Background

In its November 2023 meeting, the IFRS IC discussed 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 manufacturer published a detailed plan for the modification of the 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. The staff analysed that whether there is a constructive obligation depends on different facts and circumstances. The present obligation and probable outflow criteria are satisfied only after nine years and thereafter as the entity emits greenhouse gases. Most of the IFRS IC members agreed with the analysis and publishing a tentative agenda decision.

43 comment letters were received and most of the respondents agreed with the IFRS IC’s conclusion. They made comments on the refinements to the content and wording of the agenda decision. Moreover, the submitter of the original request to the IFRS IC submitted a follow-up request during the comment period. The second submission describes two other fact patterns similar to that described in the tentative agenda decision, but with additional information about various actions the entity has taken that affirm its intention to fulfil its commitment.

Staff analysis

While most respondents agreed with the IFRS IC’s conclusions and tentative agenda decision, some respondents specifically welcomed the discussion on identifying constructive obligations and the clarification of the past event that gives rise to a present obligation. A few of the respondents, while not disagreeing with the IFRS IC’s technical analysis and conclusions, stated or implied that they disagreed with the decision not to add a standard-setting project to the workplan.

The respondents made comments on the refinements to the content and wording of the agenda decision. Some of them suggested adding guidance on factors to consider in judging whether a net zero transition commitment creates a constructive obligation. After considering the diversifying views, as evidenced from the comments from respondents, the staff considered the IFRS IC should neither add guidance on this matter to the agenda decision, nor publish it as educational material. The staff suggested passing the matter on to the IASB to consider developing guidance as part of its provisions—targeted improvements project.

Some respondents said that the agenda decision might have been read as specifying how an entity accounts for carbon credits. The staff said that the agenda decision did not have that intention and therefore, some refinements of the drafting will be made to clarify it.

Other respondents were of the view that the agenda decision omitted some analysis on the probable outflows recognition criterion. Given IAS 37 does not define the term “outflow” and does not explicitly say there must be a “net” outflow, the agenda decision did not explain why an entity’s obligation to reduce the emission may require the exchange instead of outflow of resources. The staff acknowledged that but explained that the requirement for a “net” outflow is implicit in IAS 37 because these asset and liability definitions have been used widely in developing IFRS Accounting Standards and they are consistently used with a sense of a need for net outflows or inflows. Also, this is consistent with the conclusions in the illustrative examples accompanying IAS 37.

A few of those respondents requested clarifying whether and how to make an analogy to asset decommissioning obligations in this fact pattern. The staff said that the requirements for asset decommissioning provisions provide a useful analogy when considering commitments to offset greenhouse gas emissions. Hence, they will consider opportunities to use the analogy in any educational or communications materials they develop to support the agenda decision.

A few respondents suggested adding to the agenda decision a discussion of the information (including judgement) an entity would disclose about the provisions it has or has not recognised in relation to its net zero transition commitments. Also, it was suggested to include examples of other accounting implications of a net zero transition commitment and consider drafting amendments. The staff did not suggest adding the above in the agenda decision.

In the second submission, the submitter identified five aspects of the tentative agenda decision as limitations. The fact pattern assumes that i) the entity publishes a detailed plan of how it will achieve its net zero transition commitment at the same time as it states its commitment; ii) the transition plan never changes; iii) there is only one emissions reduction target, to be achieved within 10 years; iv) offsetting is one of the primary means of reducing emissions; and v) the entity is not committing to invest capital to meet the emissions reductions target. The submitter said these assumptions are not applicable in some cases or in reality. Nonetheless, the staff analysed the concerns raised by the submitter and concluded that all these concerns do not affect the conclusions reached in the agenda decision.

Moreover, there were two additional similar fact patterns (except that they describe entities operating in different sectors and taking different actions to affirm their commitments) which the submitter asked the IFRS IC to consider. Each of them describes an entity’s commitment to reduce its emissions by a specified amount by 2030 in line with science-based targets (a 2030 commitment). They differ from the first submission in that they include only an emissions reduction commitment, which includes a series of annual targets, and describe various actions the entity has taken that affirm its intention to fulfil its commitment. The submitter considered 17 interpretations to reach its conclusion. These mainly related to i) the entity has a constructive obligation to fulfil its 2030 commitments; ii) some of the entity’s obligations might be legal not constructive; iii) an entity must recognise a provision if the recognition criteria are met; iv) the entity’s statement and affirmative actions are the “past events” that create a present obligation; v) It is probable that an outflow of resources embodying economic benefits will be required to settle the present obligation; vi) an entity should default to recognising a provision when it announces the commitment; and vii) if an entity does not recognise a provision, it should disclose the information required by IAS 37 for contingent liabilities.

The staff acknowledged that actions that an entity takes and that publicly affirm its net zero transition commitment could increase the likelihood that the entity has a constructive obligation to fulfil the commitment. However, the staff disagreed with some key aspects of the submitter’s analysis. The staff said whether a statement of a net zero transition commitment gives rise to a constructive obligation as defined in IAS 37 depends on the facts of the commitment and the circumstances surrounding it and cannot be assumed that an entity that has taken the actions described in the fact patterns necessarily has a constructive obligation. Moreover, they did not consider making a statement of a net zero transition commitment or taking other actions that affirm an intention to fulfil the commitment are the past events that give rise to a present obligation. The entity must also have taken the actions to which the commitment applies, for example, emitted greenhouse gases it has committed to offset. Therefore, the staff considered that the fact patterns in the second submission did not raise technical issues beyond those addressed in the tentative agenda decision and did not affect the conclusions set out in the tentative agenda decision.

Staff recommendation

The staff concluded that the second submission warrants neither a second agenda decision nor re-exposure of the tentative agenda decision published in December 2023 and recommended finalising the agenda decision with some drafting changes.

IFRS IC discussion

IFRS IC members agreed with the agenda decision’s analysis and conclusion, while suggesting drafting changes. They noted that this submission was a topic of great interest and the agenda decision could be a good basis for the important project on IAS 37 for climate-related uncertainties in the financial statements. They commented that the analysis made in the agenda decision is good, fair, well written and helpful in the application of the requirements in IAS 37.

Most IFRS IC members agreed with the staff analysis on the comment letters. They understood the concerns made by respondents, mainly driven by the expectation gap that exists between a published commitment made by the management of the entity, and the fact that it is not captured by IAS 37. Nonetheless, the analysis in the agenda decision is technically correct, intuitively makes sense and addresses all the issues asked in the submission. The agenda decision is helpful to emphasise that the affirmative action to enforce a constructive obligation is not the past action that results in a provision. A few IFRS IC members said that making appropriate disclosures in the financial statements could bridge the expectation gap and could bring better connection between financial reporting and sustainability reporting. Another IFRS IC member said such commitment could be captured in other accounting requirements (e.g. non-current assets) and also under sustainability disclosure requirements. Moreover, a number of IFRS IC members said that the staff made a good decision to take up suggestions. This made the agenda decision more sensible. At the same time, they commended the staff for not taking up some of the suggestions made by respondents. They agreed that some of those suggestions should be addressed by publishing educational material or passing the matter on to the IASB to consider developing guidance as part of its provisions—targeted improvements project. They said that the current agenda decision is helpful in addressing the questions asked in the fact pattern.

Regarding the staff analysis on the second submission, IFRS IC members said that it is useful and proves that the agenda decision could be applied consistently in a wider range of fact patterns, even for those that are more complex or realistic. This was a good way to validate the robustness of the agenda decision and it further reinforced the outcome of the agenda decision. One of them said that the analysis emphasises the importance of assessing the action which affirms the constructive obligation, but such obligation is not yet “present” for a provision to be recognised.

The IFRS IC members had some discussion on “carbon credits” mentioned in the agenda decision. They agreed that their recognition and measurement is not the subject of this submission, and it should not be over-analysed. The drafting of the agenda decision will be amended to avoid discussing its recognition and measurement. The sentence “The entity will be required to purchase and retire carbon credits without receiving any resources embodying economic benefits in exchange.” was extensively discussed, which is included in analysis of the criteria “probable outflow of resources”. Some of the IFRS IC members suggested to delete the sentence because it is confusing why “purchasing” is relevant. Instead, it would be the retiring of the asset that results in the settlement of the obligation and this may raise a measurement issue of the carbon credit. If the carbon credit is an asset, retiring it is the outflow, while if the carbon offset is not an asset, purchasing it is the outflow. There are also some similar words in the conclusion part of the agenda decision, which were recommended to be removed: “if the entity has not already retired yet purchased, or has purchased and recognises as an asset…”. Some of IFRS IC members preferred keeping these words because they explain what “outflow” means and when the criterion of present obligation is met. The staff explained that the drafting is trying to capture the reason why a provision is recognised (i.e. because the carbon asset has not yet been retired to settle the obligation). They said the question was whether an entity has a present obligation due to a past event, not whether there are assets or not. If the entity has settled the obligation by whatever means, it would not have the obligation. The staff decided to amend the words to mean that the reason why there is an obligation is because the entity has not yet settled the obligation.

IFRS IC members made other suggestions on the drafting of the agenda decision to make it clearer, consistent and precise. These suggestions were either accepted by the staff or taken back for further consideration.

IFRS IC decision

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