What’s the impact on the going concern assessment and related disclosures?

What’s the issue?

Although climate change affects nearly all companies, the level and type of exposure and the impact of climate-related risks may vary by sector or geography. Certain sectors may be more exposed to climate-related risks because they emit high levels of greenhouse gases, are dependent on fossil fuels or are vulnerable to water supplies – e.g. the energy, transportation, agriculture, materials and buildings sectors¹. Nevertheless, companies across all sectors may need to consider the potential implications of climate-related risks for their going concern assessment.

For some companies, climate-related risks could give rise to events or conditions that may cast significant doubt on their ability to continue as a going concern. These events may arise from physical risks such as the destruction of a manufacturing plant in a hurricane, or crop destruction due to forest fire, flood, drought or some other climate event. These events may also stem from a large carbon footprint. This could trigger, for example, litigation that results in significant penalties for exceeding emission targets or a shift in customer preferences that results in loss of a major customer.

Management will need to assess whether the events or conditions identified, either individually or collectively, may cast significant doubt on the company’s ability to continue as a going concern. In severe cases, management will need to assess whether the going concern assumption is still appropriate as a basis for the preparation of the company’s financial statements.

Depending on the company and the sector in which it operates, the expected impact of climate-related risks on the going concern assessment may not yet be material. However, given the rapidly changing circumstances, companies need to consider and monitor this on an ongoing basis.

Getting into more detail

Going concern considerations

In assessing whether the going concern assumption is appropriate, management takes into account all available information about the future, considering the possible outcomes of events and changes in conditions, and the realistically possible mitigating responses to these events and conditions that are available. As part of its assessment, management includes the potential impacts of climate-related risks.

Management’s assessment needs to consider different scenarios, including at least one severe but plausible downside scenario.

The assumptions used in the going concern assessment need to be consistent with those used in other areas of the company’s financial statements – e.g. cash flow forecasts underlying the impairment analysis of non-financial assets – although the assessment period may vary. In addition, those assumptions should not conflict with information related to climate-related risks disclosed elsewhere in the annual report.

Budgets and forecasts

Climate-related risks could impact cash flow forecasts. For example:

• changing customer preferences and behaviour could reduce demand for goods and services;
• the sector becoming stigmatised could reduce or disrupt production capacity; 
• non-compliance with environmental regulations could result in significant fines and legal judgments; or 
• costs could increase due to rising prices and more carbon credit purchases. 

Climate change may present opportunities that could impact cash flow forecasts. For example: 

• using lower-emission sources of energy or new technologies may reduce operational costs; or
• developing and/or expanding low emission goods and services offerings may increase revenue because of higher demand for these products and services resulting from shifts in customer preferences.

It will be critical for management to assess both the positive and negative impacts that climate-change has on a company’s operations and forecast cash flows. The key issue for the company is whether it will have sufficient liquidity to continue to meet its obligations as they fall due.

Cash flow modelling needs to reflect any climate-related strategic plans approved by the board.

Financing challenges

The extent to which a company is exposed to climate-related risks may impact its ability to obtain funding so that it can continue to meet its obligations. Lenders are increasingly focused on managing their exposure to climate-related risks and are starting to include environmental aspects in their credit pricing and their expected credit loss (ECL) models as follows.

• Lenders might consider environmental aspects when pricing a loan or even demand a premium or grant a discount on the interest rate when certain climate-related targets are missed or met (so-called ESG-linked loans).
• Asset managers might exclude bonds issued by companies in certain sectors from their portfolios or significantly reduce their exposure, driving up interest rates for affected companies.
• Covenants might include climate aspects – e.g. loan agreements may provide lenders with an opportunity to withdraw financing if the borrower exceeds a certain carbon emissions target.

As a result, companies in impacted sectors need to critically evaluate, and reflect in cash flow forecasts supporting their going concern assessment, their expectations of both:

• the cost of borrowing funds in the future; and
• any barriers to obtaining funding that could arise from lenders’ climate risk management strategies, either announced or reasonably expected.

Disclosures

Climate-related risks may result in material uncertainties affecting a company’s ability to continue as a going concern or may involve significant judgements in concluding that there is no material uncertainty. IAS 1 Presentation of Financial Statements requires disclosure of those uncertainties and significant judgements involved.

Material uncertainty

While assessing the appropriateness of the going concern assumption, if management is aware of material uncertainties related to events or conditions that may cast significant doubt on the company’s ability to continue as a going concern, then the company would need to disclose those uncertainties. In our view, if there are such material uncertainties then a company should, at a minimum, disclose the following information:

• details of events or conditions and management’s evaluation of their significance in relation to the going concern assessment;
• management’s plans to mitigate the effects of these events or conditions;
• significant judgements made by management in their going concern assessment; and
• an explicit statement that there is a material uncertainty related to events or conditions that may cast significant doubt on the company’s ability to continue as a going concern, and therefore that it may be unable to realise its assets and discharge its liabilities in the normal course of business. [IAS 1.25, IU 07-10]

Close-call scenario

In some cases, management may conclude that there are no material uncertainties related to events or conditions that may cast significant doubt on the company’s ability to continue as a going concern. However, reaching that conclusion involved significant judgement. In these cases, the judgements made in concluding that there are no such material uncertainties are disclosed (a ‘close-call’ scenario). To meet these disclosure requirements, in our view similar information to that in respect of material uncertainties (as outlined in the first three bullet points above) may be relevant to the users’ understanding of the company’s financial statements. [IAS 1.122, IU 07-14]

Liquidity risk disclosures

IFRS 7 Financial Instruments: Disclosures requires disclosure of quantitative data about liquidity risk arising from financial instruments. A company also needs to explain how it is managing this risk, including any changes from the previous period and any concentrations of liquidity risk. Disclosures addressing these requirements may need to be expanded, with added focus on a company's response to the impact of climate change. [IFRS 7.33]

Examples of specific disclosures required under IFRS 7 include:

• an explanation of how a company manages liquidity risk; and
• disclosures of defaults and breaches relating to the borrowings recognised during and at the end of the reporting period. [IFRS 7.18–19, 39(c)]

Actions for management to take now

• Consider climate-related risks and opportunities and their financial impacts when performing your going concern assessment. 
• Consider different possible scenarios including at least one severe but plausible downside scenario.
• Review projected covenant compliance.
• When events or conditions are identified that may cast significant doubt on the company's ability to continue as a going concern, assess whether:
  • plans for future actions sufficiently mitigate identified events or conditions that may cast significant doubt on the company’s ability to continue as a going concern; 
  • a material uncertainty exists or it involved significant judgement (close call); or 
  • the going concern assumption may no longer be appropriate.
• Provide clear and robust disclosures, including disclosures about uncertainties identified in the going concern assessment and significant judgements involved where relevant.
• Ensure consistency of assumptions used in other areas of the company’s financial statements and that they are in sync to the extent appropriate with information related to climate-related risks discussed elsewhere in the annual report.
• Consider relevant regulatory guidance.

References to ‘Insights’ mean our publication Insights into IFRS^®

 ¹ This reflects the Taskforce on Climate-related Financial Disclosures (TCFD) grouping convention for the non-financial sector.