The IFRS Interpretations Committee recently considered the following fact pattern:

• In 20X0 an entity, a manufacturer of household products, publicly states its commitment:
  • to reduce its current greenhouse gas emissions by at least 60% by 20X9; and
  • to offset its remaining emissions in 20X9 and thereafter, by buying carbon credits and retiring them from the carbon market.

• With its statement, the entity publishes a detailed plan setting out how it will gradually modify its manufacturing methods between 20X1 and 20X9 to achieve the 60% reduction in emissions by 20X9. The modifications will involve investing in more energy-efficient processes, buying energy from renewable sources and replacing existing petroleum-based product ingredients and packaging materials with lower-carbon alternatives. Management is confident that the entity can make all these modifications and continue to sell its products at a profit.

The Committee considered whether in this situation the entity’s commitment to reduce or offset its greenhouse gas emissions creates a constructive obligation (that is whether the entity through past practice or policies or statements of intent has indicated to other parties that it will accept certain responsibilities; and whether it has created a valid expectation on the part of those other parties that it will discharge those responsibilities), and if so, whether that constructive obligation meets the criteria in IAS 37 for recognizing a provision.

In the tentative agenda decision published for comment, the Committee stated that whether a constructive obligation exists “depends on the facts of the commitment and the circumstances surrounding it. Management would apply judgement to reach a conclusion considering those facts and circumstances.” This is a fairly familiar sort of wording, perhaps not seeming to be saying much at all. But even the indication that a net zero transition commitment could constitute a constructive obligation may strike some practitioners as a radical step forward: certainly the first entity to comment on the tentative agenda decision, Rethinking Capital, saw it that way, as a major contribution to tackling an existing expectation gap “between what stakeholders such as investors and civil society may expect an entity to be responsible for and what it is required to be responsible for under IAS 37” (Rethinking Capital were right on top of it, having referred the issue to the IFRIC in the first place).

Continuing with the draft decision though, it doesn’t necessarily follow under the IAS 37 model that identifying such a constructive obligation would rapidly lead to recognizing a provision. Among other things, the standard states that ‘no provision is recognized for costs that need to be incurred to operate in the future’ and that ‘it is only those obligations arising from past events existing independently of the entity’s future actions (i.e. the future conduct of its business) that are recognized as provisions’. So, in the words of the tentative decision:

• (the obligation, if one exists) is not a present obligation as a result of a past event when the entity publicly states its commitment in 20X0. At that time, the entity has not taken the actions to which the statement applies. The costs that the entity will need to incur to modify its manufacturing methods and to offset the greenhouse gases that it emits in 20X9 onwards are costs that it will need to incur to operate in the future—the obligations for those costs do not exist independently of the entity’s future actions.
• the entity will never have a present obligation for future modifications to its manufacturing methods because the costs of those modifications will always be costs incurred to operate in the future. The entity will at some point have to pay for resources it purchases to modify its methods—for example, to pay for new plant or equipment—but only when it receives those resources.
• only when the entity has emitted the greenhouse gases that it has committed to offset will it have a present obligation to retire the carbon credits required to offset those greenhouse gases. The entity will have a present obligation to retire carbon credits only if and when it emits greenhouse gases in 20X9 and later years.

Overall, IFRIC concluded (subject to comments to be received by February 5, 2024), using its standard wording, that the principles and requirements in IFRS Accounting Standards provide an adequate basis for an entity to determine the appropriate accounting here, and so decided not to add  a standard-setting project to the work plan. Rethinking Capital’s very interesting submission points out many respects though in which the fact pattern is artificially narrow – for example, real-world transition plans would likely be multi-faceted and dynamic with a multiplicity of “past events” giving rise to separate but related obligations and commitments. It anticipates that other comment letters will yield all kinds of technical objections, arguments for pushing out the implementation of the decision, and so on, not least from the major audit firms; it also acknowledges an alternative possibility though, that the draft opinion contains enough fuzziness and uncertainty that it may ultimately change things less than Rethinking Capital and others may anticipate and hope for. Anyway, if the comment letter is even half-right, the tentative agenda decision may be far more significant than one might guess from its unassumingly technocratic nature…

The opinions expressed are solely those of the author.