Accounting for climate risk is now the auditor's business

Auditors have been put on notice that they need to consider their clients’ climate-related risks and, if material, determine whether those risks are adequately disclosed in the financial statements. A joint bulletin issued by the Australian Accounting Standards Board (AASB) and the Auditing and Assurance Standards Board (AUASB) Climate-related and Other Emerging Risks Disclosures: Assessing financial statement materiality using AASB Practice Statement 2 sets out their interpretation of the accounting and auditing standards with respect to material risk.

Materiality judgements underpin the preparation of financial statements, including recognition, measurement, presentation and disclosure. To date, there has been an emphasis on reporting climate change risks and any emerging risks in the operating and financial review (OFR) or management commentary. The Australian Securities and Investments Commission (ASIC) reviewed climate disclosure practices in 2018 and recommended, in Report 593, Climate Risk Disclosure by Australia’s Listed Companies, that directors understand and continually reassess emerging risks, including climate risks. ASIC highlights in that report that discussion of climate risk should be included in an OFR “when it could affect the entity’s achievement of its financial performance or disclosed outcomes”.

The AASB/AUASB bulletin, however, goes a step further. The bulletin is clear: if the climate-related risks are important to investors’ decision-making, those risks are material and need to be reflected in the financial statements. This shift of emphasis from the OFR to the financial statements is particularly significant for auditors. The auditor is required to provide an opinion on the financial statements but not on additional material in the annual report, such as the OFR. 

The OFR or other material in the annual report is defined in the auditing standards as “other information”, which auditors are required to read to identify any material inconsistencies with the audited financial report or any material misstatements of fact. This consideration of other information is limited to the auditor’s knowledge obtained in the audit. In contrast, if that information, including climate related risks, is addressed in the financial statements, then it will be subject to the scrutiny of an audit, necessitating engagement of expertise to understand those risks and their impact on the financial statements.

Momentum building

The momentum from investors calling for information on climate-related risks has been building following the release of the Financial Stability Board's Task-force on Climate-related Financial Disclosures (TCFD) recommendations in mid-2017. Even before the TCFD recommendations were released, the Australian Prudential Regulation Authority (APRA) believed many climate-related financial risks were no longer only future concerns, making public statements that those risks were “foreseeable, material and actionable now”. 

Investment managers Blackrock, Vanguard and HSBC have been calling for investors to consider the impact of climate-related risk on a company’s long-term financial value. Glencore responded to shareholder pressure by capping its future coal production in Australia at 2019 levels. 

In response to the TCFD recommendations, ASIC gave a clear signal to the market about its expectations, reporting that “we recommend that listed companies with material exposure to climate risk consider reporting under the TCFD framework” (Report 593), which is “specifically designed to help companies produce information that is useful for investors”.

To determine whether material climate-related risks are appropriately reflected in the financial statements, auditors need to ask clients whether:

• climate-related disclosures that have been made in the broader annual report impact the financial statements 
• any implications to the entity of climate-related risk in relation to regulatory obligations, market impacts, capital expenditure or the entity’s overall objectives and strategies have been assessed
• climate-related risks have been considered in preparing the financial statements, including fair value estimates, impairment of assets, expected credit losses and provisions, and the underlying assumptions used for estimates and impairments are disclosed 
• the absence of assessed material in an industry likely to be impacted by climate-related risks has been disclosed along with the underlying assumptions.

There is no suggestion that climate-related risk will be material to every industry or entity, but it needs to be understood alongside other existing and emerging risks in order to assess materiality that will drive disclosure.

Sustainability and finance teams within entities need to work closely together to ensure that available scientific data, including scenario analysis, informs the financial information reported. Likewise, it is imperative that auditors obtain the input of experts who can assess the impact of both physical and transition climaterelated risks.

Consideration of climaterelated risk has been overshadowed by disparate views on the reality of climate change. However, the AASB/AUASB bulletin warns that “entities can no longer treat climate-related risk as merely a matter of corporate social responsibility and should consider them also in the context of their financial statements”.

As the expectations regarding consideration of climate-related risk in the financial statements crystallise for the June 2019 reporting season, auditors need to ensure that they have a sufficient understanding of relevant climate risks in order to challenge their lients about the assumptions used to determine financial impacts and disclosures.

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