ASSURANCE AND AUDIT FUNCTIONS

SOCIAL AND ENVIRONMENT AUDITS

In recent years there has been new legislation which has been implemented to deal with environmental issues.  This has placed additional burdens on companies to comply with the new legislation.  The danger of non-compliance brings the risk of fines and bad publicity.  These are examples of environmental risks now facing companies today.

 

IMPLICATIONS FOR THE COMPANY  

We are all aware of the stakeholders in a company such as shareholders, banks, suppliers, customers, directors and employees.  We tend to forget that the environment and society are also stakeholders in companies.  Society encompasses that at international, national and local levels.

 

Traditionally, the auditor is only concerned with the shareholders as it is the latter he reports to on a set of financial statements.

In modern times, employees, the environment and society are linked.

 

The environment

There are primary and secondary impacts on the environment caused by a company’s activities.  Primary impacts are the processes of a company which are regulated by environmental legislation.  The secondary impacts relate to products of the company and they are governed by both legislation and consumer influence.

 

The company can cause harm to the environment in a number of ways such as exhausting our natural resources and emitting harmful toxins.

 

Society

Society includes consumers and it is they who will have opinions about environmental products and will purchase accordingly.

 

Society is concerned with harm to our natural resources and pollution and waste issues. The company needs society to buy its products in order that it can stay in business.

 

Employees

They have a relationship with the company in terms of their own livelihoods and their safety when at work.  They are also a small portion of consumers who will purchase products, possibly the company’s.

The company needs employees to make their products as well as natural resources.

 

It will be important for companies to have policies in place in order to satisfy all stakeholders and to communicate these policies to them.

 

IMPLICATIONS FOR THE MANAGEMENT

Management are responsible for a risk management system.  Social and environmental issues now form part of that risk.

 

The specific risks and implications that might arise are:

  • Bad publicity arising from customers or legislation issues, resulting in lost sales and reduced market share. This could lead to future going concern issues.
  • Failure to comply with product standards, whether legal or perceived, may lead to lost sales and fines and/or compensation.
  • Health and safety issues that may impact on employee safety, resulting in business interruption and/or fines/compensation.
  • Failure to comply with other employment legislation and company legislation could lead to fines, compensation or disqualification of directors.

 

Management controls

Management should put in place controls to mitigate the risks to the business.  This will vary from company to company.

 

Specific controls may include:

  • The wearing of protective clothing and waste disposal procedures in order to comply with environmental legislation
  • Human resources dept. policies and procedures to comply with employment legislation
  • Adding social and environmental values to the corporate culture, whether through implementing a corporate code of setting specific targets for social and environmental performance.

 

MEASURING SOCIAL AND ENVIRONMENTAL PERFORMANCE

Auditors may provide assurance on whether the management’s assertions about performance in these areas are fair.  Measuring social and environmental performance can be very difficult though.  It is unlikely that there are any useful ratios to use and there is rarely any profit from social or environmental activities.

 

One way to measure performance is to set targets and sustainability indicators.  You can then check whether the targets have been met or whether any of the indicators exist.

 

For example, take an oil production and retailing operation.  It will have Social and environmental issues.

  • Using natural resources
  • Operating in a heavily environmental legislative area
  • Huge number of employees
  • Some employees working in risky environments
  • Possible human right issues.

 

The company could set the following targets:

 

Environmental

  • Reduce emissions and spills
  • Develop cleaner fuels

 

 

Social

  • Reduce work related incidents
  • Stop exploiting children
  • Pursue equal opportunities for both men and women

 

The sustainability indicators could include:

  • Respect and safeguard all persons,
  • Engage and work with all stakeholders,
  • Minimise the impact of the company on the environment,
  • Use all resources efficiently,
  • Maximise profitability,
  • Maximise benefits to the whole community.

 

Some of the targets and indicators can be measured in mathematical terms.  However, others are not specific enough to be measured in that way.  It is also difficult to measure the effect of general principles which a company has attempted to incorporate into its corporate culture.

 

The company should then report on all these issues to the shareholders.  Where possible the facts included in these reports should be independently verified.

 

Social audits

Social audits establish whether a company has a rationale for engaging in a socially responsible activity.  It involves identifying that all current environmental programmes are in line with the company’s goals.  It will assess the objectives and priorities relating to these programmes and will evaluate the company’s involvement in such programmes past, present and future.

 

A cultural awareness must exist within a company in order to implement environmental policies as they require both management and staff support.

 

Social audits have increased in the United States since the Exxon Valdez incident in Alaska.

 

Environmental audits

These seek to assess how well a company performs in safeguarding the environment in which it operates and whether the company complies with its own environmental policies.

 

The auditor will apply the following procedures:

  • Obtain a copy of the company’s environment policies,
  • Assess whether such policies are likely to achieve legal standards and satisfy key customer and/or suppliers criteria,
  • Test the implementation and compliance to the policies through discussion with management, observation of procedures and controls and carrying out walk through tests where appropriate.

 

IMPLICATIONS FOR THE STATUTORY AUDIT

Social and environmental issues can affect the statutory audit.   Risks need to be considered at the planning stage, impairments and provisions may be required during substantive procedures and going concern issues may arise during the review.  Social and environmental issues are important to the audit as they can potentially impact on the financial statements.

 

As part of planning the audit, the auditor should be aware of any environmental regulations the entity may be subject to and any key social issues arising during the course of their operations.  The auditor should review the company’s quality control documentation and the results of any environmental audits carried out.

 

Examples of the impact of social and environmental matters on the financial statements:

  • Provisions re site restoration, fines etc,
  • Contingent liabilities,
  • Asset values adjusted re impairment or purchased goodwill,
  • Capital/revenue expenditure,
  • Development costs,
  • Going concern issues.

 

A key risk that arises with regard to valuation is that an asset might be impaired.  IAS 36 notes that a significant change in the technological, market, legal or economic environment of the business in which the assets are employed should trigger an impairment review.  It is possible that a significant adverse change could take place in the legal environment.

 

The auditor should carry out the following audit procedures to establish whether an impairment review is necessary:

  • Review board minutes for any indications of changes in environmental regulations
  • Review relevant trade magazines
  • Discuss with management especially those responsible for environmental issues.

 

Some environmental issues may result in provisions being required such as the clean-up of a contamination or a potential fine where environmental legislation is broken.

 

Environmental obligations would be core in some businesses such as the oil and chemical industries while in others it would not.  ISA 250, Consideration of law and regulations in the audit of financial statements, talks of laws that are central to the company’s ability to carry on a business.  In the case of a business that stands to lose its licence to carry on business in the event of non-compliance, environmental legislation is central to the business.

 

IMPLICATIONS FOR ASSURANCE SERVICES

Auditors can provide a variety of services in respect of environmental and social issues:

  • Internal audit services,
  • Review of internal controls and procedures, Management letter concerning controls,
  • Assurance services.

 

If directors issue an environmental and social report, it may contain figures and statements that are verifiable.  In addition, the auditor can obtain details of the strategy and ascertain how fully it has been implemented by making enquiries of the staff who should be implementing the strategy.

 

Question 14.1

 

Storm is a wind farm company situated on an island along the east coast of Africa.  The company was set up a number of years ago by a millionaire energy fanatic, who is the majority shareholder and he continues to loan Storm money despite its history of loss making.

The company owns and operates 15 windmills which are situated on the island.  The windmills are connected to a generator, which mainly supply the major shareholder’s dwelling on the mainland.  A small element is sold to a number of power companies.  One of these companies, Mini power, has a small equity stake in Storm.

Storm has had problems during the year.  One windmill has fallen into the sea due to coastal erosion and three more are not far off suffering a similar fate. In addition, the generator lies close to a cliff.

Furthermore, during the year Storm invested in a small stake in an oil pipeline which runs near the island.  The co-owners of the pipeline have just advised Storm that they have discovered a crack in the pipeline.

 

Required:

  • Outline reasons why social and environmental issues are of interest to an external auditor.
  • Comment on the financial implications of the above on the audit of Storm.

 

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