Explanatory Paragraphs for Issuers and Other Audit Considerations

Explanatory Paragraph

For an issuer, what paragraph is included in the auditor report?

Explanatory paragraph

An explanatory paragraph is required is included in the auditor’s report when…

• required by PCAOB auditing standards

• at auditors discretion

does inclusion of the explanatory paragraph impact auditor’s opinion?

NO

When an explanatory paragraph is included, the auditor should

• Use an appropriate heading.

• Describe the matter being emphasized.

• Refer to the related disclosure in the financial statements.

• Generally place the paragraph after the opinion paragraph.

Where is the explanatory paragraph usually located?

generally placed after the opinion section when added to unqualified report

When is an explanatory paragraph required for a going concern issue?

When there is substantial doubt about the entity’s ability to continue as a going concern.

When is an explanatory paragraph required when another accounting firm is involved?

When the auditor divides responsibility with another public accounting firm and refers to that firm’s audit/report.

When is an explanatory paragraph required because of an accounting change?

When there is a material change between periods in accounting principles or in the method of applying those principles.

Does every change in the reporting entity require an explanatory paragraph?

No. It is generally required for a change in the reporting entity, unless the change results from a transaction or event such as the creation, cessation, purchase, or disposition of a subsidiary or other business unit.

When is an explanatory paragraph required in an integrated audit?

When the auditor performs an integrated audit but issues separate reports on the financial statements and internal control over financial reporting.

When can a change in an investee require an explanatory paragraph?

When there is a change in the investee’s year-end that has a material effect on the company’s financial statements.

Quick Memorization Card: What situations can require an explanatory paragraph

G – Going concern
O – Other auditor / divided responsibility
A – Accounting principle change
R – Reporting entity change
I – Integrated audit with separate reports
Y – Year-end change of investee

When evaluating the acceptability of an accounting change, the auditor should consider whether:

• newly adopted accounting principles are in accordance w/ applicable reporting framework

• method of accounting for the change is acceptable

• disclosure related to the accounting change are appropriate and adequate

• entity has justified that the alternative accounting principle is preferable

What are circumstances that require an emphasis of matter (explanatory) paragraph

• change in ACCT estimates that is inseparable from a change in accounting principle

• correction of an error in accounting principle (cash method to accrual)

• correction of a material misstatement in previously issued f/s

• change in reporting entity that results in f/s that are, in effect, those of a different reporting entity

If a loss is probable and the amount can be estimated, what should the company do?

Accrue and disclose the loss

If a loss is probable but the amount cannot be estimated, what should the company do?

disclose the loss

If a loss is reasonably possible and the amount can be estimated, what should the company do?

Disclose the loss.

If a loss is reasonably possible but the amount cannot be estimated, what should the company do?

Disclose the loss.

If a loss is remote, what should the company generally do?

Generally ignore it; no accrual or disclosure is usually required.