Center for Advancing Accounting

The Double Materiality Audit: Assurance of ESG Disclosure

• In Event: Dialogue Session - Disclosures

Abstract

Auditors must now not only evaluate the accuracy of financial numbers but could soon be required to provide assurance on the information regarding the environmental, social justice, and good governance (ESG) claims made by its clients (SEC 2021; Harrington and Garzon 2022). Double-materiality refers to assessing materiality from two aspects: (1) the extent necessary for an understanding of the company’s financial position; and (2) the environmental, social, and governance impact of the company’s activities on a broad range of stakeholders (European Commission, 2019). For an audit, the two aspects of double-materiality are interconnected, meaning that albeit the inherently non-financial nature, ESG factors are closely associated with financial outcomes and potential business risk (Hales 2018). This research provides an understanding for such a “double materiality” audit by first identifying the current issues in ESG disclosures (e.g., lacking generally accepted ESG assurance standards or guidance in the US, limited and non-mandated external assurance, and a wide variety of ESG indices), recognizing the role of external auditors in the ESG disclosure and the interaction between a financial audit and ESG disclosure assurance, and by suggesting an audit analysis roadmap that incorporates both quantitative financial numbers and big ESG data. This paper proposes an audit approach that incorporates a “double materiality” lens of financial numbers and big ESG data to evaluate the risk of material misstatement and the reliability of ESG disclosure. Specifically, it suggests the extended audit procedures for data collection and verification, recommends criterion for the selection of ESG indices, and highlights the ongoing challenges (e.g., audit independence) and opportunities.
References
European Commission (2019), “Guidelines on non-financial reporting: supplement on reporting climate related information”, available at: https://eur-lex.europa.eu/legal-content/ EN/TXT/PDF/?uri=CELEX:52019XC0620(01)&from=EN (accessed 20/02/2021)

Hales, J. (2018). The future of accounting is now. CPA Journal, 88(7), 6-9.

Harrington, G. and Garzon, V. (2022). “Preparing for the SEC’s Continued Focus on ESG in 2022”, available at: https://www.arnoldporter.com/en/perspectives/advisories/2022/01/preparing-for-secs-continued-focus-on-esg

SEC (U.S. Securities and Exchange Commission) (2022). “SEC Response to Climate and ESG Risks and Opportunities”, available at: https://www.sec.gov/sec-response-climate-and-esg-risks-and-opportunities

Authors

• Deniz A. Appelbaum, Montclair State University

• Huijue Kelly Duan, Rutgers, The State University of New Jersey

• Hanxin Hu, Rutgers, the State University of New Jersey

• Ting Sun, The College of New Jersey