The Center for Audit Quality (CAQ) last week released a report discussing current requirements for public company auditors regarding climate-related disclosures. The publication’s goal is to provide an understanding of how company management and their auditors apply current U.S. accounting and auditing requirements for financial statements related to climate-related risks.
Demand for environmental, social, and governance (ESG) reporting is high, and investors and others using climate-related information to make decisions can benefit from a better understanding of today’s requirements as they wait for additional regulatory decisions about disclosures.
“The public company audit profession is supportive of a continued dialogue among all stakeholders in the corporate reporting ecosystem to support the presentation of consistent, relevant, comparable, and reliable climate-related measures and disclosures,” the report states.
Because most climate-related information disclosed today is available outside financial statements, auditors need to talk to individuals outside of accounting and finance, such as general counsel and sustainability or risk and compliance committees.
Although future changes to ESG standards and regulations are likely, current accounting and regulatory requirements call for companies to evaluate climate-related risks and include them in their financial reporting today. Public Company Accounting Oversight Board (PCAOB) standards require auditors to perform risk assessments, which include climate-related risks. The assessments involve gaining an understanding of the company, including its business objectives, industry, regulation, and management’s plans to deal with the potential impacts of climate.
Because most climate-related information disclosed today is available outside financial statements, auditors need to talk to individuals outside of accounting and finance, such as general counsel and sustainability or risk and compliance committees (if they exist). They also should consider information from company Websites; press releases; earnings calls; board minutes; disclosures in Form 10-K outside of financial statements (business description, risk factors, legal proceedings, and management’s discussion and analysis); and separate sustainability reports.
PCAOB standards do not require auditors to perform procedures related to disclosures in documents that do not contain audited financial statements or provide any assurance over the information. However, they are required to read other information included in documents that contain audited financial statements and evaluate any contradictory information they may present or any material inconsistencies with the financial statements. To obtain reasonable assurance the financial statements are free of material error, auditors need to consider implications of climate-related risks that are described in those documents.
Management’s process for identifying and evaluating climate-related risks and developing accounting estimates is critical to evaluating financial statement impact and adequacy of disclosures. Assumptions about climate-related risk may be just a part of how management develops its accounting estimates, and there are significant judgments involved in this area.
The CAQ report provides questions auditors might ask as they evaluate the potential effects of climate-related risks on an entity’s financial statements in several categories:
Management’s consideration: What public statements has the company made about commitments related to climate? What is the process for identifying and assessing climate-related risks and their impact on the financial statements? What estimates are related to the company’s decarbonization plan and timeline, and have they been considered in preparing the financial statements?
Legislation and regulation: What are the current and future regulations that might affect the company, and when might they take effect? What are their potential current and future impacts on valuations of assets?
Transition: How could potential changes in customer preferences related to climate and sustainability affect demand for the company’s current products? Have these been considered in developing assumptions for future cash flows and asset valuation models? Have other risks of making changes in manufacturing processes or alternative products to transition to a low carbon footprint been considered in estimating future cash flows?
Supply chain: Are the company’s key suppliers affected by climate risk, and what are the impacts on the company?