Cash flow projections

Climate-related risks and opportunities may significantly affect expectations of a company’s revenues, opex (including research and development) and capex in different ways. The following table highlights some examples.

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.

It depends on the specific facts and circumstances applicable to the asset (or CGU). 

In valuation practice, the impact of climate-related matters is generally reflected in the cash flows rather than in the discount rate, whenever possible. This may not be possible when cash flow projections relate to circumstances or events that are outside the company’s control and there is no data or evidence to support the cash flow projection. 

In some cases, climate-related matters may be reflected both in the cash flows and the discount rate – for example, because climate change measures are expected to change the cash flows (by reducing revenues or by increasing opex/capex) and increase the risk or range of outcomes of these cash flows. 

Adjustments to the discount rate may be made if they can be supported. For more information on the discount rate, see the Discount rate page.

No. The Paris Agreement¹ is an international treaty that does not specify how individual companies operate. 

Under value in use (VIU), the cash flow projection needs to be consistent with management's best estimate of future cash flows. Management's expectations may not necessarily be ‘Paris-aligned’. There is no requirement under IFRS Accounting Standards for such an alignment. 

Similarly, under fair value less costs of disposal (FVLCD), the cash flow projection needs to be consistent with a market participant’s assumptions, which again, may not necessarily be ‘Paris-aligned’.

Two approaches can be used for projecting cash flows to calculate present value – the traditional approach and the expected cash flow (ECF) approach.
[IAS 36.A2]

The traditional approach uses a single (most likely) cash flow projection and does not involve adjustments to the cash flows for their risk. In contrast, the ECF approach uses multiple probability-weighted cash flow projections.

For information on the discount rate under each of the approaches, see the Discount rate page.

It depends. Although the traditional approach is more common, it may sometimes be less suitable for reflecting climate-related matters.

In certain cases, climate-related matters may be more appropriately captured by using two or more cash flow scenarios – i.e. by applying the ECF approach. This would typically be the case for companies that are very significantly affected by climate-related risks. If significant downside scenarios are more likely and/or more severe than the upside scenarios, then climate-related matters may be more appropriately captured under the ECF approach. [IAS 36.A2, A7]

The ECF approach may be useful in identifying and modelling various potential outcomes and provides computational transparency of the expected cash flows; however, one of the main challenges in using it is estimating the probabilities assigned to each scenario.

It depends on whether the company is calculating the recoverable amount based on VIU or FVLCD.

Maintenance expenditure will often include an element of improvement simply because of the natural process of technological advancement, which requires a company to replace old equipment with newer, more technologically advanced equipment that performs essentially the same function. Despite there being a technological upgrade, a replacement may still be considered ‘maintenance’. Therefore, in some cases a company needs to use significant judgement to determine whether planned capex on assets with shorter useful lives (i.e. compared with that of the essential asset with the longest useful life – see Question 8) is more akin to maintenance expenditure or capital improvements.

In our view, factors that a company may use in determining this include: 

• the level of enhancement to the CGU’s capacity; and 
• the extent of the change to the CGU’s production process and consequently to the nature of the CGU’s products. 

For example, capex is more akin to maintenance expenditure if the CGU’s capacity (e.g. the number of items that can be produced or services provided) would not increase significantly as a result of the capex. [Insights 3.10.250.80]

When conducting an impairment test for a CGU (or a group of CGUs), it is very important to identify the essential assets of the CGU and, more specifically, the essential asset with the longest useful life. If a CGU consists of several assets that are essential to the ongoing business, then the impairment test is performed based on the essential asset with the longest useful life. The replacement of assets with shorter lives is considered part of the day-to-day servicing of that CGU, provided it maintains the CGU's level of economic benefits – i.e. the CGU's capacity remains the same. [IAS 36.49, Insights 3.10.230.60]

In some cases, a CGU may contain an intangible asset with an indefinite useful life or goodwill. In our view, a company cannot conclude automatically that the intangible asset with an indefinite useful life or goodwill is the essential asset. All facts and circumstances are considered in determining which asset is essential to the operations of the CGU. [Insights 3.10.230.70]

In our view, an essential asset need not be an asset recognised in the statement of financial position. For example, depending on the facts and circumstances of the CGU, it might be appropriate to conclude that the essential asset is an unrecognised brand. [Insights 3.10.230.90]

It depends on whether the company is calculating the recoverable amount based on VIU or FVLCD.