Getting visibility on the financial statement effects of climate change


Sue Harding


It’s the new year and that means the annual reporting season is upon us.

In this case, year-end 2022 is the third such reporting season falling after the international standard setters for accounting and audit provided their clear indication of how a company’s exposure to climate risk would be addressed under their existing standards.

However, a relatively damning report from the Carbon Tracker Initiative (CTI) last year, a follow up from the year before, evidenced continued shortfalls in both company financial statements and auditor reporting on climate. Of the 134 financial statements of carbon-exposed companies that were specifically identified by investors for engagement on net zero (i.e., the Climate Action 100+ (CA100+) focus companies), CTI found: 

  • Only three companies demonstrated how the effect of climate change was considered in the financial statements in a comprehensive manner. 
  • Only one company appeared to fully disclose the material climate-related assumptions and estimates made in producing the financial statements. 
  • Virtually all companies appeared not to have considered the consistency of information disclosed in their narrative reporting on climate risk and its effect on the company’s strategy and emissions targets, with descriptions of how these were addressed within the financial statements. For some companies, this observation relates to there being very limited information in the financial statements relative to climate disclosure presented in other reporting outside of the financial statements; for other companies there were specific issues such as seemingly inconsistent commodity price or other assumptions used in accounting best estimates compared with what was disclosed in the narrative reporting related to climate risk.   

Set against this backdrop, this blog focuses on the effect that climate risk exposure may have on the financial statements of companies that investors have singled out for engagement on the transition to net zero (i.e., CA100+ focus companies), and so may be an important focus area of investors’ assessments of corporate performance and their financial statement analysis in this reporting season. Of course, opportunities matter too – and for some companies, opportunities such as creating new or changed product offerings or implementing energy efficient ways of operating may be at least part of the answer to mitigating risk. But here the focus is primarily on risk related to carbon intensity of the CA100+ focus companies, which are 166 companies identified by investors representing US$68 trillion AUM as being key to driving the global net zero emissions transition, and include companies that generate up to 80% of corporate industrial greenhouse gas emissions. 

This blog is set out in two parts. Part 1 covers why information about climate risk exposure is relevant to financial reporting and the state of application by companies today. Part 2 highlights some of the views (or ‘myths’) commonly raised about how climate risk affects financial statements and some points for investors to keep in mind as they review and assess year-end 2022 reports.

Part 1: Why climate risk is relevant to financial reporting

Why does this matter to investors?

A company’s climate risk exposure may represent risk to their investors (investment risk). There are many aspects to how investors engage with companies on their exposure to climate risk (whether transition or physical risks), and the financial statements have a distinct part to play. This is particularly the case for companies that would appear to be most exposed to climate risk – i.e., those that have assets that are potentially overstated and/or liabilities that are potentially understated, or that may become so over time, as a consequence of climate risk. This also matters because reported profitability can affect a range of governance decisions made by a company, including its capital allocation and investment decisions, remuneration of its executives and decisions on dividend policy. It also impacts investment and stewardship decisions made by investors, for example their assessment of capital at risk, how they engage with companies, and their voting practices.  

While there may also be other pressing issues for companies (e.g., the war on Ukraine, energy pressures, inflation etc.), climate change and the response to it represent a particularly fundamental change to transitioning the entire economy to become low-carbon, with some business models likely to be completely transformed. It is also of particular importance if we are to avoid the more devastating effects of unmitigated (or less-mitigated) climate change. 

What is required of financial statements with respect to climate?

Accounting standard requirements apply both to the companies reporting in accordance with them, and to the audit firms issuing an opinion on those financial statements. For investors, they also create expectations for the reporting of financial position and performance (the numbers) as well as accompanying footnote disclosure.  

So if a company is exposed to climate risk, what should investors expect to see reported in its financial statements? There is a ‘theory’ and ‘practice’ element to this. 

In theory – what’s required under the accounting standards?

In short, the principles embedded in International Financial Reporting Standards (IFRS) require disclosure of information that is material to investors so that the financial statements can be understood. Information is material if ‘omitting, misstating or obscuring it could reasonably be expected to influence decisions that primary users of financial statements (hereafter, investors) make on the basis of those financial statements’. 1  

Relating this to climate, the IASB’s Educational Materials: Effects of climate-related matters on financial statements that: ‘Companies will therefore need to consider whether to provide additional disclosures when compliance with the specific requirements in IFRS Standards is insufficient to enable investors to understand the impact of climate-related matters on the company’s financial position and financial performance.’

The application of the accounting principles is based on the circumstances of the company, and a range of choices, judgements, estimates and assumptions made by the company in preparing the financial statements in accordance with the standards. 

Material financial and business risks associated with climate may or may not result in large adjustments to the accounting numbers, or even in significant risk of the financial statements being misstated – in other words, financial statement risk. But this is precisely why material information on this – for example, disclosure of how climate risk has been considered and the assumptions and estimates made – are so critical to an understanding of the financial statements.  However, the specific detail of what’s disclosed in order to provide such an understanding will vary depending on the circumstances of ‘at risk’ asset and liability amounts and the judgements made. 2

In practice – what’s actually being disclosed?

Far too often, however, evidence of climate risk exposure being considered in preparing a company’s financial statements either cannot be found or is incomplete. This is even the case for companies — such as oil and gas companies — where one would expect that climate risk poses clearly material business and financial risk. The Still Flying Blind report by CTI showed for the second year of their analysis that less than 4% of the 134 reports studied appeared to have comprehensively met any of five separately assessed categories relating to accounting and audit requirements. The assessments were updated for the remaining 32 CA100+ focus companies in Q4 2022, but the results were much the same with only one additional company’s reporting meeting the assessment criteria. 

While this overall picture remains disappointing, it is important to note improvements have been made. In the 2021 reports, there was an increase in the number of companies that at least have made simple assertions along the lines of noting that climate has been considered and (often) no material adjustments resulted. Although this is not sufficient to provide an understanding of the financial statements or how risk and company strategy on climate were considered, it is a helpful confirmation that the company has given some consideration to the topic and is a starting point for investors to engage with the company about it.

Generally speaking, an understanding of how climate risks and the company’s own targets have been considered would seem to require an identification of assets and liabilities that the company considers to be at-risk from factors associated with climate (or description of why assets and liabilities that investors would reasonably assume to be at risk, are not), how the accounting for these at risk items has considered climate, and information on the assumptions and estimates made. On this later point, CTI noted a marked increase in the number of companies disclosing at least some of the climate-related assumptions and estimates used in the financial statements: 58% of companies disclosed at least some of the significant quantified climate-related assumptions and estimates. This more than doubled from 25% in the previous year’s report.  

But concerns remain on how comprehensive disclosure is in making clear how climate was considered across different assets (such as property, plant and equipment (PPE), intangibles, investments, financial receivables) and liabilities (such as provisions for AROs, and legal or regulatory provisions), and across different accounting considerations (such as, for PPE, remaining lives/units and residual values, asset impairment and retirement obligations.)  Concerns can also be readily seen through a consistency lens. For example, it is still often the case that companies disclosing climate-related risks and a range of targets and steps they plan to transform their businesses to reduce emissions, also make little to no mention of whether and how such transformational changes have been considered in the financial statements. 

In addition: Net Zero / 1.5°C pathway and aligned financial statement assumptions 

Beyond the accounting requirements, investors have also requested financial information that is based on assumptions aligned with Net Zero by 2050 (or sooner) and a 1.5°C pathway, and this has also been incorporated into the CA100+ Climate Accounting and Audit Assessment. Currently, none of the focus companies appear to be using such aligned assumptions in the preparation of their financial statements, and this is unsurprising given that their current risk assessment and strategies have not become aligned. As a result, this request is for a sensitivity analysis to the use of aligned assumptions (as appropriate for the company) to provide a common benchmark on the resilience of their reported financial statement amounts. Three of the CA100+ focus companies (Eni, Equinor and Glencore) have begun to report such information in response to investor requests, potentially showing the way for others. 

Implications for the 2022 year-end reporting season

For 2022 the growing recognition that climate change will materially affect some companies, particularly the CA100+ focus companies, calls for enhanced disclosure that investors need in order to understand their financial statements. This is a critical year to start setting things right, and for material climate-related information to be provided thereby linking the company’s current risk assessment and current strategy into the current year’s accounts, and ensuring consistency of information across narrative and financial statement reporting. Risk assessment, strategy and plans may of course change in the future as climate risk and the transition unfolds, but once the linkage is made clear, it can be maintained to address such future developments, being updated as appropriate for changes in accounting best estimates. 

The alternatives to this are not appealing. Failure to incorporate the effects of a company’s exposure to climate risk into its financial statements may not only represent governance issues on the oversight of the company’s financial statement reporting and the audit, but could also encourage other governance decisions that don’t appropriately reflect these risks. For example, it could result in delayed action on climate strategy and moving to low carbon alternatives, and encourage further investment in carbon intensive assets/projects that will ultimately result in losses that could have been avoided. 

Where financial statements are yet to incorporate plans to meet emissions targets or are unclear on this, inconsistencies (at a minimum) present a confused picture to investors. But such inconsistencies also raise questions on whether the financial statements, the description of risk and strategy, or both, are misstated. 

Finally, central to the accounting requirements is that they are principle based. This is in part because it is unrealistic to think detailed rules can keep pace with every new situation before it arises. The current absence of disclosure that adequately upholds the accounting principles on material climate information suggests we might even begin to worry for the future of principle-based accounting and disclosure requirements. This can be remedied via greater attention to treating disclosure as communication – and greater challenge on whether disclosure as it stands is sufficient to provide an understanding of the extent to which and how climate has been considered. Many parties have a role to play in this – companies and those with governance responsibilities such as the board and audit committee members that oversee reporting and audit, the auditors themselves, regulators (of audit, financial reporting and markets), as well as investors. 

It’s clear that there is much work to be done, and it would seem reasonable to expect all parties will be increasingly focused on this over this year’s reporting and AGM season. Also clear is that more dialogue is needed. 

Read on for additional insight on common myths along with some points about climate risk exposure that investors may benefit from keeping in mind as they assess financial statements and engage with companies. 

Part 2: What should investors look out for in 2022 reports?

Building on improvements seen in 2021, there are several influences that may drive additional disclosure in 2022 financial statements, including the increased materiality of climate (increasing the need for disclosure of material information), and expanded activities of regulators that continue to call for more disclosure under the existing accounting standards.

Increased materiality of climate: Some of the relevant factors influencing materiality of climate include: climate risk assessment, company emissions targets and strategies, and investor interest in the topic. These all put pressure on climate-exposed companies to provide meaningful financial statement disclosure, whether or not adjustments to financial statement amounts have been required to be made in the current year. 

Circumstances will differ across companies and sectors, but the following suggest increased materiality as a general direction of travel:   

  • Climate Risk – Many companies are actively assessing climate risk to their business. Analysis for the CA100+ (October 2022 Net Zero Benchmark) found that 91% of CA100+ focus companies have aligned with TCFD recommendations either by supporting the TCFD principles or by employing climate-scenario planning. The work associated with assessing risk during 2022 should build on this, with more meaningful risk reporting. Enhanced assessment of climate risk of course drives consideration of related business and financial risks, but it also drives consideration when preparing the financial statements.  
  • Emissions Targets – The October 2022 update of the CA100+ Benchmark also found that 75% of focus companies had committed to achieve net zero emissions by 2050 or sooner across all or some of their emissions footprint (up from 69% in March 2022). In addition, over a third of CA100+ focus companies had set long-term targets that align with a 1.5°C pathway (an increase of 9% from March 2022). Plans to deliver targets are also being put into place. This is a significant movement by companies undertaking their own initiatives. Assuming these statements have substance, this should drive changes in the business to meet these targets. For example, it may be that carbon-intensive assets will need to be retired earlier than originally expected, and replaced by low-carbon alternatives. Such changes in strategy and plans may require updates to the company’s best estimates in relation to those assets. Potential accounting consequences may include: increased depreciation costs for shortened remaining asset lives, impairment charges if asset values are deemed to no longer be recoverable, and/or increased liabilities for asset retirement obligations as their amounts and timing become more clearly known.
  • Investor Interest – Investors have also made abundantly clear their interest in the topic, when it is material to a company’s business. The CA100+ has added a specific Climate Accounting & Audit Assessment to its broader Net Zero Benchmark. While the first two years of assessment have been included on a provisional basis, the assessment is expected to be fully incorporated into the Benchmark this year. Climate is also on the agenda of many individual investment organisations, and is increasingly being considered in engagement and voting policy discussions. Additionally in Europe, the Institutional Investors Group on Climate Change (IIGCC) continues to write to companies of interest and their auditors regarding expectations of financial statement information on climate. 
  • Regulatory focus – Regulators too, are focusing on whether climate risk exposure has been factored into financial statements. Climate consideration in the financial statements has again been included as a priority topic for 2022 accounts reviewed by the UK’s Financial Reporting Council (FRC), as well as by the European Securities and Markets Authority (ESMA). Specifically, the FRC will consider how adequately companies’ net zero commitments have been addressed in their financial statements; ESMA will focus on consistency of reporting on climate in and outside of the financial statements as well as several key accounting considerations including asset impairment. It seems likely that as regulators continue to interact with companies, additional disclosure is at least committed to being provided in the future, and some of this may land in the 2022 accounts. Based on the FRC’s published Case Summaries, it appears that its past interventions may have led to enhanced climate disclosures by Glencore and Shell in particular.

So what might investors bear in mind as they consider the implications of climate risk exposure in their analysis of financial statements and engagement with companies? 

Although there are requirements around how climate risk exposure is to be considered when applying accounting standards, there also appear to be some myths about applying these standards. The myths set out below are sometimes put forward as reasons why more adequate and detailed disclosure is not currently being provided. 

MYTH: Sustainability reporting is the place for such information; improvements are on the way 

Improved sustainability reporting is being developed under several initiatives, including the IFRS Foundation’s International Sustainability Standards (ISSB standards), the Corporate Sustainability Reporting Directive (CSRD) in the EU, and climate reporting proposals by the US SEC. However, none of these will cure inadequate financial statement reporting. Each of these reporting areas has its own role to play – by fulfilling the requirements for ‘narrative’ reporting including sustainability, and for the financial statements, respectively. Enhanced information on sustainability may even make more obvious the deficiencies in financial reporting, if they are not addressed in a manner that fully embraces disclosure so the financial statements effectively stand on their own to provide an understanding of how climate risk has been accounted for and the amounts at risk.  

Additionally, the infrastructure for sustainability reporting is being developed along the lines of what is already meant to be in place for high quality financial statement reporting. That is, a set of principle-based requirements, built on an understanding of: materiality, what should be included when and how it should be measured, with reported information being subject to audit/assurance. But there appears to be a gap in this thinking in that the accounting requirements are not currently being applied in a manner that delivers information adequate to understand how climate risk exposure has affected the assumptions that underpin financial statements (as is required). How can investors be confident that any new requirements on sustainability reporting will deliver what investors require when the current principles on financial reporting, developed over decades, still lack application?                                                                    

MYTH: Accounting is backward looking (and therefore future climate matters are not incorporated)

It is often said that accounting is largely backward looking, with some companies even (often mistakenly in my view) claiming their accounts are based on ‘historical cost’. In reality, expectations of the future permeate many of today’s accounting requirements. Examples include PPE balances for which depreciation estimates are reviewed for changes at least at each reporting date (including estimates of remaining lives or units of production), and retirement cost provisions for the present value of future expected costs. Additionally, impairment assessments of PPE and intangibles typically take account of current estimates of value recoverable in the future, using explicit forecasts of cash flows for an initial period, followed by future year amounts based on assumed growth rates. Amounts are discounted to a current recoverable value which incorporates uncertainty and risk. Some financial assets (trade and lease receivables, for example) are also tested for impairment based on amounts recoverable in the future, and others are carried at fair values, which also embed future expected cash flows expected by market participants.  

From these requirements, it is clear that climate is an appropriate risk to be considered in the current accounts of a company, not just something for the future. 

MYTH: Climate-related effects are uncertain and very long-term (and therefore are not captured by the accounting rules)

Absolute certainty is not a requirement of accounting, with impairment and asset lives largely being determined on current best estimates. While uncertain, there is a current state of risk assessment and climate strategy to be taken account of, with appropriate contextual disclosures being provided. 

It’s also important not to confuse indirect effects (for example on assumptions and estimates used to consider impairment of asset values such as PPE), with more direct or transactional accounting (for example the recognition of a liability for carbon costs). The former relates to how assets are allocated as costs to the income statement via depreciation or impairment, whereas the latter relates to the liability itself. Taking carbon costs as an example, it is appropriate to include in expected cash flows used to estimate an asset’s recoverable amount, the current best estimates of the cost of carbon over the life of the assets being tested; it may not be appropriate to recognise any liability in the financial statements until the excess emissions have actually been produced (and other criteria is met), which may be considerably later.  

Another issue with this perspective is that some aspects relating to climate change are not even all that long-term, including the effects already being faced in terms of extreme weather events, fires, etc. Additionally, many companies have set interim emissions targets for 2025 or 2028, and even meeting longer-term targets may require phased retirements of carbon-intensive assets, and research and development of new products and technologies in the near term (i.e., within current planning timelines). It seems unlikely that there will be a cliff effect with changes necessary occurring only in 2030 or 2050. However, it is often unclear whether any of these expected changes (near or longer-term) have been considered in best estimates or they continue to reflect business as usual having no regard for stated targets.  

MYTH: Climate is not material to the financial statements (and therefore does not need to be disclosed)

Materiality is much more than just whether large adjustments to financial statements have been made. It is framed in the requirements in qualitative as well as quantitative terms, including the external qualitative factors (climate risk being one example). 

Accordingly, where investors may have a reasonable expectation that particular assets or liabilities might be exposed to climate risk (for example, PPE exposed to the risk of impairment or potentially already being impaired) a company’s conclusion that they are not exposed or that no impairment is needed calls for disclosure of material information such as how this has been assessed and key assumptions made in arriving at that conclusion. 

For example, it would not seem reasonable to assume business as usual cash flows for an oil and gas company’s future revenue stream thereby avoiding any impairment, without disclosing material information to provide an understanding of the price and volume assumptions made. Said differently, surely it is material information to understand there has been no impairment because the company assumed business-as-usual cash flows – i.e., no decrease in oil and gas (O&G) prices or volumes over time, as if no transition will transpire. 

MYTH: Companies are not required to say more than they already are

As already indicated, it is true that there are judgements to be made on information to be disclosed. 

IAS 1, Presentation of Financial Statements, provides several overall disclosure requirements that are in addition to requirements specified in other topic-specific standards (for example those on impairment (IAS 36) and property, plant and equipment (IAS 16)). These overall requirements on providing an ‘understanding’ are described in relation to a wide array of elements including:

  • Fair presentation (para. 17) and Materiality and aggregation (para. 31): ‘provide additional disclosures when compliance with the specific requirements in IFRSs is insufficient to enable users to understand the impact of particular transactions, other events and conditions on the entity’s financial position and financial performance.’ 
  • Structure of the notes (para. 112c): The notes shall: … ‘(c) provide information that is not presented elsewhere in the financial statements, but is relevant to an understanding of any of them.’
  • Accounting policy information (para. 117): ‘disclose material accounting policy information – i.e., when considered together with other information included in an entity’s financial statements, it can reasonably be expected to influence decisions that the primary users of general purpose financial statements make on the basis of those financial statements.’
  • Judgements (para. 122): ‘judgements that management has made in the process of applying the entity’s accounting policies and that have the most significant effect on the amounts recognised in the financial statements.’ 

There is also a further requirement relating to sources of estimation uncertainty (paras. 125, 129) to: ‘disclose information about the assumptions [the company] makes about the future, and other major sources of estimation uncertainty at the end of the reporting period, that have a significant risk of resulting in a material adjustment to the carrying amounts of assets and liabilities within the next financial year.’ 

Judgement is required in applying all such requirements. Nonetheless, it seems surprising that for many of the most exposed emitters in the world so little is being said. 

Good examples are also emerging. The Still Flying Blind report identifies several companies as having met the assessment criteria for certain categories of disclosure, and includes additional examples of helpful disclosure by companies that had made progress on some (but not all) aspects. These examples can be used to inspire other companies to follow suit.

Additionally, it may be helpful to consider as a starting point on company disclosure:

  • ‘At risk’ assets and liabilities: Disclosure of assets/liabilities that are climate-exposed, for example indicating the amount or portion of PPE asset classes that are carbon-intensive (reserves of various fossil fuels, are used to produce emissions-intensive products such as ICE vehicles, or are powered by fossil fuel energy). 
  • Current assumptions: Disclosure of climate-related assumptions and estimates used, whether they have or have not been adjusted for climate risk. For example, the remaining useful lives of carbon-intensive assets, and the price/volume assumptions used in impairment testing relating to sales of commodities and carbon costs provide a starting point for investor understanding. 

And finally, it can be useful to consider whether there is an appearance of inconsistency between statements on the company’s climate strategy, targets, and risk assessment versus information on how these have been incorporated into the financial statements.  For some companies, it may only require fairly limited financial statement disclosure to bring balance to their extensive narrative reporting on climate, resolving what may otherwise appear to be inconsistent reported information.  

1 IAS 1, Presentation of Financial Statements, provides several overall disclosure requirements that are in addition to requirements specified in other topic-specific standards (for example, those on impairment (IAS 36) and property, plant and equipment (IAS 16). These overall requirements on providing an ‘understanding’ are described in relation to Fair presentation (para. 17), Materiality and aggregation (para. 31), Structure and the content of the notes (para. 112c), Accounting policy information (para. 117) and Judgements (para. 122). 

2 Both the International Accounting Standards Board (IASB) that sets IFRS used outside the USA and the Financial Accounting Standards Board (FASB) which determine standards inside the USA, have confirmed that material climate risk, as any other material risk, would be captured by their existing accounting standards. At a high level, the situation is similar under both, requiring accounting adjustments where criteria are met, along with disclosure of material information, though some of the mechanics for this differ in the detail.

Sue Harding is an independent company reporting and governance analyst with over 35 years of experience ranging from equity research and credit rating analysis, developing and interpreting IFRS and US GAAP requirements, and advising companies on effective reporting to the capital markets. She provides a range of accounting and governance research, advisory services, and training to investors and analysts, and corporates. She is a member of the Climate Accounting and Audit Project team commissioned by PRI (a group of accounting and finance experts drawn from the investor community), and a long-term participant in CRUF. Sue originally qualified as a US Certified Public Accountant and is based in London.

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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