Connectivity: are expectations too great?


Jeremy Stuber


This blog is based on my comments at the 46th European Accounting Association Annual Congress in Bucharest, Romania where I presented during a panel discussion focused on ESG information in financial statements

  • Some investors have great expectations that all climate-related information will also appear in the financial statements. 
  • This creates an expectation gap between what they anticipate finding and what they actually find in the financial statements.
  • Distinguishing between different types of climate-related information (goals, plans and actions) helps investors set more reasonable expectations.

Let me start by traveling back in time to nineteenth century London. Inside an office, a successful lawyer gives the following good advice to an ambitious young man:

“Take nothing on its looks; take everything on evidence. There’s no better rule.”

The successful lawyer is Mr Jaggers, the ambitious young man is Pip. The quote is from Great Expectations by Charles Dickens. 

As an investor, I always try to follow this good advice and look for evidence to support my forecasts. 

In the case of climate change-related information I want to know if:

  1. The company is “greenwashing”, by which I mean signaling ambitions just to make themselves look good, but without any intention of doing anything. In this case, I should ignore this information in my forecasts.
  1. The company is likely to change the way it does business, and this would have material financial consequences. In this case, I need to incorporate this information in my forecasts.

To help me decide, surely I should be able to find such evidence in the financial statements, or are my expectations simply too great? 

Project managers use the term “Cone of Uncertainty” to visualise the evolution of project risks. At the start of a project there are lots of unknowns, so the expected variance of the total project cost is very large, but over time, as the scope is defined in more detail the expected variability decreases. 

Climate change can be thought of as a huge and very long-term project. Most companies are at the very early stages, with lots of unknowns – for example, which technologies to use, how much it costs, and the possible subsidies – but over time these factors will become clearer.

When I read climate-related information, I try to distinguish between goals, plans and actions:

Goals are management statements setting out the long term ambitions. 

Having a net zero target by 2050 triggers lots of important valuation questions: how much does the business have to change to achieve this ambition and what are the risks and opportunities of the transition plan? In simple terms, is the net zero target likely to be a headwind, tailwind or neutral to growth?

However, from an accounting point of view a net zero target on its own is not an obligation and the financial implications are highly uncertain. Announcing such a goal does not create an asset or liability, so I should not expect to find any evidence of goals within the financial statements. 

Plans are detailed proposals which typically include medium term forecasts. 

Let’s consider a transition plan which involves closing down a polluting division and investing in a green division. Clearly both are important considerations when I forecast cash flows. In fact, I would tend to value these divisions separately: the polluting division is normally a heritage business, where returns on capital are more certain, but has a limited life. The green division is normally based on a new technology, where returns on capital are far less certain.

However, I need to bear in mind from an accounting point of view planned closure costs are treated differently from planned green investments. 

For the planned closure costs I would  expect to see an environmental provision on the balance sheet if all three recognition criteria under IAS 37 are satisfied i.e. there is a present obligation to clean up historic damage, the payments are probable, and they can be reliably estimated . This is where I would look for evidence of the magnitude and timing of the closure costs. The provision on the balance sheet can be treated as debt-like liability, but ideally the expected cash outflows would be disclosed so that I can model my own scenarios.

For the planned green investments I would not expect to see a liability on the balance sheet as they are simply intentions not obligations. It would not be reasonable for me to expect there to be evidence in the financial statements.

Actions are what actually happened during the accounting period. 

Green investments could be in the form of an R&D expense or capital expenditure (capex). Surely I should be able to find evidence in the financial statements? In theory, yes, but in practice disclosure is very limited.  Expense disaggregation could be improved. For example, it would be helpful to break out green R&D. Capex disaggregation could also be improved. Some companies break out green capex but not all. I look forward to sustainability reporting under IFRS S2, under which companies will report climate-related capex.

In conclusion, climate goals don’t have a place in the financials because they are too uncertain. Some climate plans have a place in the financial statements if they are certain enough to be recognised as an asset or liability, or if they are relevant to the measurement of an asset or liability. All climate actions which have resulted in financial transactions are by definition in the financial statements. The challenge here is to find these transactions, so better disclosure is needed.

Jeremy chairs CRUF UK, co-chairs the Capital Markets Advisory Committee (CMAC), which is one of the advisory groups of the International Financial Report Standards (IFRS) Foundation and is a member of the European Financial Reporting Advisory Group (EFRAG) Panel on Intangibles. He is a Fellow Chartered Accountant of the Institute of Chartered Accountants in England and Wales, qualifying with Ernst & Young. Jeremy holds MA and MEng degrees from Cambridge University.

Disclaimer: The views expressed in the blog are those of the author and do not necessarily represent the views of all CRUF participants. To read more about the CRUF’s views on this and other topics, please visit the ‘Our Views’ section of this website.


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