It’s Not What You Look at that Matters: It’s What You See, Revealing ESG in Critical Audit Matters

PCAOB Board member J. Robert Brown, Jr. spoke to ICGN about audit disclosures and ESG. An excerpt (footnotes omitted):

I’m guessing that when you think about Environmental, Social and Governance or ESG disclosure, audit regulators are not usually top of mind. Today, though, I want to share some thoughts about why they should be. The PCAOB and other audit regulators have an important role to play in the ESG disclosure space.

We all know that ESG disclosure has undergone exponential growth, both in quantity and importance. These days it’s almost impossible to pick up a newspaper or read articles via the Internet without seeing the effects of climate change, whether disappearing polar ice, rising temperatures and sea levels, the increasing severity in weather patterns, the out-of-control fires in the Western United States, or the global discourse on mandating limits on carbon emissions.

Given the importance of the area, investors and other participants in the capital markets are increasingly demanding high-quality disclosure that can be useful in making investment and voting decisions. ESG-related disclosure, however, suffers from a number of qualitative concerns that limit its utility. Not subject to, or measured against, universally accepted reporting standards, concerns can arise with respect to the comparability and completeness of the information. Not subject to a mandatory system of assurance, concerns can exist about consistency and reliability.

Not all ESG matters raise these concerns: ESG matters can and do directly affect the financial statements. Financial statements may include assumptions, estimates, and valuations that are materially impacted by the effects of climate change. In these circumstances, accounting standards ensure some degree of consistency and comparability; independent audits provide some level of completeness and reliability. These advantages notwithstanding, investors often are left unaware of the role of climate change and other ESG matters in the financial statements.

Steps taken by audit firms to become comfortable with these often difficult, uncertain, and challenging matters have generally not been made public. This, however, has begun to change. Last year, audit firms for the largest public companies in the United States were required, for the first time, to include in their reports a discussion of “critical audit matters” (“CAMs”). This is a new source of disclosure for investors, emanating not from management but from audit firms. Critical audit matters are intended to extend to the areas of the audit that are particularly difficult and particularly important. The uncertainties and complexities associated with auditing the areas of the financial statements that contain assumptions and impacts of the effects of climate change and other ESG matters can certainly qualify as a critical audit matter under this standard.

It’s Not What You Look at that Matters: It’s What You See, Revealing ESG in Critical Audit Matters

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