Accounting for climate change

10 May 2024: We have produced a guide to considering the implications of climate costs, risks, and uncertainties in your financial reporting.

1 Introduction

    1.1  
    People are increasingly interested in how public organisations  are preparing for, and affected by, climate change. Recent extreme weather events have further put the focus on, and need for, transparent and high-quality information about how climate change is affecting public organisations.

    1.2
    More public organisations are providing information in their annual reports about their greenhouse gas emissions, climate risks, and mitigation. It’s just as important to show how those emissions, risks, and mitigation actions are affecting the organisation’s financial performance, financial position, and cashflows.

    1.3 
    The financial statements also need to include enough appropriate disclosures to explain clearly and simply how these considerations have been accounted for.

    1.4 
    Current accounting standards don’t explicitly require organisations to consider the implications of climate change on financial reporting. But there are various financial reporting aspects that are directly or indirectly affected by climate risks and opportunities – such as impairment, provisions, useful life assessments, and even the “going concern” assumption (having a sound enough financial position to keep operating).

    1.5 
    We’ve set out a high-level summary of how climate change could affect various elements of an organisation’s financial statements. We highlight the main matters that should be considered when financial statements are prepared, to ensure a true and fair presentation and to provide meaningful and adequate information to users of those statements.

    2 Climate-related financial risks 

    2.1
    Climate change presents both physical risks to organisations and risks arising from moving to a low-emission operating model (transition risks).

    2.2 
    The physical risks include damage to infrastructure from rising sea levels, supply chain disruptions due to increased severe storm events, and/or chronic changes in weather conditions.

    2.3
    The transition risks from moving to a low-carbon economy include:

    • policy risks (such as higher prices on carbon);
    • regulation risks (such as compliance with new regulations);
    • technology risks (such as new competition resulting from the move to a low-carbon economy);
    • market risks (such as changing supply/demand trends due to climate change); and
    • reputational risks (such as demands or requirements to move away from fossil fuel investments and additional spending on litigation).

    2.4
    Addressing physical risks and moving to a low-carbon economy means public organisations will need to reconsider their operating models, business structures, investments, and long-term plans. This could significantly affect their financial statements and performance reporting.

    2.5
    Physical and transition risks can lead to uncertainty, such as stranded or compromised assets, threats to natural resources, regulatory changes, insurance concerns, interruptions to supply chains, coastal property devaluation, and rapidly evolving consumer demands. At worst, climate-related risks can threaten the existence of an organisation and raise questions about its financial ability to keep operating (the “going concern” assumption).

    2.6
    As well as a need to recognise provisions and liabilities arising from new regulatory requirements, organisations might have obligations arising from their own published plans and commitments to reduce their greenhouse gas emissions.

    2.7
    The strategies and plans that organisations put in place to reach their emissions reduction targets will have some financial implications and therefore affect the financial statements (either now or in the future). It is critical that finance and accounting teams are kept informed and have complete information about an organisation’s greenhouse gas reduction strategies and plans. They need to be kept up to date with any changes to those plans.

    2.8
    This means that climate or sustainability teams must interact with finance teams, so the information needed to assess any financial implications can be adequately considered for financial reporting purposes.

    3 Using this guidance

    3.1
    Climate-related risks pose unique challenges for public organisations and their auditors because the estimations and assumptions involve a high level of uncertainty and aren’t always verifiable. But it’s critical that organisations consider the effect of these risks on the financial statements. If a climate-related risk does significantly affect an organisation, senior staff need to evaluate whether the financial statements appropriately reflect it, in keeping with the applicable financial reporting standards.

    3.2
    Because there’s no specific accounting standard or pronouncement in generally accepted accounting practice that addresses this, we’ve prepared a summary of common financial statement items and aspects that could be affected by climate-related matters. It doesn’t cover everything but provides high-level guidance on the main matters to consider.

    3.3
    Technically speaking, this information is relevant for organisations using the Tier 1 and Tier 2 For-Profit and Public Benefit Organisations reporting standards issued by the New Zealand Accounting Standards Board.1

    4 Climate change and “property, plant and equipment” standards

    Applicable standards: NZ IAS 16 and PBE IPSAS 17

    4.1
    Both physical and transitional climate risks could significantly affect an organisation’s property, plant, and equipment. There might be new capital costs or new operating expenses involved in securing assets against physical damage, or in reconstructing or repairing asset damage because of weather events.

    4.2
    There will also be expenses associated with getting facilities ready for a move to a zero-carbon economy. Recognising the costs for enhancing or repairing property, plant, and equipment in the financial statements as an expense or capitalising it will require careful consideration.

    4.3
    Climate changes that increase flooding risks, that lead to rising sea levels, or the emergence of modern technologies needed to respond to climate changes could all mean that an organisation needs to reconsider the useful life estimates of its assets.

    4.4
    Decisions made by the Government or by an organisation in response to climate risks could also have a significant effect on the useful life estimates of property, plant, and equipment. Some examples include the effects of planned or potential responses such as managed retreat, closing facilities, or replacing assets.

    4.5
    When estimating the useful life of assets, organisations should consider factors such as:

    • the capability and capacity of assets to cope with expected extreme weather events (for example, the capacity of existing storm water systems or flood protection infrastructure);
    • the likelihood of a managed retreat;
    • obsolescence due to the availability of a new, climate friendly, sustainable technology;
    • legal restrictions;
    • Government actions;
    • physical damage; and
    • an organisation’s long-term plan and carbon reduction strategies.

    4.6
    The management team in an organisation would need to review the policies for “useful life” assessments, making sure that the estimates of an asset’s useful life are evaluated regularly and kept up to date.

    5 Climate change and intangible assets

    Applicable standards: NZ IAS 38 and PBE IPSAS 31

    5.1
    Transition risks are greater for organisations with climate- or environment-related intangible assets. With technologies quickly evolving, organisations holding patents in areas such as green energy and waste disposal could be particularly affected.

    5.2
    In accounting terms, the costs of developing a new intangible asset can sometimes be treated as a capital expense. An intangible asset must be something that will provide a future economic benefit for the organisation. With technologies evolving quickly, organisations will need to consider whether the “future economic benefits” test is met before treating development costs as an intangible asset.

    5.3
    Organisations might also need to rethink the estimates of useful life and the amortisation basis (spreading costs over time) used for intangible assets. They, too, could be affected by technical disruption and emerging technologies.

    5.4
    Management teams might need to reassess their policies for carrying out useful life assessments and regularly check that the amortisation basis is still appropriate. These factors will also affect intangible assets with an indefinite useful life, because impairment testing would have to be done with more caution.

    6  Climate change and accounting for any impairment of assets

    Applicable standards: NZ IAS 36, PBE IPSAS 21, and PBE IPSAS 26

    6.1
    At the end of each reporting period, organisations need to assess whether there are any indications that certain assets could be impaired (meaning the asset’s recoverable amount   is lower than the value that asset is recorded as having).

    6.2
    Climate risks, both physical and transitional, could result in the need to record an impairment of assets in the financial statements. Assets might be physically damaged or become obsolete because a new green technology has emerged or there’s a preference for more sustainable products and services.

    6.3
    Tier 1 and 2 public benefit organisations will also have to consider the impact of climate risks when determining the remaining service potential of assets that don’t generate cash. These non-cash-generating assets can reduce in value if they’re damaged by or exposed to extreme weather events. Their service potential can also be affected by transitional risks, such as any government restrictions on the use of certain assets or an organisation’s decision to move to lower emission or more sustainable assets and technologies.

    6.4
    Because assets generate economic benefits, changes in an organisation’s expected cash flows – either a change in the period over which the assets can generate cash flows or a change in the cash flows generated by the asset – can affect the value of the assets.

    6.5
    In short, it is critical that an organisation factors in any changes in the market’s preference for green technology and sustainable goods or services, and exposure to physical damage, when performing impairment calculations.

    7 Climate change and provisions, contingent liabilities, and contingent assets

    Applicable standards: NZ IAS 37 and PBE IPSAS 19

    7.1
    Climate change risks could affect the liabilities recognised and the related disclosures in the organisation’s financial statements. With increasing regulatory requirements and stakeholder expectations, organisations need to fulfil their climate change obligations and commitments (statutory obligations and constructive obligations). Not meeting them could expose organisations to penalties, fines, and legal action. In financial statements, that means recognising provisions or disclosing contingent liabilities.

    7.2
    Climate risks could also affect an organisation’s long-term provisions, such as money ear-marked for the cost of dismantling or restoring assets or facilities. Or a decision (from the Government or from the organisation) about a managed retreat could require the organisation to purchase properties or other assets exposed to risk from extreme weather events.

    7.3
    Organisations are required to provide adequate disclosures about provisions, contingent liabilities, and major assumptions that affect any recognised provisions. Climate change risks could affect some critical assumptions for certain provisions and contingent liabilities. It is sensible to specifically consider regulatory requirements, whether existing contracts could become onerous, and any existing climate-related legal claims.

    Financial instruments

    7.4
    Climate risks have the potential to change how an organisation measures the value of its financial instruments  and the disclosures about them. The physical, reputational, and legal risks posed by climate change could increase the organisation’s exposure to credit risks and therefore its calculations of expected losses.

    7.5
    It would be sensible for organisations to review whether any of their financial assets (specifically borrowers and trade receivables) are exposed to more risk for climate-related reasons and might affect the organisation’s ability to settle the obligations.

    7.6
    The number of organisations issuing “green debt” and “green investments”, and the funds raised by green debt, have increased in the last couple of years. The increases are expected to continue. Organisations need to consider the requirements of accounting standards in detail when accounting for these types of financial instruments, from classification, to measurement, and to disclosures.

    7.7

    Generally accepted accounting practice requires organisations to provide extensive disclosures about the nature and extent of risks arising from financial instruments (including credit risk, liquidity risk, and market risk) and how these risks are managed. Organisations will need to consider the climate-related aspects of risk and provide adequate disclosure in the financial statements.

    Valuation – fair value measurement

    7.8
    Climate risks could affect the value of assets and liabilities that are measured on a fair value basis. This can be because of changing consumer preferences, market drivers, technology disruptions, regulatory requirements, impact on duration and value of expected cashflows, and/or expected or actual physical damages. When ascertaining fair values, especially  where unobservable inputs are used, organisations should consider the broader implications of climate risk on their calculations.

    7.9
    The fair value calculations for non-cash-generating assets could be affected by factors such as (exposure to) severity and frequency of extreme weather events, government restrictions on the use of assets, or organisation’s strategies and plans to meet their emissions targets.

    8 Climate change and the presentation of financial statements

    Applicable standards: NZ IAS1 and PBE IPSAS 1

    8.1
    “Going concern” is the basic accounting assumption that requires organisations to evaluate their ability and intent to continue to operate for the foreseeable future. Climate change challenges could affect an organisation’s ability to continue as a going concern.

    8.2
    Organisations need to evaluate their exposure to climate risks and any implications of that for their going concern assumption. If there are uncertainties about it, organisations are required to provide an adequate disclosure to explain the uncertainties.

    Judgements and uncertainties

    8.3
    The estimations, judgements, and assumptions that organisations make about future operations and expectations have a significant impact on their financial statements. Therefore, in keeping with generally accepted accounting practice, an organisation is required to provide appropriate information (disclosures) on the key assumptions and judgements that have been used when preparing the financial statements.

    8.4
    Disclosing climate-related matters could be essential where those matters are affecting the judgements and assumptions used by management. Organisations should ensure that they provide relevant and reliable information about climate-related aspects, to help users of the financial statements to understand the judgements and assumptions used.

    Carbon offsets

    8.5

    Although increasing numbers of organisations are purchasing carbon offsets because they do not expect to achieve their emission reduction targets, there is no specific accounting standard, guidance, or interpretation that specifically deals with accounting for carbon offsets. This means that each organisation needs to have its own policy for accounting for carbon offsets.

    8.6
    It is debatable whether carbon offsets purchased to offset emissions are assets or expenses. Given the lack of guidance in accounting for carbon offsets, we are interested in supporting auditor judgments about appropriate accounting policies for them. We have encouraged auditors to email their queries to the Audit Quality team at the OAG for consideration.

    9 Climate change and forecast financial statements

    9.1
    When preparing forecast financial statements, public organisations should ensure that the implications of climate-related matters are appropriately estimated and considered. The aspects discussed above are just as relevant to the forecast financials.

    9.2          
    As many public organisations are setting greenhouse gas emissions (reduction) targets and preparing strategies to attain these emissions targets, it is critical that the financial implications and financial impacts of any reduction targets, strategies, and plans are considered in the forecast financial statements.

    9.3
    It is therefore essential that the climate/sustainability teams interact frequently with the accounting and finance teams to ensure that information needed about climate-related matters is appropriately considered in the forecast financial statements.


    1: This guidance does not go into the detail of accounting standards and their requirements. It is not comprehensive nor intended to be a complete guide for accounting. Also, it does not substitute any existing accounting standards or GAAP requirements, nor provide additional requirements.