Auditors Mum on Risks That Climate Poses for Corporate Profits

Even as scorching temperatures break records and insurers abandon hurricane-prone areas of the US, the financial toll of altered weather patterns and business strategies doesn’t surface in most corporate balance sheets or income statements.

Auditors, too, have been silent on the impact the threat from a warming planet could have on companies’ long-term success, even survival.

Although auditors weigh climate-related risks as they vet corporate revenue and liabilities, that work isn’t reflected in their annual reports to the market. Investors say that leaves them in the dark about business models at risk of drying up and how soon profits may evaporate.

“Too many companies make net zero pledges, don’t examine their fundamental business plans and by extension their financial statements in light of material risks posed by climate transition issues,” said Jon Lukomnik, managing director of Sinclair Capital. “And too many auditors don’t challenge that.”

US rules dictating how companies should discuss efforts to cut harmful carbon emissions aren’t expected until at least the fall and it’s not clear if those final rules will extend to the audited financial statements as the Securities and Exchange Commission has proposed.

Although many companies issue voluntary reports detailing efforts to curb travel or buy greener electricity, few expect to account for those costs until they become significant. Without spelling out how climate may ripple across corporate accounting, companies could hide behind rosy profits while ignoring looming risks, investors say.

Rare Disclosures

Auditors from Deloitte LLP and Ernst & Young LLP were among the few who said that they considered climate and transition risks when vetting the 2021 books and footnotes of a pair of clients.

Deloitte auditors wanted to know how “the pace of decarbonization and the energy transition, and new environmental regulations” could alter the petroleum refiner PBF Energy Inc.'s expected future cash flows, capital expenses and the longevity of certain long-term assets. The inquiry was part of the auditor’s work assessing if the company needed to write down the value those assets—a complex analysis that triggered a disclosure in the company’s 2021 audit report.

How long several AES Corp. power plants would continue running given the operator’s decarbonization goals and the “potential risks associated with climate change” also proved a complex assessment for EY auditors, warranting a note in the company’s 2021 audit report.

PBF and AES did not respond to requests for comment.

Such direct references to climate risks and decarbonization are scarce, according to a Bloomberg Tax review of 10-Ks filed with the commission in 2022 that featured extended audit reports—a list of 4,780 predominantly US-based businesses.

Instead, US auditors commonly discuss issues that could be related to climate change such as wildfire and hurricane damage or how changing prices or future demand could affect oil producers and vehicle manufacturers.

To scrutinize auditor disclosures, Bloomberg Tax in March pulled annual audit reports filed with the SEC and checked those records for more than six dozen keyword terms including “climate change,” “energy transition” and “carbon neutral.”

Eyes on Reporting

Deloitte auditors consider climate risks that could impact their work vetting clients’ accounting. But looming regulations and even expanded voluntary reporting could lead to more audit reports that refer to climate change, said Laura McCracken, Deloitte’s deputy leader of the quality, regulatory and risk practice.

The firm declined to comment specifically on PBF’s audit.

“This is a bit of a transitional period and we recognize the demand, that investors are looking for this,” McCracken said. “As companies’ climate commitments start to materialize in the financial statements and disclosures, we could see more CAMs in the future,” she said of extended auditor disclosures known as critical audit matters.

And it’s not just Deloitte. Auditors at its competitors EY, KPMG and PwC have all begun asking clients more questions about how climate commitments and risks could reshape the balance sheet or drive up costs.

But there’s not a one-for-one match between auditors’ own risk assessments and what they discuss in their report to investors because audit and accounting rules dictate what they can disclose to investors.

“This continues to be a focus area for our firm,” PwC LLP said in a statement. “We believe it’s important for our audit reports to convey information that complies with the standards but also reflect the audit work that we’ve done.”

KPMG and EY declined to comment.

A Climate Proposal

For many companies, costs to mitigate climate change like phasing in more energy-efficient equipment or adopting technology to reduce pollution aren’t financially severe enough to warrant a mention in their financial statements yet. For other companies expenses to decommission power plants might not have occurred yet and so wouldn’t factor into their current financial reporting under existing accounting rules.

Without those disclosures in the audited financial statements, there’s little for auditors to discuss in their own separate report to investors.

The SEC has proposed new rules that could change that. The rules would require companies to report climate-related costs if they amount to 1% or more of any financial statement line item. The fate of the widely panned financial statement requirement is unclear as the SEC works to finalize its climate disclosure package as soon as the fall.

Financial statements and related footnotes serve as the source of the auditor’s report to investors under US audit rules and don’t take into account management statements on strategy or risks. The resulting auditor disclosure is a subset of what the company has already covered in its corporate accounting.

Since 2019, auditors have told investors about the most difficult accounts to verify and what steps they took to check management’s accounting. Those disclosures, or critical audit matters, frequently cover revenue or mergers and acquisitions, but not climate risks, which typically doesn’t show up as a financial statement account.

“Until we see management putting more out there about climate risk, I don’t believe that we should expect to see more climate risk CAMs,” said Linette Rousseau, an assistant accounting professor at the University of Houston.

Reporting Gap

Many investors expect to already see that climate assumptions have been baked into corporate financial statements especially for companies in high-impact sectors like agriculture and energy or to explain why they haven’t.

“Investors would want to understand why the auditors think that management’s judgments are reasonable in the face of this enormous systemic shift,” said Barbara Davidson, head of accounting, audit and disclosure for the Carbon Tracker Initiative, a think tank that researches how climate change could impact financial markets.

Auditors for just six UK and European companies, including Shell Plc and Rio Tinto Plc, at least partially addressed how they factored climate risks into their audit, according to a Carbon Tracker report that looked at 134 heavy emitters worldwide.

The group held auditors to a high bar and the outside accountants of 46 US companies, including AES, didn’t give enough consideration to climate risk when they vetted those corporate financial statements, the report said.

“There is a considerable gap between what the rules say and what is actually taking place,” said David Pitt-Watson, a fellow at the Judge Business School at Cambridge University.

Auditors are supposed to ensure that companies comply with accounting standards that require firms to explain how assumptions could alter their profits and asset values. Accounting standard setters have said that climate risks should be treated like any other risks which investors would consider to be significant under existing requirements.

“If companies and auditors are going to do anything, then before thinking about any new rules, let’s make sure that we’ve got the existing rules properly implemented,” Pitt-Watson said.