Accounting for Sustainability: Understanding and connecting sustainability and financial reporting

IAS 1/IAS 8 requires disclosure of material uncertainties relating to events or conditions which may cast significant doubt upon an entity’s ability to continue as a going concern, or of significant judgements made in concluding there are no material uncertainties related to the going concern assumption. Such uncertainties may arise from climate-related factors.

Example: The introduction of legislation directly affecting an entity’s business model, or giving rise to increased compliance costs, may cast significant uncertainty upon theentity’s ability to continue as a going concern. Alternatively, management may have applied significant judgement about the effectiveness of the entity’s planned response in concluding that there is no material uncertainty.

IAS 2 sets out the accounting rules for inventories, focusing on how to measure and recognise their cost as an asset until the related revenue is earned. It guides how to determine inventory cost, when to expense it, and when to write it down to net realisable value.

Example: The net realisable value of inventories could be impacted by climate-related factors, when either selling prices decline or costs of completion increase. Changing consumer behaviour could cause a fall in demand for a product, raw material sourcing constraints could cause an increase in completion costs, a regulatory change could render inventories obsolete, or a significant weather event could cause physical damage to inventories. If such instances mean that the cost of inventory is no longer recoverable, IAS 2 Inventories requires that such inventories be written down to their net realisable value.

IAS 12 Income Taxes prescribes the accounting treatment for current and deferred tax liabilities and assets, ensuring that the tax effects of transactions and events are recognised in the financial statements in the appropriate periods.

Example: New levies or taxes may be introduced to encourage decarbonisation. Any levy liabilities should be recognised as the obligation is triggered under law (per IFRIC 21 Levies) and any income tax effects should be incorporated into normal IAS 12 accounting. Care should be taken when distinguishing between a levy and income taxand the application of IFRIC 21 or IAS 12 as this has proven to be a challenging area as new taxes/levies have been introduced in the past.

IAS 16 and IFRS 16 sets out the accounting treatment for property, plant, andequipment. Key issues include changes in the recognition and useful life or residualvalue of assets.

Examples:

• When climate-related risks are significant, concerns over viability could mean that the criterion (in IAS 16:7 for property, plant and equipment) that costs are only recognised as an asset when it is probable that future economic benefits associated with the asset will flow to the entity is not met.
• Climate-related risks may also affect the depreciation or amortisation of assets (property, plant and equipment) through a change in their useful lives or residual values.

Such factors should be incorporated into a review of an asset’s useful life and residual value.

Pension trustees are required to consider all material financial risks, including the exposure of pension assets to climate change risk.

Example: Demographic assumptions and investment performance can vary significantly under different climate change scenarios, affecting the measurement of pension asset and liability balances at the balance sheet date.

IAS 20 Accounting for Government Grants and Disclosure of Government Assistance outlines how to recognise and measure government grants and the related disclosure requirements in financial statements.

Example: Under IAS 20, a Swiss company that receives government grants or subsidies through the Swiss Climate and Innovation Act to develop low-carbon technologies must recognise these grants in its financial statements. Whether government grants which are intended to compensate entities for costs related to 'green' capital or operating expenditure are within the scope of IAS 20 and how such grants should be recognised in profit or loss on a systematic basis, will depend on the nature of the grants and the conditions attaching to them.

IAS 36 Impairment of Assets requires entities to review their assets regularly and recognise an impairment loss if the carrying amount exceeds the recoverable amount, ensuring assets are not overstated on the balance sheet.

Example: Climate-related issues can be an indicator of impairment. For example, a significant decline in demand for products that emit greenhouse gas emissions could indicate that a manufacturing plant may be impaired and need to be tested for impairment. New environmental regulations may also affect a company’s activities significantly and could be a sign of impairment. Such factors could also affect the estimated cash flows used in determining the recoverable amount of an asset or group of assets.

Additionally, for carbon-emitting industries that are subject to a cap-and-trade scheme, such as EU’s Emissions Trading System, the future prices of CO₂ emission certificates could be a key parameter to estimate when determining the recoverable amount of an asset or a cash generating unit.

IAS 37 Provisions, Contingent Liabilities and Contingent Assets sets out the accounting requirements for recognising and measuring provisions, as well as disclosing contingent liabilities and contingent assets, ensuring that potential future obligations and uncertainties are appropriately reflected in the financial statement.

Example: Environmental and regulatory factors can influence how companies recognise, measure, and disclose liabilities under IAS 37. This includes levies or fines for failing to meet regulatory targets, contingent assets from a potential insurance recovery associated with repairing damage sustained to a manufacturing facility during a significant weather event, contractual obligations, or product modifications required to comply with evolving Standards. As an example, a consumer goods company is operating in several countries with stricter environmental regulations. The company anticipates that it will need to invest in new product packaging solutions to meet regulatory requirements and will therefore evaluate whether this commitment creates a provision.

IAS 38 Intangible Assets provides guidance on the recognition, measurement, and amortisation of intangible assets. Companies may acquire carbon credits to meet their net-zero targets and classify these as IAS 38 Intangible assets when the relevant criteria are met.

Example: A company buys carbon credits to offset its own greenhouse gas emissions. The company determines that the credits are in scope of IAS 38 (using the IAS 38:2 guidance) and classifies and accounts for the credits as intangible assets. In addition, adaption of an entity’s business to address climate change issues could result in additional research and development activities, which may have to be recognised as intangible assets.

IFRS 2/IAS 19 incentive schemes that depend on the achievement of specific climate related targets, such as GHG emissions reduction goals, should be carefully evaluated.

Example: A company introduces a long-term incentive plan for its senior management, where part of the award is conditional on achieving specific GHG emissions reduction targets over a three-year period. The plan grants share options that vest only if the company reduces its carbon emissions by 20% compared to the baseline year.

IFRS 7 requires companies to share information about their financial instruments, including the risks involved and how they manage those risks. Climate-related issues can impact the risks arising from financial instruments.

Example: Companies may need to disclose how they assess the risk of their trade accounts receivable when their customers have an increased exposure to climate-related risk. Where a significant climate-related event has occurred, the effect of this event on trade receivables at balance sheet date should be disclosed.

IFRS 9 sets principles for reporting financial assets and liabilities. Climate-related issues can affect how financial instruments are accounted for in several ways. The IASB amendments to IFRS 9 and IFRS 7 provide guidance on accounting for contracts referencing nature-dependent electricity, such as renewable energy power purchase agreements (PPAs), where electricity supply varies due to uncontrollable natural conditions.

Example: A manufacturing company enters into a solar electricity contract. The company must evaluate whether the electricity supplied is predominantly nature dependent and in scope of the amendments. For such contracts, there may be judgment to determine whether these are accounted for as executory (own use) contracts or as financial instruments. 

IFRS 13 explains how to measure the fair value of assets and liabilities. Climate-related issues can affect these values, for example, the market views on environmental regulation may change the value of an asset or liability. When fair values are based on estimates that cannot be directly observed, IFRS 13 requires using assumptions that market participants would make, including those about climate risks. Companies must disclose the inputs used in these measurements and explain how sensitive the values are to changes in these assumptions.

Example: A manufacturing company owns a production plant located in a coastal area vulnerable to rising sea levels and increased frequency of severe storms due to climate change. The company needs to measure the fair value of this plant and disclose assumptions applied.

IFRS 17 covers how insurance contracts are accounted for. Climate-related issues can cause insured events, like business interruptions, property damage, illness, or death, to happen more often or sooner. This can affect the assumptions used to calculate insurance liabilities. Climate-related risks may also require companies to disclose how they manage these risks and how changes in risk factors might impact their insurance contracts.

Example: A company holds a property and business interruption insurance policy with an insurer. The property is in an area increasingly prone to flooding and severe storms due to climate change. The insurer has updated its assumptions to reflect higher climate-related risks, such as more frequent floods. As a result, the insurer increases premiums to cover the higher expected claims.