Question Tag: Other Matter Paragraph

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  • 10 Marks

AA – Nov 2023 – L2 – Q5c – Completion Procedures and Reporting

This question requires brief notes on the terms: Qualified opinion, Disclaimer of opinion, Emphasis of Matter paragraph, and Other Matter paragraph.

ISA 705: Modifications to the opinion in the independent auditor’s report and ISA 706: Emphasis of Matter paragraphs and Other Matter paragraphs in the independent auditor’s report provide modifying phrases for use when issuing modified reports.

Required:
Write brief notes on the following terms:

i) Qualified opinion
ii) Disclaimer of opinion
iii) Emphasis of Matter paragraph
iv) Other Matter paragraph
(10 marks)

  • Qualified Opinion:
    A qualified opinion is expressed when the auditor concludes that an unmodified opinion cannot be issued, but the misstatement or scope limitation is not pervasive. The financial statements are fairly presented, except for the issue identified, which may be a material misstatement or a limitation on audit scope.
  • Disclaimer of Opinion:
    A disclaimer of opinion is expressed when the auditor is unable to obtain sufficient appropriate audit evidence to form an opinion, and the possible effects are so material and pervasive that the auditor cannot express an opinion on the financial statements.
  • Emphasis of Matter Paragraph:
    An Emphasis of Matter paragraph is used to draw attention to a matter appropriately presented or disclosed in the financial statements that is fundamental to users’ understanding. It does not affect the auditor’s opinion but highlights important matters.
  • Other Matter Paragraph:
    An Other Matter paragraph is included in the auditor’s report to highlight a matter other than those presented or disclosed in the financial statements that, in the auditor’s judgment, is relevant to users’ understanding of the audit, the auditor’s responsibilities, or the auditor’s report.
  • 20 Marks

AAA – May 2021 – L3 – Q3 – Reporting | The audit approach

Evaluate the appropriateness of draft auditor’s reports for two clients and discuss the use of emphasis of matter and other matter paragraphs in audit reports.

You have recently been promoted to Senior Manager of Life Matters and Associates, a firm of Chartered Accountants. As part of your job description, you are to handle two clients in a given month. Below are some issues you will be faced with during the audit of these clients. The financial year-end for each client is 30 September 2020.

You are reviewing the Audit Senior’s draft auditor’s reports for the two clients, Factory Co Ltd and Toys Co Ltd.

Toy Co Ltd

The Audit Senior suggests that Toys Co Ltd’s audit opinion should not be qualified but should include an emphasis of matter paragraph after the audit opinion to highlight the situation below:

In October 2020, a legal claim was filed against Toys Co Ltd by a toy retailer. The suit was from a customer who slipped on a greasy step outside one of the retail outlets. The matter has been fully disclosed as a material contingent liability in the notes to the financial statements. Audit working papers also provided sufficient evidence that no provision is necessary as Toys Co Ltd’s lawyers have stated in writing that the likelihood of the claim succeeding is remote. The amount of the claim is fixed and is adequately covered by cash resources.

Factory Co Ltd

Factory Co Ltd, a listed company, permanently closed several branches in May 2020, with all closure costs finalised and paid in August 2020. The said branches all produced the same items, which contributed 10% of Factory Co Ltd’s total revenue for the year ended 30 September 2020 (2019 – 23%). The closure has been discussed accurately and fully in the Chairman’s statement and Directors’ Report. However, the closure was not stated in the notes to the financial statements nor separately disclosed on the financial statements.

The audit senior has proposed an unmodified audit opinion for Factory Co Ltd as the matter has been fully addressed in the Chairman’s statement and Directors’ Report.

Required:

a) Evaluate whether the Audit Senior’s draft auditor’s report is appropriate, and where you disagree, recommend the amendment necessary to the draft auditor’s report of:

i) Toy Co Ltd (4 marks)

ii) Factory Co Ltd (6 marks)

b) Assuming the auditors of Life Matters and Associates are contemplating whether to use an emphasis of matter paragraph and other matter paragraph in the audit report, explain both options and the situations when each is relevant. (10 marks)

a) Evaluation of Draft Auditor’s Reports:

i) Toy Co Ltd:

  • Legal Claim Evaluation: The claim was an event after the balance sheet date. Suppose the accident occurred before the year-end of 30 September 2020. In that case, the claim gives additional evidence of a year-end condition and thus meets the definition of an adjusting post-balance sheet event. In this case, the matter appears to have been properly disclosed in the notes to the financial statements per IAS 10: Events After the Balance Sheet Date and IAS 37: Provisions, Contingent Liabilities, and Contingent Assets. A provision would only be necessary if the claim was probable to succeed, and there is sufficient appropriate evidence that this is not the case. There is, therefore, no material misstatement.
  • Audit Opinion Recommendation: The audit manager is correct to propose an unmodified opinion. However, the audit report doesn’t need to contain an emphasis of matter paragraph. ISA 705: Modifications to the Independent Auditor’s Report states that an emphasis of matter paragraph should be used to highlight a matter where there is significant uncertainty. Uncertainties are only regarded as significant if they involve a level of concern about the company’s going concern status or would have an unusually significant effect on the financial statements. This is not the case here, as there is enough cash to pay the damages in the unlikely event that the claim goes against Toys Co Ltd. This appears to be a one-off situation with a low risk of the estimate being subject to change, and thus there is no significant uncertainty.

(4 marks)

ii) Factory Co Ltd:

  • Discontinued Operations: The factory closures constitute a discontinued operation per IFRS 5: Non-Current Assets Held for Sale and Discontinued Operations due to discontinuing a separate major component of the business. It is a major component due to the 10% contribution to revenue in the year to 30 September 2020 and 23% contribution in 2019. In addition, it is a separate business component of the company due to the factories having made only one item, indicating a separate income-generating unit.
  • Disclosure Requirements: Under IFRS 5, there must be separate disclosure on the face of the income statement of the post-tax results of the discontinued operation and of any profit or loss resulting from the closures. The revenue and costs of the discontinued operation should be separately disclosed either on the face of the income statement or in the notes to the financial statements. Cash flows relating to the discontinued operation should also be separately disclosed per IAS 7: Cash Flow Statements. In addition, as Factory Co Ltd is a listed company, IFRS 8: Operating Segments requires separate segmental disclosure of discontinued operations.
  • Audit Opinion Recommendation: Failure to disclose the above information in the financial statements is a material breach of International Accounting Standards. The audit opinion should therefore be qualified on the grounds of disagreement on disclosure requirements of IFRS 5, IAS 7, and IFRS 8. The matter is material but not pervasive, and therefore an ‘except for’ opinion should be issued. The opinion paragraph should clearly state the reason for the qualification and indicate the financial significance of the matter. The audit opinion relates only to the financial statements that have been audited. Therefore, the contents of the other information (Chairman’s statement and Directors’ Report) are irrelevant when deciding if the financial statements show a true and fair view or are fairly presented.

(6 marks)

b) Emphasis of Matter and Other Matter Paragraphs:

  • Emphasis of Matter Paragraph:
    • An ’emphasis of matter’ paragraph is used to draw the reader’s attention to a matter presented or disclosed in the financial statements, which is fundamental to understanding those financial statements.
    • When an auditor’s report contains an emphasis of matter paragraph, the opinion is not modified. Therefore, it can only be used where the auditor has obtained sufficient appropriate audit evidence that the matter is not materially misstated in the financial statements. (If the matter is materially misstated, a modified opinion is required.)
    • Although the opinion is not modified, there is an item in the financial statements, properly presented or disclosed, that the auditor wishes to bring to the attention of users because it is fundamental to an understanding of the financial statements.
  • Circumstances for Emphasis of Matter Paragraph:
    • Where there is an uncertainty relating to the future outcome of exceptional litigation or regulatory action.
    • A significant subsequent event that occurs between the date of the financial statements and the date of the auditor’s report.
    • Where the entity has adopted a new IFRS early, which has had a pervasive effect on the financial statements.
    • To draw attention to a major catastrophe that has had, or continues to have, a significant effect on the entity’s financial position.
    • Early application of a new accounting standard that has a pervasive effect on the financial statement.
  • Other Matter Paragraph:
    • An ‘other matter’ paragraph is used if the auditor considers it necessary to communicate a matter other than those included in the financial statements that, in his opinion, is relevant to users’ understanding of the audit, the auditor’s responsibilities, or the auditor’s report.
    • This is the paragraph that is used to highlight a matter that has not adequately been presented and disclosed in the financial statements but, in the auditor’s judgment, is fundamental for users’ understanding of the audit, audit work, and the auditor’s responsibility.
  • Circumstances for Other Matter Paragraph:
    • Where the auditor is unable to resign from the engagement even though the possible effect of a limitation of scope imposed by management is pervasive (relevant to users’ understanding of the audit). This should be rare in practice.
    • Where local law or custom allows the auditor to elaborate on his responsibilities in his report (relevant to users’ understanding of the auditor’s responsibilities or auditor’s report).
    • Another example when an other matter paragraph might be used is when the prior year financial statements were audited by a previous auditor, or not audited because this is the first-year audit for the current auditor.
    • The auditor is reporting on a set of financial statements prepared using different frameworks, e.g., both IFRS and GAAP.

(10 marks)

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