Reporting for a new regime

Companies in Ireland cannot afford to ignore the impact of emerging ESG requirements on their annual reports and financial statements—now is the time to act, write Fiona Hackett and Emer Fitzpatrick 

2022 was an unprecedented year of change for environmental, social, and governance (ESG) reporting. 

It was the year the European Union published the Corporate Sustainability Reporting Directive (CSRD), leading French Economy Minister Bruno le Maire to declare “Greenwashing is over”. 

Also published in 2022, to support the implementation of CSRD, were 12 draft European Sustainability Reporting Standards (ESRS).

The International Sustainability Standards Board (ISSB) issued two exposure drafts: one on climate-related disclosures; and another on general disclosures concerning governance and other sustainability matters. 

And in the US, the Securities Exchange Commission (SEC) issued a lengthy exposure draft containing proposed rules on climate disclosures. So, what will all of this mean for Irish companies preparing their annual reports in 2023 and beyond?

Sustainability disclosures

Each of these “big three” proposals will require extensive sustainability disclosures in the front half of the annual report. 

These proposals may sit alongside, incorporate, or supersede existing sustainability reporting, such as EU Taxonomy, Task Force on Climate-Related Financial Disclosures (TCFD), or Global Reporting Initiative (GRI) Standards—to name a few. 

In tandem with this, however, companies will also need to keep in mind any statements they make relating to their ESG-related activities and commitments.

This is particularly important because, in addition to a heightened focus on sustainability reporting, 2022 also brought a notable rise in the number of Irish companies pledging to set and meet ambitious ESG-related targets. Here are three examples of what we mean:

“Our company plans to be net zero by 2030.”
“The group will achieve Net Zero on Scope 1 and Scope 2 emissions by 2040.” 
“X percent of our revenue will be derived from sustainable products by 2035.”

Regulatory scrutiny

Increased stakeholder and investor focus on ESG has led to rising regulatory scrutiny on this issue among financial regulators around the world. 

In Ireland, the Irish Auditing and Accounting Supervisory Authority (IAASA) issued a publication on climate related disclosures in financial reports in October 2022. 

Demonstrating IAASA’s engagement with companies on areas of potential greenwashing, the publication focused on the consistency of climate-related information provided by companies via financial statements and other means, including the front half of the annual report. 

The publication included a list of questions/additional information IAASA had requested, and is expected to request in future reviews from companies in response to statements and pledges made by these companies in relation to climate change. 

IAASA’s publication focused solely on climate change. However, the messages contained within the publication are relevant to any sustainability pledges, statements or pronouncements made by a company, and their impact on its financial statements. 

All of this increased scrutiny of ‘front half’ ESG disclosures is set to have a significant impact on the financial statements of Irish companies in 2023 and beyond. 

In responding to this shift, Irish companies must consider the impact of all ESG pledges and statements made at all levels of the organisation, and the potential impact they will have on their financial statements. 

Financial statement focus areas

There needs to be clear and consistent messaging on all relevant ESG matters throughout a company’s non-financial and financial reporting. The impacts of ESG pledges and statements must be carefully assessed—and fully disclosed and explained within the financial statements. 

This goes against the longstanding understanding that, where the ESG statements, claims and commitments made by a company had no significant financial impact, there was no need for disclosure in the financial statements. 

Now, where a company believes that the financial impact of an ESG pledge is negligible or not material to the financial statements, it must nevertheless consider disclosing this fact. Non-disclosure is no longer an option.

To help illustrate the potential implications for a company’s financial statements, let’s take one of three sustainability pledges used above—“our company plans to be net zero by 2030”.

Having made this statement, this company must now be able to detail the actions it will undertake to ensure that it can indeed reach the net zero target it has set for 2030. Some areas to consider are outlined below.

Impairment of tangible and intangible assets: 

Depending on how the net zero pledge will be implemented, companies should consider whether any risk relating to the pledge constitutes an impairment indicator as detailed in IAS 36, paragraph 9  that requires an impairment test to be carried out. For example, if a company needs to update its manufacturing process to emit less greenhouse gases in order to meet its net zero target, this might be an indication that a manufacturing plant is impaired. 

When carrying out an impairment test under IAS 36, companies can choose to use a value in use (ViU) model or a fair value less costs of disposal (FVLCD) model to complete this test. 

In a ViU model, future cash flows shall be estimated for the asset in its current condition (IAS 36, paragraph 44). Over time, the impact of a net zero pledge may result in an adjustment to these future cash flows. 

The ViU model, by its nature, restricts when the benefits of restructuring and improvements, or enhancements of an asset’s performance, can be taken into account. Expected benefits from restructuring can only be reflected in a ViU calculation once a company is committed to the restructuring. 

IAS 37 provides guidance on when a company is committed to restructuring. For improvements or enhancements to assets, expected benefits can only be recognised when a company has started to incur the related expenditure. 

If a terminal value is used in the calculation of ViU, the impact of a move towards net zero will need to be factored into the calculation of an appropriate terminal value. 

If you have made adjustments to future cash flows for the impacts relating to the net zero pledge, it is unlikely that any adjustments will be needed to the discount rate used in the ViU calculation. Continue to use existing methods for calculating the cost of capital and avoid double counting risks. 

Where companies choose to utilise a FVLCD model for impairment testing, consideration needs to be given to the definition of fair value in IFRS 13. 

Fair value is defined as “the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date”. 

Market participants, including investors, are becoming increasingly concerned about the importance companies are placing on the impact of ESG. 

There is a particular focus on understanding how companies plan to achieve their pledges or commitments, and what financial impact ESG will have on the company. 
This translates into the price that market participants are willing to pay to acquire assets.
 Appropriate adjustments for the issues market participants see in relation to ESG and sustainability need to be factored into FVLCD models.

IAS 36 requires detailed disclosures in relation to impairment testing. It is imperative that companies provide adequate information to support any assumptions contained in ESG statements and pledges as part of their impairment work.

Useful lives of assets: 

ESG statements or pledges may result in the need for a reassessment of the useful lives and residual value of a company’s tangible assets. 

Striving to be net zero by 2030 may, for example, result in earlier obsolescence or retirement of assets, legal restrictions may curtail the use of assets, and assets may become inaccessible. 

IAS 16 paragraph 6 defines the useful life of an asset as “the period over which an asset is expected to be available for use by an entity”. 

The assessment of useful life will be based on a company’s best estimate, and this estimation will involve a level of judgement. Companies should consider the IAS 1, paragraph 125 requirements in relation to disclosure of estimation uncertainty associated with useful economic life.

Provisions: 

Companies need to consider whether the ESG statements or pledges they are making (such as the commitment to reach net zero by a certain date, for example) give rise to legal or constructive obligation. 

IAS 37 provides guidance as to when an obligation arises here, including a description of what a constructive obligation is. A company will need to determine whether a provision should be recognised, or contingent liability disclosed, as a result of any ESG statement or pledge it has made.

The above list is not exhaustive and additional areas within the financial statements may also need to be considered.

Additional considerations

What is most important for companies to remember is that careful consideration must now be given to any ESG-related statements, commitments or pledges made—and that a thorough analysis and impact assessment of how these statements will affect the company’s financial statements will be needed.

And this cannot solely become the responsibility of the finance team. Input from all relevant stakeholders will be required. A collaborative cross-company approach will be crucial to appropriately and adequately address ESG issues. 

It is a tall order. The pace of recent developments in ESG reporting are akin to a Japanese bullet train hurtling towards its destination. 

The upshot for Irish companies is that they can no longer afford to ignore the impact of this rapid change on their financial statements and annual report as a whole. 
The level of stakeholder, investor and regulatory scrutiny will only increase this year and beyond. Now is the time to act.

Fiona Hackett is a Director in PwC’s Corporate Reporting Services and chairs the Financial Reporting Technical Committee of Chartered Accountants Ireland

Emer Fitzpatrick is a Senior Manager in PwC’s Corporate Reporting Services