ACCA P7 (INT) Advanced Audit & Assurance - Study Text

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Chapter 16: Current issues II

The auditor may find evidence of a risk of a material misstatement in the financial

statements due to environmental matters. For example, evidence of such a risk may

be discovered in the following circumstances:

 The auditor might discover the existence of a report about material

environmental problems, prepared by environmental experts, internal auditors

or environmental auditors.

 The auditor might discover evidence of a violation of environmental laws and

regulations, which is mentioned in correspondence with regulatory agencies, or

a report issued by a regulatory agency.

 The auditor may find that the name of the entity is included in a public register,

or plan, for the restoration of soil contamination.

 There may be reports or comments in the press or other media about the entity

and its involvement or responsibility for major environmental problems.

 The auditors may find comments relating to environmental matters made in

solicitors’ letters to the entity.

 The auditors might suspect environmental risks when they find large or unusual

fees charged by environmental consultants, or large payments of penalties as a

result of a violation of environmental laws and regulations.

1.4 Substantive procedures to detect a material misstatement due to

environmental matters

The external auditors may design substantive tests for detecting a material

misstatement in the financial statements due to environmental matters. The

substantive tests may consist of the following checks:

 A review of documents such as:

− minutes of meetings (board meetings, audit committee meetings,

environmental committee meetings)

− industry information

− media comment

− environmental reports and audits

− internal audit reports

− due diligence reports

− reports from regulators

− correspondence with environment agencies

− correspondence with solicitors.

 The auditors may use an external expert to provide advice (in accordance with

ISA 620).

 The auditors may use the work done by the internal audit department to

investigate environmental risks and controls within the entity.

 The auditor may make some enquiries about the insurance cover obtained by the

entity for its environmental risks.

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 The auditors should obtain written representations from management that they

have considered the effects of environmental matters on the financial statements,

and that:

− they are not aware of any material liabilities or contingencies arising from

environmental matters, including those resulting from illegal or possibly

illegal acts

− they are not aware of environmental matters that may result in a material

impairment of assets, or

− if they are aware of such matters, they have disclosed all the relevant facts to

the auditor.

 The auditor should ask about the policies and procedures of management for

assessing the need to write-down the carrying amount of assets, in situations

where any impairment of assets has occurred due to environmental matters. The

auditor should also consider the adequacy of any write down of assets that the

entity has made.

 The auditor should ask about the policies and procedures that are used by the

entity to help identify liabilities, provisions or contingencies arising from

environmental matters.

 The auditor should ask about events or conditions that may give rise to

liabilities, provisions or contingencies arising from environmental matters. For

example, the auditor should ask whether there have been:

− violations of environmental laws and regulations

− penalties arising from violations of environmental laws and regulations, or

− claims and possible claims for environmental damage.

 If the entity has identified a need for site clean-up costs, restoration costs or

penalties arising from non-compliance with environmental laws and regulations,

the auditors should enquire about any related legal claims or possible legal

claims.

 The auditor should ask whether there is any correspondence from regulatory

authorities relating to environmental matters. When such correspondence exists,

the auditor should consider whether the correspondence indicates the existence

of a liability, provision or contingent liability.

 When property (land or buildings) has been abandoned, purchased, or closed

during the period, the auditor should ask about regulatory requirements for

cleaning up the site, or about the intentions of the entity with regard to clean-up,

future removal of the building and site restoration at the end of the asset’s life.

 The auditor should perform analytical procedures and consider, as far as

practicable, the relationships between financial information and quantitative

environmental information. For example, the auditor might analyse the entity’s

environmental records and establish whether there is a relationship between raw

materials consumed and waste production/emissions.

 The auditor should review and test the process used by management to develop

accounting estimates and disclosures relating to environmental matters. A

review might consist of obtaining an estimate from an independent expert to

corroborate the estimates of management. Alternatively, the auditor might be

Chapter 16: Current issues II

able to verify the estimates of management from subsequent events after the

reporting period.

 For all liabilities, provisions, or contingencies related to environmental matters,

the auditor should consider whether the assumptions underlying the estimates

are appropriate, and whether the amount of the liability, provision or

contingency is reasonable.

 The auditor should review the adequacy of the disclosures in the financial

statements about the effects of environmental matters.

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Social and environmental reports and audits

 The significance of social and environmental reporting

 Environmental reports

 Environmental audits

 Social reports and audits

 Audit evidence for social and environmental reports

2 Social and environmental reports and audits

2.1 The significance of social and environmental reporting

Under pressure from public opinion, many entities are now aware of social and

environmental issues, and the effect that the entity has on social and environmental

matters in the countries where it operates. If it fails to recognise social and

environmental problems, and is not seen to be doing something about them, an

entity’s reputation may be at risk. Reputational risk can have consequences for

customer demand for the entity’s products. Many members of the public may refuse

to buy goods from companies, or invest in the shares of companies, unless those

companies have ‘healthy’ social and environmental policies.

The senior management of some major entities would argue that they show more

concern for social and environmental matters than governments.

It has therefore become increasingly important for companies to demonstrate their

social and environmental policies, by publishing social and environmental reports,

or through their web sites, advertising and media reports.

In most countries, reporting on social and environmental issues is voluntary.

However, the EU has recently issued an accounts modernisation directive, requiring

quoted companies to publish a business review each year. This review should

include information about a range of issues, including social and environmental

matters.

Environmental policies

An entity’s environmental policies might cover such matters as:

 energy consumption

 pollution

 the use of natural resources and sustainability of the business

 use of re-cycled materials.

Chapter 16: Current issues II

Social policies

Social policies might cover such areas as:

 employee rights (for example, rights to trade union membership)

 employee training and development

 human rights

 child labour in developing countries

 equal opportunities

 health and safety matters

 relationship with the local community

 supporting local, national and international good causes.

Many large companies now publish a social and environmental report, sometimes

called a sustainability report. The aim of such reports is to demonstrate that the

company has a strong social and environmental conscience, and is actively engaged

in improving social and environmental conditions.

Credibility can be added to these reports by an independent verification statement

from a firm of accountants or similar firm of independent external experts.

2.2 Environmental reports

Many larger entities whose activities have an environmental impact now publish an

annual environmental report or sustainability report. This may be published as part

of the company’s annual report. More often, it is published as a separate document.

The contents of environmental reports are not regulated, and although the external

auditors may review the reports, they are not included within the scope of the

statutory audit opinion. However, some entities engage external ‘environmental

experts’ to review and report on their environmental reports.

An environmental report is seen as an important indicator of the commitment that

the entity is giving to its impact on the physical environment and the future of the

planet and its peoples.

An environmental report may cover such matters as:

 environmental performance targets and the extent to which they have been

achieved (for example, in its 2005 sustainability report, Shell reported on

whether it had met targets with respect to oil spills and greenhouse gas

emissions)

 relevant environmental regulations imposed on the entity, and the extent to

which they are complied with

 compliance with industry standards or other environmental standards

 the entity’s policy on ‘sustainable development’. Sustainability refers to the

ability of the entity to meet the needs of the present generation of customers

without adversely affecting future generations. For example, a supplier of timber

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may have a policy of re-forestation of large geographical areas, to replace timber

that they cut down

2.3 Environmental audits

An environmental audit can be defined as:

‘…a management tool, comprising a systematic, objective assessment of how well an entity

is performing with the aim of safeguarding the environment by enhancing management

control of environmental practices including compliance with appropriate legislation and

regulations.’

An environmental audit may be performed by:

 the entity’s external auditors, or

 the internal auditors, or

 external environmental experts.

Environmental audits are not subject to the same high level of regulation as

financial audits. However, if an environmental audit is performed by professionally

qualified accountants, it would be subject to the usual requirements of codes of

professional practice for accountants.

Typically, an environmental audit involves an assessment of all impacts of the

entity’s activities on the environment, including:

 compliance with environmental regulations, for example on pollution of land,

water and air

 waste disposal

 recycling policies

 sourcing of raw materials.

The accountant performing an environmental audit will determine the

environmental policies that the organisation has in place, and assess the entity’s

performance based on measurable performance criteria. For example, actual

performance measures for pollution might be compared with pre-established

targets.

2.4 Social reports and audits

Many entities now publish a ‘social report’ or social information, often together with an

environmental report. These reports may be subject to an audit or review process, by

the entity’s external auditors, internal auditors or external experts.

An extract from the social report section of Shell’s 2005 Sustainability Report gives

some indication of the topics that these reports might cover.

Chapter 16: Current issues II

Example

Extracts from Shell’s 2005 Sustainability Report

Living consistently by the Shell General Business Principles remains an important

part of our culture. It requires concerted effort, particularly as the search for more

oil and natural gas continues to take us to difficult locations and sensitive countries.

Human rights

We turn our commitment to human rights into action in many ways. One is by

providing employees with a safe and healthy workplace, and access to unions,

grievance procedures and staff councils. Another is avoiding the use of child labour.

A third is taking security measures that do not compromise the rights of the

communities in which we operate.

We use independent Country Risk Assessments from a leading international human

rights institute to help us understand human rights risks when we enter a new

location…. Risk areas are highlighted, such as labour rights of migrant workers or

behaviour of security forces. We then develop a set of actions to help us avoid

violating rights in these risk areas.

Contractors

Contractors must manage HSE in line with our Health, Safety and Environment

standard and are expected to follow our, or equivalent, business principles. In many

countries, we work with contractors to help them understand and comply with

these requirements. If they cannot, we are required to review the relationship.

In 2005, we cancelled 63 contracts because of such concerns.

Shell General Business Principles

Our people

We are committed to preventing incidents – such as spills, fires and accidents – that

are a risk to people, the environment and our facilities. All Shell companies,

contractors and joint ventures we control are obliged to operate in line with our

Health, Safety and Environment (HSE) standard.

It requires them to take a systematic approach to managing their HSE risks. All our

major facilities must be certified to the international ISO 14001 environmental

standard. Sites must have emergency response plans and test them regularly, so that

damage can be minimised in the event of an incident. We investigate serious

incidents and near misses so we can learn from them and help prevent similar

incidents happening in the future.

Labour rights and child labour

We have made a specific commitment not to exploit children, through direct

employment or indirectly through joint ventures, contractors or suppliers. By the

end of 2005, Shell companies in nearly 90% of the countries where we operate had

procedures to prevent the use of child labour…. Shell companies in nearly 70% of

countries where we operate screened their contractors for child labour and nearly

two-thirds screened their suppliers, up from less than a third five years ago.

Paper P7: Advanced audit and assurance (International)

Shell in society: our contribution

Our biggest contribution to society is through our products – the energy and

petrochemicals that modern economies need. But our operations can also

make a strong, positive contribution to development.

Turning payments to governments into social benefits

In 2005, we paid over $19 billion in corporate taxes and $2 billion in royalties. We

collected more than $72 billion in sales taxes and excise duties….

In energy-producing countries, oil and natural gas revenues can bring widespread

benefits. Managed well, the money can fund services such as schools and hospitals

and diversify the economy. Managed badly, it can stimulate corruption, breed

conflict and hurt the country’s competitiveness. We encourage and support host

governments’ efforts to use energy revenues wisely. We enforce our policy of zero

tolerance of bribes and facilitation payments….

2.5 Audit evidence for social and environmental reports

In most countries there are currently only limited statutory requirements, or no

statutory requirements at all, about social and environmental reporting. For

example in the European Union, quoted companies are required to include some

information about social and environmental risks in their annual business review,

but there are no rules about what these disclosures should contain.

Since companies decide what to include in their social and environmental report,

the report may contain very few verifiable numbers and may consist largely of

narrative (‘words, not numbers’).

However some companies have chosen to include quantified performance

measurements in their social and environmental report. (Some companies publish

‘sustainability reports’. These report figures for financial performance, social

performance and environmental performance. Sustainability reports are sometimes

referred to as ‘triple bottom line reporting’, because they present performance

reports for each of these three areas.)

When social and environmental reports include quantified performance figures,

performance is often reported by comparing actual performance against target for a

number of different ‘key performance indicators’ or KPIs. The KPIs vary according

to the nature of the company and its business.

To make these reports more convincing and believable to users, the figures may be

audited to verify that they are reliable. In the past a P7 exam question has asked

candidates to suggest:

 a number of different KPIs for a social and environmental report and

 suggestions about how an auditor might obtain evidence to verify the reliability

of the performance measurements in the report for each KPI.

Chapter 16: Current issues II

Example: KPIs

The KPIs and sources of audit evidence in the table below are illustrative only. They

provide an indication of the nature of performance measurements for social and

environmental issues. The selection of KPIs is a matter of choice for the company

itself, and the performance measurements used therefore vary widely. (Remember

that social issues include matters relating ot employment and employees as well as

matters relating to society as a whole and the ‘corporate citizenship’ of the

company.)

Key performance indicator Possible source of audit evidence

Social indicators: employees

% of employees who are women,

or from particular ethnic groups or

in particular age groups (as

evidence of non-discrimination)

Personnel file

Staff turnover ratio Personnel files

Spending on employee training

Cash book or training account in the main

ledger

Absentee levels

Payroll records, records of medical evidence

of ‘sick leave’

Injuries at work: number or

expressed as a% of the work force

Health and safety records

Social indicators: customers and

general public

Customer satisfaction

measurements: number of

complaints as a % of sales orders

Records in sales administration

Spending on charitable causes, or

investment in particular

communities

Cash book or relevant expenditure account

in the main ledger.

Environmental indicators

Increase or reduction in

consumption of natural resources

(water) and energy

Invoices from utility companies

Pollution levels Official regulatory measurements

% of waste re-cycled Observation

Investment in environmentally-

friendly materials (such as re-

cycled paper)

Observation, purchase orders

Paper P7: Advanced audit and assurance (International)

ACCA P7 (INT) Advanced Audit &amp; Assurance - Study Text - 2010 (Emile Woolf Publishing)

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ACCA P7 (INT) Advanced Audit & Assurance - Study Text - 2010 (Emile Woolf Publishing)