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Climate change poses physical risks that can be detrimental to the financial health of companies. This stems from direct damage to their infrastructure and also disruptions to their operations and supply chains due to extreme weather events.
Carbon taxing and limitations to climate-related schemes that arise from climate change regulations would also have a transitional impact on a company’s financial statements. This particularly applies to industries that are most impacted by climate change, such as agriculture, energy, food and forestry, material and building, and transportation.
In line with the latest standards updates and the effects of climate-related matters on financial reporting, potential climate-related financial implications may arise. We include below some of the considerations which may impact various sections of the Financial Reporting Standards.
Accounting estimates
Value is affected when opportunities or risks are high. Reporting companies need to reassess their accounting estimates, particularly fair value measurement, as climate-related opportunities or risks grow. For instance, if market participants have a negative perception of climate-related risks, it could lead to a decrease in demand for a product and a drop in the fair value of the company's manufacturing plants and equipment. This could result in impairment issues for the company and impact the cash-generating units related to the manufacturing operation.
Useful life of assets
Due to climate-related regulations or company strategies, such as restrictions or the availability of certain resources, the useful life of assets may be revised. This applies to both owned and leased assets of the reporting company. For instance, a logistics company intends to sell and replace their diesel truck fleet sooner than planned due to climate change risks and new regulations limiting diesel usage. Therefore, the useful life of the trucks will be shorter, leading to potential impairment issues.
Loan portfolio
Depending on the severity, duration, and jurisdictional factors of the potential climate-related risks assessed at the reporting date, changes to the loan portfolio of the reporting company will impact the measurement of expected credit losses. This impact can be more significant when the sudden effects of climate change occur. For instance, if a borrowing company’s business strategies are disrupted due to an unforeseen climate disaster, this may lead to a higher probability of loan default. As a result, the expected credit losses of the reporting company (as a lender) may increase.
Contracts
The risk of having onerous contracts is higher during periods of heightened climate volatility. For example, contract renewals under the reporting company may be halted because the services mentioned in the contract are associated with high climate-related risks. This limits the chance to recoup the initial investments and can also result in losses and contingent liabilities if the contract becomes onerous. Insurance companies will also face unique challenges compared to companies in other industries.
Listed below are simple steps (3Cs) to guide you on what to do next:
- Comply with climate change regulations
Ensure compliance with climate change regulations and remain well-informed about the latest developments in this dynamic ESG industry.
- Check available government schemes
It is imperative to stay abreast of existing government schemes and incentives that can assist your business in effectively addressing the challenges brought about by climate change.
- Construct strategies to mitigate climate-related risks
To effectively address the risks associated with climate change, it is essential to develop and implement strategies that aligns with your business and forward-looking strategies.
