In a previous post, “Properly Done Audits Are A Powerful Tool For Addressing Climate Change,” I wrote about recent guidance from the International Accounting Standards Board (IASB) and the International Auditing and Assurance Standards Board (IAASB) regarding climate change the preparation and auditing of a company’s financial statements. The basic point is that this guidance sets the right rules for companies calculating their profits, and gives investors a powerful tool to engage with portfolio companies on their climate transition strategies. To the extent a company’s financial statements do not take into account the material climate risks posed to their assets and ability to operate as an ongoing concern, they risk presenting a misleading view. Investors should use their votes on corporate board members and the company’s auditor to signal demand for reliable financial reports that make climate impacts clear.

At the end, I also raised the issue of whether the same is true for the United States where companies use U.S. Generally Accepted Accounting Principles (U.S. GAAP) instead of the International Financial Reporting Standards (IFRS) issued by the IASB. In doing so I referenced a recent paper by Samantha Ross: “The Role of Accounting and Auditing in Addressing Climate Change.” Ross is well-qualified to opine on this question. She is a former special counsel at the U.S. Securities and Exchange Commission; a former chief of staff and special counsel at the Public Company Accounting Oversight Board (PCAOB); and the founder of AssuranceMark, the Investors’ Consortium for Assurance.

Her paper is well-informed and worth a careful read. Ross states that “There are four steps the SEC can take, entirely within its own authority, to bring those tools to bear in addressing the climate crisis.

1. Fully enforce existing accounting and related disclosure requirements to reflect the financial impacts of the climate crisis and the transition to a low-carbon economy.
2. Update disclosure, through a staff accounting bulletin and other guidance and rulemaking, to spread identified best practices about material climate-related information across industries and markets.
3. Leverage the audit to build a solid bridge between climate-related risks and corporate financial reporting.
4. Address the ways in which the existing U.S. accounting standards exacerbate systemic climate risks.”

I would like to focus on (3). And in the spirit of my previous post showing a taste for the arcane, I would like to drill down on just one point: The Critical Audit Matter (CAM). “A CAM is any matter arising from the audit of the financial statements that was communicated or required to be communicated to the audit committee, and that 1) relates to accounts or disclosures that are material to the financial statements; and 2) involved especially challenging, subjective, or complex auditor judgment.” The Public Company Accounting Oversight Board, the U.S. regulator of audit firms, adopted this requirement in 2017 for audit reports of the financial statements of large, accelerated filers for periods ending on or after June 30, 2019, that are filed with the SEC.

While I consider myself reasonably well-versed on the topic of disclosure—and in complete agreement with all of the recommendations Ross makes regarding what the SEC should do in this domain—I had never heard of the CAM concept, so this caught my capital market activist (CMA) eye and I read the PCAOB’s Staff Guidance “Implementation of Critical Audit Matters: The Basics.” It states that “The description of the principal considerations should be specific to the circumstances and provide a clear, concise, and understandable discussion of why the matter involved especially challenging, subjective, or complex auditor judgment. The communication should be tailored to the audit to avoid standardized language and to reflect the specific circumstances of the matter.”

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