IFRS Sustainability Disclosure
Standards
From September 2024, the SBR exam will test candidates on the IFRS
Sustainability Disclosure Standards. Candidates will need to be able to use
their knowledge of IFRS S1 and IFRS S2 to assess disclosures of climate-related
risks and opportunities. Candidates may also have to appraise the factors
which impact the usefulness of sustainability-related disclosures. This article
highlights some of the key principles within IFRS S1 and IFRS S2, which will
aid candidates with their understanding of this topic.
Background
In recent years, there has been a growing awareness of sustainability-related risks and
the potential impact which these may have on an entity’s current and future financial
position, performance, and cash flows. Investors require high-quality information about
these risks, as well as potential sustainability-related opportunities when making
investment decisions. Although sustainability reporting has become increasingly
prominent, the proliferation of different, voluntary reporting standards and frameworks
has caused fragmentation, and this has limited the usefulness of the information
provided.
The IFRS Foundation believed that the information needs of investors were not being
met. In response to this, they founded the International Sustainability Standards Board
(ISSB), which has the aim of developing a global baseline of sustainability standards.
In 2023, the ISSB issued its first two sustainability disclosure standards. These are:
IFRS S1 General Requirements for Disclosure of Sustainability-Related Financial
Information; and;
IFRS S2 Climate-related Disclosures.
These two standards are included on the list of Examinable Documents for Strategic
Business Reporting (SBR) exams from September 2024 onwards.
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IFRS Sustainability Disclosure Standards
General requirements
Entities apply IFRS S1 when preparing and reporting sustainability-related financial
disclosures. IFRS S1 refers to four areas of core content that entities should provide in
their sustainability-related financial information:
Governance – the governance processes used to monitor and manage
sustainability-related risks and opportunities.
Strategy – the approach to managing sustainability-related risks and opportunities.
Risk management – the processes used to identify, assess, and monitor
sustainability-related risks and opportunities.
Metrics and targets – the entity’s performance in relation to sustainability-related
risks and opportunities, including progress towards any targets set.
As well as applying the principles in IFRS S1, entities must refer to other issued IFRS
Sustainability Disclosure Standards when disclosing information about specific
sustainability-related risks and opportunities. This means that entities must use IFRS S2
when preparing disclosures of climate-related risks and opportunities.
As no further IFRS Sustainability Disclosure Standards have yet been issued,
sustainability-related disclosures related to non-climate issues must be prepared using
the principles in IFRS S1 only. The ISSB will eventually draft, consult on, and issue a suite
of other sustainability disclosure standards but, in the meantime, IFRS S1 requires users
to consider the disclosure topics covered in standards issued by the Sustainability
Accounting Standards Board (referred to as the SASB Standards) and to assess
whether they are applicable.
IFRS S1 does permit entities to omit information about sustainability-related
opportunities from sustainability-related financial disclosures if that information is
commercially sensitive. However, the exemption does not apply to any information that
is already publicly available, neither does it apply to sustainability-related risks.
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IFRS Sustainability Disclosure Standards
Interconnectedness
There are several similarities between the principles and concepts in IFRS Sustainability
Disclosure Standards and in IFRS Accounting Standards.
Both sets of standards use the same two fundamental characteristics of useful information
(relevance and faithful representation), as well as the same four enhancing qualitative
characteristics (comparability, verifiability, timeliness, and understandability).
The definition of materiality across the two sets of standards is also the same:
‘Information is material if omitting, misstating or obscuring that information could reasonably
be expected to influence decisions that the primary users of general-purpose financial reports
make on the basis of those reports.’
Both sets of standards identify the same primary user of financial reports: current and potential
investors, lenders, and other creditors.
IFRS S1 specifies that sustainability-related financial disclosures must be reported at the same
time as the related financial statements. The reporting period for the sustainability-related
information must also be the same as for the financial statements. Both sets of standards
require the disclosure of comparative information.
The treatment of material, prior period errors in sustainability-related financial information is
also based on the same principle as in IFRS Accounting Standards: these errors must be
corrected retrospectively by restating comparative amounts for the prior period, unless this is
impractical.
Climate-related disclosures
Risks and opportunities
The SBR syllabus for exams from September 2024 onwards requires candidates to assess
disclosures of climate-related risks and opportunities. Entities apply IFRS S2 when producing
climate-related disclosures. The purpose of these disclosures is to provide information about
climate-related risks and opportunities that the primary users of its financial reports would find
useful.
Climate-related risks can be separated into two broad categories:
physical risks, and
transition risks.
Physical risks result from weather-related events, such as floods or droughts. They also result
from longer term climatic changes; for example, rising temperatures may lead to rising sea
levels as well as a loss of biodiversity.
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IFRS Sustainability Disclosure Standards
Transition risks result from the move towards a lower-carbon economy.
Entities are required to provide disclosures about its governance, so that the users of its
financial reports can understand how climate-related risks and opportunities are identified,
monitored, and managed.
When identifying sustainability-related risks and opportunities, entities must use all reasonable
and supportable information that is available to them without undue cost of effort. Data
sources can be internal or external, and might include risk management processes, external
reports or statistics, and industry experience. Assessments of what constitutes undue cost or
effort will change over time and depend on the benefits of the information provided to the
users.
The following is an example of a disclosure of some of the climate-related risks and
opportunities facing an international restaurant business:
Physical risks
Our business model relies on large quantities of raw materials. Increased levels of flooding due to
climate change has affected the quantity and quality of several key ingredients. This leads to price
volatility, which reduces profit margins.
Restaurants in some locations are heavily impacted by water shortages and chronic weather events.
These events may cause temporary closures but can also increase the costs of insurance premiums.
Transition risks
Climate-related laws and regulations are regularly changing. Our restaurants operate in more than 90
countries around the world. Compliance costs are high. Moreover, increased regulation can result in
higher operational costs, such as in relation to the cost of energy.
Many of our customers pay close attention to our climate-related strategies and targets. If these are
deemed insufficient, then our brand value will decline. Reputational damage will impact our market
share and our share price.
Opportunities
To achieve our goals, we are pursuing more efficient operations through investment in new
technologies. In the long-term, we expect a significant decline in energy-usage, with a resulting
increase in reported profit margins.
With regards to identified risks and opportunities, the entity would need to disclose the impact
on its strategy and decision making. It must also outline the effect of the risks and
opportunities on its financial position, financial performance, and cash flows in the current
reporting period, as well as the anticipated effect in the short, medium, and long term.
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IFRS Sustainability Disclosure Standards
To help users assess the adaptability of the entity, information must also be provided about the
resilience of the entity’s strategy and business model to climate-related changes. This includes
providing information about climate-related scenario analysis that the entity has carried out.
Metrics
Entities are required to disclose metrics and targets that will help the primary users understand
its performance in relation to climate-related risks and opportunities. IFRS S2 states that this
involves providing information about any climate-related targets that the entity has set, as well
as information about its greenhouse gas (GHG) emissions.
Greenhouse gas emissions
In accordance with IFRS S2, entities are required to disclose gross GHG gas emissions. This
disclosure must be broken down into Scope 1, Scope 2, and Scope 3 emissions. These are
defined as follows:
Scope 1 – direct GHG emissions that occur from sources that are owned or controlled by an
entity.
Scope 2 – indirect GHG gas emissions from the generation of purchased or acquired
electricity, steam, heating, or cooling consumed by an entity.
Scope 3 – indirect GHG emissions (not included in Scope 2) that occur in the value chain of
an entity.
An example disclosure of gross GHG emissions is provided below:
GHG emissions (metric ton CO2e) 20X6 20X5
Scope 1 GHG Emissions 1,153,352 1,045,243
Scope 2 GHG Emissions 4,534,212 4,734,243
Scope 3 GHG Emissions 7,432,435 7,875,432
This disclosure is important because it helps users of the sustainability-related financial
information assess the entity’s exposure to climate-related risks and opportunities. Entities with
higher GHG emissions are potentially more exposed to climate-related transition risk because
they will be more heavily impacted by legal, technological, market and reputational risks. In
particular, shifting consumer demands could lead to severe reputational damage for entities
that do not make sufficient progress in reducing their GHG emissions.
For some industries, Scope 3 emissions can account for almost 90% of total GHG emissions. For
this reason, Scope 3 emissions are sometimes perceived as a hidden risk – especially if
undisclosed. The requirement in IFRS S2 to disclose Scope 3 GHG emissions therefore gives a
more complete picture of an entity’s overall carbon impact, and it also enables investors to
compare the carbon-impact of entities with different business models (such as those which
heavily outsource activities and those that do not).
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IFRS Sustainability Disclosure Standards
It can be difficult to measure GHG emissions, particularly those falling into Scope 3, and many
different methodologies exist. For this reason, IFRS S2 requires entities to measure GHG
emissions in accordance with Greenhouse Gas Protocol: A Corporate Accounting and
Reporting Standard (2004), unless an entity is legally required to use a different method. This
consistent approach reduces the risk of bias, helping to ensure a faithful representation of the
underlying phenomena. There are also some exemptions and simplifications for entities in the
first year of applying IFRS S2.
Targets
IFRS S2 requires entities to provide information about the climate-related targets it has set.
Below is an example of an extract from a disclosure note for an international hotel business:
The company aims to reduce water consumption per occupied room by 20% from a 20X0 baseline by
the end of 20X9. By the end of 20X6, the reduction in water consumption per occupied room since
20X0 was 8.4%. We are behind schedule on this goal but continue to explore opportunities to reduce
water consumption.
The company plans to reduce net carbon dioxide emissions by 30% from a 20X0 baseline by the end
of 20X9. To achieve this, we will reduce gross emissions by 10%, while also making use of carbon
credits. These credits are generated from projects that use technology to capture carbon dioxide from
the atmosphere before storing it safely underground. The carbon credits have been independently
verified by the Global Carbon Council. By the end of 20X6, net and gross carbon dioxide emissions
had reduced by 24% and 2% respectively. We are behind schedule on our gross target but have
implemented a new executive management share-based payment scheme which will vest if the goal
is achieved.
If entities disclose a net GHG emissions target, IFRS S2 also requires disclosure of the gross
target. This is because a reduction in net GHG emissions can be achieved without making
changes to the entity’s business model, for instance, through the purchase of carbon credits.
IFRS S2 defines a carbon credit as ‘an emissions unit that is issued by a carbon crediting
programme and represents an emission reduction or removal of greenhouse gases.’ IFRS S2
requires entities to disclose their planned use of carbon credits to achieve any net greenhouse
gas emissions target. Disclosure of the planned use of carbon credits in achieving climate-
related goals is important because some carbon capture technologies may prove ineffective, or
there might be a change in regulations that ban entities from using certain schemes. The
prices of carbon credits may also change significantly, which will impact these plans and,
therefore, the entity’s ability to meet its targets.
This article was published In June 2024 by ACCA