I realize this title isn’t a very enticing one to most readers. But please bear with me. I promise that the story gets more interesting as it goes along.

As I noted in a previous post, the Trustees of the IFRS Foundation had a meeting on March 2-4 and discussed their proposed “Sustainability Standards Board (SSB).” The current plan is a formal announcement at COP 26 in November of this year. Its top priority will be disclosures regarding climate change. I obviously don’t know how long this will take—hopefully not too long.

In the meantime, there is an elephant in the reporting room—and one which is beginning to make its presence felt. The most important disclosures which companies make are in their Annual Accounts, which calculate profits and solvency. Extraordinarily, these reports usually ignore climate issues. So an oil well is valued as though the oil extracted from it will be sold for $80 per barrel in 2050. On that basis companies invest in stranded assets, declaring profits that must never be realized if we are to live in a sustainable world.

When these companies are challenged, they note, (correctly) that U.S. and International Financial Reporting Standards (IFRS) don’t directly mention climate change. But that doesn’t mean that climate can be disregarded in calculating the value of assets and liabilities, any more than any other external event. What is needed is guidance on climate change disclosure when it is a material issue, and how it affects asset values and profits. That applies to many, if not most, companies.

David Pitt-Watson, Visiting Fellow, Cambridge Judge Business School | CAMBRIDGE JUDGE BUSINESS SCHOOL

In November 2019, the elephant began to make its presence felt. Nick Anderson, a member of the International Accounting Standards Board (IASB) published: “IFRS Standards and climate-related disclosures.” Anderson’s article “provides an overview intended to help investors understand what already exists in the current requirements and guidance on the application of materiality, and how it relates to climate and other emerging risks.” On September 16, 2020 investor groups including  the Principles for Responsible Investment (PRI) representing over $100 trillion in assets issued a statement calling “companies to ensure that their financial reports and accounts reflect the recent opinion from the International Accounting Standards Board (IASB) and are prepared using assumptions consistent with the Paris Agreement on climate change.” If that were done, it would put an end to stranded assets.

In response to stakeholder requests for more information on this topic, on November 20, 2020 the IFRS Foundation published educational material  as a complement to Anderson’s article. That same month, the UK’s Financial Reporting Council published its “Climate Thematic” report which makes recommendations for how boards, companies, auditors, and professional bodies and regulators can better address the issue of climate change.

The “Effects of climate-related matters on financial statements” begins by noting that “IFRS Standards do not refer explicitly to climate-related matters. However, companies must consider climate-related matters in applying IFRS Standards when the effect of those matters is material in the context of the financial statements taken as a whole.” In other words, even before the SSB establishes explicit standards for climate reporting, climate is an important topic that needs to be considered in preparing a company’s financial statements. The educational document notes some key areas for consideration: such as:

·     IAS 1: Presentation of Financial Statements (sources of estimation uncertainty and significant judgements and ability of the company to operate as a going concern, where climate change is obviously related to both

• IAS 2: Inventories (Climate-related matters may decrease the value of inventories or even make them obsolete)
• IAS 16: Property, Plant, and Equipment (e.g., additional investments to mitigate the effects of climate change)
• IAS 36: Impairment of Assets (e.g., emission-reduction legislation might increase manufacturing costs, thereby decreasing the cash flows from this asset)
• IAS 37: Provisions, Contingent Liabilities and Contingent Assets (e.g., restructuring costs necessary for redesigning products and services to achieve climate-related targets)
• IFRS 13: Fair Value Measurement (e.g., potential climate-related legislation could affect the fair value of an asset of liability), and IFRS 17: Insurance Contracts (e.g., the extent to which the company’s climate risk is covered by current insurance contracts).

Interesting, right? There’s more. Financial statements need to be approved by an external auditor. Towards that end, on October 1, 2020 the International Auditing and Assurance Standards Board (IAASB) issued a staff audit practice alert on climate-related risks. IAASB Technical Director Willie Botha stated that “This Staff Audit Practice Alert shows that while the phrase ‘climate change’ does not feature in the ISAs, the auditor’s responsibilities under the ISAs encapsulate the consideration of events or conditions relevant to the susceptibility to misstatement of amounts and disclosures in an entity’s financial statements, which would include climate-change risk.” This supports the PRI’s request “That auditors only sign off financial statements which are consistent with the IASB opinion in the letter and the spirit, which include showing the key assumptions that have been made with regard to climate-related risks.”

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