The consideration of climate-related risks in an audit of financial statements
By Anne Adrain, Head of Sustainability and Reporting
12 October 2020
Recent guidance from the IAASB on the consideration of climate-related risks in an audit of financial statements
The issue of climate change is at the forefront of the minds of many investors and other stakeholders as its impacts are becoming increasingly apparent. The International Auditing and Assurance Standards Board (IAASB) has recognised that climate change is likely to have some impact on most, if not all, entities and, as a result, has implications for auditors.
As a result, they have issued guidance, in the form of a Staff Audit Practice Alert, to assist auditors understand what already exists in the current International Standards on Auditing (ISAs) and how that relates to auditors’ considerations of climate-related risks in an audit of financial statements.
Background
The IAASB guidance acknowledges that the term climate change does not feature within the current ISAs. However, it emphasises that auditors are required to identify and assess the risks of material misstatement of the financial statements, to perform audit procedures in response to those risks and to obtain audit evidence that is sufficient and appropriate to provide a basis for opinion in the auditor’s report. For certain entities, climate-related events and conditions may contribute to the susceptibility to misstatement of certain amounts and disclosures in an entity’s financial statements.
The auditor’s responsibility in an audit of financial statements is to obtain reasonable assurance about whether the financial statements as a whole are free from material misstatement to enable the auditor to report on whether the financial statements are prepared, in all material respects, in accordance with the applicable financial reporting framework. If climate change impacts the entity, then the auditor should consider whether the financial statements appropriately reflect this. In addition, auditors need to be aware of how climate-related risks relate to their responsibilities under professional standards, and applicable law and regulation. The guidance therefore highlights some of the current ISAs that may be relevant as part of the auditor’s consideration of their responsibility in relation to climate-related risks.
ISAs that are most relevant for auditors when considering climate-related risks
The following list contains the ISAs highlighted by the IAASB which may be most relevant to the auditor’s consideration of climate-related risks.
ISA 315, (Revised 2019) Identifying and assessing the risks of material misstatement - The auditor may consider the implications of climate-related risks when obtaining an understanding of the entity and its environment, including the entity’s business model, industry factors, regulatory factors and other external factors.
ISA 320, Materiality in planning and performing an audit - Climate-related risks may affect the auditor’s determination of materiality and performance materiality in accordance with ISA 320.
ISA 330, The auditor’s response to assessed risks - ISA 330 requires the auditor to design and perform further audit procedures whose nature, timing and extent are based on, and are responsive to, the assessed risks of material misstatement at the assertion level and to conclude whether sufficient appropriate audit evidence has been obtained.
ISA 250 (Revised), Consideration of Laws and Regulations in an Audit of Financial Statements – With regard to climate-related risks, other laws and regulations may include environmental regulations. A breach of such regulations may have a material effect on the financial statements.
ISA 450, Evaluation of Misstatements Identified during the Audit – The auditor is required to accumulate misstatements identified during the audit and determine whether these are material individually or in aggregate. Circumstances which may affect the evaluation include:
*the omission of information that, although not required by the applicable financial reporting framework, may be important to user’s understanding of the financial statements; and
*other information to be included in the entity’s annual report that may reasonably be expected to influence the economic decisions of the users of the financial statements.
ISA 540 (Revised), Auditing Accounting Estimates and Related Disclosures - For some entities, climate-related risks may have an impact on their accounting estimates. These may include impairment of property plant and equipment or goodwill, fair value estimates, provisions and contingent liabilities and mineral reserves. The auditor may consider a variety of factors when auditing accounting estimates including:
- regulatory factors;
- the appropriateness of the assumptions, methods and data used by management;
- the degree to which the accounting estimate is subject to estimation uncertainty and may be impacted because of climate change;
- the degree to which climate change affects the complexity of the accounting estimate; and
- the degree to which climate change affects the subjectivity of the accounting estimate.
Disclosures (various ISAs, including ISA 330 and ISA 540 (Revised)) - It is expected that more and more climate-related disclosures will be included in the financial statements because of the increasing impact of climate-related risks on entities’ financial statements and the interest of investors therein.
The IASB’s publication ‘IFRS Standards and climate-related disclosures’ highlights, among other matters, requirements that may be relevant to climate-related disclosures.
ISA 620, Using the Work of an Auditor’s Expert - Auditors of entities that are affected by climate-related risks may determine that the engagement team requires specialised skills or knowledge to appropriately identify and assess the risks of material misstatement or to respond to assessed risks. If expertise in a field other than accounting or auditing is necessary to obtain sufficient appropriate audit evidence, the auditor is required to determine whether to use the work of an auditor’s expert.
ISA 570 (Revised), Going Concern - There may be certain instances when a climate-related risk could give rise to an event or condition that may cast significant doubt on the entity’s ability to continue as a going concern, for example, extreme weather events.
ISA 260 (Revised), Communication with Those Charged with Governance - Communication with those charged with governance should include, among other matters, the auditor’s views about significant qualitative aspects of the entity’s accounting practices, including accounting policies, accounting estimates and financial statement disclosures. For entities affected by climate change, this may include the effects of climate-related risks on these aspects.
ISA 700 (Revised), Forming an Opinion and Reporting on Financial Statements - The auditor is required, when forming an opinion, to conclude whether the financial statements as a whole are free from material misstatement, whether due to fraud or error, taking into account, among other matters, the auditor’s conclusion, in accordance with ISA 450, whether uncorrected misstatements are material, individually or in aggregate. Climate-related risks that could give rise to material misstatements (if uncorrected), may relate to the appropriateness or adequacy of disclosures or the application of the entity’s accounting policies. If the auditor concludes that, based on the audit evidence obtained, the financial statements as a whole are not free from material misstatement, the auditor is required to modify the opinion in the auditor’s report in accordance with ISA 705 (Revised).
ISA 701, Communicating Key Audit Matters in the Independent Auditor’s Report - When ISA 701 applies, the auditor is required to determine key audit matters to be communicated in the auditor’s report. The degree to which climate-related risks require auditor attention in performing the audit, may result in determining such a matter to be a key audit matter. This determination may be affected by significant auditor judgements or specific events and transactions.
ISA 720 (Revised), The Auditor’s Responsibilities Relating to Other Information – Because the majority of climate-related information is currently disclosed in other information, when reading the annual report, the auditor is required to consider whether there is a material inconsistency between:
- the other information, including any climate-related information contained therein, and the financial statements; and
- the other information, including any climate-related information contained therein, and the auditor’s knowledge obtained in the audit.
The auditor is also required to remain alert for indications that the other information, not related to the financial statements or the auditor’s knowledge obtained in the audit, appears to be materially misstated.