Reporting Uncertainties and ESG Matters

For many companies, voluntary reporting under various sustainability frameworks and standards evolved in its own silo, separate from financial reporting and its sister discipline, financial planning and analysis (FP&A). However, as sustainable business or environmental, social, and governance (ESG) disclosures receive more scrutiny from the markets, ratings companies, and regulatory authorities, it’s become increasingly important that the objectives of these professional teams collaborate to ensure consistency of reported information.

The interpretative guidance on internal control over sustainability reporting (ICSR) from the Committee of Sponsoring Organizations of the Treadway Commission (COSO) addresses the importance of aligning an entity’s various subcategories of objectives, including those related to financial reporting, nonfinancial reporting, compliance, operations, and sustainable business (see Achieving Effective Internal Control over Sustainability Reporting (ICSR): Building Trust and Confidence in Sustainable Business Information Through the COSO Internal Control—Integrated Framework, 2023).

Because corporate professionals in different functional areas—sustainability, finance and accounting, internal audit, and risk management—oversee different data streams and systems, it’s critical that these professionals collaborate to make sure that disclosures via different delivery systems are interconnected. That is, information provided in a sustainability or ESG report needs to provide a cohesive narrative and consistent indicators.

In the United States, while stakeholders wait for new climate-related regulations from the U.S. Securities & Exchange Commission (SEC), it’s valuable to realize that regulators, including the SEC, already have oversight capabilities regarding climate-related information and disclosures. Similarly, new mandatory reporting requirements and standards are bringing about renewed attention and assessment of risks related to the climate crisis and how this may affect the financial statements. These assessments bring about three categories of risks:

• Physical: the risk that a severe weather event or modifications in climate negatively affect a business. This includes a major storm destroying property, including financial assets such as a portfolio of mortgages loans secured by property in high-risk locations.
• Transition: the risk from a failure to modernize assets, operations, or investments in a timely way to meet the demands of customers and other stakeholders for low- or zero-emissions products and services.
• Litigation or regulatory: the potential risks from changes in law or stakeholder rights to assert claims related to the climate crisis.

Each of these risks, to some extent, represents an estimate or expectation of future conditions, and timing is a key element to these assessments. It’s the forward-looking nature of the data necessary to make these assessments that’s inherent in much of the proposed accounting and disclosure around climate and other sustainable business matters. Further, such assessments—estimating the future—connect many sustainable business and financial reporting items.

An International Accounting Standards Board (IASB) project is looking into the application of International Financial Reporting Standards (IFRS) Accounting Standards with the objective of considering the reporting of the effects of climate-related and similar uncertainties in the financial statements. As IASB Chair Andreas Barckow explained, “At its March 2023 meeting, the [IASB] started a project to explore whether and how companies’ financial statements can provide better information about climate-related risks. This project and the work of our sister board, the International Sustainability Standards Board (ISSB), complement each other and illustrate how the work of the two boards is connected.” In 2023, the IFRS Foundation, taking steps to harmonize ISSB Standard S1 and S2 with the IFRS Accounting Standards (IAS), updated and released educational material, Effects of climate-related matters on financial statements. The document highlights many areas of climate-related business risks and how they have a material effect on the financial statements taken as a whole, excluding management commentary.

This educational material raises such items as:

IAS 1 – Presentation of Financial Statements: Disclosure of assumptions about the future that have a significant risk of causing a material adjustment to the carrying amount of assets and liabilities over the next fiscal year.

IAS 1 – Going concern: Assessment of a company’s ability to continue as a going concern based on information about the future, at least but not limited to 12 months from the end of the reporting period.

IAS 2 – Inventories: Write-down of inventories if the cost is not recoverable, such as due to changes in customer preference.

IAS 12 – Income Taxes: Inability to recognize deferred income tax benefits because of a change in business model.

IAS 16 – Property, Plant and Equipment,IAS 38 – Intangible Assets,IAS 36 – Impairment of Assets: Estimation of useful lives and residual value based on failure to modernize or legal restrictions on the use of assets; impairment of assets that aren't recoverable.

IFRS 9 – Financial Instruments: Evaluations of changes in borrowers’ creditworthiness based on expectations of severe weather events, customer preferences, or regulatory changes.

This updated IFRS Educational Material is similar to the Financial Accounting Standards Board (FASB) staff educational paper Intersection of Environmental, Social, and Governance Matters with Financial Accounting Standards, released in 2021. In the FASB version, the staff makes similar observations about, for example, disclosures around risks and uncertainties (Topic 275, Risks and Uncertainties); expectations on the useful life of property, plant, and equipment (Topic 360); intangible assets (Topic 350); recoverability of income tax benefits (Topic 740); and the accrual or disclosure of contingencies (Topic 450).

The common feature of these items is that measurement depends on the ability to assess and estimate future circumstances and their effects on the reporting entity’s performance, cash flows, and financial condition. While traditionally, financial reporting has been based on an historical perspective, a summation of past transactions and events, sustainable business accounting and reporting, inherently, is about stakeholders’ willingly continuing to make valuable resources available for an entity’s use into the future and the entity’s ability to satisfy these stakeholder expectations. Further, while estimating the future raises concerns about releasing speculative information in external financial reports, internally, it’s a core competency of management accountants in the arenas of planning, risk management, and capital budgeting.

This provides one more proof point about meeting the challenges of sustainability or ESG accounting and disclosure: It takes multidisciplinary expertise and competencies throughout the organization’s information team.