Written by: Tyler Mudd
In today’s world, sustainability has become extremely important for investors when making key decisions about where to place their capital. Transparency and accountability are paramount in environmental justice, and the International Sustainability Standards Board (ISSB) has introduced two sets of disclosure requirements, International Financial Reporting Standards (IFRS) S1 and IFRS S2, aimed at improving environmental practices in company disclosures regarding sustainability.
IFRS S1 focuses on general sustainability disclosures, while IFRS S2 specifically addresses climate-related disclosures. These standards align with the recommendations of the Task Force on Climate-Related Financial Disclosures (TCFD) and make valuable reports on climate-related financial information. In doing so, these standards provide investors with valuable insights into a company’s prospects.
The effects of climate-related matters on financial statements are not solely limited to large public companies. Small and medium-sized enterprises (also known as SMEs) are equally affected by climate change and its management. As climate change increasingly impacts business models, cash flows, financial position, and performance, the users of SMEs’ financial statements are growing more interested in understanding these risks. Although the current version of the IFRS for SMEs Accounting Standard does not explicitly mention climate-related matters, companies must consider them if they have a material effect on the financial statements as a whole.
The IFRS Foundation published several articles in November 2020 that emphasized the consideration of climate-related matters within the IFRS Accounting Standards. In addition, the Exposure Draft of the IFRS for SMEs Accounting Standard, issued in September 2022, proposed changes that explicitly addressed climate-related matters. By doing this, companies can refer to the provided tables within the document, which offer references to the Exposure Draft, allowing them to anticipate potential future updates.
These sections of the IFRS for SMEs Accounting Standard highlight the relevance of climate-related matters. For example:
Section 3: Requires management to assess a company’s ability to continue as a going concern when preparing financial statements. If, for example, a company is subject to business disruption from severe weather events, does it have the liquidity to navigate those business disruptions to support its going concern conclusion?
Section 8: Requires disclosure of material accounting policies and specific assumptions applied. By extension, assumptions and further information relating to management’s going concern assessment as well as the realizability of assets would be disclosed.
Sections 17 & 18: Require companies to review and reflect the estimated residual values and expected useful lives of assets if estimates might have changed since the most recent reporting date arising from climate-related matters.
Section 21: Climate-related matters and the effect on matters related to levies imposed by governments for failure to meet:
- Climate-related targets
- Regulatory requirements to remediate environmental damage
- Contracts that may become onerous (for example, due to potential loss of revenue or increased costs due to climate-related changes in legislation)
- Restructurings to redesign products or services to achieve climate-related targets
Section 27: Requires a company to write down inventories to their estimated selling price less costs to complete and sell. As the transition to a lower-carbon economy continues, there will be increased risk of product obsolescence. Companies should continue to closely monitor the potential for obsolescence of inventory.
Section 29: Requires companies to recognize deferred tax assets for deductible temporary differences and unused tax losses and credits, to the extent it is probable that future taxable profit will be available against which those amounts can be utilized. If there are any changes in foreign or domestic tax laws to support the transition to lower carbon, then companies will need to closely examine and disclose impacts to their deferred taxes.
To facilitate the adoption of IFRS S1 and S2, the ISSB intends to collaborate with many jurisdictions and companies. Additionally, a Transition Implementation Group will be established to assist companies in applying these standards, while providing both support and guidance during the complicated transition period. Capacity-building initiatives will also be launched to ensure effective implementation of these standards across various organizations. This, along with collaboration with the Global Reporting Initiative (GRI) will be maintained to promote valuable reporting when combining ISSB Standards with other reporting standards.
In all, the introduction of IFRS S1 and S2 by the ISSB is fundamentally important to the future of sustainability-related disclosures in capital markets worldwide. These standards not only enhance trust and confidence in company disclosures but also provide investors with a comprehensive understanding of the impact of climate-related risks and opportunities within a company’s prospects. By creating a common language and a global baseline for sustainability-related disclosures, the ISSB has created a more transparent and sustainable future within the world of finance.
