Climate change affects an ever-increasing group of industries and companies. New risks create uncertainty for business models and forecasts, for example, and could lead to changes in strategy. On the other hand, the changes in strategy could result from new opportunities. Therefore, climate change has impacts on corporate activity, and these are expected to affect companies’ profitability, financial position and cash flows. Hence, financial reporting is affected by the impacts of climate change.

In the European Common Enforcement Priorities (ECEP¹) related to IFRS enforcement, the European Securities and Markets Authority (ESMA) has included climate-related matters as a priority since 2021. To dive more deeply into the subject, ESMA studied financial statement practices and published the report “The Heat is On: Disclosures of Climate-Related Matters in the Financial Statements” on 25 October 2023. The examples presented in the report are hoped to help listed companies and auditors as they prepare for the financial statements of 2023.

Disclosing impacts of climate change – IFRS requirements

The current IFRS cover the handling of phenomena such as climate change in IFRS financial statements, although climate change is not expressly mentioned in them. The IASB has published material that helps in the application of the IFRS on this subject: “Effects of climate-related matters on financial statements”.

IAS 1 Presentation of Financial Statements requires disclosure of information on judgements that the management has made, assumptions about the future, and key sources of estimation uncertainty. Climate change impact assessment typically includes a large amount of uncertainty and consideration. Moreover, in accordance with IAS 1.17, when preparing financial statements, the management must assess whether the financial statements contain all the material information from investors’ point of view and, if necessary, the presented information must be supplemented. According to IAS 1.7, information is material if omitting, misstating or obscuring it could reasonably be expected to influence investment decisions. In assessing materiality, the company may seek additional guidance from the IASB’s voluntarily applicable “IFRS Practice Statement 2: Making Materiality Judgements”.

Five themes in the ESMA report

The objective of the report published by ESMA is to promote the coherent and transparent disclosure of climate-related matters in IFRS financial statements. The report covers topics on which climate change could have a material impact. The topics are discussed in a practical manner, providing examples from companies’ notes to the financial statements, and the requirements of the IFRS are addressed briefly.

The examples are selected from the 2022 IFRS financial statements of 22 European companies. The companies are major listed companies representing nine industries on which climate change is expected to have a substantial impact. In connection with each example, ESMA explains why the note in question could be beneficial to the user of the financial statements and to what companies should pay attention. However, ESMA emphasises that the report does not dictate a certain way in which climate-related matters should be presented. IFRS enforcement is always carried out on the basis of the requirements of the standards.

In the ESMA report, the examples are divided into five topics. The information disclosed by companies is inspected based on the IFRS standard applied to the topic in question. The topics are:

1. judgements made by management, sources of estimation uncertainty, and accounting policies (IAS 1)
2. impairment of assets (IAS 36)
3. useful lives of tangible and intangible assets (IAS 16, IAS 38)
4. provisions (IAS 37)
5. other topics.

Companies should consider supplementing information on major sources of estimation uncertainty and judgements made by management if climate-related matters have material impacts on the company. Moreover, disclosure may be necessary in cases in which the management has, in its judgement, determined that the impact in question is not material to the company for the time being. This allows the investor to be certain that the management has considered the matter and is monitoring it. In any case, with the operating environment changing rapidly with respect to climate-related impacts, assessments should be made regularly. Due to changes in regulations or the demand environment, for example, an impact that was deemed immaterial in the previous financial statements could quickly become material.

If climate-related matters have a material impact, for example, on cash flows or discount rates, it would be appropriate for the company to consider providing more detailed information on the assumptions used, for instance. Scenario modelling would potentially be a good tool for dealing with the uncertainty related to forecasts. Climate change and its associated impacts may result in changes in the business models and business structures of companies. This could influence the method of defining cash generating units.

For intangible and tangible assets, regulatory developments or changes in the production process resulting from climate targets, for example, could lead to a shortening in the economic life of assets. For this reason, companies should regularly assess the various potential impacts of climate change on the value of assets.

In addition to having considered examples from the perspective of applying the IFRS in its report, ESMA has also assessed the coherence of the financial reporting and sustainability reporting disclosed in the examples. The connectivity between financial reporting and sustainability reporting is an area currently being developed by the IASB, ISSB (International Sustainability Standard Board) and EFRAG (European Financial Reporting Advisory Group). The development work is expected to produce a definition for the connectivity concept, which will contribute to ensuring the transparency, coherence, and usefulness of information across different parts of a company’s annual report.

It is important that companies focus on the coherence of financial and sustainability information when disclosing information on climate targets or measures required by transition plans, for example. The objective should be to enable the user to obtain a complete picture of the current financial impacts of climate change on the company and the associated risks and uncertainties. ESMA recommends that companies disclose climate-related matters in a single note to the financial statements or list the relevant notes.

For further information, please contact:

Nina Lindeman, Senior Specialist, nina.lindeman(at)fiva.fi

¹ European common enforcement priorities 2023