By: Larry Bradley, Global Head of Audit at KPMG International 

What’s the issue?

Investors expect a company’s financial statements, management discussion and analysis (MD&A) and sustainability-related disclosures to provide a coherent, connected and integrated picture. They are asking whether accounting standards produce financial statements that fairly reflect climate- and other sustainability-related risks and opportunities discussed in the front part of the annual report.

Connected information requires connected standard setting, so the International Accounting Standards Board (IASB) has just kicked off its project on climate-related risks in the financial statements. This project is part of a package of connectivity measures announced by the IASB and International Sustainability Standards Board (ISSB) chairs.

This is an important project. Investors need confidence that IFRS® Accounting Standards are equipped to deal with the new questions raised by climate-related risks and opportunities. They need information to make sophisticated judgements; they do not need the illusion of certainty over inherently uncertain events.

So, what should the IASB be doing?

Driving better connectivity. Transparency is the best response to uncertainty. We encourage the IASB to seek opportunities for better connectivity between the front and back parts of the annual report. The IASB will need to collaborate with the ISSB to achieve this.

The IASB can re-emphasise the long-term nature of materiality judgements. Companies need to focus on the essential question: would an investor make a different decision if a piece of information were included? This requires a long-term horizon. Too often, companies fall back on a quantitative ‘percentage of current earnings’ rule of thumb. This could mean information about risks that might only crystallise in the long term is overlooked. The IASB could emphasise the longer-term aspects of materiality considerations, for example by incorporating the guidance on high-impact, low-likelihood events that it developed for management commentary into the IAS 1 Presentation of Financial Statements explanation of materiality.

And the IASB can drive enhanced disclosures in the financial statements. Disclosing key risks, judgements, estimates and sensitivities is more helpful than describing a single predicted outcome. Amendments to IAS 1 (to broaden the scope of judgements to be described beyond those expected to change in the next financial year) and IAS 36 Impairment of Assets (for the disclosure of sensitivity analysis) could support this.

Making focused changes

Achieving connectivity does not require a rewrite of the accounting rule book. A return to ‘big bath’ impairment provisions would harm the transparency that investors need.

Instead, we encourage the IASB to stay principles-based, and focus on targeted amendments to individual accounting standards, rather than developing a new climate-specific standard. These amendments could address the new types of judgements companies now need to make. For example, how should a company assess the potential valuation and impairment judgements arising from a newly announced climate-related strategy when the details of that strategy have not yet been operationalised?

The amendments could also clarify the assumptions to be made under some accounting standards when making long-term judgements. For example, should companies continue to have flexibility in determining the discount rate used to measure long-term provisions? Should impairment assessments be undertaken on a more granular basis?

And they could target emerging trends which raise new questions about when an asset or liability should be recognised and measured. One example is that of carbon offset schemes.

Keeping things moving: Don’t stop at climate

Climate-related risk is just one of the long-term risks that increasingly need to be considered in reporting. The IASB will find similar issues on other topics affecting a company’s long-term prospects – such as human capital. The solutions it develops for climate-related risk should apply equally to those other topics, whether they relate to sustainability or other factors.

Larry Bradley is Global Head of Audit at KPMG International.