As we covered here, the IASB has issued Climate-related and Other Uncertainties in the Financial Statements, an exposure draft of proposed illustrative examples.

The exposure draft “proposes eight examples illustrating how an entity applies the requirements in IFRS Accounting Standards to report the effects of climate-related and other uncertainties in its financial statements (in the expectation) that these illustrative examples will help to improve the reporting of the effects of climate-related and other uncertainties in the financial statements, including by helping to strengthen connections between an entity’s general purpose financial reports.” One of the examples is built on the following fact pattern:

• The entity operates in a capital-intensive industry. The entity is exposed to climate-related transition risks that might affect its ability to recover the carrying amount of some of its non-current assets. The entity has no goodwill or intangible assets with indefinite lives.
• During the current reporting period, there are indications that some of the entity’s non-current assets might be impaired. Because it is not possible to estimate the recoverable amount of the individual assets, the entity tests the cash-generating unit (CGU) to which they belong for impairment. The entity concludes that the CGU’s recoverable amount is greater than its carrying amount, and therefore recognizes no impairment loss.

The exposure draft notes: “IAS 36 does not require an entity to disclose information about the assumptions used in determining a CGU’s recoverable amount if the CGU includes no goodwill or intangible assets with indefinite lives and the entity recognized no impairment loss for that CGU during the period.” The question though is whether IAS 1 requires disclosure beyond what’s specified in IAS 36, given the IAS 1.125 requirement to disclose information about the assumptions an entity 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. In this fact pattern, the entity concludes that additional disclosure is required, noting among other things that the judgments it made “reflect the entity’s expectations about highly uncertain future events, such as government actions to reduce the effects of climate change and the timing of such actions (and that this) high level of subjectivity and complexity increases the risk that the assumptions might change due to new information or new developments,” and “frequent new climate-related market, economic, regulatory and legal developments might affect the judgements the entity has made.” Relevant factors in this fact pattern include that “the CGU makes up a large portion of the entity’s total assets (and) therefore, a potential impairment loss from a relatively small adjustment to the total carrying amount might be material,” and the sensitivity of the CGU’s carrying amount to the assumptions applied.

Based on the IASB’s research, “some stakeholders might interpret the requirement in paragraph 125 of IAS 1 as applying only to assumptions about uncertainties that will be resolved within the next financial year. In accordance with this view, assumptions about uncertainties that will be resolved after the end of the next financial year are never within the scope of paragraph 125 of IAS 1.” But the draft example “illustrates that paragraph 125 of IAS 1 also applies to assumptions about uncertainties that will be resolved only after the end of the next financial year. Specifically, that paragraph applies if there is a significant risk that a change in those assumptions within the next financial year would result in a material adjustment to the carrying amount of assets or liabilities. The IASB concluded that this example could help an entity determine whether to disclose information about climate-related and other assumptions, including assumptions about events or conditions that might occur in the medium or long term.”

Still, the flip side is that IAS 1 as drafted wouldn’t apply if no such significant risk applies within the next financial year, however much uncertainty might apply to the entity’s climate-related prospects in the medium or long term. In this regard, another of the proposed examples relates to an entity operating “in a jurisdiction whose government has announced regulation that would restrict the entity’s ability to operate and generate profits in that jurisdiction in the future” – in this fact pattern the effective date of the regulation is unclear, but further out than the next financial year. In analyzing this fact pattern (and focusing in particular on how reduced future profitability might affect the recovery of a deferred tax asset), the exposure draft cites paragraph 31 of IAS 1, requiring an entity to consider whether to provide additional disclosures when compliance with the specific requirements in IFRS Accounting Standards is insufficient to enable users of financial statements to understand the effect of transactions and other events and conditions on the entity’s financial position and financial performance. This may be the best “hook” that IFRS provides in its current form, but it’s hardly a very direct or holistic way of grappling with the disclosure implications of such a huge and pervasive issue…

The opinions expressed are solely those of the author.