(This article was published on 28 June 2021 and updated on 29 January 2026)
Highlights
What’s the issue?
Under IAS 36 Impairment of Assets, companies are required to assess at each reporting date whether there is an indication that an asset or cash-generating unit (CGU) may be impaired1. One such indicator is significant changes with adverse effects in the technological, market, economic or legal environment in which the company operates that have taken place during the period (or will take place in the near future). Transitioning to a lower-carbon economy may trigger such adverse effects. Therefore, a company needs to consider the impact of climate-related matters in assessing whether assets or CGUs may be impaired. [IAS 36.9, 12(b)]
A company typically tests for impairment using a discounted cash flow (DCF) technique to calculate the recoverable amounts of assets or CGUs.
Climate-related risks may have a significant impact on a company’s future cash flows. If this impact is ignored when performing impairment calculations, then the carrying amounts of assets such as goodwill, property, plant and equipment, right-of-use assets and intangible assets could be overstated.
Getting into more detail
How might climate-related matters affect cash flow projections?
Climate-related risks and opportunities2 may significantly affect a company’s strategy, as well as its expectations of revenues, operating expenses (including research and development) and capital expenditure, in different ways. The following table highlights some examples.
| Impact | Potential effects on cash flow projections |
| Customer and supplier behaviour | Revenue and growth may change as customer preferences shift towards more sustainable products. The cost base may also change because of the impact of climate-related matters on suppliers – e.g. suppliers may pass increased costs through the supply chain. |
| Government policies and legislation | The introduction of new climate-related policies or legislation – e.g. a new carbon tax – may affect revenues or operating costs. |
| Technological developments | Emerging green technology may affect a company’s competitiveness in the market and may result in higher capital expenditures to develop or acquire equivalent technology. |
| Physical impacts of climate change | Impacts such as rising temperatures, or an increase in the frequency and severity of extreme weather events, may give rise to higher insurance or maintenance expenditure. They may even limit the suitability of current operating locations. |
Some companies have climate-related opportunities as well as risks. For example, proactive companies that develop green products or implement decarbonisation plans may gain access to new markets, benefit from shifting consumer preferences or improve energy efficiency.
How do you factor the impact of climate-related matters into cash flow projections?
When calculating the recoverable amount (i.e. the higher of value in use (VIU) and fair value less costs of disposal (FVLCD)) using a DCF technique, the following are some of the aspects that a company needs to consider.
The calculation of VIU reflects considerations such as the estimated future cash flows that a company expects to earn from the asset or CGU and possible variations in the amount or timing of those future cash flows. These cash flows need to be based on reasonable and supportable assumptions that represent management’s best estimate of the range of economic conditions that will exist over the remaining life of the asset. [IAS 36.30(a)–(b), 33(a)]
A company needs to consider whether and how climate-related matters may affect the asset or CGU when making reasonable and supportable assumptions. For example, a company should consider the impact of future changes in climate-related legislation (e.g. a carbon tax law that is expected to be enacted). Depending on the legislative process, it may be challenging to determine the impact of the future changes. If sufficient information about the future changes is available and management’s best estimate is that the changes may have a significant impact on VIU, then the company reflects the impact when determining VIU. [Insights 3.10.285]
Two approaches can be used to project cash flows.
- Single cash flow approach (‘traditional approach’): A company uses a single most likely cash flow projection.
- Expected cash flow approach (‘ECF approach’): A company uses multiple, probability-weighted cash flow projections. [IAS 36.A2, A4–A14]
Although the traditional approach is more commonly used, it may sometimes be less suitable for reflecting climate-related matters.
The ECF approach may help to identify and model various potential outcomes and provides transparency over how the expected cash flows were calculated. However, one of the main challenges in using it is estimating the probabilities assigned to each scenario.
If significant downside scenarios are more likely and/or more severe than upside scenarios, then climate-related matters may be more appropriately captured under the ECF approach. [IAS 36.A2, A7]
Whichever approach a company adopts, the rate used to discount cash flows does not reflect adjustments for factors that have been incorporated into the estimated cash flows (and vice versa ) to avoid double counting. For more information on how climate-related matters might affect the discount rate, see our article What’s the impact on the discount rate used in testing of non-current assets for impairment?
When calculating VIU, cash flow projections reflect the asset in its current condition, and therefore:
- exclude capital expenditure (and any related benefits) to improve or enhance an asset’s performance that has not been incurred;
- include capital expenditure (and any related benefits) to improve or enhance an asset’s performance that has been incurred; and
- include capital expenditure necessary only to maintain the performance of an asset. [IAS 36.44(b), 45(b), 48-49]
Capital expenditure should be considered incurred once the project has substantively begun, rather than it being necessary for the project to have been completed. [Insights 3.10.250.20]
Management may need to apply judgement to assess whether capital expenditure expected to be incurred in response to climate-related matters (e.g. making an asset compliant with climate-related laws or regulations) is more akin to maintenance expenditure or capital improvements (see Cash flow projections Question 9).
FVLCD is a market-based measurement – therefore, maintenance and future capital expenditure to improve or enhance an asset’s performance (and any related benefits) are included in the cash flow projections if this is consistent with a market participant’s perspective. [IFRS 13.2, 22]
Companies commonly use a five-year forecast period when calculating the recoverable amount. If a company has an asset or CGU with a useful life that extends beyond the forecast period, then it needs to calculate a terminal value for the asset or CGU.
For many companies, the major impacts of climate-related matters are expected in the long term – far beyond the forecast period. In such cases, the terminal value is expected to be more affected than the forecast period.
Some examples of how climate-related matters may impact the assumptions used in terminal value calculations include the following.
- Forecast period: The forecast period may need to be prolonged if it would take longer to reach a steady state in the development of the business – e.g. because of the company’s strategy to mitigate climate-related risks. For VIU, a forecast period longer than five years can be used only if management is confident that its projections are reliable and can demonstrate its ability, based on past experience, to forecast cash flows accurately over that period. In some cases this issue can be resolved using a two-stage or other terminal value model (see Terminal value Question 3). When calculating FVLCD, the forecast period can be extended if this is consistent with the perspective of a market participant. [IAS 36.35]
- Cash flows: The level of cash flows in the final forecast year may need to be adjusted to reflect the cash flows in the steady state. The final year of the forecast period should be used to extrapolate cash flows into the future only if it represents a steady state in the development of the business. [Insights 3.10.230.50]
- Long-term growth rate (LTGR): The LTGR(s) may need to be adjusted to reflect the impact of climate-related matters in the steady state – e.g. to reflect a future decrease in demand for the CGU’s products. When calculating VIU, the LTGR is steady or declining, consistent with that of the product/industry/country, unless an increase is in line with objective information. The LTGR used in FVLCD reflects that which a market participant would use. [IAS 36.33(c), 36, 37]
Furthermore, the useful economic life of the CGU may become limited as a result of the impact of climate-related matters.
Disclosures
Users need to understand whether and how climate-related matters are reflected in the calculation of the recoverable amount. To meet users’ expectations, companies need to consider the specific disclosure requirements in IAS 36 and the overarching disclosure requirements in IAS 1 Presentation of Financial Statements.
IAS 36 requires disclosure of the key assumptions used to determine the recoverable amount when testing goodwill and indefinite-lived intangible assets for impairment, as well as sensitivity information if a reasonably possible change in a key assumption would cause an impairment loss. For example, if the future prices of greenhouse gas emissions are a key assumption, then the company discloses these assumptions. [IAS 36.134(d)–(f)]
For impairment testing of assets other than goodwill and intangible assets with an indefinite useful life, companies are encouraged, but not required, under IAS 36 to disclose the assumptions used in determining the recoverable amount. However, such disclosure may be needed under IAS 1 if it is material for the user’s understanding of the company’s financial position or performance. [IAS 1.17(c), 31, 112, 36.132]
IAS 1 also requires a company to disclose:
- key assumptions and major sources of estimation uncertainty that have a significant risk of resulting in a material adjustment to the carrying amount of assets or CGUs within the next financial year – e.g. these disclosures may be needed when the impact on the cash flow projections of changes to climate-related legislation is uncertain; and
- key accounting judgements – e.g. whether significant capital expenditure to be incurred is more akin to maintenance or enhancement when calculating VIU. [IAS 1.122–123, 125, 129]
Connectivity
Users need to be able to connect the information in the financial statements – e.g. the assumptions used in calculating the recoverable amount – with the information a company provides outside the financial statements (e.g. in the front part of the annual report or other general purpose financial reports). For example, they want to understand whether and how a company’s net-zero commitment or plan to transition to a lower-carbon economy affects the calculation of the recoverable amount.
Although the data and assumptions used to disclose information in the front part of the annual report may differ from those used in the financial statements, they need to be consistent where appropriate – i.e. considering the recognition and measurement requirements of IFRS® Accounting Standards.
If differences exist – e.g. because VIU does not reflect certain asset enhancements or uncommitted restructurings disclosed in the front part of the annual report – then disclosing the significant differences in assumptions, and the reasons for them, may help users understand and reconcile the information.
Regulatory expectations
Climate-related information is a key area of focus for many regulators. For example, a report by the European regulator ESMA3 provides examples of disclosures of the impact of climate-related matters on impairment of non-current assets, together with explanations of why such disclosures may be useful to users of financial statements. ESMA expects companies to consider these examples when assessing and disclosing the degree to which climate-related matters play a role in the preparation of the financial statements.
For more guidance on disclosures and regulatory expectations see Have you disclosed the impacts of climate-related matters clearly?
Actions for management to take now
Consider whether:
- cash flow projections reflect the potential impact of climate-related matters;
- the assumptions used in the cash flow projections are consistent (where appropriate, considering the requirements of IAS 36 for VIU and IFRS 13 for FVLCD) with the company’s strategy and the climate-related information provided outside the financial statements. Careful consideration needs to be given to the consistency between these assumptions and the scenario analyses (PDF 139 KB) performed to assess the resilience of the company’s strategy to climate-related risks and opportunities; and
- appropriate disclosures have been provided about significant judgements, assumptions and estimates made to calculate the recoverable amount.
References to ‘Insights’ mean our publication Insights into IFRS®
1 Irrespective of any indicator of impairment, IAS 36 requires goodwill, intangible assets with indefinite useful lives and intangible assets not yet available for use to be tested for impairment at least annually.
2 Read our article to find out more about how climate-related risks and opportunities may impact a company’s strategy, financial reporting and sustainability reporting.
3 European Securities and Markets Authority
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