Everybody is talking about climate. Boards, investors, auditors and regulators all consider the reporting of both the effects of climate change on companies and the impact of a company’s activities on the climate to be of vital importance. These conversations are generally most advanced in larger companies and in sectors most directly affected by climate change, with requirements for climate-related disclosures in annual reports being focused initially on listed companies (who are generally also IFRS reporters).

Those preparing accounts under FRS 102 The Financial Reporting Standard applicable in the UK and Republic of Ireland are typically less advanced in considering climate-related matters, although this varies between sectors, as do the resources available.

For larger entities, certain requirements are already, or soon will be, in force. The Streamlined Energy and Carbon Reporting (SECR) rules have been in place for several years for large, private UK companies and limited liability partnerships (LLPs). Meanwhile, for those in scope, The Companies (Strategic Report) (Climate-Related Financial Disclosure) Regulations 2022 (sometimes referred to as ‘the TCFD Regulations’) and its LLP equivalent are effective for periods beginning on or after 6 April 2022.

It might seem that smaller entities have little in common with listed or larger private entities. Nevertheless, some may fall within the value chains of larger companies and be asked to provide data as inputs to Scope 3 emissions. Whatever the driver, for those with material climate information to report in FRS 102 financial statements, considering emerging themes and lessons that can be learned from this early reporting is a useful exercise.

The Financial Reporting Council (FRC) and the Financial Conduct Authority (FCA) have both recently published reviews of first-year Task Force on Climate-related Financial Disclosures (TCFD) reporting, with one of the key themes being connectivity between narrative reporting and the financial statements.

In addition, in November 2021, the FRC issued FRS 102 Factsheet 8: Climate-related matters to help FRS 102 preparers consider how climate-related matters are reflected in the financial statements. The factsheet helpfully summarises both UK narrative reporting requirements and FRS 102 requirements that are relevant to climate reporting, with examples provided.

An analysis might start with the following questions and their potential effect on the financial statements.

Risks are categorised into physical risks (the effects of extreme weather events or longer-term shifts in climate patterns) and transition risks (the impact of moving to a low-carbon economy). Identifying climate-related risks involves considering systemic, long-term risk, which requires a different lens from traditional risk management. It might need input from multiple business areas and require expertise beyond that used in the business’s existing risk management processes. Materiality also matters: some risks might not be considered significant to the business even in the long term; others may be magnified beyond the immediate financial effects, for example if they affect long-term value or stakeholders.

Climate-related risks and opportunities are considered in developing a strategy (including any transition plans). This may evolve over time and in response to new risks and opportunities. Each entity’s strategy will be unique, but might include items such as emissions reduction initiatives, changes to supply chain and development of new products. The impact of strategic plans on budgets, forecasts and the financial statements should be assessed.

Financial consequences of climate change may be identified even before a strategic plan is fully formed. For example, it may be obvious that there are impairment indicators or that the useful lives of existing assets need to be reassessed. EY’s report Towards TCFD compliance (May 2021) discusses understanding the climate risks and opportunities and developing and implementing strategy on pages 28 and 29. In addition, the UK government’s Transition Plan Taskforce is expected to issue guidance shortly on developing and implementing a transition plan.

Data will be required to meet relevant mandatory reporting obligations, but also for any targets and metrics that management decides to monitor as part of its strategy. Data needed could be far-reaching and extend beyond the entity to its suppliers and customers. Focus will be required on the completeness and accuracy of this data, and its consistency across different areas of the business. While analysis and strategy are developing, it is likely that companies will identify data gaps. This is common, and while improvements can be made over time, the data that does exist with appropriate explanation - may still be useful to users of financial statements.

The case study that follows highlights some of the factors companies might consider when preparing their financial statements, but is not intended to be comprehensive. It is for illustrative purposes only and is based on a fictitious entity; any resemblance to an actual entity is entirely coincidental. The financial effects of and nature of disclosures needed concerning climate change will depend on the particular facts and circumstances, and often may require the application of judgement and the use of estimates.

A UK food manufacturer, FM Limited, makes a variety of meat and delicatessen products sold to grocery retailers in the UK and abroad. Climate-related risks identified include:

Transition risks

• Environmental regulation of farming increasing raw material cost
• Rising price of energy
• Changes in consumers’ dietary behaviours
• Reputation risk for producing emissions-intensive food
• Increasing regulation of manufacturing processes

Physical risks

• Weather events affecting distribution of goods
• Rising temperatures affecting sourcing of raw materials
• Supply chain resilience in water-stressed regions

The board considers sustainability matters important to the business model as consumers become increasingly conscious of the effects on the environment of the food they eat. It is working on a commitment to make its manufacturing facilities net zero by 2050, which will include the use of new technologies and ways of working, as well as the use of carbon offsets. Scope 1 and 2 emissions reduction plans are to be implemented at one of its two manufacturing sites (Site A), which include efficiency and waste reduction measures as well as the purchase of new ‘green’ machinery. Expenditure will begin during 2023, although the new machinery will not be available for use until the beginning of 2024.

Management has entered into a green energy contract for part of the business’s needs, at higher cost than its traditional energy contract, and is looking for ways to reduce food waste and plastic packaging. FM Limited’s current bank loan matures in 2023 and it is discussing terms of a new loan that include an interest charge partially linked to environmental, social and governance (ESG) targets (‘green loan’).

Using the FRC’s factsheet for guidance, the company considers the following matters, among others, when preparing its accounts under FRS 102 for the year ended 31 December 2022, both in considering disclosures of identified effects and the disclosure of no effect (‘nil return’ disclosure) – see table.