Accounting Standard for Climate Change: Mind the Gap

IFRS Sustainability standards seems to hold promise for achieving global convergence in sustainability reporting standards.

Authors: Ersa Tri Wahyuni and Yohanes Handoko Aryanto*

Recently, the accounting profession and also the market regulator were made excited by the issuance of Sustainability Standard (IFRS S1 and S2) by the prominent global accounting standard setter, IFRS Foundation. Finally, this could be the panacea for competing sustainability standards in the global arena such as GRI standard versus SASB standard.

IFRS S1 and S2 claim to provide sustainability-related information for users of general-purpose financial reports. For reporting entities, adherence to these standards can be beneficial in assessing the company’s exposure to sustainability issues, enabling strategic adjustments to meet targets such as the Paris Agreement or the UN SDGs. For users of financial reports, sustainability-related information can be useful for allocating resources to reporting entities.

IFRS Sustainability standards seems to hold promise for achieving global convergence in sustainability reporting standards, which is currently often referred to as an “alphabet soup” due to various frameworks and disclosure requirements. Unfortunately, in some jurisdictions, several sustainability reporting requirements have also been enacted for reporting entities. For instance, the European Sustainability Reporting Standards (ESRS) in the European Union, or the SEC requirements regarding climate-related disclosures. In Indonesia, OJK has POJK 51/2017 which has been the standard for sustainability reports since 2017.

Based on the current situation, the issue of sustainability reporting standards going forward will revolves around concerns of consistency, comparability, and reporting frameworks. However, there are other more substantial issues related to reporting standards that directly impact the achievement of sustainability targets, and these need to be promptly addressed by accountants. There are substantial gap in the current financial reporting standards on how to account the climate-related transaction, and a few will be disccused below.

Please, Mind The Gap

Last September, Indonesia was thrilled for the Voluntary Carbon Market (VCM) inaugurated by President Jokowi. Although the market attracted good number of transactions only on the opening day, It is understandable that the carbon market would become an active market and attract more participants only after some years. Nevertheless, the VCM market participants have no accounting guidance on how to account the carbon certificates in their book. Currently, there is no specific accounting treatment for recording carbon certificates in the VCM or Cap & Trade market already in place in Indonesia.

In the absence of accounting standard, companies then need to exercise their professional judgement on the accounting policies for these certificates. The international concensus is to apply Inventory or Intangible Asset accounting standard depending if the certificates is hold for sale or for the company’s own use. However, these two standards were initially developed not to cater this needs, thus many companies feel dissatisfied for not being able to book the fair value difference of the certificates in their profit.

Other crucial issues is accounting for Carbon Capture Technologies or CCS (Carbon Capture & Storage). There is a huge gap on how the companies should account the measurement of CCS facilities. The current accounting standards are not sufficient to provide fair representative view of the economic nature of the CCS.

Technically, CCS requires exploration and evaluation (E&E) drilling to find structures capable of storing CO2. This exercise is very expensive, as ensuring that captured carbon can be stored underground for the long term requires drilling to at least 1 KM. The challenge is that CCS technology is costly. The current cost of CCS ranges around USD 100-130/ton of CO2 or even higher. Meanwhile, carbon value is still below that cost. In this situation, the economic benefits of CCS will only emerge in the future when the carbon value is higher than the cost of capturing carbon using CCS. If a company decided to build CCS facility, it would be difficult to recognise it as an asset as the future economic benefits of such facility is unpredictable.

In such technical conditions, companies conducting E&E drilling to find carbon storage need to record a significant E&E costs, creating a burden the financial performance. Specific accounting guidance is pivotal to reduce the burden to make CCS technology more attractive and driving its global growth. The current accounting policy for E&E in IFRS 6 only applies to mineral resources E&E costs, thus CCS is excluded from the scope.

Without a specific accounting treatment for CCS, the company once again needs to exercise their professional judgement in developing their own accounting policy. Although IFRS provides a framework on how a certain accounting policy should be developed (see IAS 8), nevertheless these self-made accounting policies may ignited more disputes with their external auditors and and creates incomparability of financial reports. 

The huge gap of accounting standard for climate-related transaction can not be narrowed down by adopting IFRS S1 and S2. Indonesian accounting profession and regulators should focus more on developing guidance for this type of climate-related transactions, instead of rushing in adopting IFRS S1 and S2. Carbon Market has already been in place and several companies are considering to develop CCS as a solution to reduce carbon in the atmosphere.

The world’s biggest issue today is the climate crisis, which is closely tied to the concentration and emissions of carbon and greenhouse gases. Climate actions, be it mitigation or adaptation, require substantial financial support. From an accounting perspective, these substantial cost can decrease the company’s profitability in the short to medium term, as many critical green technologies have not yet reached an economically viable level.

Accountants can be the key actor to drive the development of essential green technologies by prioritizing the true substance and impact of financial transactions of sustainability issues. This shift towards substantial solutions is crucial, particularly in ensuring the success of these technologies before they become economically viable. Financial accounting standards hold the potential to do so much more than simply aligning disclosure frameworks; they can actively promote and accelerate the transition towards sustainable and environmentally responsible practices.

*Yohanes Handoko Aryanto is a Senior Expert Business Trend from PT Pertamina (Persero), Indonesia

Ersa Tri Wahyuni
Ersa Tri Wahyuni
Ersa Tri Wahyuni is an Associate Professor in Accounting from Universitas Padjadjaran, Indonesia.