion" when management adequately discloses future events, the outcome of which are not susceptible of reasonable estimation. Under U.S. auditing standards an emphasis-of-matter paragraph may be added by the auditor

If the matter is of such importance that it is fundamental to the users' understanding of the financial statements. International Standards on Auditing recommend the addition of a paragraph describing the significant uncertainty.

Alert Included in General Use Communications. An auditor's written communication that is required by GAAS to include an alert that restricts its use may be included in a document that also includes an auditor's written communication that is for general use.

In such circumstances, the use of the general use communication is not affected by the alert if the two types of communication are clearly in-differentiated,such as through the use of headers.

If an accounting change does not have a material effect on the FS of the current year,

It will be disclosed in the notes to the FS of the current year, but no modification of the auditor's report is necessary.

Emphasis of a matter, such as the existence of significant transactions with related parties,

May result in an additional paragraph added to an otherwise unmodified opinion.

If the change in accounting principle were material for the current year, it would be treated as a consistency modification in the auditor's report for the current year.

Since there is no material effect in the current year, no modification to the auditor's report is required.

If an accounting change has no material effect on the comparability of the financial statements,

The auditor does not need to recognize the change in the current year's auditor report.

When a. Contingent liability is probable, but not estimable, it should be disclosed in the footnotes. A qualified opinion due to a scope limitation results when

The auditor is unable to obtain sufficient appropriate audit evidence and the auditor concludes that the possible effects of any undetected misstatement could be material but not pervasive.

Lack of Consistency. Consistency deals with the comparability of the financial statements from year to year. Unless the auditor's report explicitly states otherwise, the auditor's report implies that the financial statements are comparable between periods.

The auditor should evaluate whether the comparability of consistency of the financial statements between periods has been affected by a change in accounting principle or by an adjustment to correct a material misstatement in previously issued financial statements.

When management does not provide reasonable justification that a change in accounting principle is preferable and it presents comparative FS,

The auditor should express a qualified opinion each year that the FS initially reflecting the change are presented.

The examiners like to ask questions about uncertainties, such as lawsuits. Management must analyze the existing conditions surrounding the uncertainties. The decision to accrue and/or disclose is based on the probability of loss and whether the loss can be estimated.

The chart below shows the different scenarios. If Loss Is: Probable. Can Estimate Loss Amount: Accrue and disclose. Cannot Estimate Loss Amount: Disclose --------------------------

The examiners like to ask questions about uncertainties, such as lawsuits. Management must analyze the existing conditions surrounding the uncertainties.

The decision to accrue and/or disclose is based on the probability of loss and whether the loss can be estimated. The chart below shows the different scenarios. If Loss Is: Reasonably possible. Can Estimate Loss Amount: Disclose. Cannot Estimate Loss Amount: Disclose. --------------------------

The examiners like to ask questions about uncertainties, such as lawsuits. Management must analyze the existing conditions surrounding the uncertainties. (3)

The decision to accrue and/or disclose is based on the probability of loss and whether the loss can be estimated. The chart below shows the different scenarios. If Loss Is: Remote. Can Estimate Loss Amount: Generally ignore. Cannot Estimate Loss Amount:Generally ignore.

Effect of an Acceptable Change on the Auditor's Report. If the effect of a change in accounting principle is immaterial no revision to the report is necessary. if the effect is material an emphasis-of-matter (explanatory) paragraph should be added.

The emphasis-of-matter (explanatory) paragraph should describe the change in accounting principle and provide a reference to the entity's disclosure about the change.

Report Requirements. the explanatory paragraph does not have a title. The paragraph should describe the matter being emphasized and the location of relevant disclosures about the matter in the financial statements.

The explanatory paragraph will generally follow the opinion paragraph when added to an unqualified report, but may be placed either before or after the opinion paragraph to emphasize a matter.

Explanatory Paragraph (Issuers) = Public Company. An explanatory paragraph is included in the auditor's report when required by PCAOB auditing standards or at the auditor's discretion.

The inclusion of an explanatory paragraph in the auditor's report does not affect the auditor's opinion. The explanatory paragraph does not have a heading.

When an entity changes its method of accounting for income taxes, which has a material effect on comparability, the auditor should refer to the change in emphasis-of-matter paragraph Added to the auditor's report. This paragraph should identify the nature of the change and

The paragraph should refer to the note in the FS that discusses the change in detail. Following is an examples of an appropriate emphasis-of-matter paragraph: "as discussed in Note X to the FS, the company changed its method of accounting for income taxes in X2."

An auditor most likely would express an unmodified opinion and would not add additional paragraph to the report if the auditor believes that

There is a probable likelihood of a material loss resulting from an uncertainty that is sufficiently supported and disclosed.

Sale of a discontinued operation may be discussed in an emphasis-of-matter paragraph of the auditor's report,

Which would also refer to the related footnote.

Subsequent events may be discussed in an emphasis-of-matter paragraph of the auditor's report,

Which would also refer to the related footnote.

The pro forma effects of a business combination maybe included in emphasis-of-matter paragraph of the auditor's report,

Which would also refer to the related footnote.

Sample Other-Matter (Explanatory) Paragraph. this report is intended solely for the information and use of [list or refer to the specified parties]

and is not intended to be used by anyone other than these specified parties.

The circumstances that require an auditor to add an explanatory paragraph in an issuer audit report

are very similar to the circumstances that require an auditor to add an emphasis-of-matter or other-matter paragraph to a nonissuer audit report.

Alert That Restricts the Use of the Auditor's Written Communication. The auditor may be required by GAAS or may decide that it is necessary to include the language in the auditor's report (or other written communication) that restricts the use of the auditor's written communication.

in the auditor's report, such language is included in an other-matter (explanatory) paragraph.

Emphasis-of-Matter Paragraphs Nonissuers = Private Company. An emphasis-of-matter paragraph is included in the auditor's report when required by GAAS or at the auditor's discretion. An emphasis-of-matter paragraph is used when referring to a matter that is appropriately presented or disclosed

in the financial statements and is of such importance that it is fundamental to the users' understanding of the financial statements. the inclusion of an emphasis-of-matter paragraph in the auditor's report does not affect the auditor's opinion. = still unmodified.

Candidates will probably receive questions involving the emphasis-of-matter, other-matter, or explanatory paragraphs.

it is important to note that the use of such paragraphs still represents an unmodified (unqualified) opinion. The additional language is used to highlight particular circumstances without modifying the opinion.

Use May Be Necessary = Professional Judgement. an other-matter paragraph may be necessary in the following circumstances: ☐ to describe the reasons why the auditor cannot withdraw from an engagement when the auditor is unable to sufficient appropriate audit evidence due to a

management-imposed scope limitation and the possible effects on the financial statements of undetected misstatements could be both material and pervasive, but the auditor is unable to withdraw from the engagement.

☐ Supplementary information required by the Financial Accounting Standards Board (FASB), the Governmental Accounting Standards Board (GASB), or the Federal Accounting Standards Advisory Board (FASAB) has been omitted; the presentation of such information departs materially from FASB, GASB, or FASAB guidelines;

the auditor is unable to complete prescribed procedures with respect to such information; or the auditor is unable to remove substantial doubts about whether the supplementary information conforms to FASB, GASB, or FASAB guidelines.

When there has been a change in accounting principles, but the effect of the change on the comparability of the financial statements is not material,

the auditor should not refer to the change in the audit report. The auditor does not need to explicitly state whether the change conforms with GAAP because the effect of the change is immaterial.

☐ if an entity's financial statements include a significant investment accounted for using the equity method, the auditor's evaluation of consistency should include consideration of the investee. if the investee makes a change in accounting principle that is material to the investing entity,

the change should be described in an emphasis-of-matter [explanatory] paragraph. other changes in accounting estimates or corrections of errors [i.e., mathematical mistakes, oversights, etc.] do not affect the consistency standard and do not affect the auditor's report.

A qualified opinion due to a material misstatement of the financial statements would be issued if the client did not disclose

the contingent liability in the footnotes to the financial statement and the resulting misstatement was material but not pervasive.

In evaluating the acceptability of the accounting change, the auditor should consider whether the newly adopted accounting principle is in accordance with the applicable financial reporting framework,

the method of accounting for the change is acceptable, the disclosures related to the change are appropriate and adequate, and the entity has justified that the alternative accounting principle is preferable.

Other-matter paragraphs (Nonissuers) = Private Company. an other-matter paragraph is included in the auditor's report when required by GAAS or at the auditor's discretion. Other- matter paragraphs refer

to matters other than those presented or disclosed in the financial statements that are relevant to the users' understanding of the audit, the auditor's responsibilities, or the auditor's report.

Client:Nonissuer. Paragraph Type: Other-matter Location Relative to Opinion Paragraph: After. (1). Change in audit opinion. (2). Restrict use of report. (3). Prior financial statements audited by prior auditor and prior auditor's report is not presented. (4). Comparative financial statements

where the current year is audited and prior period is not audited. (5). Material inconsistency in other information. (6). Report on supplementary information within auditor's report. (7). Refer to required supplementary information. (8). Report on compliance included in auditor's report.

Use May Be Necessary = Professional Judgement. an explanatory paragraph may be used whenever an auditor

wishes emphasize a matter regarding the financial statements.

Examples of Circumstances That Affect Consistency. The following situations require an emphasis-of-matter (explanatory) paragraph: ☐ a change in accounting estimate that is inseparable from a change in accounting principle [e.g., a change in depreciation method].

☐ corrections of an error in accounting principle [e.g., from cash method to accrual method]. ☐ A change in reporting entity that results in financial statements that are , in effect, those of a different reporting entity. ☐ correction of a material misstatement in previously issued financial statements.

the explanatory paragraphs should be placed before the opinion paragraph when:

☐ financial statement are prepared in accordance with a special purpose framework. ☐ the prior year audit opinion is updated.

Content of the Alert. Unless otherwise specified by GAAS, the alert that restricts the use of the auditor's written communication should include the following items: ☐ a statement that the auditor's written communication is intended solely for the information and use of the specified parties.

☐ identification of the specified parties for whom use is intended. ☐ a statement that the auditor's written communication is not intended to be and should be used by anyone other than the specified parties.

Use of the Alert. an auditor's written communication should include an alert that restricts its use when the subject matter of the auditor's written communication is based on: ☐ measurement or disclosure criteria that are suitable for only a limited number of users who have an adequate understanding of the criteria;

☐ measurement or disclosure criteria that are available only to specified parties; or ☐ matters identified during an audit engagement that are not the primary objective of the audit engagement [commonly referred to as a by-product report].

☐ there has been a material change between periods in accounting principles or in the method of their application. ☐ a material misstatement in previously issued financial statements has been corrected.

☐ other information in a document containing audited financial statements is materially inconsistent with information appearing in the financial statements. ☐ selected quarterly financial data required by SEC Regulation S-K has been omitted or has not been reviewed.

☐ law, regulation, or generally accepted practice require or permit the auditor to provide further explanation of the auditor's responsibilities.

☐ the auditor has been engaged to report on more than one set of financial statements when each set of financial statements has been prepared in accordance with a different general-purpose framework.

Use of Explanatory Paragraphs. Use Required. An explanatory paragraph is required in the following circumstances:

☐ the prior year opinion is updated. ☐ Financial statements are prepared in accordance with a special purpose framework. ☐ there is substantial doubt about the entity's ability to continue as a going concern.