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Modifications to Audit Reports that Do Not Affect the Audit Opinion.

Circumstances requiring modifications to, or departures from, an unqualified auditor's opinion are described, together with appropriate guidance, in AU-C section 705, "Modifications to the Opinion in the Independent Auditor's Report," for non-SEC entities, including governments, and in Auditing Standard (AS) 3105, Departures from Unqualified Opinions and Other Reporting Circumstances, for SEC issuers and other entities for which an auditor has been engaged to audit and report based on PCAOB standards. Such modifications include qualified opinions, adverse opinions (which are extremely rare), and disclaimers of opinion (which are auditor assertions that an opinion cannot be expressed). Depending on the nature, magnitude, and pervasiveness of the potential effects of the matters in question, as well as their significance to the financial statements, qualified opinions or disclaimers often result from scope limitations or restrictions that may be imposed by clients or by circumstances that preclude the auditor from forming an unqualified opinion.

This article, however, is primarily about matters that may affect an auditor's report without affecting the opinion. Such matters may result in additions to a standard audit report of one of two different types: 1) "emphasis-of-matter" paragraphs that are considered necessary to draw users' attention because the matter is of such importance that it is fundamental to users' understanding of the financial statements, and 2) "other-matted" (referred to in PCAOB standards as "explanatory") paragraphs. Some emphasis-of-matter and other-matter/explanatory paragraphs are required by the applicable auditing standards, and some are included based solely on auditor's discretion. Emphasis-of-matter paragraphs report only matters that are appropriately presented or disclosed in the financial statements and are of such importance to be considered fundamental to users' understanding of the financial statements. Other-matter paragraphs report matters considered relevant to users' understanding of the audit, the auditor's responsibilities, or the auditor's report other than matters that are appropriately presented or disclosed in the financial statements.

Although these matters are described, together with appropriate guidance, in AU-C section 706, Emphasis-of-Matter Paragraphs and Other-Matter Paragraphs in the Independent Auditor's Report, for reports on financial statements of non-SEC entities, including governments, and in AS 3101, The Auditor's Report on an Audit of Financial Statements When the Auditor Expresses an Unqualified Opinion, for reports on financial statements of SEC issuers and other entities for which the auditor has been engaged to report based on PCAOB standards, the requirements of the standards applicable to the use of such paragraphs are complicated, hard to find, and confusing.

Recent Changes

Recent amendments to AU-C section 706, which will be effective for years ending in December 2020 (early adoption is not permitted), will not affect the current requirements regarding circumstances in which a modification to an auditor's report is necessary, or for determining the type of modification. Effective for years ending in or after December 2020, the new AU-C section 703 will add requirements applicable to reports on the financial statements of certain employee benefit plans.

Also effective for years ending in or after December 2020, if the auditor is engaged to communicate key audit matters (KAM), use of an emphasis-of-matter paragraph will not substitute for including the matter in the KAM section if it meets the definition of a KAM, but inclusion of such a matter in a KAM will preclude the need to include it elsewhere in the audit report. The same is true when reporting on critical audit matters (CAM) for SEC issuer clients.

Financial Statements of Private Entities

For audit reports on financial statements of private entities, emphasis-of-matter paragraphs are limited to those that are about material accounting or presentation matters, provided they are appropriately presented or disclosed in the financial statements. (If not appropriately presented, they would necessarily require an opinion modification.) These are distinguished from other-matter paragraphs, which are not about accounting or presentation matters and therefore not about matters presented or disclosed in the financial statements. Rather, they are included in the audit report because they are deemed relevant in the auditor's professional judgment to users' understanding of the audit, the auditor's responsibilities, or the auditor's report. In other words, other-matter paragraphs relate to auditing, rather than accounting, matters.

As shown in Exhibit 1, however, a major source of confusion about this topic for some practitioners is the blurring of this line of distinction in AS 3101, which states that in certain matters that are about accounting rather than auditing, subjects are required to be communicated in "explanatory," rather than emphasis-of-matter, paragraphs, the latter of which are always discretionary under the PCAOB standard. As in AU-C 706, emphasis-of-matter paragraphs are always about accounting or disclosure matters that are appropriately presented in the financial statements.

In both standards, discretionary auditor communications are described as matters that an auditor "may consider" (not "should consider") including in the audit report; thus, documentation of such consideration is not required but nevertheless may be considered beneficial.

In addition to the foregoing, AU-C 600.30 requires an auditor who refers to a report of other auditors that contains an emphasis-of-matter or an other-matter paragraph to make reference to such paragraph in a similar emphasis-of-matter or other-matter paragraph. Also, AU-C 930.42-.43 states that an auditor is required to include another-matter paragraph when interim financial information that has been reviewed in accordance with AU-C 930, "Interim Financial Information," is included in a document containing audited financial statements does not appear to be presented in accordance with the applicable financial reporting framework, and the auditor's separate review report referring to the departure is not presented.

Similar Reporting for Reviews and Compilations

With the exception of reviews of interim financial statements performed for clients that have annual audits, reporting on compilation and review engagements are governed by Statements of Standards for Accounting and Review Services (SSARS), specifically, AR-C 80 and 90, respectively. AR-C 80 does not provide for emphasis-of-matter paragraphs specifically by name or, except as noted in the last bullet below, other-matter paragraphs, but does provide similarly for nonstandard additional paragraphs whenever--

* the financial statements are prepared in accordance with a special purpose framework (AR-C 80.21),

* the reporting accountant is not independent (AR-C 80.22),

* the financial statements omit substantially all required disclosures (AR-C 80.27),

* the financial statements are accompanied by supplementary information that was not subject to compilation procedures, but no separate report on the supplementary information is issued (AR-C 80.35), or

* supplementary information is required by a designated accounting standards-setter (RSI). In this one instance, the mandatory additional report paragraph is referred to as an other-matter paragraph, and it has specified required content (AR-C 80.37 and .A44, and if the RSI is entirely omitted, AR-C 80.39).

AR-C 90 requires certain emphasis-of-matter paragraphs and other-matter paragraphs in review reports, if appropriate, under the circumstances listed in Exhibit 2.

Reviews of interim financial statements or information performed for private and public clients that have annual audits are governed, respectively, by AU-C 930 and AS 4105, "Reviews of Interim Financial Information."

AU-C 930.38 requires an emphasis-of-matter paragraph indicating substantial doubt if conditions that raise such doubt exist as of the interim reporting date, provided there is appropriate disclosure in the interim financial information of a private entity to the extent required under the applicable reporting framework. This requirement applies without regard to whether the previous annual audit report did or did not contain such an emphasis-of-matter paragraph.

Although not clearly stated in any ASB standard, AU-C 930.A61 implies only by illustration that an emphasis-of-matter paragraph is also required in an audit report when there is an inconsistency in the application of accounting principles. AU-C 930 contains no examples of discretionary emphasis-of-matter paragraphs.

AS 4105.41 suggests that an accountant may wish to emphasize in a separate explanatory paragraph any substantial doubt about a public entity's ability to continue as a going concern or lack of consistency in the application of accounting principles affecting the interim financial information, provided that such matters are appropriately disclosed in the interim financial information. In addition, AS 4105.44 and .45 expressly state that without regard to whether the previous annual audit report did or did not contain an explanatory paragraph indicating substantial doubt, the reporting auditor is not required to modify the report when there is adequate and appropriate disclosure in the interim financial information, even if conditions that raise such doubt exist or continue to exist as of the interim reporting date. The auditor may, however, add a discretionary explanatory paragraph if a report is issued.

It should be noted that issuance of a report on an interim review for an SEC issuer is not required under any circumstances (unless engaged to do so). However, if a report is issued, AS 4105.50c-d requires an auditor to include an explanatory paragraph in circumstances when selected quarterly financial data is required by item 302(a) of Regulation S-K but is omitted or not reviewed.

AS 4105 makes no provision for emphasis-of-matter paragraphs.

Howard B. Levy, CPA, is a principal and director of technical services at Piercy Bowler Taylor & Kern, CPAs, Las Vegas, Nev., and an independent technical consultant to other professionals. He is a former member of the AICPA Auditing Standards Board and its Accounting Standards Executive Committee, and a current member of its Center for Audit Quality's Smaller Firms Task Force. He is a member of The CPA Journal Editorial Advisory Board.
Exhibit 1

Summary of Required and Discretionary Emphasis-of-Matter and
Other-Matter/Explanatory Paragraphs in Audit Reports

                          For Non-SEC                For SEC
                           Entities                  Issuers
                          (AU-C 706)                (AS 3101)
Required emphasis-
of-matter
paragraphs:

When substantial             .A14
doubt exists (i.e.,   (& AU-C 570.15-.16)
that has not been
satisfactorily
mitigated) about an
entity's ability to
continue as a going
concern

When there has been          .A14
a change in              (& AU-C 708.
accounting                  08-.13)
principles or in
the method of their
application or a
change in the
reporting entity
that has a material
effect (accounting
changes and other
matters disclosed
in the notes to the
financial
statements are
assumed to have
been judged to be
material)

When the auditor's       .A15 (& AU-C
(or a                       560.16c
predecessor's)          & AU-C 700.54)
current opinion on
prior-period
financial
statements
presented differs
from the original
opinion issued
thereon because of
changes to the
financial
statements or
related notes (may
be an other-matter
paragraph for a
private company if
it does not involve
the financial
statements or
related notes)

When financial                A14
statements have         (& AU-C 800.19)
been prepared in
accordance with a
special purpose
framework other
than a regulatory
basis of accounting

Required
other-matter/
explanatory
paragraphs:

When reporting on     .A15 (& AU-C 725.09)
supplementary
information in the
body of audit
report on the basic
financial
statements

When prior-period        .A15 (& AU-C
financial                 700.57-.58)
statements
presented have not
been audited, or
have been audited
by another auditor,
and the report on
the prior period's
financial
statements is not
presented

When reporting on            ,A15
special purpose         (& AU-C 800.20)
financial
statements prepared
in accordance with
a contractual,
regulatory, or
other basis of
accounting when use
of the audit report
is restricted
pursuant to AU-C
905.06

When a report on             ,A15
compliance with         (& AU-C 806.13)
aspects of
contractual
agreements or
regulatory
requirements is
included in an
audit report on
financial
statements

When supplementary       .A15 (& AU-C         .18j (& AS 2705.03 &
information               730.07-08)                  .08)
required by the
applicable
financial reporting
framework has been
omitted or departs
materially from
applicable
requirements, or
the auditor is
unable to complete
prescribed
procedures with
respect to such
information or has
substantial doubt
about whether the
information meets
such requirements

When other                   ,A15              .181 (& AS2710.04)
information             (& AU-C 720.12)
contained in a
document together
with audited
financial
statements is
materially
inconsistent with
the financial
statements, and
management refuses
to make an
appropriate
revision

When substantial                               .18a (& AS 2415.12)
doubt exists (i.e.,
that has not been
satisfactorily
mitigated) about an
entity's ability to
continue as a going
concern

When the auditor                             .18b (& AS 1205.06-.09)
decides to refer to
the report of other
auditors

When there has been                          .18c (& AS 2820.12-.15)
a change between
periods in
accounting
principles or in
the method of their
application that
has a material
effect

When a material                                .18d (& AS 2820.06
change in the
reporting entity
(that does not
result from a
transaction or
event) has occurred

When a material                             .18e(& AS 2820.09 &16-.17
misstatement in
previously issued
financial
statements has been
corrected

When the auditor                               .18f (& AS 2201.88)
performs an
integrated audit
and issues separate
reports on the
company's financial
statements and
internal control
over financial
reporting

When management's                            .18g (& AS 3105.59--.60
required report on
internal controls
over financial
reporting is not
required to be, and
has not been,
audited

When the auditor's                           .18h ($ AS 3105.52-.53
(or a                                               & .56-.58
predecessor's)
current opinion on
prior-period
financial
statements differs
from the original
opinion issued
thereon because of
changes to the
financial
statements or
related notes

When selected                                  .18i (& AS 4105.50)
quarterly financial
data required by
Item 302(a) of
Regulation S-K is
omitted, not
appropriately
presented, or not
been reviewed

When there has been                            .18k (& AS 2503.32
a change in an
investee year-end
that has a material
effect on the
financial
statements

Suggested examples
of discretionary
emphasis-of-matter
paragraphs:

When there is an              .A2                      .19
uncertainty
relating to the
future outcome of
unusually important
litigation or
regulatory action

When there has been           .A2
a major catastrophe
that has had, or
continues to have,
a significant
effect on the
entity's financial
position

When there have               .A2                      .19
been significant
subsequent events

When there have               .A2                      .19
been significant
transactions with
related parties

When there have                                        .19
been other
significant
transactions

When there are                                         .19
accounting matters
(that do not
involve changes in
accounting
principles)
affecting the
comparability of
the financial
statements with the
prior period

When the entity is                                     .19
a component of a
larger business
enterprise

Suggested examples
of discretionary
"other-matter"
paragraphs:

When the auditor is           .A6
unable to obtain
sufficient
appropriate audit
evidence due to a
limitation on audit
scope is imposed bv
management that is
pervasive, and is
unable to withdraw
from the engagement

When the auditor is           .A7
permitted (or
required) by law,
regulation, or
generally accepted
practice to
elaborate on
matters providing
further explanation
of the auditor's
responsibilities

When engaged to               .A9
report on two sets
of financial
statements--that is,
in accordance with
a general purpose
framework (e.g.,
U.S. GAAP) and
another general
purpose framework
(e.g.,
International
Financial Reporting
Standards) and the
frameworks are
acceptable

Exhibit 2

Summary of Required and Discretionary Emphasis-of-Matter and
Other-Matter Paragraphs in Review Reports for Non-SEC Entities
(Except on Interim Financial Statements for Annual Audit Clients)

                                   Emphasis-of-Matter   Other-Matter
Required paragraphs:
When reporting on supplementary                          .83 or .86
information or RSI in the body
of main report

When the prior period financial                             .50
statements were audited and the
auditor's report on the prior
period financial statements is
not reissued

When financial statements have            .A43
been prepared in accordance with
a special purpose framework
unless prepared in accordance
with a regulatory basis of
accounting

When a report contains an alert                          .A44, .A61
that restricts its use

When substantial doubt exists             .A67
(i.e., that has not been
satisfactorily mitigated) about
an entity's ability to continue
as a going concern

When the auditor's (or                   .A76c              .A49
predecessor's) current
conclusion on prior-period
financial statements differs
from the original opinion issued
thereon because of changes to
the financial statements or
related notes (may be an other-
matter paragraph if it does not
involve the financial statements
or related notes)

Suggested examples of
discretionary paragraphs:

When there is an uncertainty              ,A96
(but less than substantial
doubt) regarding the entity's
ability to continue as a going
concern for at least a year from
the report date

When there is an uncertainty               d
relating to the future outcome
of unusually important
litigation or regulatory action

When there has been a major               .A96
catastrophe that has had, or
continues to have, a significant
effect on the entity's financial
position

When there have been significant          .A96
subsequent events

When there have been significant          .A96
transactions with related
parties

When engaged to report on two                              .A101
sets of financial
statements--that is, in
accordance with a general
purpose framework (e.g., U.S.
GAAP) and another general
purpose framework (e.g.,
International Financial
Reporting Standards) and the
frameworks are acceptable
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Title Annotation:COLUMNS: Auditing
Author:Levy, Howard B.
Publication:The CPA Journal
Date:Aug 1, 2019
Words:2723
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