Growing concerns about the impact of climate-change on business performance have increased demand for greater climate-related disclosures at large companies. The quality of those disclosures, however, relies on the seriousness and efficacy of the audits that underpin them. With a colleague, Prof Colin Haslam of Queen Mary, University of London, I have been looking at this issue in new research undertaken at Sheffield University Management School. The question we have asked is to what extent do auditors treat the impact of climate change on multinational company balance sheets as being a part of their role?
To answer this question, we examined the audit reports of all FTSE 100 companies at the end of 2021 that ended in that year to determine whether their auditors included climate-related issues within the scope of their audit work in that year. Whether climate risks were deemed in scope or not, we examined whether an audit opinion was expressed on the impact of climate related matters on the financial statements, and whether that impact was deemed to be material or not.
The results were disappointing, to say the least. Thirty-nine (39%) per cent of auditors did not refer to climate-related change as an issue of concern when stating the scope of their audit work in 2021 whilst just thirty-six per cent (36%) of auditors expressed an opinion on the impact of climate change on the financial statements (accounts) of the companies that they were auditing in 2021 and just two audit opinions in 2021 considered climate-related issues to be of significance. These were of Persimmon plc, where issues relating to flooding risk were discussed and noted as not creating a risk, and Meggitt plc, where issues relating to obligations for mine reinstatement remediation in the USA were noted but were considered to be adequately provided for because an adverse opinion was not given.
Whilst there were other occasions, for example in the case of the two major oil companies in the FTSE 100, where climate issues were discussed by auditors at length in their report, in these cases the auditors ultimately decided that their client's business model was satisfactory and that the accounts were true and fair despite being prepared on a basis that many commentators think to be unsustainable and a risk to the planet. As a result, they were among the 34 audit firms offering an opinion on this issue in 2021, only to dismiss it as immaterial to the accounts on which they were reporting.
There were, unsurprisingly, variances in approach between the audit firms. The auditor who most often treated climate-related risks as outside the scope of their audit work was KPMG: fifty per cent (50%) of their audits make no reference to the issue when they were detailing the scope of the work undertaken. In contrast, PWC included climate-related issues within the scope of their work more often than any other auditor. Seventy-eight per cent (78%) of their audit reports refer to climate or the environment as being within the scope of the work that they undertook.
Amongst the Big 4 audit firms, EY were most likely to ignore climate change-related issues when offering their audit opinion, doing so in seventy-one per cent (71%) of all their audit reports. This was marginally greater than Deloitte, who did so in sixty-nine per cent of their audit reports (69%). In contrast the audit firm most likely to refer to climate change-related issues when reporting their opinion on financial statements was PWC, who did so in forty-eight per cent (48%) of their audit opinions. This does, however, mean that no auditor in 2021 commented on climate change-related issues in a majority of their audit reports.
The most common reasons given for not commenting on climate-related matters in the audit report were that:
- The issue was beyond the scope of the audit (the most common opinion supplied).
- The effects of climate change were not material within the period analysed by the audit;
- The identified climate-risk to the carrying value of assets, whether tangible (e.g. plant and equipment) or intangible (e.g. goodwill) was considered to be amply accommodated within the valuation margins available, meaning the risk of additional impairments being required was small, and so was dismissed;
- The issue was simply immaterial.
Some surprising sectors saw no mention of climate-related issues. No auditor referred to this issue as being within the scope of audit work in the case of water companies and paper and packaging companies. The sectors where climate change was most likely to be dismissed as immaterial were telecoms, real estate letting, retailing, software and general manufacturing and distribution.
In general, the audit reports issue provide little indication of concern about climate change or of a willingness to address issues relating to climate change within financial reporting. Nor was there any indication of consistent approaches to climate change within audit firms.
Clearly this situation is not good enough. It seems that auditors are doing their utmost to avoid their responsibility on this issue, either pretending that the current definition of going concern lets them off the hook for such long-term issues, or that directors' reporting outside the accounting framework absolves them from responsibility to consider climate change within it. Both are obviously untrue for an issue of this consequence.
We argue that a financial Reporting Standard on this issue is now required, and that the International Sustainability Standards Board approach is inadequate. Such a standard then clearly requires that a related auditing standard be delivered. Only then might the audit profession and their clients transform their approach to this issue so that stakeholders receive the assurances that they need that the FTSE 100 are taking their responsibility for climate change seriously. At present we are a very long way from that.
As we noted in our conclusions:
The reasons auditors might have for not commenting on climate related issues have to be deduced from the comments that they did make in audit reports in 2021, almost all of which appear to be intended to limit their liability with regard to this issue. A number of excuses appear to be offered by auditors for adopting this approach.
Firstly, one of the most common reasons for not commenting appears to be the willingness of auditors to dismiss the future consequences of the current actions of their clients. They do this by literally discounting those events that might happen more than twelve months after the date of the audit opinion being formed as if they are of no current concern. The passage of time is, of course, fundamental to the process of accounting. Financial statements are prepared for periods of time that are, by definition, in the past. However, the requirement that an auditor appraise the ability of their client to continue as a going concern necessarily requires that the future as well as the past be considered by the auditor when forming their opinion. Despite this many auditors appear to be making use of an artifice, which is the pretence that going concern need only be considered for a period of twelve months after the date of the audit opinion, to suggest that matters arising thereafter are of no concern to them. That, however, does not prevent them considering the nature of other long-term liabilities arising well into the future when forming their audit opinion on matters such as contractual obligations for decommissioning and remediation in energy and mining companies, and this exclusion of similar concern arising with regard to climate related issues does, therefore, appear incongruous.
Second, there appears a willingness to ignore potential claims arising from beyond the boundaries of the corporation as defined for the purposes of accounting. This is reflected in the dismissal, explicitly noted in one case but seemingly commonplace in others, of what are called Scope 3 climate emissions. These are the climate emissions that are produced by third parties to the organisation on which auditors is explicitly reporting but which arise as a consequence of that reporting entity's activities. This audit approach represents a very narrow view of the likely responsibility of corporations in the light of developing law on such issues that would suggest that Scope 3 emissions can create liabilities for companies even if they occur beyond the boundaries of what is usually described as the calculable space of the corporation.
Third, auditors would appear to be engaged in regulatory arbitrage when seeking to avoid their liability for reporting on these issues. By either noting that the directors of the entity on whose financial statements they are expressing opinion are reporting separately on climate related issues, most notably through use of Task Force on Climate-related Financial Disclosures, or are reporting on climate related issues within the narrative notes within the financial statements that are not specifically within the scope of the audit, the auditors seek to exclude their responsibility for this issue as if that other disclosure absolves them from considering the issue further. This would appear to be game playing on the part of auditors on an issue of great significance that they should now accept the responsibility to address.
The result of these actions by auditors is that they, their clients, and the financial statements they produce are failing to tackle the issues arising from climate change as they impact on the corporate sector. Unless this changes, and auditors and their clients accept responsibility for this issue it is not clear how issues relating to climate change can be properly addressed by the UK corporate sector in the future at potential cost to us all.
This has to change.
Our full report is here.
 The calculable space defines the transactions falling within the scope of the financial statements.
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