Ed. note: Today’s guest blog is from Dan Goelzer. Dan is a retired partner at Baker & Mackenzie and the inaugural Chairman of the Public Company Accounting Oversight Board (PCAOB). He is also a member of our Advisory Board.
In March, the SEC proposed a far-reaching set of climate-related disclosure rules. Among other things, the proposal would add considerable information related to the impact of climate change to the notes to the financial statements, much of it at the low materiality threshold of one percent of a line item. Capturing and reporting this information would require companies to make significant changes to their information systems and would also require the exercise of a significant amount of judgment. Since these new disclosures would be part of the financial statements (and the controls over the disclosures would be part of the company’s internal control over financial reporting), both the disclosures and the controls would be within the scope of the external auditor’s work. The same aspects of the proposals that would make implementation challenging for companies could make the auditing challenging as well.
As part of that same proposal, the SEC seeks quantitative disclosure of Scope 1 and 2 greenhouse gas emissions – and in many cases Scope 3. Moreover, larger public companies — accelerated filers — would be required to include in their SEC filings an attestation report from an independent third-party expert on their Scope 1 and Scope 2 emissions. The attestation would not necessarily have to be provided by the company’s financial statement auditor, or indeed by a CPA. Nonetheless, it seems likely that in many cases companies would retain their auditor for this new GHG disclosure attestation.
On August 12, in an action that attracted far less public attention than the climate disclosure proposals, the SEC approved several amendments to the Public Company Accounting Oversight Board’s auditing standards. These changes strengthen the requirements for planning and supervision of audits that use accounting firms in addition to the firm that issues the auditor’s report. In an increasingly globalized world, U.S. public companies often have operations in numerous countries around the world, and their audits often require the participation of accounting firms in many jurisdictions. The amended PCAOB standards are intended to increase and improve the lead auditor’s involvement in and evaluation of the other auditors’ work in these situations.
The PCAOB describes the amendments as requiring “a risk-based supervisory approach” to oversight of other auditors. The Board’s release says that its inspections have found deficiencies in other auditors’ compliance with PCAOB standards, often in critical audit areas. The PCAOB expects the amendments to improve audit quality and increase the likelihood that auditors will detect material misstatements in the financial statements and material weaknesses in ICFR. Investors, who rely on financial reporting in making investment decisions, should benefit as a result.
These two seemingly unrelated developments suggest a question: How would the auditing challenges likely to arise under the climate change disclosure rules, if they are adopted as proposed, interact with the new PCAOB standard on supervising the work of other auditors?
Potential Impact on SEC Climate Disclosure Attestations
Of course, in the case of the audit of a multinational company where audit firms in several jurisdictions are used, the new standard will apply. The multi-national’s subsidiaries will have to establish systems and controls to capture the necessary information for the consolidated entity’s climate change financial statement reporting. Depending on materiality and other audit planning considerations, at least some local auditors will have to audit those aspects of the subsidiaries’ controls and reporting. The lead auditor will have to supervise that work under the new standard and may have to educate the other auditors about the SEC’s climate change disclosures and how to audit them. That may well involve considerable effort for both the lead auditor and the other auditors, especially in the first year. The same challenges would have existed, even without the new PCAOB standard, but the new standard will, no doubt, force auditors to devote extra time and effort to compliance and to making sure that the other participating firms understand the SEC’s climate rules and appropriately audit the resulting disclosures.
Attesting to GHG emissions disclosure under proposed Item 1505 is also likely to require procedures to be performed at multiple locations, potentially in a number of different countries. However, because the GHG emission disclosures (as they are currently proposed) would be outside of the financial statements, emissions attestations will not be part of the financial statement audit and will be outside the PCAOB’s authority. Therefore, the new standard on supervising the work of other auditors will not apply. Nonetheless, as a practical matter, the large international accounting firms will almost certainly apply the same kind of lead auditor supervision to GHG emissions attestations involving other firms as they would to the financial statement audit. Failure to do so would entail a high level of liability and reputational risk as illustrated by the SEC’s recent enforcement against Vale which involved non-financial audit failures. (Ed. note: I blogged previously on a couple other potential risks in this regard.)
The first years of both disclosure and auditing under the SEC’s climate change proposals are likely to be difficult for all concerned. Implementation challenges will be formidable. The PCAOB’s new standard on supervising the work of other auditors should however give investors some added confidence in the auditing of the financial statement climate disclosures of companies that operate in multiple jurisdictions.