Thursday, June 1, 2023

Climate change and its impact on financial statements

The new financial rules on sustainability represent a milestone in the preparation of accounting information for companies for two reasons: the first is that it will be possible to have a comprehensive and unique framework that promotes social responsibility and care for the environment; the second, that said framework will use a structured language that is understandable for the areas that prepare the accounting or financial reports of the companies.

In this era of disruption for finance and business, sustainability and the climate change play a leading role. According to Deloitte’s 2022 CxO Sustainability Report, 97% of companies have felt the impact of climate change, including operational and supply chain disruptions, regulatory uncertainty, and increased employee anxiety. .

That’s why stakeholders increasingly expect executives to tackle climate change under pressure from regulators, boards, customers, shareholders and employees alike. At this point it can be said that there is progress, but is it enough?

On the other hand, Deloitte’s most recent 2023 CxO Sustainability Report indicates that 59% of companies use more sustainable materials (recycled, products with fewer emissions) and 54% use efficient energy or environmentally friendly technology. environment.

Given these changes, it is important to ask how the regulators of generally accepted accounting standards have analyzed these effects in Costa Rica?

Current context

The International Financial Reporting Standards (IFRS) approved to date, do not include explicit references to climate-related issues. However, the application of current accounting standards requires entities to consider weather-related changes in their business and operating environment, when those changes have a direct or indirect material effect on the financial statements.

Although the IFRS have not included explicit references to climate, the IFRS Foundation has published educational materials to illustrate such considerations. These materials provide examples of how an entity might consider weather-related effects (impairment, acceleration of impairment, or liabilities) when applying current accounting standards in preparing the financial statements, including their disclosures.

Some examples are:

If weather-related events create material uncertainties, related to events or conditions that cast significant doubt on a company’s ability to continue as a going concern, IAS 1 (which refers to the presentation of financial statements) requires disclosure of those uncertainties.

· The impact of weather could cause a company’s inventories to become obsolete, its selling prices to decrease, or its costs of completion to increase. If the cost of inventories cannot be recovered, IAS 2 (the standard that refers to inventories) requires the company to record those inventories at their net realizable value.

· The effects of climate change could affect the estimated residual value and expected useful life of assets, this can occur due to obsolescence, legal restrictions or inaccessibility of assets.

· Weather events could also affect the recognition, measurement and disclosure of liabilities in the financial statements when applying IAS 37 (standard that refers to provisions, contingent liabilities and contingent assets). In this case they could be related to: levies imposed by governments for not meeting climate-related targets, or for discouraging or encouraging specific activities; regulatory requirements to remedy environmental damage; contracts could become onerous (due to potential loss of revenue or increased costs as a result of changes in weather-related legislation); or restructurings to redesign products or services to achieve climate-related objectives.

Sustainability information becomes relevant

The detailed financial impacts are not new, however, in recent years Environmental, Social and Governance (ESG) issues have become more important, not only for companies, but also for investors, regulators, customers and suppliers, which has driven by the need to make known what organizations are doing in a consistent, complete, comparable and verifiable manner.

For this reason, the International Sustainability Standards Councilcreated by the IFRS Foundation, has been working on a single regulatory framework for companies to report non-financial information related to sustainability and climate.

The Board has published two drafts of those standards: one on General Requirements for Sustainability Disclosures Related to Financial Information (IFRS S1) and another on Climate-Related Disclosures (IFRS S2). These are proposals based on existing standards and frameworks, such as those of the Sustainability Accounting Standards Board and the recommendations of the working group on Weather-Related Financial Disclosures.

Now, what does each standard indicate? IFRS S1 establishes general requirements regarding sustainability issues that companies must disclose periodically. For example, what kind of governance structure do they have to identify, assess and monitor climate or societal related risks; the way in which they manage and mitigate those risks; the company’s strategy for addressing significant risks and opportunities related to sustainability; and their metrics and objectives, that is, the commitments they have to combat climate change, the measurements they make and the actions with which they plan to meet their goals.

For its part, IFRS S2 focuses specifically on the issue of climate and the disclosures that companies must make, specifically regarding their environmental impact. For example, the measurement of greenhouse gases.

Moving towards a sustainable approach should not only be limited to the exclusive work of accounting teams, but should encompass all areas of the organization. Today, as a path is opened to include information that was previously considered non-financial in financial statements, sustainability issues have come to occupy a place of great importance on the agenda of financial directors, boards of directors, investors, regulators and among others. the different participants of the global business ecosystem.

When a company adopts a sustainability strategy, it is actually creating a value strategy, and this implies making investment decisions, financing, mergers and acquisitions, tax planning, legal aspects, as well as production processes. For example, it could happen that the organization modifies its supply to comply with its sustainable strategy and with its commitments to reduce the emission of greenhouse gases. greenhouse effect.

As part of a new era of finance and business, in which sustainability has taken a leading role, making transparent the commitments, strategies and results related to ESG aspects, as well as climate change, are tasks to which companies must begin to adapt.

By: Gustavo Arias

Deloitte Audit Partner


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