FINANCIAL REPORTING & IR

Climate change is increasingly influencing how companies assess the value of their assets. For investors, understanding how climate-related risks are reflected in financial statements, especially through impairment testing under IAS 36, is essential for making informed decisions.

While regulatory changes may slow the pace of climate risk disclosures, climate change remains a key concern for investors. It can affect business operations, future cash flows and ultimately, the value of investments.

What Is Impairment Testing?

Impairment testing is the process companies use to determine if their assets – such as factories, equipment, or goodwill – are still worth what’s recorded on the balance sheet. If an asset’s value drops due to market changes, new regulations, or other risks, the company must reduce its value in the financial statements. This can impact reported profits and shareholder value.

IAS 36 requires companies to look for ‘impairment indicators’ at each reporting date. These indicators can be internal (like declining performance) or external (such as new laws or market shifts). Climate change can trigger both types of indicators; for example, stricter emissions laws, changing consumer preferences, or a company’s own commitment to decarbonization.

How Does Climate Change Affect Impairment Testing?

Several factors, listed below, come into play when determining the impact of climate change on an asset.

Identifying Impairment Indicators

Climate-related risks can signal that an asset may be impaired. Examples include:

• New environmental regulations that increase costs or restrict operations;
• Shifts in customer demand toward greener products;
• Commitments to reduce carbon emissions, which may require retiring assets earlier than planned; and
• Higher cost of capital for companies exposed to climate risks.

These factors can lead to significant changes in a company’s business model, operations, and financial outlook.

Reflecting Climate Risks in Financial Assumptions

When companies estimate the value of their assets, they make assumptions about future cash flows. Climate change can affect these assumptions in several ways:

• Forecasting lower revenues or higher costs due to climate-related impacts;
• Considering the financial effects of transition plans, such as moving to carbon-neutral operations; and
• Adjusting for risks that may not be fully captured in historical data.

The key for investors is to understand how companies are incorporating climate risks into their financial models and whether these assumptions are reasonable and transparent.

Disclosure Requirements: What Should IROs Include?

While IFRS standards do not mention climate change explicitly, companies must disclose material climate-related assumptions and judgments in their financial statements. Key disclosures include:

• The assumptions used in impairment testing (e.g. future carbon prices, regulatory changes);
• How those assumptions were determined (e.g. past experience, external sources);
• Sensitivity analyses showing how changes in key assumptions could affect asset values; and
• Consistency between disclosures in the financial statements and the front part of the annual report (like management commentary or sustainability reports).

Regulators like the Canadian Securities Administrators (CSA) are monitoring for misleading disclosures, including greenwashing. IROs should check that climate-related information is clear, transparent and consistent across all company reports.

Practical Takeaways for Investors

• Climate risks can trigger asset write-downs. Watch for companies exposed to new regulations, changing markets, or ambitious decarbonization plans.
• Financial assumptions should reflect climate risks directly. Look for evidence that companies are considering climate impacts in their forecasts.
• Disclosure is key. Seek clear explanations of climate-related assumptions, sensitivity analyses, and consistency across reports.
• Regulatory scrutiny is increasing. The CSA and other regulators are focused on the quality and accuracy of climate-related disclosures.

Climate change is a complex and evolving risk for Canadian companies and their investors. Understanding how climate-related factors affect impairment testing under IAS 36 can help investors make better decisions and hold companies accountable for transparent reporting.

Terry Liu, CPA, is a Partner, and Brian Rajadurai, CPA is a Senior Manager, at KPMG Canada.