The Double Materiality Audit: Assurance of ESG Disclosure

Abstract

Auditors must now not only evaluate the accuracy of financial numbers but could soon be required to provide assurance on the information regarding the environmental, social justice, and good governance (ESG) claims made by its clients (SEC 2021; Harrington and Garzon 2022). Double-materiality refers to assessing materiality from two aspects: (1) the extent necessary for an understanding of the company’s financial position; and (2) the environmental, social, and governance impact of the company’s activities on a broad range of stakeholders (European Commission, 2019). For an audit, the two aspects of double-materiality are interconnected, meaning that despite their inherently non-financial nature, ESG factors are closely associated with financial outcomes and potential business risk (Hales 2018). This research provides an understanding for such a “double materiality” audit by first identifying the current issues in ESG disclosures, recognizing the role of external auditors in the ESG disclosure and the interaction between a financial audit and ESG disclosure assurance, and by suggesting an audit analysis roadmap that incorporates both quantitative financial numbers and big ESG data. This paper then proposes an audit approach that incorporates a “double materiality” lens of financial and ESG data to evaluate the risk of material misstatement and the reliability of ESG disclosure. Specifically, it suggests the extended audit procedures for data collection and verification, recommends criterion for the selection of ESG indices, and highlights the ongoing challenges (e.g., audit independence) and opportunities.

Keywords: Double Materiality, ESG Assurance, ESG disclosure, Audit

JEL Classification: M42, M48