When teaching students about sustainability disclosures and reporting, it can be very easy for them to wonder what it has to do with accounting and how it really joins up to the financial statements. This disconnect with the numbers in the accounts is only strengthened further when the research done by students finds that the sustainability disclosures made by entities are often in completely separate documents to the annual report.
While a lot of the discussion centres around the work being done by the International Sustainability Standards Board (ISSB) – which has so far published IFRS S1, General Requirements for Disclosure of Sustainability-related Financial Information, and IFRS S2, Climate-Related Disclosures – it is also important to consider how this fits within the financial statements of an entity.
For a provision to be recognised in the financial statements there must be three elements present
As part of this, the International Accounting Standards Board (IASB) is looking specifically at how some climate-related issues should be addressed under the existing suite of IFRS Standards.
Commitments to offset
The first of these issues arose when the IFRS Interpretations Committee (IFRIC) was asked to clarify how IAS 37, Provisions, Contingent Liabilities and Contingent Assets, applies to commitments an entity makes to reduce or offset its future greenhouse gas emissions (net-zero transition commitments).
As a reminder, for a provision to be recognised in the financial statements there must be three elements present: a present obligation from a past event, followed by a probable outflow of resources, of which a reliable estimate can be made.
In considering the decision, IFRIC looked at each of these elements in the context of an example with two components:
- an emissions reduction commitment, where an entity commits to reducing greenhouse gas emissions by a specified amount by a specified date
- an emissions offset commitment, where the entity will purchase and retire carbon credits to offset the remaining annual emissions after that future date.
Constructive obligation
In considering the above scenario, IFRIC looked at an example where an entity states in 20X0 that it will reduce emissions by 20X9. IFRIC decided that the first element of IAS 37 to consider was whether a constructive obligation existed. This will depend on the actions the entity has taken and whether its stated commitment creates an expectation that it will fulfil the commitment. If not, there would be no provision recorded.
Even if a constructive obligation does exist, there is a question as to whether this represents a present obligation from a past event. In this case, the published commitment itself isn’t enough to create a present obligation.
The main issue noted by IFRIC in recognising that a present obligation exists is that IAS 37 states that no provision is recognised for costs that need to be incurred to operate in the future. IFRIC deemed that the entity would only have a present obligation for commitment 2 above in 20X9 when they have emitted gases that they then need to offset.
IAS 37 is ‘sufficient to deal with climate-related commitments without further standard-setting’
While settling the obligation will carry an element of cost, IFRIC noted that meeting commitment 1 above would also bring some potential assets in exchange. This could be in the form of modified equipment, or packaging, or ingredients that could be used in the manufacture of goods for a profit. It was noted that commitment 2 would simply result in an outflow of resources.
Consistent with IAS 37 stating that it is extremely rare that estimates can’t be made, the committee concluded that it was likely that estimates could be made of the potential outflows.
Resulting treatment
As a result of considering each of these elements, it was concluded that the entity would not make a provision in 20X0 when it made the commitments, as it is not a present obligation from a past event. No provisions would need to be made until 20X9, at which point the entity would have a provision for offsetting any emissions made after this date.
It would be useful to illustrate how to report the effects of climate-related uncertainties
The result of this decision is that IFRIC deemed IAS 37 to be sufficient to deal with climate-related commitments without the need for further standard-setting.
Alongside this, the IASB has noted that it would be useful to develop examples to illustrate how to apply IFRS Standards to report the effects of climate-related and other uncertainties within the financial statements.
These examples could potentially include guidance on judgments, additional disclosures on estimations or risk, impairment calculations, disaggregated information and decommissioning provisions.
The next step on this is that an exposure draft will be issued containing these examples during 2024. These will again not result in changes to specific standards but, if adopted, would be included as illustrative examples that would accompany IFRS Standards.
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Watch Adam Deller’s series of videos explaining the fundamentals of IFRS Standards
