Making audit reports add up for firms

Pic: Not all business operators in Vietnam understand the nuts and bolts of audit reports - Photo: Le Toan

As companies are due to submit their audited financial statements, which will subject to scrutinizing during Annual General Shareholder Meetings, it has become increasingly important for stakeholders to navigate and understand the key elements of the audit reports attached to the financial statements - an area that is not familiar to everyone.

The public tends to recognise any issues mentioned in audit report as “points being highlighted by the auditor” regardless of where or how the issue is mentioned. It has been observed in quite a number of listed companies’ financial statements published so far this year that there is an increasing appearance of “Emphasis of Matter” paragraph right after the audit opinion section.  Many users often wonder what auditor wants to communicate within this Emphasis of Matter (EOM) paragraph and how the issues mentioned add to the overall picture of the related financial statements’ truth and fairness?

The meaning of an EOM in audit report is different from a qualification – an audit report with an EOM is still considered a “clean audit report” assuming that there is no other issue subject to auditor’s qualification. On another word, the auditor has been able to obtain sufficient audit evidence regarding the recognition, presentation and disclosure in the financial statements of the matter being highlighted in the EOM but the auditor would like bring such matter to the financial statements readers’ attention due to its importance to the user’s understanding of the financial statements while the financial statements are considered to give a true and fair view. However, auditors and financial statements reader should be cautious about the use of EOM paragraphs. In fact a widespread use of EOM paragraphs diminishes the effectiveness of auditor’s communication of such matters. Additionally, incorporating too much information in an EOM may imply that the audited entity’s management has not included enough information in the related financial statements.

In general, an EOM paragraph is used mainly in the case that a significant uncertainty exists having a material effect on the financial position and performance of the audited entity. A common example of significant uncertainty is relating to the ability of the entity to continue as a going concern which may be subject to the occurrence or non-occurrence of future events. When adequate disclosure about the uncertainty is provided in the financial statements, the auditor would ordinarily include an EOM paragraph to highlight the uncertainty that may cast significant doubt on the entity’s ability to continue as a going concern.  However, the important point is that the auditor has not opined that the going concern is not appropriate.  The auditor has still agreed that the going concern is still appropriate and the financial statements are true and fair.

If the entity does not provide adequate disclosure about the uncertainty in the financial statements, an emphasis of matter paragraph would be inappropriate since the financial statements as a whole are not true and fair.  Instead, the audit opinion would have to be qualified.  In case the auditor is unable to obtain sufficient audit evidence about the ability to continue as a going concern or does not agreethat going concern assumption is  appropriate, the auditor would express a disclaimer of opinion or adverse opinion.

Significant uncertainty may also exist in relation to results of outstanding lawsuit filed against the entity. In this case the lawsuit is on-going and has not been concluded at the year-end while based on information available at the year-end date it is not possible for entity’s management to assess the potential outcomes of the case. Similar to the uncertainty over going concern, if the uncertainty over the lawsuit is explained sufficiently in the note to financial statements; the auditor would include an EOM to refer to such explanation as opposed to the case where there is not sufficient explanation regarding the lawsuit in the financial statements, a qualified opinion is likely to be needed, assuming the potential contingent effects is material to the financial statements.

Uncertainties however must associate with a future event and therefore issues for which there are indications or conditions confirming their existence at the balance sheet date should not be mentioned in an EOM. Cases such as additional provision for income tax which should have been accrued based on the prevailing tax regulations but in fact not being made as management arguing that it is subject to official tax notice or allowance for bad debts not being provided for as management is working toward revising the original payment terms are clearly not matters of uncertainty for which a qualification is appropriate not an EOM. Similarly issues that associate with wrong accounting treatments should never be reported within an EOM.

The need to distinguish an EOM and a qualification is key to understand audit reports. Audit reports, as the final products of the audits and their quality, play a fundamental role in bringing transparency to the capital market. In order for a financial statements user to make informed decision he needs to learn how to extract the right information when reading audit reports.  Understanding of situations where EOM paragraphs may be used also helps user to evaluate the quality of the audit report to a certain extent.

The views expressed by the author here do not necessarily represent the views and opinions of KPMG Vietnam.