Sustainability and ESG Auditing
With the pressure on organizations to embark on sustainable business, environmental, social, and governance (ESG) factors remain critical in business reporting. Charles (2019) underlines the significance of intern auditors in a company's journey toward compliance with ESG rules and regulations and ethical and sustainability standards. According to Ojetunde et al. (2024), internal auditors need to know the growing expectations of the company's sustainability management and assurance of the integrity of the reported schemes on ESG to audit. This article covers the ever-increasing significance of ESG auditing and internal auditors' contribution to endorsing green auditing and sustainable business operations.
The Growing Importance of ESG Factors
Environmental, Social, and Governance (ESG) factors are now a common influence in investment decisions and authorities' mandates. It has become common for firms to report their ESG performance related to various factors, including their effect on the environment, social responsibilities, and governance structures (Bonrath & Lopez-Kasper, 2022). Not only does this have to be done for compliance purposes but to ensure that stakeholders, both shareholders and the public, have confidence in the company.
Charles (2019) stresses the heightened demand by stakeholders for more transparency in ESG reporting. Sustainability has become essential in today's corporate world, as has diversity and ethical governance, which organizations must prove their compliance with. ESG information can be considered a complex and significant disclosure, so internal auditors also have considerable responsibility in checking for the accuracy and completeness of the provided information and the adequacy of the company's activities towards the requirements of the legislation and stakeholders. As an extension of financial auditing, ESG auditing involves considering non-financial data about an organization's performance and its effect on the broader society and the environment.
Green Auditing and ESG Compliance
On the other hand, environmental auditing is the assessment of the performance and efficiency of an organization's environmental management and sustainability regimes. Green auditing, an ESG auditing subsidiary, targets environmental aspects, including carbon footprint, energy efficiency, waste, and resource consumption. Prodanova & Sotnikova (2023) emphasize green auditing and how it is effective in determining areas of concern in the organization and ways of making it more environmentally friendly.
An organization's team of internal auditors is expected to assess its sustainability activities in terms of their effectiveness and relevance to the sphere's standards (Ojetunde et al., 2024). Such types of auditing involve determining how organizations exist and function to meet environmental standards, such as the Paris Agreement used in addressing climate change and monitoring sustainability goals and plans. Another aspect of green auditing is checking the organization's supply chain to determine if it complies with sustainable practices throughout the value chain.
Ensuring the Integrity of Social and Governance Audits
Due to the ever-developing ESG regulatory environment, governments and regulatory authorities continuously implement new standards that support sustainable development and corporate social responsibility. Charles (2019) also explains that internal auditors should regularly update themselves on these regulations and ensure their organization complies with the current ESG standards. This will involve evaluating the organization's current ESG policies and protocols and compliance with national and international standards.
Besides the legal requirement, internal auditors must guarantee that the organization provides accurate and transparent information on ESG. Non-financial information typically covered in ESG reporting spans diversity and inclusion, community and social responsibility, and anti-corruption standards (Lee & Kim, 2022). The management of an organization and its auditors must ensure that these disclosures are accompanied by relevant data supporting the organization's claims and that the organization is implementing its espoused ESG standards. Failure to prepare and present ESG reports risks damaging corporate reputation and possibly facing punitive legal actions.
The Role of Internal Audit in Promoting ESG Best Practices
Besides evaluating compliance, internal audits actively advance ESG standards in organizations. Bonrath and Lopez-Kasper (2022) state that auditors should fully engage the senior management and board to achieve sustainability within the company. Internal audits also involve assessing the organization’s strategic direction toward sustainability and checking whether it is consistent with its strategic goals.
The internal auditors shall also give other insights on enhancing the organization's ESG performance. This kind of audit makes detecting compliance issues easier and evaluating opportunities that may improve environmental stewardship, social responsibility, and governance (Prodanova & Sotnikova, 2023). For instance, auditors can recommend that an organization adopt measures towards reducing carbon emissions, increasing efficiency in energy use, and diversity and inclusion of employees. If implemented by the organization, these recommendations can enhance sustainable development goals and strengthen socially responsible businesses.
Challenges in ESG Auditing
Although ESG auditing is crucial for firms' sustainability, it has limitations within the internal auditing profession. Ojetunde et al. (2024) further state that one central concern is that there currently needs to be uniform standards in ESG reporting. Even though many reporting frameworks are available, including the Global Reporting Initiative (GRI) and the Sustainability Accounting Standards Board (SASB), several approaches to ESG reporting still need to be developed. This may challenge the auditors, especially in determining the comparability and consistency of the ESG disclosures.
Another area for improvement is the difficulty of evaluating non-financial performance indicators. However, ESG indicators may be more qualitative and somewhat discretionary than numeric financial values. Auditors must learn to assess these non-financial measures and ensure the underpinning information is accurate (Lee & Kim, 2022). Also, auditors must consider legal requirements as they are given new ESG standards within different industries and must meet relevant norms.
Conclusion
Sustainability and ESG auditing have become essential elements of the risk management system, and companies are experiencing innovative expectations to act sustainably and ethically. As pointed out by researchers, internal auditors have a significant function in supporting organizations in adhering to ESG regulations and integrating sustainable initiatives in their operations, besides offering credible and transparent ESG information. The internal audit, in collaboration with green audits and ESG, thus enables organizations to demonstrate credibility to their stakeholders while working towards sustainable value creation. That said, ESG auditing has its issues: there is no prevailing approach to reporting or substantial commonality in approaches; measuring non-financial variables also has problems. Thus, in the context of these changes, auditors should at least endeavor to anticipate them and ensure that the companies they work with can handle all these changes and transition into the future.
References
Bonrath, A., Eulerich, M., & Lopez-Kasper, V. (2022). Internal auditor's role in ESG disclosure and assurance: an analysis of practical insights. Corporate Ownership & Control, 20(1). https://papers.ssrn.com/sol3/papers.cfm?abstract_id=4070755
Charles, S. (2019). Charles Financial Strategies LLC. Charles Financial Strategies LLC. http://charlesfs.com
Lee, J., Kim, S., & Kim, E. (2022). Environmental responsibility, social responsibility, and governance from the perspective of auditors. International Journal of Environmental Research and Public Health, 19(19), 12181. https://doi.org/10.3390/ijerph191912181
Ojetunde, E., Emezirinwune, D., Emezirinwune, M., Denwigwe, C., & Eyiaro, R. (2024). Integrating Environmental, Social, and Governance Criteria in Corporate Auditing: A Multiple Criteria Decision Making. https://worldscientificnews.com/wp-content/uploads/2024/03/WSN-191-2024-102-126.pdf
Prodanova, N., Tarasova, O., & Sotnikova, L. (2023). ESG audit and its fundamental concepts. In E3S Web of Conferences (Vol. 402, p. 13025). EDP Sciences. https://doi.org/10.1051/e3sconf/202340213025