What is the underlying difference between impact materiality and financial materiality?
As organizations are mandated to assess both impact materiality and financial materiality of potential sustainability topics, it is crucial to understand the differences between the two.
An impact materiality assessment determines material topics based on an organization’s actual or potential impacts on people and the environment, within the organization’s operations and value chain. It is important to note that material here is not defined in the traditional auditing sense, as determining materiality during a financial statement audit. Instead, material as defined by the CSRD is used to describe a sustainability topic that has significant impact of an organization’s activities or performance. Accordingly, the impact materiality perspective focuses on the effect an organization has on the world. A sustainability topic is assessed based on:
- Likelihood and severity of the topic’s impact on people and the environment.
- Whether the topic is actual or potential.
- Whether the impact of the topic is positive or negative on people and the environment.
An example of a material topic to consider for a software company could be to assess the impact of locating data centers in potentially water-scarce or water-dense regions of the world.
On the other hand, a financial materiality assessment determines whether a sustainability topic has potential financial risks or opportunities for an organization. The financial materiality perspective assesses whether a sustainability topic creates risks or opportunities that have a material impact on factors such as:
- An organization’s cash flow.
- Growth and development.
- Financial performance.
- Timespan of impact: short, medium, or long term.
One example of a material topic to consider as part of the assessment could be potential areas for loss of physical assets due to extreme weather conditions.
What is internal audit’s role in Double Materiality Assessments?
Internal audit can play a unique role in delivering assurance on the DMA, and there are numerous areas for value creation.
Because of internal audit’s independence within an organization, objective evaluation of the DMA can be provided. Evaluation of the DMA can help to validate the methodology used in the assessment and verify the accuracy and reliability of the data. Internal audit’s review can therefore assess the robustness of the DMA method and help to identify areas where efficiency and effectiveness may be improved.
Further, an additional set of eyes on the DMA can help verify that no sustainability topics — whether actual, potential, positive, or negative — have been omitted from the assessment, and can validate that no emerging risks and opportunities have been overlooked. Internal audit’s review of the DMA can therefore help to prevent errors or misrepresentations of material sustainability topics, and thereby improve overall compliance with the ESRS.
Lastly, as the DMA will later be assessed by an external audit, internal audit’s review of the DMA can establish preliminary assurance of the process and overall outcome.