14.3 Emphasis-of-Matter & Other-Matter Paragraphs (AU-C 706)

14.3 Emphasis-of-Matter & Other-Matter Paragraphs (AU-C 706)

Core Principle: Under AU-C 706 (Emphasis-of-Matter Paragraphs and Other-Matter Paragraphs in the Independent Auditor's Report), an auditor may draw users' attention to critical information without modifying the audit opinion. AU-C 706 establishes two distinct communication vehicles: (1) Emphasis-of-Matter (EOM) paragraphs, which reference matters appropriately presented or disclosed in the financial statements that are fundamental to user understanding, and (2) Other-Matter (OM) paragraphs, which reference matters outside the financial statements that are relevant to users' understanding of the audit, the auditor's responsibilities, or the auditor's report.

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1. Emphasis-of-Matter (EOM) Paragraphs

An Emphasis-of-Matter paragraph is a paragraph included in the auditor's report that refers to a matter appropriately presented or disclosed in the financial statements that, in the auditor's professional judgment, is of such importance that it is fundamental to users' understanding of the financial statements.

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|                                THE THREE CARDINAL RULES OF AN EOM PARAGRAPH                             |
|                                                                                                         |
|   1. MUST BE IN THE FINANCIAL STATEMENTS:                                                               |
|      The matter must be properly accounted for and disclosed in the notes (e.g., Note 14).              |
|      If the matter is not disclosed, it is a GAAP DEPARTURE (AU-C 705), NOT an EOM!                     |
|                                                                                                         |
|   2. MUST STATE OPINION IS NOT MODIFIED:                                                                |
|      The paragraph must include the explicit sentence: "Our opinion is not modified in respect          |
|      of this matter."                                                                                   |
|                                                                                                         |
|   3. MUST REFERENCE THE SPECIFIC FOOTNOTE:                                                              |
|      The paragraph must direct the reader directly to the client's footnote disclosure.                 |
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Formatting and Placement Requirements

Under AU-C 706, when the auditor includes an Emphasis-of-Matter paragraph in the audit report, the auditor must:

• Place it in a separate section of the report. Placement depends on the nature of the matter and the auditor's judgment of its significance; it often follows the Basis for Opinion section (or the Key Audit Matters section when KAMs are presented).
• Use the heading "Emphasis of Matter" or another appropriate heading that includes the term (e.g., "Emphasis of Matter—Subsequent Event").
• Include in the paragraph a clear reference to the matter being emphasized and to the specific footnote disclosure in the financial statements that addresses the matter.
• Explicitly state that the auditor's opinion is not modified in respect of the matter emphasized.

Standard Illustrative Wording for an EOM Paragraph

"Emphasis of Matter We draw attention to Note 12 of the financial statements, which describes the uncertainty related to the outcome of the patent infringement lawsuit filed against the Company by TechCorp. Our opinion is not modified in respect of this matter."

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2. Mandatory vs. Discretionary EOM Triggers

GAAS distinguishes between circumstances where an Emphasis-of-Matter paragraph (or dedicated explanatory section) is mandated by specific AU-C standards and circumstances where it is added at the auditor's professional discretion.

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|                                 MANDATORY VS. DISCRETIONARY EOM TRIGGERS                                |
|                                                                                                         |
|   MANDATORY TRIGGERS (Specific GAAS Requirements)     DISCRETIONARY TRIGGERS (Auditor Judgment)         |
|   - Substantial doubt about going concern             - Major catastrophe or natural disaster           |
|     (AU-C 570 - dedicated section)                    - Significant related party transactions          |
|   - Justified change in accounting principle          - Unusually important subsequent events           |
|     with material effect (AU-C 708)                   - Significant regulatory or litigation uncertainty|
|   - Special purpose framework presentation (AU-C 800)                                                   |
|   - Correction of material misstatement in previously                                                   |
|     issued financial statements / restatement (AU-C 708)                                                |
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Detailed Analysis of Mandatory Triggers

1. Substantial Doubt About Going Concern (AU-C 570): If management's evaluation reveals substantial doubt about the entity's ability to continue as a going concern, and management has included adequate disclosures in the footnotes (ASC 205-40), the auditor issues an unmodified opinion but must include a dedicated explanatory section titled "Substantial Doubt About the Entity's Ability to Continue as a Going Concern." (Under SAS 134, this dedicated heading replaces the generic EOM heading, but operates under the same non-modifying rules).
2. Change in Accounting Principle / Inconsistency (AU-C 708): When an entity changes an accounting principle (e.g., moving from FIFO to LIFO, or adopting a new FASB ASU) that has a material effect on comparability between periods, and the auditor agrees with the change, the auditor must issue an unmodified opinion with an EOM paragraph pointing to the accounting policy note.
3. Correction of a Material Misstatement (Restatement) (AU-C 708): When previously issued financial statements have been restated to correct a material prior period error (under ASC 250), the auditor must include an EOM paragraph referencing Note X, stating that the prior statements have been restated and summarizing the error.
4. Special Purpose Frameworks (AU-C 800): When financial statements are prepared using a comprehensive basis of accounting other than GAAP (e.g., Cash basis, Modified Cash basis, Tax basis, Regulatory basis, or Contractual basis), the report must include an EOM paragraph alerting readers to the basis of accounting and referencing the disclosure note describing the framework.

Detailed Analysis of Discretionary Triggers

Auditors exercise professional judgment to emphasize other critical footnote disclosures:

• Major Catastrophe: A hurricane, fire, or earthquake destroyed 30% of the entity's manufacturing facilities after the balance sheet date, fully disclosed in the subsequent events note.
• Significant Related Party Transactions: The entity entered into a massive lease and licensing agreement with an entity controlled by the majority shareholder, appropriately disclosed under ASC 850.
• Unusually Important Subsequent Events: The entity agreed to be acquired in a multi-billion-dollar merger announced between the balance sheet date and report release date.

Exam Trap: An Emphasis-of-Matter paragraph can never be used to fix or compensate for missing or deficient disclosures! If a client experiences a catastrophic fire or going concern crisis but refuses to disclose it in the notes, the auditor cannot issue an unmodified opinion with an EOM. The omission of required footnote disclosures is a GAAP departure that requires a Qualified or Adverse opinion under AU-C 705!

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3. Other-Matter (OM) Paragraphs

An Other-Matter paragraph is a paragraph included in the auditor's report that refers to a matter other than those presented or disclosed in the financial statements that, in the auditor's professional judgment, is relevant to users' understanding of:

1. The audit;
2. The auditor's responsibilities; or
3. The auditor's report.

Formatting and Placement Requirements

• Must use the heading "Other Matter" or another appropriate heading.
• Placed in a separate section whose position depends on the matter, often after any Emphasis-of-Matter section, or near the end of the report when it relates to other reporting responsibilities.

High-Frequency Other-Matter Applications on the CPA Exam

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|                                 PRIMARY APPLICATIONS OF OTHER-MATTER PARAGRAPHS                         |
|                                                                                                         |
|   1. COMPARATIVE STATEMENTS AUDITED BY PREDECESSOR AUDITOR (AU-C 700):                                  |
|      When comparative financial statements are presented, the prior period was audited by a             |
|      predecessor auditor, and the predecessor's report is NOT reissued. The current auditor adds an OM  |
|      stating: prior period audited by predecessor, date of report, type of opinion, and reasons.        |
|                                                                                                         |
|   2. SUPPLEMENTARY INFORMATION ACCOMPANYING STATEMENTS (AU-C 725):                                      |
|      Reporting on whether supplementary schedules (e.g., consolidating schedules) are fairly stated in  |
|      all material respects in relation to the financial statements as a whole.                          |
|                                                                                                         |
|   3. REQUIRED SUPPLEMENTARY INFORMATION - RSI (AU-C 730):                                               |
|      Explaining whether RSI (e.g., MD&A, pension disclosures) required by GASB/FASB is present, whether |
|      auditor applied limited inquiry/analytical procedures, and disclaiming an opinion on the RSI.      |
|                                                                                                         |
|   4. RESTRICTION ON USE OF THE AUDITOR'S REPORT (AU-C 905):                                             |
|      Alerting readers that the report is intended solely for specified internal/contractual users.      |
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4. Comprehensive Comparison: Emphasis-of-Matter vs. Other-Matter

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5. Realistic Exam Scenarios & Analysis

Scenario 1: Restatement of Prior Period Statements During the 2025 audit of Vantage Technologies, management and the auditor discover that 2024 revenue was overstated by $4.2 million due to a premature billing error. Management restates the 2024 comparative financial statements and provides comprehensive, transparent disclosures in Note 3 explaining the error, its tax impact, and the line-by-line restatement figures.

• Reporting Response: The auditor issues an unmodified opinion on the 2025 and 2024 financial statements. The auditor must include an Emphasis-of-Matter paragraph referencing Note 3, describing the restatement, and affirming that the opinion is not modified with respect to this matter.

Scenario 2: Predecessor Auditor Report Not Reissued Beacon Manufacturing presents comparative two-year financial statements for 2025 and 2024. The 2024 statements were audited by a predecessor auditor who issued an unmodified opinion on March 12, 2025. The predecessor auditor's report is not reissued with the comparative package.

• Reporting Response: The successor auditor issues an unmodified opinion on the 2025 statements. To address 2024, the successor auditor includes an Other-Matter paragraph stating that: (1) the 2024 statements were audited by another auditor, (2) the date of their report was March 12, 2025, (3) the predecessor expressed an unmodified opinion, and (4) the substantive nature of any explanatory paragraphs.