The Future of Audit Part 3: The rise of ESG in audit

Simon de Souza, 2 February 2024

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In this blog, we follow on our ‘The Future of Audit’ series and delve into the topic of ESG and its significant impact on businesses and the audit profession.

What is ESG?

ESG stands for Environmental, Social and Governance and collectively for businesses, it’s a framework of operation to ensure that the business acts responsibly and considers its impact on the environment and society.

All three components of this are broad, but some elements of each of these are as follows:

  1. Environmental – This includes considerations around the impact the business has on the environment and covers areas such as:
    • minimising carbon emissions and moving towards net zero
    • reviewing the businesses supply chain and considering how to minimise its impact
    • reviewing its waste management processes
    • considering the impact of the business on biodiversity
  1. Social – This includes the following considerations:
    • the business’ practices on diversity and inclusivity in the workplace,
    • policies on human rights,
    • the businesses framework for employee welfare and development
    • its involvement in the community and any initiatives it’s involved in
  1. Governance – The governance component is important in driving the other areas and these have several considerations which include, but is not limited to, policies on the business’s management structure, board diversity, bribery and corruption and reviewing employee compensation.

Why is it important?

ESG encourages businesses to act responsibly and having a positive impact on its environment and stakeholders.

Having robust policies in place can provide a number of benefits, such as:

  1. Assisting in recruitment and retaining talent, developing customer relationships and attracting investment with a number of these parties placing more importance on a business’s ESG policies
  2. Reducing costs in the longer term with a focus on reducing waste
  3. The corporate reporting landscape is continuously changing with further disclosure on ESG matters expected and so early consideration can prepare for an easier transition

Position in respect of financial reporting

Qualifying large UK companies are required to make a number of disclosures in respect of greenhouse gas emissions, energy consumption and energy efficiency and some additionally are required to report on sustainability and considerations of climate related financial disclosures.

The International Sustainability Standards Board (“ISSB”) in June 2023 released 2 standards, IFRS S1 and IFRS S2 in relation to sustainability and climate related disclosures. These have not yet been endorsed for use in the UK, but it’s expected that this year it’ll be agreed whether it will be or whether a UK equivalent of these will be issued instead.

The disclosure requirements for these standards exceed the current disclosures required for qualifying large companies and the expectation is that the level of disclosure required will continue to increase over time.

Small and medium sized entities are not required to currently make these disclosures in their financial statements, but again it’s also expected this will change in the near future.

The requirements in IFRS S1 and IFRS S2 include the reporting of scope 3 emissions which requires companies to calculate the greenhouse gas emissions in its value chain. To assess this companies will then need to understand the emissions from its customers and suppliers resulting in small and medium sized entities needing to understand their own greenhouse gas emissions profile to present to the reporting entities. Therefore, there is the expectation that even if reporting for some entities is not required in their own financial statements, they will need to have their own understanding of their greenhouse gas emissions for these reasons.

Despite a number of companies not requiring to make these disclosures, there are a number that have chosen to disclose these details anyway in their financial statements as they pursue their own ESG strategy.

Concerns around greenwashing

With this being such a high-profile area, there are a number of concerns that have been reported with the concept of greenwashing often being highlighted. Greenwashing is making false or misleading claims that suggests a business is more environmentally friendly than in reality it is.

These concerns can be allayed to stakeholders through assurance engagements in respect of ESG.  

What the future will look like

The requirements of ESG disclosure are continuing to increase in financial statements. We’re equipped to assist in the preparation of these disclosures and reviewing systems and processes to capture this information.

ESG assurance engagements will start to become more common, whether this is based on Agreed Upon Procedures to review specific areas or a more formal opinion in accordance with ISAE (UK) 3000. This is still in the early stages as companies come to grips with the ever-changing landscape but is expected to be a focus going forward for assurance practitioners.

How can we help

At Lubbock Fine, we understand the complexities and evolving nature of ESG on the landscape for businesses. To have a confidential conversation regarding this, please get in touch with Partner Simon de Souza (simondesouza@lubbockfine.co.uk)