Background

The IFRS IC received a submission asking its views on how IAS 37 applies to climate-related commitments in a fact pattern where an entity, which is a manufacturer of household products, publicly states a net-zero transition commitment. The manufacture published a detailed plan for the modification of its manufacturing method to achieve 60% reduction in emissions in nine years and buy carbon credits to offset its remaining emissions after those nine years. The submitter asked i) whether the public statement of a net zero transition commitment creates a constructive obligation as defined in IAS 37; ii) whether a constructive obligation created by a net zero transition commitment meets the criteria in IAS 37 for recognising a provision; and iii) if a provision is recognised, whether the expenditure required to settle it is recognised as an asset or as an expense when the provision is recognised.

Staff analysis

The staff did not perform outreach on this matter because the IASB’s discussions and decision to refer the topic to the IFRS IC provided evidence that the matters described in this submission have widespread and a material effect on those affected.

Regarding whether the statement of a net zero transition commitment in the fact pattern creates a constructive obligation, the submitter was of the view that there are other parties to whom the entity making a net zero transition commitment would owe an obligation as required by IAS 37:20 and whether the commitment raises a valid expectation among those other parties that the entity will discharge the commitment, which satisfies the definition of a constructive obligation. The staff agreed that there are other parties to whom the entity would owe a constructive obligation to reduce its greenhouse gas emissions. However, they did not agree with the submitters that this necessarily creates a constructive obligation. Factors to consider would include whether the statements indicate to the public at large that the entity has accepted a responsibility to fulfil its stated commitments and communicates that responsibility in a sufficiently specific manner to raise a valid expectation in the public at large. The staff said management could refer by analogy to the criteria set out in IAS 37:72 & 74 and they provided some examples of factors affecting the management’s conclusion. The factors may include a) the language used in the statement; b) the specificity and status of plans supporting the statement; c) the timing of the actions required to fulfil the commitment and d) publicly available evidence of progress to date, achieved milestones it committed to in previous statements may enhance expectations. 

In respect of whether a constructive obligation created by a net zero transition commitment meets the criteria in IAS 37 for recognising a provision, the first criterion in IAS 37:14 is whether the entity has a present obligation as a result of past event. The submitter said this criterion is met because the statement of commitment is a past event that gives rise to a present obligation. The staff disagreed because the event that creates a present obligation is the action to which the statement or law applies, resulting in a requirement for an outflow of resources. The costs of modifying its manufacturing methods and the costs of purchasing and retiring carbon credits are costs to be incurred to operate in the future, i.e. the entity will never have a present obligation for those costs. Accordingly, only when the entity emits the gases it has committed to offset it will have a present obligation. Therefore, the staff was of the view that the present obligation and probable outflow criteria are satisfied only after nine years and thereafter if the entity emits greenhouse gases. It will therefore incur a present obligation for the expenditure required to offset its past emissions. If it has not already bought the carbon credits needed to offset its past emissions, and assuming that a reliable estimate can be made of the amount of the obligation, the entity recognises a provision for the cost of buying and retiring those carbon credits.

Regarding the question of how an entity accounts for the expenditure required to settle a net zero transition provision, the submitter suggested that an entity could capitalise the expenditure in analogy to the costs of settling asset decommissioning provisions. The staff commented that in a scenario where a provision is recognised, an entity recognises the expenditure required to settle that provision as an asset only if that expenditure gives rise to—or forms part of the cost of—an item that qualifies for recognition as an asset in accordance with an IFRS Accounting Standard.

The staff noted that regardless of whether a provision is recongised as a result of the net zero commitment, the actions the entity plans to take to fulfil that commitment could affect the amounts at which the entity measures its other assets and liabilities. For example, if the entity’s plans to involve replacing existing property, plant or equipment sooner than was previously expected, the entity might need to test impairment under IAS 36, reassess the useful life and the residual value applying IAS 16 and assess whether there is a change in decommissioning or environmental rehabilitation applying IAS 37 and IFRIC 1. Also, if the changes needed to reduce an entity’s emissions will increase the costs the entity incurs to produce its goods or supply its services, the entity has to consider onerous contracts applying IAS 37 and reflect changes in assumptions about those costs when testing impairment of non-current assets.

Moreover, the staff said that the commitment could affect the information the entity discloses in its financial statements about existing assets and liabilities whose carrying amounts could be affected by the actions needed to fulfil the net zero transition commitment, e.g. assumptions made about the future under IAS 1:125, key assumptions about the recoverable amount under IAS 36:134 and description of each class of provision under IAS 37:85.

Based on this analysis, the staff considered that the principles and requirements in IAS 37 provide an adequate basis for an entity to determine how to apply that Standard to climate-related commitments. Therefore, this matter does not satisfy the criterion in the Due Process Handbook to be added as a standard-setting project.

Staff recommendation

The staff recommended that the IFRS IC does not to add a standard-setting project to the work plan and instead publish a tentative agenda decision outlining how an entity applies IAS 37 to climate-related commitments.

IFRS IC discussion

IFRS IC members gave a lot of input to each question in the agenda decision.

They first discussed the question of whether the statement of a net zero transition commitment in the fact pattern creates a constructive obligation. They generally commented that the analysis in the agenda paper is structured and helpful. They agreed that it would be based on judgement depending on the facts and circumstances. They appreciated the factors affecting management’s conclusion as set out in the agenda paper because it helps entities to determine what to consider to reach the conclusion on whether there is a constructive obligation. Given that there is no specific detailed fact pattern, IFRS IC members thought it was a good idea to set out the factors an entity has to consider. Some suggested to add the factors in the agenda decision. However, other members commented that these indicators are not what is stated in IAS 37 and preferred not to add them. Instead, they recommended referring to the factors to consider for restructuring provisions in IAS 37. Moreover, the IFRS IC members agreed that the first step of the assessment is to determine whether further analysis is needed to assess if there is present obligation in order to know if a  provision should be recognised.  

In respect of whether a constructive obligation created by a net zero transition commitment meets the criteria in IAS 37 for recognising a provision, IFRS IC members agreed with the staff’s analysis considering the three criteria in IAS 37 for the provision to be recognized. These are clearly explained in the agenda paper. They considered it is important to explain whether there is an obligating event as at the reporting date. It is useful to explain that the entity will never have a present obligation for the future modifications to the manufacturing method because the costs are to be incurred in the future, and only nine years later when it emits greenhouse gases would the entity have a present obligation which results in an outflow of resources to offset them. The timing of the existence of a present obligation is crucial for a provision to be recognised.

Several IFRS IC members considered that there is an expectation gap with regard to the users of the financial statements. When the users notice the commitment, they question why no provision was made for the entity’s promise. It is difficult to distinguish between an obligation and a present obligation under IAS 37. One IFRS IC member tried to explain in layman’s terms that an entity would have a present obligation when it makes a damage, for example, to a power station (analogy to making emissions) and is committed to fix it (analogy to committing to offset it). A number of IFRS IC members agreed with this and liked the analogy. 

Some IFRS IC members considered it is important to distinguish between an exchange and a transfer of resources. If an entity makes a payment and gets something of value in return, it is an exchange but not a transfer of resources so no provision should be made. In the fact pattern, there is an exchange of resource to get the credits and they are used to offset the obligation. When there is transfer (i.e. outflow) of resources, this would result in a provision to be recognised. It is important to determine whether a provision should be made with this distinction in mind.

Another IFRS IC member raised the concern about the validity of the entity’s expectation to discharge its obligation. They raised the question of what happens if something outside the control of the entity happened and this triggers reversal of the provision. The staff responded that there would be no provision until nine years later, which is the only point when the entity could determine whether to recognise a provision, so there is nothing to reverse before that. That discussion was about the derecognition question, which is different from the recognition question raised in the submission. One IFRS IC member emphasised that it is important to note the scope of the agenda decision, which is “recognition” but not measurement or derecognition of provision. Another IFRS IC member said that the provision is measured at an estimated amount which is recognised initially, followed by a continuous assessment of whether the obligation still exists and the amount of resources needed to settle the obligation. Facts and circumstances could change, and the entity may come to the conclusion that the provision has to be reversed subsequent to initial recognition. However, this does not mean it was an error to recognise the provision in the first place.  

One IFRS IC member suggested expanding the other considerations to include stating that the commitment could affect the amounts at which the entity measures its other assets and liabilities which is described in the agenda paper. Several IFRS IC members agreed that this is useful information and should be added in the text of the agenda decision. However, the Chair disagreed because it would make the agenda decision lengthy and go beyond the scope of the questions asked. Some IFRS IC members suggested that it could be published as explanatory material in addition to the agenda decision while others still considered it useful to add a short paragraph mentioning the factors in the agenda decision. The staff and the Chair said that the IFRS IC has not previously included such detail in agenda decisions and suggested to briefly lay out that entities have to consider the impact on other assets and liabilities.

The staff also discussed the proposed amendments to the agenda decision with the IFRS IC members. The main amendments considered were : 1) referring to the factors that need to be considered for restructuring provisions to determine whether there is a constructive obligation, (however, a few IFRS IC members pointed out that some of the criteria are not relevant to the provision described in the fact pattern and the staff finally decided not to make an analogy to this); 2) adding a sentence to describe that entities would have to consider how the commitment could affect the measurement of other assets and liabilities; and 3) emphasising that it is the outflow of resources instead of the purchase of credits that is the deciding factor in one of the criteria for the provision to be recognized. The staff will add simple examples for what is meant by “outflow of resources”.

IFRS IC decision

The IFRS IC, by a unanimous vote, decided to publish a tentative agenda decision with the suggested changes discussed during the meeting.