The historic Paris Agreement was signed by world leaders on 12 December 2015. It committed them to tackling climate change and its negative impacts. Specifically, its goals were to reduce global greenhouse gas emissions and limit temperature increases this century to 2°C, and try to limit the increase even further to 1.5°C. What is more, the Paris Agreement resolved that developing countries should be financially supported to adapt and change by developed nations. To date, more than 190 countries plus the European Union have signed up.
The beauty of the Paris Agreement is that it creates a framework for the transparent monitoring and reporting of countries’ climate goals, and it has put net-zero emissions not only on governments’ agendas but also on those of individual companies. The sticking point is that companies cannot achieve Paris Agreement ambitions alone. It is going to take a worldwide movement to achieve Paris Agreement goals.
“I am not aware of any company or auditor that has asserted the accounts they have either prepared or audited are ‘Paris-aligned’ and we do not consider it possible to make that assertion under existing accounting and reporting regulations,” says EY’s Gary Donald. “Many companies talk about being ‘Paris-aligned’, but there is significant uncertainty surrounding the ways in which society, government policy, technological advancement and the world economy will change over the next 30 years and the extent to which such changes will meet the aspirations of the Paris Agreement and whether and how these will affect an individual company.
“Whilst companies can commit to these aspirations, financial reporting under IFRS is based on reasonable and supportable assumptions that represent management’s current best estimate of the range of economic conditions that will exist in the foreseeable future,” continues Donald. “There are no accounting and reporting standards that govern the application of ‘Paris-aligned’ accounting within the financial statements. There needs to be some kind of mechanism to translate the Paris Agreement into what this means for an individual company.”
Donald’s focus is on the extractive industries – that is oil and gas, and mining. Clearly, these sectors are carbon-intensive, but Donald is emphatic that the Paris Agreement applies to all companies. “Climate change conversations are happening in all board rooms, no matter what industry you're in,” he says. “If you're in heavy industries, the impact will be more material, but climate is applicable to everybody. This is also consistent with the call by the IIGCC in their statement that “There is no predetermined list of companies that will be materially impacted, as in principle all companies are exposed to climate risk”.
The strategy has to be consistent with the financial statements
So, what does Donald think a set of Paris-aligned accounts should look like? “Each company needs a set of definitions that can be used to make judgments,” he responds. “Companies can come up with what they think are best estimates based on various data points but, for me, there needs to be transparency and consistency in the definitions and measurement of targets so stakeholders can understand what it all actually means, and to be able to compare the financial impact of climate change on one company to another.”
He says there has been a huge improvement in reporting because of the Taskforce for Climate-related Financial Disclosures (TCFD) work. “But, in practice, a lot of TCFD reporting we are seeing at the moment is akin to telling the story as opposed to laying out pathways and targets so that you can actually measure how companies are progressing,” says Donald.
He points out that companies must become accustomed to aligning their climate-related actions narrated in the front part of the company accounts with the financial statements. “There is, on the one hand, what companies say in their strategy, and then there is what the financial statements say. The strategy has to be consistent with the financial statements and be reflected in its plans and forecasts” he says.
In what ways do companies struggle most in connecting the front and the back end of the company report? “The most difficult part is providing disclosure on assumptions used in estimates in the financial statements and how these reflect an appropriate or reasonable accounting interpretation of the business model, strategy and objectives that are set out in the front half,” he responds. And how could companies improve their performance in that area? “We need guidance, perhaps from expert organisations, to help translate ‘Paris-aligned’ into something that is concrete enough to base assumptions on,” he says. “A lot of the financial statement disclosures would be under IAS 1 type estimate disclosures.”
As to where this guidance should come from, Donald says “we’ve got the IFRS framework, but I think there's room for some guidance to achieve consistency,” he says. “The IAS 1 requirement to disclose information about the assumptions a company makes about the future that could have a significant risk of material adjustments to the carrying amounts of assets and liabilities within the next financial year could be extended beyond a 12-month horizon.”
Ultimately, do Paris-aligned accounts mean potential adjustments to the balance sheet or additional disclosures in the notes, with sensitivity analysis as to what the impact of alternative scenarios could be? “It could be both,” Donald responds. “And Scope One, Two (together, operational emissions) and Three could all have potential impacts on the balance sheet, even though Scope Three (value chain emissions) is so much more difficult to get your arms around.” Other environmental aspects, such as biodiversity and water scarcity are also important assumptions, although Donald notes incorporating these will also be challenging.
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