Consider climate-related risks in financial statements, warns IASB

Saturday, 01 July 2023

Emma Foster

    Long-range risks with the potential to significantly impact financial statements, such as environmental, social and governance risks, should be considered now, warns the International Accounting Standards Board.

    As chair of the International Accounting Standards Board (IASB), which serves more than 140 jurisdictions around the world, Dr Andreas Barckow spends much of his time listening to what’s on his stakeholders’ minds.

    “I’m basically on tour 30 to 40 per cent of my time, engaging with public authorities, auditors, preparers, users, any type of stakeholder relevant for our work, explaining what we are doing and asking, am I hearing anything new I need to feed back?” says the London-based head of the global accounting standard setter.

    And the messages he’s hearing from Australia? They’re no different to those he hears all over the planet.

    “ESG and sustainability are high on everybody’s minds,” says Barckow, during a visit to Australia in June jointly hosted by the AICD and the Australian Accounting Standards Board (AASB).

    “So too are concerns about changes in reporting and accounting requirements more broadly — and about the amount of change that particularly preparers see coming towards them.”

    These are concerns he takes seriously, acknowledging how important it is for the IASB to “pick the right battles” or risk jurisdictional carve-outs, which, in turn, threaten its ultimate goal of supporting functioning global capital markets.

    He’s also mindful that these same stakeholders must now accommodate two global standard-setting boards since the creation in 2021 of IASB’s sustainability focused, independent “sister”, the International Sustainability Standards Board (ISSB), which is currently in heavy consultation mode.

    In response, Barckow says the IASB has deliberately limited the addition of new projects to its agenda, concentrating instead on finalising the 20-plus already in plan.

    The most imminent of those are recently issued amendments relating to supply chain financing disclosures and international tax reforms. Soon to be released are amendments to the presentation of primary financial statements and disclosures on subsidiaries without public accountability and rate regulated activities.

    However, the projects attracting the most attention are among the three added to the IASB’s research pipeline — in particular, a new review of climate-related risks in financial statements.

    The interest is heightened given that this comes as all eyes are on the release of the ISSB’s second standard — known as S2 — focused on climate disclosures and likely to form the basis of the mandatory climate reporting regime proposed for Australia from as early as 1 July 2024.

    Climate reporting heats up

    Barckow is keen to point out the IASB climate risk project is not about creating another climate standard, rather it’s about exploring whether “anything is needed to clarify how our principles-based literature applies to climate risk”, he says.

    “We were confronted with investor views in particular, asking how could it be that companies are making bold net zero pledges and we’re not seeing anything in the financial statements?”

    Although not surprised by the disconnect, given time horizons in accounting conventions tend to focus on the period up until the balance sheet date, not beyond, Barckow says long range risks such as ESG that have the potential to significantly impact the financial statements should be considered.

    “We do not want to change our literature, but we want to help preparers in making that assessment, to demonstrate how you apply the principles to particular risks that are not yet on the radar,” he says.

    “When the ISSB finishes their work [on S2] we want to be assured that the information ties in neatly with the information being provided by financial statements.”

    Without pre-empting the outcome, Barckow hints that the review will focus on the impairment standard IAS 36, IAS 37 on provisions, and also IAS 1, which relates to the presentation of financial statements.

    “We might add one or two illustrative examples to IAS 1 that would demonstrate how you apply the general principles of materiality of the use of significant judgement in the context of these long-range risks,” he says.

    Recognising the scale of change

    It’s a project being keenly followed by Dr Keith Kendall GAICD, chair of the AASB, accountable for both financial and sustainability reporting standard setting in Australia.

    “It’s difficult to understate the importance we’re giving to sustainability reporting at the moment,” he says.

    Although most of Australia’s top companies provide sustainability reporting — and it’s been a part of the governance landscape in various guises for around three decades — Kendall is not convinced that the local ecosystem yet recognises the scale of the change coming with mandatory climate reporting.

    “The only thing in the history of financial reporting in Australia that comes close to this was the adoption of international financial reporting standards (in 2005),” he says, noting that Australia was an early adopter of IFRS, recognising its importance in shoring up the nation’s place in the global economy by enabling access to foreign capital markets.

    It’s an outcome Kendall says will also be true of the ISSB standards, which he expects will become a global sustainability baseline for investors.

    “At least with IFRS we were taking a familiar subject, but dealing with it in a different way,” he says.

    “But this is a completely new way of thinking. The vast majority of sustainability reporting is about looking forward, about what you see as the company’s risks in the next five, 10, 20 years. We’re very conscious of the fact that there’s a level of concern in the director community about how you can make appropriate disclosures regarding the future, which is inherently uncertain.”

    Kendall urges company directors to review the final version of ISSB’s S2 Climate-related Disclosures, on which the Australian standard is expected to be modelled, and to assess the quality and efficiency of their organisations’ data collection, particularly around emissions disclosures.

    Directors should also be alert to the consistency of assumptions used throughout their reporting, says Barckow.

    “The last thing you want to see are different assumptions being used in financial reports than you are using in the sustainability or other space.”

    Catching up with intangibles

    Another of the IASB’s pipeline projects to spark interest among global standard setters, including in Australia, is the review underway of the standard relating to intangible assets, IAS 38.

    Barckow explains that it’s in need of modernisation to reflect the growing importance of intangibles in today’s business models.

    “Most economies around the globe have moved from a manufacturing orientation into a service orientation and it’s high time for us to review our existing standard, which is more than 20 years old,” he says.

    In preparing IASB representations for this review, Kendall notes the AASB is partnering with other national standard setters, particularly in the Asian region, to gather evidence.

    “The major intangible asset that companies talk about is goodwill, which is currently covered by the standard,” he says.

    “We’re conducting research to find out how, in practice, market players deal with things like customer lists, for example. These are not recognised as an asset, although our preliminary evidence shows that for some businesses, this is one of their most significant assets.”

    Digital march picks up pace

    Separately, Barckow flags digital financial reporting as a theme climbing up the priority lists of the reporting ecosystem, including in Australia.

    Already required throughout Europe, the US and other global jurisdictions, he notes that global regulators have been “quite clear” that when ISSB’s first standards are adopted within the next year, they should come with a digital taxonomy from day one.

    Although it hasn’t yet been mandated in Australia, the Parliamentary Joint Committee Inquiry into the Regulation of Auditing in Australia in 2020 recommended digital financial reporting should become “standard practice”.

    “It’s around the accessibility of the information on a global scale,” says Barckow, who is a firm advocate of the advantages of digital financial reporting.

    He’s also led changes in the IASB approach to standard setting to build in digital taxonomy considerations upfront, rather than sequentially.

    “It’s far more cost-beneficial for users on a global scale to mass survey a huge amount of financial reports in one go, rather than one by one — so it’s really about economies of scale,” he says. “That is a very simple, but very powerful, argument for digital consumption.”

    Kendall advises that a potential adoption hurdle in Australia has been confusion about what digital financial reporting exactly is — that it’s not simply the creation of a PDF report as many assume — and questions the benefits.

    He notes that these are issues the AASB is keen to address through an education program.

    Among the minority who are up to speed, Kendall says they are “strongly in favour”, although a key hesitation, as always, is in the upfront cost of implementation and the lack of impetus in the absence of a regulatory directive.

    “It’s not currently an issue that’s front and centre, particularly while the focus is overwhelmingly on the introduction of sustainability reporting,” says Kendall.

    “But I suspect that it will come to the surface and regulators will start talking about it in a more forceful way.”

    This article first appeared under the headline ‘The Message is Clear’ in the July 2023 issue of Company Director magazine.

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