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Climate-related disclosures and investor focus - Coggle Diagram
Climate-related disclosures and investor focus
How climate change impact the companies'
business model
risk strategy
effect on its financial statements
Investors need to know
future challenges that the company faces
what the company’s plans are to deal with these challenges
Although minimum legal requirements have been met, investors require additional information for their decision making process.
Although some companies have set strategic goals such as net zero or carbon neutral
often unclear from their reporting how progress towards these goals will be achieved, monitored or assured
The Paris Agreement (United Nations)
legally binding international treaty on climate change
require a significant reallocation of company resources if the agreed goals are to be met
companies could be exposed to a wide range of risks and opportunities as they aim to meet these goals
Companies will need to disclose the financial implications of climate-related challenges that face them
The Task Force on Climate-related Financial Disclosures’ (TFCD)
As the demand for climate-related disclosure by investors and other stakeholders increases, many companies are developing their climate governance in line with reporting frameworks
Some of the information that investors may require
the arrangements in place and strategy for assessing and considering climate-related issues
the metrics used to monitor climate-related goals and targets
the opportunities and risks concerning climate-related issues which are most relevant and material to the company’s business model and strategy
the potential effects on the company’s profitability, net assets, products, customers, suppliers etc of different climate scenarios
are the risks and opportunities reflected in the financial statements, for example the effect of assumptions used in impairment testing, depreciation rates, decommissioning etc
the assessment of the company’s viability over the longer-term taking into account climate-related issues
the viability of the company’s business and business model
Climate change and International Financial Reporting Standards (IFRS® standards)
no single IFRS standard which addresses climate change
However, IFRS standards provide a framework
for incorporating the risks of climate change into companies’ financial reporting
Companies must consider climate-related matters when the effect is material on the financial statements
IAS® 1, Presentation of Financial Statements
IAS 1 requires disclosure of information
not specifically required by IFRS standards and
not presented elsewhere in the financial statements
but that is relevant to an understanding of the financial statements
requires a company to consider whether any material information is missing from its financial statements
such as the impact of climate-related matters on the company’s financial position and performance
Disclosure of assumptions about climate-related matters may be required
where assumptions have been affected by climate change
For example
estimates of future cash flows for impairment testing purposes, or
the calculation of decommissioning obligations
The disclosure may include the nature of the assumptions or the sensitivity of the calculations
IAS 1 requires disclosure of the judgements that have a significant effect on the amounts recognised in the financial statements
IAS 1 requires management to assess a company’s ability to continue as a going concern
Climate-related matters may create material uncertainties that cast significant doubt upon a company’s ability to continue as a going concern
IAS 1 requires disclosure of those uncertainties
IAS 2, Inventory
Climate-related matters may cause a company’s inventories to become
obsolete
value to decline
costs of completion to increase
Estimates of NRV will be based on the most reliable evidence available of the amount which the inventories are expected to realise
IAS 12, Income Taxes
Climate-related matters may affect a company’s estimate of future taxable profits
which may result in
potential deferred tax assets not being recognised, or
the derecognition of already recognised deferred tax assets
IAS 16, Property, Plant and Equipment
review the residual value and the useful life of an asset at least at each financial year end
if expectations differ from previous estimates, any change should be accounted for prospectively as a change in estimate
Climate-related matters may affect the estimated residual value and expected useful lives of assets
because of obsolescence or legal restrictions on their use.
IAS 36, Impairment of Assets
Indication of impairment
Climate-related matters
A decline in demand for products that are not environmentally friendly
An adverse change in the business environment of a company
In assessing value in use, a company is required to calculate cash flow projections based upon reasonable and supportable assumptions that are the best estimate of the future economic conditions
Thus, companies will need to consider whether climate-related matters affect those assumptions.
Companies are required to disclosure the events, circumstances and assumptions that led to the recognition of an impairment loss, which could include climate-related events
IAS 37, Provisions, Contingent Liabilities and Contingent Assets
Climate-related matters may affect the recognition, measurement and disclosure of liabilities related to such things as
penalties imposed by governments for
not meeting climate-related targets or
causing environmental damage
In addition, contracts may become onerous due to a change in inventory purchasing strategy or redesign of products
Companies should disclose major assumptions about any future events that have affected a provision or contingent liability
IFRS 9, Financial Instruments
Climate-related matters may affect a lender’s exposure to credit losses,
caused by environmental disasters or regulatory change
and also a borrower’s ability to meet its debt obligations to the lender.
Climate-related matters may, therefore, affect the calculation of expected credit losses if there is an impact on the different potential future economic scenarios or the assessment of a significant increase in credit risk
classification and measurement of loans may be affected as lenders may include terms linking contractual cash flows to an entity’s achievement of climate-related targets
The lender would need to assess whether the contractual terms of the financial asset give rise to cash flows that are solely payments of principal and interest on the principal amount outstanding.
Additionally, climate-related targets may create an embedded derivative that needs to be separated from the host contract
Climate change may reduce the probability of a hedged forecast transaction occurring or affect its timing
In this case, the hedge accounting relationship may need to be terminated or there may be hedge ineffectiveness.
Similarly, a reduction in the volume of highly probable forecast transactions may lead to partial termination under IFRS 9.
IFRS 13, Fair Value Measurement (FVM)
When making the critical assessments and judgements for measuring fair value
the entity should consider what conditions and the corresponding assumptions were known or knowable to market participants.
The impact of climate change on FVM would depend on
the evaluation of whether the climate change would have impacted market participants’ valuation assumptions at the reporting date.
The information such as climate-related legislation available to the market at the reporting date may be relevant in making this evaluation
This would include any corroborative or contrary evidence such as the timing and trajectory of observable market price movements of related assets in the relevant markets, as well as information from other sources of market data up to the reporting date.
Depending on the facts and circumstances of each case, disclosure may be needed to enable users to understand whether or not climate change has been considered for the purpose of FVM
Users should understand the basis for selecting the assumptions and inputs that were used in the FVM and the related sensitivities.