In its September 2023 meeting, the IASB discussed its new project titled Climate-related and Other Uncertainties in the Financial Statements. In particular, the IASB discussed potential actions it could take to help address concerns about reporting the effects of climate-related risks in financial statements. The IASB decided to consult the IFRS IC on how entities apply the requirements in IAS 36 in measuring value in use when an asset is subject to highly variable future cash flows over an extended time horizon.

Based on the initial work performed by the project’s staff, some concerns related to how entities reflect climate-related risks in impairment calculations performed applying the requirements in IAS 36:33(a)-(b), 35-36 and 38. The effects of climate-related risks can result in the potential for high variability in future cash flows. Some of that variability may extend well beyond the five-year period specified in IAS 36:33(b) and also affect the extrapolation of cash flow projections based on financial budgets/forecasts, as required by IAS 36:36. The staff’s work highlighted concerns about potential:

• Lack of compliance due to misunderstanding of the requirements—some entities may not be adequately factoring climate-related risks into impairment calculations over extended time horizons. Specifically, cash flow projections used in measuring value in use may not adequately ‘represent management’s best estimate of the range of economic conditions that will exist over the remaining useful life of the asset’ (IAS 36:33(a)) or the terminal value estimated by extrapolating cash flow projections may not be representative of a steady state
• Limitations of the requirements—some entities interpret IAS 36:35 as prohibiting them from forecasting cash flows for a period longer than five years when calculating value in use. This can result in entities calculating a terminal value based on cash flows expected in year five, even when those cash flows are not indicative of profitability in the long term
• Unclear requirements in IFRS Accounting Standards Standards—when measuring the value in use of an asset, entities may not properly consider that cash flows (or discount rates) used should represent management’s best estimate of the range of economic conditions that will exist over the remaining useful life of the asset

The IASB seeks input from the IFRS IC on the concerns identified. Specifically:

• How do entities reflect the potential for high variability in future cash flows over an extended time horizon when calculating the value in use of an asset?
• Is there diversity in how entities understand and apply the requirements in IAS 36 in reflecting such variability in value in use calculations?

IFRS IC discussion

The IFRS IC members commented on the uncertainties brought by climate-related matters in the impairment assessment in various aspects.

Some of them said that the cost of equity and discount rate have not been adjusted for the premium brought by different risks, one of which is the sustainability factors, because of lacking data for it. In addition, the beta in the discount rate calculation may also need to be adjusted considering climate-related matters. However, one IFRS IC member did not agree that the discount rate should consider an entity-specific risk adjustment as this is full of uncertainty. Instead, these risks would be factored in by preparing multiple scenarios of cash flow forecast. One IFRS IC member commented that only the base case is approved by the management and other cases are prepared by the personnel doing the impairment assessment. She also commented that the forecast approved may be based on the particular purpose of the management in achieving some target but may not be reasonable and supportable. The staff responded that IAS 36 requires entities to use a forecast which is consistent with other information on hand, so entities should revisit it until it is reasonable and supportable in accordance with IAS 36 for the purpose of impairment assessment. Another IFRS IC member commented that there is a fair amount of judgement to be made and it would be difficult to factor in all climate-related matters in the cash flows. She gave the example that if something severe and unexpected happened, significant judgement is required to consider how to reflect that in the future forecast. Some entities might adopt a prudent approach when calculating the value in use, which results in significant impairment while it might be reversed in later periods. In view of the uncertainties and judgements required, several IFRS IC members said making disclosure requirements and performing a sensitivity analysis as required by IAS 1 and IAS 36 would be useful when uncertainties are difficult to be captured into the cash flows forecast or discount rate.

A few IFRS IC members were of the view that entities tend to use a country-specific growth rate without considering factors specific to the entity and asked for guidance and examples for determining the growth rate in the value in use calculation. They said the growth rate should not be too aggregated and should consider different factors. Negative growth rates would have to be used in some scenarios.

In terms of diversity in practice, one IFRS IC member said that the diversity is due to not all entities using multiple scenarios in projecting cash flows. Another said that there is a lack of comparability in the disclosures because they applied different judgment on what to disclose. One IFRS IC member was of the view that it is natural to have diversity in the application of the IAS 36 requirements, which results in different accounting consequences because the impairment assessment involves a high degree of judgement.

Some IFRS IC members raised the issue that there is a need to reconcile the value in use amount to the market capitalisation when it is far above it. It would be contradictory if the forecasted cash flows were much better than what market participants expect. They suggested amending IAS 36 by requiring the reconciliation of these amounts.

Most of the IFRS IC members considered that there is nothing wrong with the framework of IAS 36 itself and that there is sufficient guidance in IAS 36 on what entities should consider with regard to time horizons and risks, which exist in different uncertainties. Climate-related matters are new but not fundamentally different from what entities have to consider for other uncertainties. Instigating standard-setting may not be effective when considering the costs and benefits. They recommended adding application guidance or examples (e.g. disclosures, determination of growth rate, distinguishing replacement and enhancement, etc.).  The Chair asked whether IFRS IC members would prefer this to making amendments to the standards. One IFRS IC member said that it would be an efficient approach after considering the benefits and costs and publishing an article with an illustration of examples would be helpful. However, rather than giving an oversimplified fact pattern for illustration, one IFRS IC member would prefer expanding Appendix C of IAS 36 by adding more consideration for climate-related matters in the mechanism of conducting impairment assessments to indicate factors to consider for climate-related matters.