Climate-related risks are an emerging area that may have a direct impact on entities’ financial statements.
In April 2019, the Australian Accounting Standards Board (AASB) and the Auditing and Assurance Standards Board (AUASB) reissued a joint paper identifying how disclosures on climate-related risks are becoming more important to users of financial statements (Joint AASB and AUASB Bulletin).
While the paper discusses how climate-related risks could be considered material to investors’ decisions, the matters raised in the paper are also relevant to assessing the information needs of broader users of financial statements.
What should preparers consider?
In preparing financial statements, entities should consider:
- whether users could reasonably expect that emerging climate-related risks could affect the amounts and disclosures in the financial statements
- what disclosures about the impact of climate-related risks on the assumptions made in preparing the statements are material.
Disclosures of climate-related risks in financial statements should focus on how the risks specifically relate to amounts reported in the financial statements, or the basis on which the statements have been prepared.
Disclosures on the entity’s policies or overall approach to managing climate-related risks belong in the annual report or other documents outside of the financial statements.
Who is most likely to be impacted?
Climate-related risks may arise from potential natural disasters and changes in climate patterns, and the related technology, market, legal, and government policy risks.
Specific industries that are more likely to be impacted by climate-related risks include:
- energy, transportation, construction and agriculture
- financial sector entities, such as insurance groups, investment entities and asset managers.
What areas are most likely to be impacted?
You should focus the new disclosures on how climate-related risks were addressed via the key assumptions you applied when developing accounting estimates and calculations. Specific financial statement areas that may be impacted by climate-related risks include:
- asset impairment, including increased costs and/or reduced demand for products and services that may impact on impairment calculations
- changes in asset useful lives
- changes in the fair value of assets due to climate-related risks
- potential provisions or contingent liabilities
- changes in expected credit losses for loans and other financial losses.
The discussion paper includes consideration of how climate-related risks may impact these areas.
Management should consider both the size and nature of the impact of climate-related risks. If users reasonably expect these risks to be disclosed in the financial statements, then management should consider disclosing their assessment of climate-related risks in certain areas, even if these do not have a direct dollar impact on the financial statements at the present time.
What will your auditors consider?
Auditors will assess the impact of climate-related risks in the following ways:
- potential climate-related risks, as part of their risk assessment
- appropriate responses to identified climate-related risks
- whether climate-related risks are relevant for accounting estimates, including assumptions used to arrive at a fair value estimate and potential impairment.
Actions for 2019–20
In planning for the 2019–20 financial statements, entities and their auditors should consider whether there are any climate-related risks that need to be disclosed. Even where there appears to be nothing immediate, possible future impacts should be considered, along with how you should reflect these in key management assumptions and judgements. This may include:
- future cash flow projections
- decisions on how and when existing assets will be replaced
- the need to provide now for the cost of future action arising from climate-related risks.