Accounting for climate: getting the numbers investors need

Investors are calling out for hard information on the impacts climate change will have on companies. While the discussion in the ‘front end’ of annual reports is useful – and getting better climate disclosures there is vital – most investment decisions, both by companies and investors, depend on the numbers disclosed in the audited financial statements in the ‘back end’.

The financials define profitability and drive executive remuneration, so ensuring they properly reflect climate-related risks is crucial. Fuller financial disclosures also enable investors to incorporate climate risks into their investment decision making, helping focus investment on those companies that are more likely to thrive in a carbon-constrained future. At the moment, most companies assume business as usual in their financial statements, at the same time as recognising that business as usual is something that the planet simply cannot sustain.

That’s why it’s so significant that accounting standard-setter the IASB (International Accounting Standards Board) published a paper towards the end of last year on the accounting treatment of climate issues. This paper explains that companies reporting under IFRS (International Financial Reporting Standards, i.e. companies from the bulk of the world outside the US) already need to incorporate material climate change issues into their financial reporting.

In particular, it says that the effects of climate change need to be considered when companies are assessing a number of crucial accounting calculations, including: asset valuations and impairments; useful lives of assets; provisions and liabilities arising from fines or penalties; and credit losses for loans. Management should also disclose the climate-relevant assumptions that they make in creating their accounts – such as asset lives or the future price of oil – along with the sensitivities of their reported numbers, to changes in those assumptions, so that investors can test how different climate-related forecasts might affect the financials. If business as usual assumptions are used, investors will now have the insight needed to challenge them.

The new IASB paper already seems to be having some impact – in the last few months Total and Repsol have both written down the value of their asset bases, using oil price assumptions that are closer to those that might be consistent with the Paris Agreement. The impact of changing assumptions is also shown by BP and Shell, which have both flagged massive asset write-downs (of up to $17.5 billion and $22 billion respectively) because they are moving to adopt more realistic future oil price assumptions. But as investors, we need this change to be delivered not just by one sector, but across the investment universe. This will happen, but only if companies and their auditors are aware of the importance of the IASB paper.

Next steps

The PRI is actively promoting the IASB paper and encouraging companies, auditors, regulators and investors to respond appropriately. Because materiality in IFRS is based on the views and wishes of investors, it is very important that investment institutions continue to emphasise to their investee companies, as well as publicly, that climate change is material and that they expect financial reporting to reflect this.

We are working with audit firms, the wider accounting profession, company directors and regulators to promote the paper and encourage its full implementation.

Throughout the year, we will also work with investors to promote awareness of the IASB paper and will seek to bring its importance to life by reworking some key numbers in the accounts of leading companies to explore the scale of the potential impacts of climate change.

This blog is written by PRI staff members and guest contributors. Our goal is to contribute to the broader debate around topical issues and to help showcase some of our research and other work that we undertake in support of our signatories.

Please note that although you can expect to find some posts here that broadly accord with the PRI’s official views, the blog authors write in their individual capacity and there is no “house view”. Nor do the views and opinions expressed on this blog constitute financial or other professional advice.

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