The proportion of UK organisations identifying climate change in their annual reports as a principal risk has increased significantly in the last year, however the quality of climate-based reporting remains a work in progress, a new ICAEW report is warning.

Senior stakeholders from a range of UK organisations shared their views on climate-related reporting as part of a roundtable discussion that informed a new ICAEW report, Climate-related reporting: sharing reflections on the 2021/22 reporting season.

Ahead of the discussion, the ICAEW Financial Reporting Faculty undertook desktop research that revealed 51% of sampled FTSE 350 annual reports identified climate change as (or part of) a principal risk in 2020. The following year, this increased to 74%. This is a positive trend that indicates that businesses are taking climate-related issues much more seriously.

The faculty found that 46% of 2021 reports made reference to ‘climate’ in the financial statements, compared with 26% in the previous year. However, attendees pointed out that the quality of climate-related reporting had room for improvement.

In particular, attendees commented that the strategy element of decision making within companies will often come first. There isn’t necessarily a full plan of action, governance or resources needed to back the strategy up. As a result, many transition plans are aspirational and aren’t yet built into internal budgeting.

Sometimes plans are made before any assessment of what is possible has been completed. This can make some statements around climate change and climate risks in the front half of the annual report feel overstated.

Of the 26 companies that identified climate change as a principal risk in 2021, 12 made no further mention of climate in the financial statements at all. This suggests an imbalance – also mentioned in the Financial Reporting Council’s (FRC’s) CRR thematic review. The degree of emphasis placed on climate-related risks in the front half of the annual report is not always consistent with the extent of climate-related impacts disclosed in the financial statements.

The roundtable participants outlined several reasons for this. First, the tendency for companies to set out their intentions before embedding them into their operational plans. This will take time, so reporting will be imbalanced at the earlier stages of the process. Audit committees need to be challenging what’s in the report in a more robust and informed way. 

“Companies need to better communicate ways in which audit committees have challenged assumptions and estimates embedded in the financial statements that may be affected by climate,” the report states. “It’s important to recall when evaluating the narrative disclosures in the front half that the time horizons discussed are often much longer term than those considered by accounting standards.”

Forecasts and budgets used to produce cash-flow projections for impairment reviews usually cover up to a five-year period. For example, IAS 36 Impairment of Assets states that projections should cover a maximum period of five years unless a longer period can be justified. The plans and scenarios in the front half of a company’s report are looking much further ahead.

Accounting standards such as IAS 37 Provisions, Contingent Liabilities and Contingent Assets affect the degree to which climate-related commitments are reflected in financial statements. However, participants pointed to paragraph 112 of IAS 1 Presentation of Financial Statements, which requires reporters to provide relevant information not specifically required by IFRS standards.

Challenges for companies to improve climate-related reporting include difficulties obtaining data from suppliers, risks of errors within the data collected and the volume of data. There is also a real lack of experience and education of climate-related reporting, particularly within finance teams.

“Considering climate as part of the well-trodden path of financial reporting, and applying the rigour associated with the financial reporting process, is something that finance teams are more than capable of once they are given the right resources and guidance to do so,” says the report.

Scenario analysis as part of the TCFD recommendations is not well understood. Boards and audit committees need to prioritise this complex area of climate-related reporting. The TCFD Knowledge Hub has a page dedicated to scenario analysis to help reporters in this area.

Views are mixed on whether businesses have made a good start, or if they need to do more, faster. New regulatory requirements will accelerate the pace of change and raise the bar higher for businesses and preparers of accounts. “The market expects improvements year on year. In this ever-evolving sustainability reporting landscape, companies must strive for better, with the support of investors, auditors and regulators.”