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‘Little evidence’ of climate risk effects in financial statements

Author: ICAEW Insights

Published: 26 Oct 2021

Over 70% of listed companies representing some of the world’s biggest corporate carbon emitters failed to disclose the effects of climate risk in their 2020 financial statements, according to a report from financial think-tank Carbon Tracker.

Despite significant financial risks faced from the climate crisis and net zero pledges made by many, the report criticises audit firms after it emerged that in 80% of cases, external auditors did not appear to assess the effects of climate risks when auditing them.

The study Flying Blind: The glaring absence of climate risk in financial reporting analysed financial statements from 107 publicly-listed organisations deemed either carbon-intensive or crucial to the energy transition, including those in the oil and gas, transportation and utilities sectors and household names including Chevron, Exxon Mobil, BMW, and Air France-KLM. 

It concluded there is little evidence that companies incorporate material climate-related matters into their financial statements. Carbon Tracker also found that most climate-related assumptions and estimates are not visible in the financial statements. Even when climate-related matters are touched on, most companies do not tell a consistent story across their reporting.

Another concern raised by the report is the lack of consistency across company reporting; 72% of companies showed no evidence of follow through from other discussions of climate risks or emissions targets to their treatment in the financial statements, or explained any differences. Despite this, 63% of the auditor consistency checks did not identify these inconsistencies.

At the same time, companies do not appear to use ‘Paris-aligned’ assumptions and estimates aligned with the Paris Agreement, which seek to limit the rise in global temperatures to well below 2°C above pre-industrial levels and to pursue efforts to keep the rise to 1.5°C.

Barbara Davidson, senior analyst at Carbon Tracker and lead author of the report said, based on their significant exposure to transition risk, and with many announcing emissions targets, substantially more consideration of climate matters in the financials had been expected.

“Without this information there is little way of knowing the extent of capital at risk, or if funds are being allocated to unsustainable businesses, which further reduces our chances to decarbonise in the short time remaining to achieve Paris goals,” Davidson said.

Global accounting and auditing standard setters have clarified that material climate-related risks should not be ignored in accounts or in audits. At the same time, there are growing calls among investors for directors and auditors to always consider material climate risks when preparing and auditing financial statements.

Michelle Cardwell, ICAEW Technical Manager for Audit, Assurance and Financial Reporting, described the report as a “sobering read” but said it was important for companies and auditors to be held accountable on the reporting of climate risks in financial statements. “The report shows how much work is still needed to meet the goals of the Paris Agreement.”

Cardwell said companies and auditors need to ensure accounts reflect material risks – including climate change. “Investors are making it clear that they consider this material important to financial statements, and standard-setters have told us they believe climate risk should be factored in. This report should be a wake-up call for accountants and auditors for 2021 year ends and beyond.”

“It can be complex for companies to translate how a net zero commitment impacts the numbers in the financial statements. Directors need to consider all aspects of the business strategy and their plans for addressing climate risks, and how these may impact each line of the balance sheet and income statement. For example, if you manufacture petrol cars, your existing plant and machinery to make them – you might find you cannot use them for as long as you originally planned – that will impact their useful economic lives and therefore value. Equally, regulatory changes may mean your existing inventory might not sell for its expected value.”

These challenges mean companies may need to factor in additional time for making these assessments, as well as further training longer term. IASB has issued educational material to help preparers understand the effects of climate-related matters on financial statements. Getting this right is key. Cardwell said the annual report and accounts should be joined up and should allow investors to understand not just the directors’ strategy for dealing with climate-related risks, but also how they translate into the financial assumptions underpinning the financials.

“Financial statements are an accountability mechanism. They allow us to measure the action behind the words. If the numbers do not seem to include climate-related assumptions and estimates, then it raises the question – is this because directors aren’t matching their words with actions? If there is a material inconsistency between what directors are saying and the numbers, then auditors should be highlighting this to stakeholders,” Cardwell said.

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