Audited financial statements and climate-related risk considerations

Sep 12, 2021
Financial reporting SEC matters Audit PCAOB matters

The Center for Audit Quality recently issued a publication, Audited Financial Statements and Climate-Related Risk Considerations, which is intended to provide a foundational understanding of how key elements of current U.S. accounting and auditing standards are required to be applied with respect to climate-related risks and audited financial statements.

Although current U.S. generally accepted accounting principles do not include explicit references to climate-related risks, management is required to consider such risks when their effects could reasonably be material to the financial statements. To the extent climate-related risks become risks of material misstatement such that there could be accounting or disclosure impacts, management also would be responsible for modifying its internal controls over financial reporting to properly identify and consider such risks.

The financial-reporting requirements for climate-related risks depend on several factors, including the nature of the entity’s business, its industry, geographic footprint, types of underlying transactions and the significance of the climate-related risk to the entity’s business, among others. The time horizon for which climate-related risks come to fruition also will vary by entity and industry; therefore, while risks may exist, the impact on the current-period financial statements may not be material. Forward-looking climate-related risks that potentially could impact an entity’s financial statements typically fall into one of two categories:

  • Physical risks, for example, the risk that an entity’s facilities will be damaged by a severe weather event
  • The risks associated with the transition to a low-carbon economy, for example, regulatory risk associated with required changes to a company’s business

Financial statement auditors have a responsibility to consider the appropriateness of management’s consideration of the financial statement implications of potential risks of material misstatement, which encompasses climate-related risks. When assessing the potential impact of climate-related risks, the auditor might consider it necessary to conduct inquiries of management, including personnel outside the finance department, to understand how and when management expects climate-related risks could impact the entity and how management plans to consider such risks in the preparation of the financial statements. The auditor also would consider information outside of the financial statements, including press releases, sustainability reports, board minutes and industry-specific publications, among others.

Further, auditors have a responsibility to read other information included in documents that contain audited financial statements, such as climate-related disclosures included in the description of the business, discussion of legal proceedings, risk factors, and MD&A, and consider whether such information, or the manner of its presentation, is materially inconsistent with information appearing in the audited financial statements.