The Impact of Climate Change in the Valuation of Production Assets via the IFRS Framework

An Exploratory Qualitative Comparative Case Study Approach

Rebecca Scholten 1 , Tineke Lambooy 2 , 3 , Remko Renes 4 , and Wim Bartels 5
  • 1 Assistant Director - Corporate Responsibility Lead, EY, Amsterdam, The Netherlands
  • 2 Corporate Law, Nyenrode Business University, Breukelen, The Netherlands
  • 3 Airlangga University, Surabaya, Indonesia
  • 4 Center for Accounting, Auditing & Control, Nyenrode Business University, Straatweg 25, Breukelen, The Netherlands
  • 5 KPMG, Partner Corporate Reporting, Amstelveen, The Netherlands
Rebecca Scholten
  • Corresponding author
  • Assistant Director - Corporate Responsibility Lead, EY, Amsterdam, The Netherlands
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, Tineke Lambooy
  • Corporate Law, Nyenrode Business University, Breukelen, The Netherlands
  • Airlangga University, Surabaya, Indonesia
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, Remko Renes
  • Center for Accounting, Auditing & Control, Nyenrode Business University, Straatweg 25, Breukelen, 3620 AC, The Netherlands
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and Wim Bartels

Abstract

An interesting relatively new development in the field of corporate climate change disclosures is the Task force on Climate-related Financial Disclosures (TCFD). The TCFD aims to help identify the information needed by financial stakeholders to appropriately assess and price climate change related risks and opportunities. In its first Report (2016), the TCFD recommends that companies provide climate change related disclosures specifying the impact thereof on their financial performance through mainstream (i. e. public) financial filings.

In this paper, we look at the financial accounting standards as an institutional framework, and in particular pose the question to what extent this framework supports companies to disclose how climate change impacts their operations and the value of the production assets. To test to what extent companies make disclosures in relation to climate change, we selected four energy companies and conducted a comparative case study analysis. Our focus is on the valuation of production assets, more specifically, drilling platforms, windmill platforms, heavy equipment and transport means used to support the production, and pipes and cables to transport the energy units produced.

Interesting findings were: (i) in all four cases, potential future changes (caused by climate change) concerning the valuation of the production assets are not (yet) accounted for in their Balance Sheet Annex. This is remarkable because climate change is likely to have an effect on the future value of the production assets employed in the two types of industries, among others caused by the development that renewable energy demand increases at the expense of non-renewable energy demand; and (ii) the current financial reporting system does not support renewable energy companies to provide meaningful and quantitative insights in expected increases of their future cash inflows and their financial and innovation potential. This impedes financiers and investors to accurately and meaningfully assess the value of a renewable energy company’s business compared with a non-renewable company’s business.

Table of Contents

  1. 1Introduction
  2. 2Extant literature: Theory concerning corporate reporting on GHG and climate change impact
  3. 3Research question
  4. 4Methodology
  5. 5Results
    1. 5.1Case study findings and comparative analysis [questions 1-8]: Company characteristics and accounting policies
      1. 5.1.1The legal and reporting characteristics of Companies A-D [questions 1,2, 3]
      2. 5.1.2The business activities of the Companies A-D [question 4]
      3. 5.1.3Mutual dependencies and cooperation [question 5]
      4. 5.1.4Accounting standards, policies on valuation of production assets and impairment [question 6]
      5. 5.1.5Valuation of reserves [question 7]
      6. 5.1.6Reference to future cash and income streams [question 8]
    2. 5.2Case study findings and comparative analysis [question 9]: The application of climate change key indicators
      1. 5.2.1Non-renewable energy companies, accounting policies and climate change
      2. 5.2.2Renewable energy companies, accounting policies and climate change
  6. 6Conclusion
    1. 6.1Limitations of the research
    2. 6.2Future research
  7. References
    Rethinking Non-Financial Reporting: A Blueprint for Structural Regulatory Changes
  1. 1.Beyond Non-Financial Reporting: A Blueprint for Deep Structural Regulatory Changes, by David Monciardini, https://doi.org/10.1515/ael-2020-0092.
  2. 2.Non-Financial Reporting & Corporate Governance: Explaining American Divergence & Its Implications of Disclosure Reform, by Virginia Harper Ho, https://doi.org/10.1515/ael-2018-0032.
  3. 3.The impact of climate change in the valuation of production assets via the IFRS framework – An exploratory qualitative comparative case study approach, by Rebecca Scholten, https://doi.org/10.1515/ael-2018-0032.
  4. 4.A country-comparative analysis of the transposition of the EU Non-Financial Directive an institutional approach by Selena Aureli, https://doi.org/10.1515/ael-2018-0047.
  5. 5.The Challenges of Assurance on Non-financial Reporting, by Amanda Ling Li Sonnerfeldt, https://doi.org/10.1515/ael-2018-0050.
  6. 6.Integrated reporting and sustainable corporate governance from European perspective, by Jukka Tapio Mähönen, https://doi.org/10.1515/ael-2018-0048.
  7. 7.Why ‘less is more’ in non-financial reporting initiatives: concreate steps towards supporting sustainability, by Georgina Tsagas, https://doi.org/10.1515/ael-2018-0045.
  8. 8.Planetary boundaries and corporate reporting the role of the conceptual basis of the corporation, by Andreas Jansson, https://doi.org/10.1515/ael-2018-0037.
  9. 9.The financialization of civil society activism: sustainable finance and the shrinking of bottom-up engagement, by Davide Cerrato, https://doi.org/10.1515/ael-2019-0006.
  10. 10.Paradise Lost Accounting Narratives Without Numbers, by Mario-Abela, https://doi.org/10.1515/ael-2019-0035.

1 Introduction

The focus of this paper is on the production of non-renewable and renewable energy, because the influence of non-renewable energy on climate change is, according to Walter (2017), “one of the few that qualifies not only as a systematic risk — in other words, something that investors cannot diversify away from — but also as a systemic risk — that is, something that could be a source of contagion that extends across markets”. Subsequent IPCC studies (IPCC, 2001, 2007, 2013) conclude that our society is not proceeding fast enough with implementing the needed transition towards a low carbon economy, i. e. moving from an energy production system that mainly relies on non-renewable resources (oil, coal and gas) to one based on renewable resources such as water, wind and sun. The total amount of Green House Gases (GHG) increases every year (IPCC, 2013).

According to Samuelson (2012), modern groups of multinational companies (MNC) are larger than most governments, are talent and resource rich, and perhaps the best hope we have to address problems that span nation states and even continents. Indeed, many MNCs embarked on a path to address their GHG impacts, partly incentivised by carbon emission credit systems (cap & trade), e. g. the EU Emission Trading System (EU ETS, Lambooy, 2014, p. 80), which impose rules on companies with heavy GHG emitting installations in the EU to comply with an emission regulating system. Some scholars are critical about the ability of the ETS to tackle the problem of GHG emissions (Böhringer, 2014; Vlachou, 2014). Besides the EU, several other jurisdictions and states have introduced carbon emission credit systems. In addition to implementing legally required carbon emission credit programmes, companies also found motivation – often encouraged by NGOs and investors – to adopt GHG reduction and other policies pursuant to their gained insight that companies have a role to play in encountering climate change. Examples are the Global Reporting Initiative (GRI G4 Guidelines, now GRI Standards), AccountAbility (the AA1000 Series of Standards), United Nations Global Compact (the Ten Principles), International Integrated Reporting Council (IIRC – the International Framework), the Sustainability Accounting Standards Board (SASB), the Climate Disclosure Standards Board (CDSB), the Carbon Disclosure Project (CDP), 1 the Carbon Tracker 2 and the World Business Council on Sustainable Development (WBCSD). The WBCSD is an international non-governmental organization which forms alliances with MNCs that commit to achieving concrete goals in respect of climate change mitigation and other CSR objectives. In 2018, the WBCSD and the Committee of Sponsoring Organizations of the Treadway Commission (COSO) launched a new approach that addresses the “increasing need for companies to integrate environmental, social and governance (ESG)-related risks into their ERM processes” (COSO & WBCSD, 2018).

Besides mapping climate change risks and measuring GHG emissions, companies apply corporate climate change mitigation strategies. These include measures such as reducing energy use, developing and selecting alternatives for traditional fossil fuel and gas resources, and applying compensational measures for GHG by – for instance – participating in reforestation projects (Lambooy, 2014). The EU Directive 2014/95, i. e. the corporate accounting directive concerning the publication of CSR information, has now been implemented in the laws of most European jurisdictions. Pursuant to this piece of EU regulation, large listed companies, which are based in the EU, must report on environmental issues, i. e. among other disclosing information on the impacts of their activities on the environment (including the climate) and on the risks related to those impacts. For example: how will the risk of climate change impact their activities? And: will the companies’ activities influence climate change? These MNCs are to publish a ‘Non-Financial Disclosure Statement’ as part of their annual report, in which they have to report on these type of subjects.

Sustainability accounting and reporting has been considered and discussed since the 90’s. (Gilbert & Rasche, 2007; Lambooy & Flokstra, 1997). The growing attention for sustainable business behaviour made the development of evaluation mechanisms of corporate ecological, social and governance (ESG) performance important (Göbbels & Jonker, 2003; McIntosh, Thomas, Leipziger, & Coleman, 2003). The topic of social and environmental auditing has received ample attention in scholarship, especially the resulting development that multiple methods have been introduced to measure and report about GHG. However, as regards the mechanisms that are employed in financial reports and disclosure statements (hereafter: financial statements), not many scholars have assessed the question of how corporate climate change policies and approaches are linked to the question of how to value production assets. According to the Association of Chartered Certified Accountants (ACCA), commenting on the mechanism of corporate reporting, the purpose of corporate reports is “to communicate the reporting organization’s performance over the reporting period, whether for compliance or stakeholder information purposes” (ACCA, 2016). While there is not a single definition of performance, in the context of the organization, it can be understood as “the end result of management’s processes and actions in relation to corporate goals” (ACCA, 2016). Hence, the question emerges to what extent such end result indeed reflects corporate goals, risks and opportunities related to climate change.

The goal of this paper is to explore how corporate climate change policies and approaches are linked to the question of how to value production assets. Moreover, we aim to explore how this matter has been taken up by non-renewable energy companies and renewable energy companies, and what the differences are between them in following the accounting frameworks in the valuation of their production assets. This paper proceeds as follows. The theory as developed in the extant literature will be elaborated in Section 2. The research questions are presented in Section 3, and in Section 4 we explain the methodology that we employed. In Section 5, we present the findings of our exploration via case studies of the corporate approach towards embedding climate change effects in the valuation of non-renewable and renewable energy investments. The last section of the paper concludes with our findings and highlights the contribution to the existing literature.

2 Extant literature: Theory concerning corporate reporting on GHG and climate change impact

Various authors discussed the commensuration of GHG disclosure and reporting mechanisms in general, such as Kolk et al., arguing that the response of companies to the pressure of investors through the CDP and in other ways, is impressive but that “neither the level of carbon disclosures nor the more detailed carbon accounting provide useful information for investors, NGOs, policymakers, and other stakeholders” (2008, pp. 719). Lambooy and van Rumpt (2014) also dispute the validity of current GHG disclosures of companies. To increase validity they recommend the use of external assurance. Moreover, companies employ different methodologies, which makes the information incomparable, i. e. between companies but often also between subsequent years of one company. And finally, they state that the GHG disclosures not always cover all activities worldwide of one MNC, let alone its supply chain or value chain.

Warwick and Chew (2012) also reflects on the metrics of disclosures, but looks specifically into the accounting standards that are applied by companies in their reporting on GHG rights and obligations (hereafter: allowances) pursuant to the EU ETS and other cap and trade systems. According to Warwick, 32 countries in total have a regulated system. The study reflects on how companies in EU ETS jurisdictions report on GHG allowances with the goal to gain an empirical understanding of how GHG allowances (granted as well as purchased) are accounted for. Warwick also discusses IAS 38 (intangible assets) and its equivalent, AASB 138. He points out that as an exception IAS 2 (inventories) is used if allowances are held for sale in the ordinary course of business. He finds many mismatches and concludes that even regarding the regulated EU ETS system, there is no uniformity in accounting for GHG allowances.

Evangelinos, Nikolaou, and Filho (2015) oversees all different aspects of corporate sustainability strategies directed at climate change; i. e. mitigation strategies, measuring and accountability strategies, including GHG measuring and reporting (not limited to cap and trade systems and the accounting of allowances). He proposes to develop an integrated environmental accounting model because the lack of uniformity in GHG accounting information cancels to a great degree the purpose of accounting methods for increased reliability, trustworthiness and comparability. Evangelinos et al. suggests to develop a normative framework to record information on climate change practices, as is depicted in Figure 1.

Figure 1:
Figure 1:

Normative theoretical framework for corporate environmental accounting, adapted from Evangelinos et al. (2015).

Citation: Accounting, Economics, and Law: A Convivium 10, 2; 10.1515/ael-2018-0032

Moreover, he proposes to translate corporate strategies into environmental accounting, and to divide such information into: financial terms (Balance Sheet and Profit &Loss Account), and non-financial terms (Balance Sheet Annex).

However, according to Lois Guthrie, former director of the Carbon Disclosures Standard Board (CDSB) and responsible for CDSB’s work to develop a framework to share environmental information in mainstream corporate reports, it is challenging to set up a system that becomes institutionalised. Building on this, Guthrie states that “new initiatives come and go because it is not clear how they fit into the existing landscape” (ACCA, 2016, pp. 6). For example, when looking at the CDSB, it can be stated that they deployed accounting expertise in shaping corporate disclosure. According to Thislethwaite (2015) the discussions around using accounting expertise in the area of climate change involves many uncertainties and diverging interests. His analysis revealed that these uncertainties conflicts with established accounting practices. In addition, it has been contended that the existing international auditing standards have no rules for verifying ‘forward-looking information’ such as climate change risks (EY, 2017).

Financial statements are foremost prepared to provide financial information about the reporting entity and to support economic decisions of investors, banks, contract parties and other stakeholders. As described in the Conceptual Framework of the International Financial Reporting Standards (IFRS), economic decisions depend on several components. Among others, these include the returns that investors expect from their investment via dividends or share value increases. As stated in the Conceptual Framework: “Investors’, lenders’ and other creditors’ expectations about returns depend on their assessment of the amount, timing and uncertainty of (the prospects for) future net cash inflows to the entity. Consequently, existing and potential investors, lenders and other creditors need information to help them assess the prospects for future net cash inflows to an entity” (2010). To a large extent, financial reports are based on estimates, judgements and models rather than exact depictions. Financial reports also provide information about the effects of transactions and other events that change a reporting entity’s economic resources, assets and claims. An example of this is standard 36 of the International Accounting Standards (IAS). To clarify: the IAS were issued by the International Accounting Standards Board (IASB) and its predecessor, the International Accounting Standards Committee (IASC), while IFRS refers to International Financial Reporting Standards, published by the International Accounting Standards Board (IASB), starting from 2001. When the IASB was established in 2001, it was agreed to adopt all IAS standards, and name future standards as IFRS. IAS standard 36 (IAS 36) provides when a reporting entity needs to apply an ‘impairment test’ to an asset. The Australian Accounting Standard Board (AASB) employs a similar rule under standard 136 issued by the Australian Accounting Standards Board Accounting Standards (AAS 136). Extracts of both provisions are included in Figure 2.

Figure 2:
Figure 2:

IAS 36 and AASB 136.

Citation: Accounting, Economics, and Law: A Convivium 10, 2; 10.1515/ael-2018-0032

Source: Websites IASB and AASB. Italics in the citations are added by authors.

Various types of economic resources affect a reporting entity’s prospects for future cash flows in different ways. Some future cash flows derive directly from existing economic resources, such as accounts receivable. Other cash flows result from employing several resources in combination to produce and market goods or services to customers, such as machinery and installations. Although those cash flows cannot be identified in relation to individual economic resources (or claims), users of financial reports need to know the nature and amount of the resources available for the use in a reporting entity’s operations. As stated in the IFRS Conceptual Framework: “financial information is capable of making a difference in decisions if it has predictive value, confirmatory value or both. Financial information has predictive value if it can be used as an input to processes employed by users to predict future outcomes.” Moreover, there is no need for financial information to be a specific forecast in order to have predictive value because the predictive value is employed by users in making their own predictions (IFRS Conceptual Framework, 2010).

An interesting development in the field of corporate reporting is the establishment of the Task Force on Climate-related Financial Disclosures (TCFD). The TCFD aims to “help identify the information needed by investors, lenders, and insurance underwriters to appropriately assess and price climate-related risks and opportunities” (TCFD, 2017a). The framework can be seen as containing voluntary recommendations with a focus on decision-useful information. Since their focus is purely on climate, the TCFD states that investors can make better informed decisions when they are aware of relevant climate change risks and exposures of companies over the short, medium and long-term. In 2016, the TCFD launched a draft report suggesting innovative methods for reporting on probable future developments related to climate change, affirmed in a final report published in 2017. An overview of the most important climate change risks identified by the TCFD can be found in Figure 3.

Figure 3:
Figure 3:

Typical categories of climate-related risks and opportunities.

Citation: Accounting, Economics, and Law: A Convivium 10, 2; 10.1515/ael-2018-0032

Source: (TCFD, 2017b).

According to the TCFD, financial markets have to price risk and in doing so can support efficient and informed capital-allocation discussions. The TCFD deems high quality financial reporting as crucial in this process. Additionally, they point out the increased importance of understanding the governance and risk management context in which financial results are achieved. The TCFD recommends that preparers of climate-related financial disclosures provide such disclosures specifying this broader context in their mainstream (i. e. public) financial filings. The innovative way which is advised by the TCFD is that organisations apply the ‘scenario analysis’ methodology, for example by describing which potential impacts climate change will have on their business under different future global temperature scenarios, including a 2-degree temperature rise scenario as agreed in the Paris Agreement of 2015. Concluding, the TCFD stretches the boundaries of current financial disclosure requirements and emphasizes forward-looking scenario analysis. These recommendations are pertinent to financial reporting, including the application of the IFRS (Walter, 2017).

3 Research question

As indicated in the introduction, the goal of this paper is to explore how corporate climate change policies and approaches are linked to the question of how to value production assets. Moreover, we aim to explore how this matter has been taken up by non-renewable and renewable energy companies, and what the differences are between them in following the accounting frameworks in the valuation of their production assets.

We reiterate that institutionalisation is a social process by which individuals come to accept a shared definition of social reality (Comyns, 2014). As a result, institutional elements become incorporated in organisational structures, and hence influence the internal decision-making processes. For our study, we decided to look at the generally accepted accounting standards (IFRS and similar frameworks such as the AABS) as an institutional framework, and to pose the question to what extent this framework supports and encourages companies in truthfully disclosing how climate change impacts their operations and the value of their production assets. We are interested in negative impacts (e. g. when production assets decrease in value or become obsolete due to a reduced demand for the products) as well as positive impacts (e. g. in the form of value rise of production assets pursuant to increased business opportunities).

During the literature research we discovered no other normative framework for integrated reporting that can or should be used in all situations and by all companies. We reference in this context the recommendations included in the TCFD Report as a potential addition to the accounting frameworks. Subsequently, we draw on Evangelinos’ et al. (2015) proposal for a normative framework for accounting on environmental issues in financial and non-financial reporting, and submit the question how climate change can be incorporated.

In our study, we limit ourselves to the subject of the valuation of production assets and related disclosures (notes, management discussion & analysis). Hence, we exclude from our research topics such as corporate reporting on (i) GHG strategy and ambitions and (ii) the quantity of GHG emissions and GHG allowances. We thus focus on whether the financial accounting standards stimulate companies to include information on climate change in their financial statements and its impacts on the production assets valuation. In this vein, relevant corporate documents for inspection and covered by IFRS (or similar frameworks such as the AAS) are the Balance Sheet and Balance Sheet Annex (compare Evangelinos et al., Figure 1, pp. 263). Additionally, if a company has listed securities at a stock exchange, the type of information in which we are interested usually also needs to be disclosed in investor reports. We included such investor reports in our research data. However, as each stock exchange imposes its own sets of disclosure rules on the companies listed at that stock exchange, we did not examine potential differences in such rules as our focus is on the application of international generally accepted accounting standards.

Attempting to make the discussion more tangible, we decided to test our research goal within the context of one sector, the energy sector. As indicated in the introduction, this sector is currently in the spotlight in terms of companies that (need to) address climate change because states have agreed that we need to reform our economy into a low carbon economy. We wish to explore whether how the present accounting standards work for non-renewable and renewable energy companies in respect of the way in which they present their assets in the context of generating (future) profits and taking into account the effects of climate change. We will research this question by testing the application of the current IFRS and AAS rules in view of the enhanced call by the TCFD for broad organizational reporting, and its recommendations to address climate change risks in the financial statements. The research question therefore is:

To what extent do financial accounting standards allow and encourage disclosures in the financial statements on the business impact of climate change of non-renewable and renewable energy companies, in particular on the valuation of production assets?

By answering this question, we aim to explore the potential of spurring investments into renewable energy assets.

4 Methodology

We applied a combined research methodology. After a literature study, on which basis we decided on the theoretical foundations of the research project, we assessed the elements of the accounting standards that are pertinent for answering the research question. Next, we analysed the recommendations of the TCFD and selected criteria that can be tested in case studies pertaining to companies in the energy sector.

As our focus is on the motivation provided by companies for the valuation of their production assets, we pursued a qualitative methodology. We conducted four exploratory case studies (Yin, 2009, p. 58). We have chosen an exploratory approach because of the lack of academic literature on this topic in order to gain insight in the manner in which companies apply the institutional framework which we examine. Subsequently, we combined the findings of the four cases, applying the comparative case study methodology offered by Groenland, i. e. the so-called ‘matrix’ method (Groenland & Jansen, 2010). In the presentation of the case studies, our findings are recorded in a systematic way. In order to preserve the anonymity of the companies, each case study and each company will be referred to as “Case Study” and “Company” followed by a letter of the alphabet, i. e. Case Study A and Company A.

For each case study, we examined the most recent information published by the company in relation to the valuation of its assets and the impact of climate change, including (1) the Financial Statements comprising the Balance Sheet, the Profit & Loss Statement and the Balance Sheet Annex (containing an explanation of the company’s accounting policies); (2) the Directors’ Report; (3) the website of the company; (4) Consolidated Financial Statements and the Directors’ Report of a parent company if relevant/available; (5) investors communications, including parts of mandatory SEC disclosures, if available on the website of the company and relevant for answering the research question. All materials relate to the book year 2016 and we closed the research by the end of 2017. In regard of all four case studies, we could not find any scenario analysis yet, as proposed by the TCFD, evidently because the draft TCFD Report was only released by the end of 2016. Hence, we had to look for other types of information included in the sources listed above that regards the impact of climate change on the valuation of production assets.

We designed a template with questions (see Table 1). The first part of the questions aims to identify the company, the second part relates to the company’s accounting policies, the valuation of the production assets, and to what extent climate change is brought up in the comments in the Balance Sheet Annex, e. g. to motivate the application of impairment. Impairment is a correction mechanism to adjust the book value of a certain asset in case this is necessary due to the occurrence of qualitative or quantitative circumstances that have a negative impact on the market value of that asset (hence, having as effect that the market price is lower than the book value). For our analysis, we are only interested in circumstances related to climate change. We therefore drew on the TCFD Report to select the indicators which comprise circumstances that relate to climate change.

Table 1:

Questions template.

1.What is the legal name of the company? Is the company part of a corporate group? If so, please describe which position does the company occupy in the group. [Type of company]
2.Does the company publish single company financial statements? To which year do they pertain? And is the financial information of the selected company also integrated in the consolidated accounts of the group (same year)? [Single/Consolidated]
3.What is the legal form of the company? Is the company a listed company? If so, at which stock exchange are the securities listed? [Legal form/Listed shares]
4.Describe the activities of the company. [Activities]
5.Does the company have group companies with which it closely cooperates in conducting its business? Please describe the (mutual) dependency. [Cooperation/Dependency]
6.On the basis of which accounting framework, standards and policies are the company’s assets valued, in particular the assets that are necessary for the energy production, e. g. property, plant, drilling, machinery and other equipment, platforms in sea, wind mills, solar power installations, energy transport pipes and cables (Property, Plant & Equipment)? To what extent and based on which indicators (circumstances) and arguments does the company decide on impairment (i. e. applying a downward correction to the value of particular assets. [Accounting standards/Impairment]
7.What does the company report about its reserves, if any? And if so, how? [Reserves]
8.In which way does the company refer to its future cash flow and income streams? [Future cash flow]
9.Concerning the topics of the questions 6–8, does the company elaborate on key climate change indicators that (can) affect the figures included in its financial statements, e. g. elaboration in the Balance Sheet Annex, the Director’s Report, investors’ updates or elsewhere? (Based on the TCFD Report, a list is drawn up comprising key issues to assess). [Climate change indicators, in line with Figure 3]

Source: Design is based on Evangelinos’ et al. Theoretical framework for environmental accounting.

We targeted our research on the financial valuation of productions assets. In the case of energy companies, these include for instance: drilling platforms, gas pump installations, windmill platforms and windmills, solar power installations, heavy equipment and transport means used to support the production, pipes and cables to transport the energy units produced (Property, Plant & Equipment).

Firstly, we assessed the company’s accounting policies applicable to the valuation of assets in this category. Secondly, we examined if the companies applied impairment. Specifically, we searched if, and to what extent and in which way, climate change played a role in the company’s motivation for the valuation of its production assets and for applying or not applying impairment to such assets. To this end, the Balance Sheet Annex constituted an important part of the documents under review.

The selection of the case study companies was done on the basis of the following criteria:

  1. For reasons of theoretical replication (Yin, 2009, p. 58), we selected four large energy companies and we purposefully selected two non-renewable energy companies and two renewable energy companies, because we expected rival explanations concerning the impact of climate change on the business and assets in the two differing industries.
  2. A selected company must preferably apply IFRS accounting standards to minimise potential technical accounting differences. A company applying a comparable accounting standard such as AASB can also be selected.
  3. A selected company must publish statutory Financial Statements. Hence, the company can be part of a larger conglomerate of companies, a corporate group or a MNC, but its statutory financial reporting document must be accessible on a single company basis as we aimed to examine the way in which the company that owns the production assets, reports on them.

The two authors with expertise in the accounting practice conducted the four case studies. They reviewed the financial statements and other explanatory documents published by the companies. They specifically searched for disclosures in relation to the topic of climate change. Any description by the companies of the effects of climate change on their business and assets and their reflection thereon, were analysed. In addition to this analytical approach, search terms were deployed to systematically check all available documents. The search terms included: climate change, climate risks, and circular economy. For each case study company, the authors completed the answers to the template questions on a fact sheet.

The two accounting experts first performed all four case studies in an independent way. Secondly, for purposes of triangulation, they discussed any deviations in their research results and decided on a common conclusion regarding the answer to each question for each of the four case studies. This resulted in one fact sheet with answers to the template questions per case study.

We had a brainstorm session with all four authors to discuss the case study results as reflected in the four fact sheets and to analyse the findings in the light of the extant literature and our research questions.

Next, we produced a matrix which included the answers to the questions for all four case studies for purposes of comparison. A summary of the matrix is presented in Table 2. In this way, we could also identify if any information was lacking and still had to be produced for completing the fact sheets. Hence, subsequent information was added so that that all four cases would be comparable.

Table 2:

Summarized research findings.

QuestionCase Study ACase Study BCase Study CCase Study D
1. [Type of company]Parent companySubsidiary of two parent companies (each holds 50 %)Parent companyParent company
2. [Statutory Financial Statements/Consolidated reports]Statutory 2016Statutory 2016Statutory 2016Statutory 2016
Consolidated 2016Consolidated 2016Consolidated 2016Consolidated 2016
3. [Legal form/listed shares]Limited liability company, listedLimited liability, not listedLimited liability, listedLimited liability, listed
4. [Activities]Purchasing, production and marketing of natural gas and electricity.Oil & gas production in the North Sea.Planning, construction and operational management of wind farms.Development of large-scale wind and solar projects.
5. [Cooperation/ Dependency]NoNoNoTied to sister companies through stapled stock arrangement
6. [Accounting standards/Valuation of Property, Plant and Equipment / Impairment policies]IFRSIFRSIFRSAustralian Accounting Standards (AAS)
Items of property, plant and equipment are recognized at historical cost less any accumulated depreciation. Besides internal sources of information, impairment is tested on the basis of: “(1) significant changes in the economic, technological, regulatory, political or market environment; (2) fall in demand; and (3) adverse changes in energy prices and (…) exchange rates.”The valuation of its oil and natural gas operations’ assets comprise machine and technical equipment and construction in progress.

Costs for producing oil and gas wells as well as for uncompleted wells are capitalized following the “successful efforts method”. Assets or groups of assets are tested for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable.
Property, plant and equipment are valued at historical cost less any accumulated depreciation and any accumulated impairment losses of these assets. Assets are tested for impairment when there is an indication that they need to be impaired on the basis of changing conditions or circumstances.The value of property, plant and equipment, such as wind turbines and associated plants, is measured as the cost of the asset less accumulated depreciation and impairment. The value of property, plant and equipment such as wind turbines and associated plant is measured as the cost of the asset less accumulated depreciation and impairment.
7. [Reserves]Gas that has been explored and injected into underground storage facilities is included in the balance sheet under Inventories. It is measured at weighted average purchase cost upon entering the transportation network. Impairment loss is recognized.Oil & gas reserves are not included in the Statutory Financial Statements or other disclosures.

It remains unclear whether non-financial information on proven reserves is accounted for in other corporate entities within the group.
The Consolidated Annual Report 2016 refers to the installed capacity of owned windfarms of approximately 238MW, which according to the Annual Report results in approximately 500 million KwH of electrical power delivered per year.Future wind and solar energy are not accounted for in the Financial Statements.

Concessions, e. g. for wind parks or solar PV parks, are neither accounted for in the Financial Statements.
8. [Future cash flows and income streams]There is no inclusion of future cash flow information in the annual reporting. We note that impairment tests are based on future cash flows for property, plants and equipment (see above Q6).No specific reference to future cash flows were included in the Financial Statements.hThere is not a specific reference to future cash flows, however the Annual Report does provide an estimated figure of yearly energy production and future production capacity.No specific reference to future cash flows, however future cash flows are used for assessing value in use. Also, currently installed and future energy production is disclosed.
9. [Climate Change indicators]The AR 2016 addresses several risks in relation to climate change:

– The regulatory and political environment (p. 45)

– Social acceptability of its business activities i. e. license to operate (p. 47)

– The impacts in terms of energy demand (p. 47)

However, a connection between these risks and the valuation of assets was not established in the Report.
Impact factors due to climate change risks were not recorded in the Financial Statements.

The sole “Environmental target” for 2015 comprises the preparation for an “Energy Efficiency system that can be certified to the ISO 50,001 standard”.
It is stated that regulatory measures and the planetary boundaries create an opportunity for products and services of renewable energy companies. Climate change is mentioned as a risk because the amount of wind can vary considerably in subsequent years. However, a connection between this risk and the valuation of assets is not made in further detailed or quantitative terms.The AR 2016 comprises many references to climate change and specifically to the Paris Agreement. The Group determines the recoverable amount of the CGU based on value-in-use calculations. The calculations use cash flow projections covering the total life of the wind farms. The Group makes assumptions re expected wind resources, availability, prices, operating expenses and discount rates in calculating the value-in-use of its CGU.

Source: Authors’ own.

5 Results

5.1 Case study findings and comparative analysis [question 1–8]: Company characteristics and accounting policies

In this section, the findings that we collected from the fact sheets, the brainstorm session and the combined comparative cases matrix, are presented. Sub-Section 5.1 contains a report in regard to the legal characteristics and the accounting policies of the selected case studies, i. e. the Companies A, B, C, and D (see the questions 1–8 in Table 1). In Sub-Section 5.2, we discuss the findings concerning question 9 (see Table 1), i. e. to what extent the Case Companies elaborate on key climate change indicators that (can) affect the figures included in its financial statements. We also analyse the findings and provide some exploratory conclusions.

5.1.1 The legal and reporting characteristics of Companies A-D [questions 1, 2, 3]

Of the selected companies, each of the Companies A, C and D is a parent company of a corporate group, Company B is a joint venture of two companies, each of them part of a large oil & gas group of companies (each owns 50 % of Company B). All four Companies A-D publish statutory Financial Statements. We examined on the basis of availability the 2016 Financial Statements of the Companies A, C and D and the 2015 Financial Statements of Company B. Furthermore, financial information concerning each of the four Companies A-D is included in the respective consolidated corporate group reports. The relevance hereof is that besides examining the statutory company Financial Statements of each selected company, we could also review the respective consolidated reports in order to find additional information for answering the questions. We examined on the basis of availability: the 2017 consolidated reports (Company A) and the 2016 consolidated reports (Companies B, C and D).

5.1.2 The business activities of the Companies A-D [question 4]

Companies A and B are engaged in energy production from non-renewable sources. Company A, based in France, is primarily engaged in the production and distribution of electricity and natural gas, upstream and downstream in the entire energy value chain. Company B operates oil & gas production platforms in the North Sea. The other two companies, C and D, are in the business of renewable energy. Company C’s core business covers the planning, construction and operational management of wind farms in Germany and abroad, and since 2010, also solar power. Company D is the largest owner, developer and operator of windfarms in Australia.

5.1.3 Mutual dependencies and cooperation [question 5]

With regard to potential (mutual) dependencies, we ascertained that the Companies A, C and D are parent companies that direct their group companies. Additionally, Company D is tied to two sister companies (3 sister companies in total) through a stapled stock agreement. As indicated above, Company B is a subsidiary of two companies (each is 50 % owner), which are each part of a large oil & gas group of companies. Concerning the listed European company, i. e. the ultimate parent companies of Company B, it is noted that Company B contributes 5 % to the total revenues of the consolidated industrial group.

5.1.4 Accounting standards, policies on valuation of production assets and impairment [question 6]

Three of the Companies apply the IFRS accounting framework in their financial statements, i. e. the Companies A, B and C. Company D follows the Australian Accounting Standards & Corporations Act 2001 (AAS). We examined how the four Companies valued their production assets (Property, Plant & Equipment). All Companies indicated that they apply the method of historical cost less any accumulated depreciation and any accumulated impairment losses of the assets. We will now elaborate on each of the Companies’ financial reporting practices concerning their production assets.

Concerning Company A, it was found that the 2016 consolidated Financial Statements have been prepared using the historical cost convention. A distinction is made between:

Items of property, plant and equipment [which] are recognized at historical cost less any accumulated depreciation and any accumulated impairment losses. (Registration Document 2016, pp. 206)

and

Investments into assets for exploration and production of mineral resources (i.e.: natural gas) [which] are capitalized in the balance sheet as ‘pre-capitalized exploration costs’. (Registration Document 2016, pp. 210)

With regard to impairment, Property, Plant and Equipment are tested – besides internal sources of information – on the basis of the following external indicators:

(1) Significant changes in the economic, technological, regulatory, political or market environment in which the entity operates or to which an asset is dedicated; (2) Fall in demand; and (3) Adverse changes in energy prices and US dollar exchange rates [Italics added by authors]. (Registration Document 2016, pp. 211)

They also state that:

If the recoverable amount of an asset is lower than its carrying amount, the carrying amount is written down to the recoverable amount by recording an impairment loss. The recoverable amount is the higher of its fair value less costs to sell and its value in use. Value in use is primarily determined based on the present value of future operating cash flows and a terminal value [Italics added by authors]. (Registration Document 2016, pp. 211)

Concerning impairment of Property, Plant and Equipment and intangible assets, Company B states that: “Assets or groups of assets are tested for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable” (Company B, AR2015, pp. 15). The Company indicates that goodwill is tested on a yearly basis. As the general method applied for impairment, it is stated that the:

recoverable amount is the net present value of the future cash flows of the asset or group of assets under business plan assumptions. If the carrying amount exceeds the recoverable amount, the asset (group) is considered impaired and is written down to its recoverable amount. (Company B, AR2015, pp. 15)

Furthermore, it is communicated that Property, Plant and Equipment assets that have previously been impaired, will be annually submitted to an assessment to determine whether the current recoverable amount is higher than the current carrying value, in which case the impairment loss is (partially) reversed and the carrying amount of the asset is increased.

Company C reports that its “assets are resultantly valued at historical cost less any accumulated depreciation and any accumulated impairment losses of these assets” (Company C, Geschäftsbericht, pp. 98). Impairment is applied when there is an indication that the assets “may be impaired on the basis of changing conditions or circumstances” (Company C, Geschäftsbericht, pp. 99).

In its Key assumptions for value-in-use calculations, Company D firstly states that the determination of the recoverable amount of the Cash Generating Unit (CGU) is based on value-in-use calculations (Company D, AR2016, p. 74). Secondly, it is mentioned that the calculations use cash flow projections covering the total life of the wind farms, which is greater than or equal to 25 years. Thirdly, assumptions are made around expected wind resource, availability, prices, operating expenses and discount rates in calculating the value-in-use of its CGU, whereby Company D indicates that “variations in the estimates and assumptions may have a significant risk of causing a material variation to the calculated recoverable amount of assets and liabilities” (Company D, AR2016, p. 88).

5.1.5 Valuation of reserves [question 7]

For Company A, it is recorded that:

So-called working gas [gas that has been explored and injected into underground storage facilities] is included in the balance sheet under ‘Inventories’. It is measured at weighted average purchase cost upon entering the transportation network. An impairment loss is recognized when the net realizable value of inventories is lower than their weighted average cost. (Company A, Registration Document, pp. 212)

In its Financial Statements, Company B does not report on any oil & gas reserves. Potentially, there are oil & gas reserves disclosed in the consolidated reports of one or both of its two parent companies. Company C refers to the installed capacity of owned wind farms and estimates how many KwH of electrical power will be delivered per year (Company C, Geschäftsbericht, 2016, p. 14). Company D does not report on future wind and/or solar radiation in its Financial Statements, nor on its concessions for wind parks or solar Photo Voltaic (PV) parks.

5.1.6 Reference to future cash and income streams [question 8]

Concerning Company A, there is no information on future cash flows in its Financial Statements. We do note however, that its accounting policies indicate that impairment tests are based on future cash flows for Property, Plants and Equipment (see the findings presented above under Q6). Also for Company B, there is no reference to future cash flow in the Financial Statements. However, the accounting policies of this company indicate that for the application of impairment to Property, Plants and Equipment, the recoverable amount is “the net present value of the future cash flows of the assets under business plan assumptions”. Company C does not include a specific reference in its Financial Statements to future cash flows, however an estimated figure of the amount of yearly energy to be delivered is provided. Company D extensively explains which market mechanisms can affect future cash flows and income streams, and how the company has hedged risks. A summary of all case studies’ results is included in Table 2. The objective of IFRS (applicable to Case Study Companies 1–3) as well as of the AAS (applicable to Case Study Company 4) is that companies provide a true and fair presentation of equity and revenues. This applies to non-renewable energy companies as well as renewable energy companies. From this perspective, non-renewable and renewable energy companies have to provide comparable annual reports. The stated objective also implies that the Case Study Companies are to produce an adequate representation of past and present valuation of their company assets.

Based upon our case research, we can conclude that the IFRS and AAS accounting standards concerning the subject of the valuation of production assets are indeed applied in a similar way by all four Case Study Companies. Furthermore, we found that the Case Companies’ expectations, budgets or scenarios concerning the future value of the production assets are not accounted for in the examined Financial Statements. This is interesting because the potential future value of assets of non-renewable energy companies and renewable energy companies may differ between the industries, due to the differences in their business and business environment. The business model of non-renewable oil & gas companies relies upon finding and exploiting oil & gas reserves, and hence they disclose proven reserves in monetary units in their Balance Sheet Annex. In contrast, the business model of renewable energy companies is based on recurring wind and solar radiation patterns. They cannot disclose proven reserves. Neither did we come across any information in their Balance Sheet Annex concerning future wind and solar radiation patterns, and the connection to the resulting energy production. Disclosures by renewable energy companies concerning those sources of energy are limited to the information on non-financial indicators such as installed maximum energy production capacity, i. e. not in monetary units.

5.2 Case study findings and comparative analysis [question 9]: The application of climate change key indicators

Concerning the valuation of production assets, reserves and future cash flows and income streams, we researched whether the Case Companies elaborate on key climate change indicators that (can) affect the figures included in their Financial Statements. Hence, regarding each of the Case Study Companies, we specifically examined the Balance Sheet Annex, the Director’s Report and investors’ updates on this point. The key climate change indicators that we looked for are the ones mentioned in the TCFD Report (2017a, see Figure 4). Our findings are presented below.

5.2.1 Non-renewable energy companies, accounting policies and climate change

We observed that the test which is used by the Case Study Companies A and B to decide whether impairment of production assets would be necessary, is mostly phrased in a broad and general manner, such as “changes in conditions or circumstances”, or “changing conditions and circumstances” and “whenever events or changes in circumstances indicate”. None of the two non-renewable energy companies specifically refer to climate change as a circumstance relevant for the impairment test. While it is noted by Company A in its Annual Report 2016 that the current transition towards a low-carbon economy impacts the demand and prices of non-renewable energy, no connection was established between the impacts of climate change on the business model of Company A on the one hand and the motivation to impair the value of production assets on the other hand. Company B only referred to an impact of environmental targets in the context of “the preparation for an (internal) Energy Efficiency system that can be certified to the ISO 50,001 standard.”

Neither did the Companies A and B in the application of their impairment test point at the development that governments’ climate mitigation regulation causes an increase in legislation in many jurisdictions. Examples thereof include the introduction of GHG cap and trade systems and GHG taxes, and the imposing of stricter rules on capturing GHG and finding safe storage places.

Furthermore, in the context of impairment, the non-renewable energy companies did not allude to the increasing risk of shareholders’ demands aimed at a change of the business model towards renewable energy production because of climate change. In this vein, we note that non-renewable energy oil & gas companies are also at risk that shareholders decide to disinvest because they consider oil and gas exploration and other assets ‘stranded assets’. An illustration thereof is the proposal by a shareholder to ExxonMobil (May 31, 2017) to ‘Increase Capital Distributions in Lieu of Investment’:

Investors are concerned [that] ExxonMobil is at risk of eroding shareholder value through investments in what may prove economically stranded, unburnable assets in a low carbon demand scenario. Lessons learned from the stranding of assets via the recent fall in the oil price gives food for thought about what the impact of the introduction of carbon pricing (or similar measures from Paris COP21) on higher-cost fossil fuel reserves might be. (ExxonMobil, Notice of 2017 Annual Meeting and proxy statement, pp. 61 and SEC, 2017)

Companies A and B did not refer to such developments in their disclosures on the valuation of their production assets.

Additionally, we observe an increased risk of litigation from private parties, including societal organisations and NGOs, against non-renewable energy companies in the USA, Australia and Nigeria, claiming that such companies should not be getting permissions to start new operations or to continue their business (Lambooy & Palm, 2015) or that they change their business model towards a model that supports climate change mitigation. These imminent risks have not been brought up in the examined documents of the Companies A and B as a trigger to impair their production assets.

We conclude that although all of the abovementioned considerations warrant a cautious approach by non-renewable energy companies concerning the valuation of their production assets, we did not find any disclosure to that end in the impairment motivation policies, nor did we see impairment applied for reasons related to climate change. This is remarkable because the IFRS Conceptual Framework allows and encourages such a cautious approach, since the impairment triggers related to climate change provide relevant information for (potential) investors. Moreover, the TCFD (2017a) recommends to all industries, but in particular to those industries that are and will be impacted severely by climate change (non-renewable energy companies fall within that category), to give full attention to climate change in the company strategy and management policies. The TCFD (2017a) also recommends that companies develop (multiple) long-term scenario analyses concerning climate change effects and include them in their financial statements. The consequence hereof would be that companies are to include arguments related to their scenario analysis in the motivation for impairment of production assets and reserves. Hence, adding to Evangelinos’ et al. proposal for a normative environmental accounting framework, we recommend that these type of arguments and reasoning always be included in the Balance Sheet Annex.

5.2.2 Renewable energy companies, accounting policies and climate change

Global renewable energy production increased with a record growth of 9 % to 2,017 Gigawatt in 2016, according to Renewables 2017 Global Status Report (www.ren21.net). Taking these economic facts into consideration, it is notable that our findings re the valuation of the production assets by the Companies C and D reveal that these renewable energy companies do not point at climate change as a matter that impacts the value of their production assets positively, for example by extended depreciation periods of increased market prices of renewable energy. An additional reason for a less conservative valuation approach regarding the production assets would be that the Companies C and D operate in a ‘healthier’ business sector, at least a sector which is not readily expected to be targeted by investors and public interest groups in connection with climate change. It is not likely that renewable energy companies will be exposed to the risks that are pertinent to non-renewable energy companies as explained above.

Although the renewable energy companies did not refer to climate change in their production assets valuation accounting policies, they did point out that climate change offers business opportunities to them. Company C states: “These opportunities relate amongst others to the market developments due to climate change”. The Annual Report 2016 states that regulatory measures as well as the planetary boundaries create an opportunity for the Company’s products and services (Company C, Geschäftsbericht, pp. 67). With regard to business risks due to climate change, Company C indicated: “The single risk that relates to climate change is the amount of wind that can vary considerably in subsequent years” (Company C, Geschäftsbericht, pp. 75). However, a connection between this risk and the valuation of assets was not established in the Balance Sheet (Annex) in further detailed or quantitative terms.

Another interesting observation is that Company C reports that the windfarms, which have been produced by the Company itself, are valued at internal cost price and may contain hidden reserves as the actual value in a situation of sale would be higher than the book value.

Company D also reports on ‘potential windfalls’. The notes which outline the depreciation charges for the key estimate “useful lives of assets regarding wind turbines and associated plant”, state: “It is possible that these assets will have total useful economic lives in excess of 25 years in which case additional revenues will be received without a matching depreciation charge” (AR2016, pp. 70). Since the value of installed assets, such as production platforms and wind turbines, represents past and present value, future value will remain hidden, i. e. neither disclosed in the revaluation of assets, nor in the non-financial disclosures. In contrast, non-renewable energy companies usually disclose proven oil & gas reserves in their Balance Sheet in accordance with the policies disclosed in their Balance Sheet Annex.

Within the context of generally accepted accounting standards like IFRS and AAS, impairment decisions can only result in a downward correction of the value of assets, i. e. a write off. Revaluation of assets in general is not applicable, although the underlying calculations and business model parameters – in theory – could trigger these. For example, windfarms may improve their models for wind speed forecasting, which will contribute to an increase of future electricity production by the existing turbines (i. e. production assets). Since future electricity production cannot be disclosed in a way comparable to the valuation and presentation of proven oil & gas reserves by non-renewable energy companies, renewable energy companies cannot financially benefit from current updates in future production forecasts by a revaluation of their production assets. As a consequence renewable energy companies cannot account for these potential future benefits in their Balance Sheet.

Contrasting this approach with that of the presentation of oil & gas reserves of non-renewable energy companies that have not been extractable in the past and present but might become so in the future because of changes of external factors, e. g. increase of oil price or innovative exploration methods, we note the following. In that situation, non-renewable energy companies can apply lower depreciation costs to the associated installed assets since they will be deployed for a longer time span, and hence these non-renewable energy companies benefit financially.

Company D provides detailed estimates of its sensitivity related to the level of electricity and environmental certificate prices and the volatility thereof, based on “an historical basis and market expectations for future movement” (Company D, AR2016, pp. 88). The Company stresses that its electricity and environmental certificates are exposed to the risk of changes in the market prices in the regions where the Company operates and sells in Australia. A decrease in the electricity or environmental certificate price will reduce the revenues earned. The Company mitigates such a financial risk by entering into power purchase agreements and green product purchase agreements. The company minimises future price volatility by fixing the sales price of the electricity and environmental certificates which it will produce in the future.

In conclusion, Company C and D signal in their disclosures that their products and services are in demand and that this demand is growing due to climate change and related developments. They indicate that political and legislative developments are supportive of the popularization of renewable energy production. Company C indicates that climate change also constitutes a risk in terms of less predictable wind patterns. The Companies, however, do not establish a quantitative relationship between these positive business opportunities and business risk on the one hand and the valuation of their production assets on the other hand.

Additionally, where non-renewable energy companies usually disclose proven oil & gas reserves in their Balance Sheet in accordance with the policies disclosed in their Balance Sheet Annex, the renewable energy companies cannot activate the future electricity potential resulting from their production assets. We note that the Companies C and D do not communicate in their Financial Statements their knowledge about wind and solar radiation patterns and the associated expectations regarding future electricity production.

6 Conclusion

In this study, the goal was to explore how corporate climate change policies and approaches are linked to the question of how to value production assets. Moreover, we aimed to explore how this matter has been taken up by non-renewable energy companies and renewable energy companies, and what the differences are between them in following the accounting frameworks in the valuation of their production assets.

The institutional framework that is applicable to the valuation of production assets of energy companies are generally accepted accounting standards (the IFRS conceptual framework). We explored if they sufficiently encourage energy companies to reflect on climate change in the valuation of their production assets, taking into account the new initiative of the Task Force on Climate-Related Financial Disclosures (TCFD 2016, 2017a, 2017b).

As we were particularly interested in the motivation provided by companies for explaining their choices, we pursued a qualitative methodology. In performing the case studies, we used the climate change indicators provided in the TCFD recommendations as a guide for designing our question template. In this exploratory case study research, we tested if, and to what extent, these four companies provide information on the impact of climate change on their production assets and future cash inflows.

Our main conclusions are as follows:

  1. The application of the accounting standards by non-renewable energy companies and renewable energy companies is executed in a similar way. Overall, it became apparent that potential future changes concerning the valuation of their production assets are not accounted for by the Case Companies in the three sets of Financial Statements based upon IFRS and the one set of Financial Statements based upon AAS. We point out that the effect of climate change will likely have a very different impact on the future value of the production assets of the four energy companies in the two types of industries. That is: non-renewable energy oil & gas companies may expect lower future cash inflows when they own so-called ‘stranded assets’. This assumption is supported by the shareholder’s proposal proposed at the general meeting of ExxonMobil, dated May 31, 2017, regarding the erosion of the shareholder value because of Exxon’s investments in unburnable assets while currently operating in a low-carbon energy demand scenario (see Section 5.1). On the other hand, the two case studies for the renewable energy companies reveal that it is probable that they currently undervalue the future potential of their business model as renewable energy will become more and more in demand in a low-carbon energy demand scenario. The reasons for this are, for example, that renewable energy companies are not allowed under IFRS and AAS to account for the potential additional energy production (and revenues) of the existing energy production assets achievable among other because of technological upgrading and/or the development of more sophisticated underlying weather models.
  2. Referring to Evangelinos et al. (2015), we remark that all Case Companies had an opportunity to include information about their expectations as to what extent climate change mitigation policies impact their business model, future cash inflows, and valuation of production assets, in their Balance Sheet Annexes (level 3 in the Evangelinos’ et al. normative framework). However, in response to the question whether, and in which way, the four Case Companies include considerations concerning climate change impacts in the motivation for the valuation of their production assets, we found that none of the four Case Study Companies revealed any climate change specific information in their Balance Sheet Annexes. Even so, none of the four Case Study Companies applied any impairment to such assets because of reasons related to climate change. Technically, an impairment is one of the instruments provided for in the accounting standards, i. e. to downgrade the value of an asset (thus, upgrading the value of an asset is not allowed). For example, when the cost of exploration increases too much, future cash flows to be earned from ‘old’ energy sources will decrease, and hence might indicate an impairment trigger in regard of their production assets. As argued, in the future, continued and difficult discussions on impairment are also expected regarding the non-renewable energy sector’s (stranded) assets due to climate change (see the Sections 2 and 5.2). On the other hand, renewable energy companies have disclosed, respectively, in their Balance Sheet Annexes and/or Management Reports, that climate change mitigation policies augment their business opportunities, e. g. implying upside changes for the potential and/or estimated energy production of currently installed production assets. Company D specifically indicated that climate change has a positive effect on the prices of the electricity produced.
  3. Concerning the question whether the financial stakeholders are enabled “to assess an entity’s prospects for future net cash inflows”, we found that renewable energy companies cannot benefit from impairments when e. g. due to innovation of production assets, the economic lifetime increases and/or the asset is able to generate more energy. These potential ‘hidden reserves’ of renewable energy companies are based upon future increased energy production and revenues of installed production, whereas the financial statements comprise according to generally accepted accounting standards predominantly past and present value, not future value. We point out that, although the demand of renewable energy already increases rapidly, the accounting standards do not avail the impairment instrument to renewable energy companies to reflect this. Case Studies C and D show that the current system does not support renewable energy companies to provide financial stakeholders with insights in expected increases in their future cash inflows and their innovation potential.

Concluding, the IFRS framework does not sufficiently encourage energy companies to reflect on climate change in the valuation of their production assets. However, the framework provides options to report on climate change, e. g. in the Balance Sheet Annex. The TCFD recommendation to develop climate change scenarios can be used as a guidance in this process (see Section 2 above). The TCFD deems high quality financial reporting as crucial in this process and they point out the increased importance of understanding the governance and risk management context in which financial results are achieved.

Additionally, we recommend that renewable energy companies include information about wind and solar radiation patterns and estimates of future energy production of installed production assets in their Balance Sheet Annex comparable with the disclosure of proven oil and gas reserves, which are usually disclosed in barrels (i. e. non-financial). While non-renewable companies disclose proven energy reserves, it would provide a more comparable picture if renewable energy companies disclose similar information to financial stakeholders. In order to enable an accurate and meaningful assessment of a renewable energy company’s prospects for future net cash inflows, existing and potential investors most likely will appreciate such disclosures because they demonstrate the effect of climate change on the renewable energy business.

6.1 Limitations of the research

As a consequence of the design of our research, the external validity of our research is limited. We only conducted four case studies. However, since the selection of the Case Study Companies was based upon theoretical replication, we do not anticipate to find significant different results when examining more energy companies’ financial statements pertaining to the reporting year 2016.

Although we aimed to minimise the technical accounting differences by restricting the selection of the Case Study Companies to IFRS companies only, we decided to also select one Australian renewable energy company that reports according to the AAS. While technical accounting differences may occur, we nonetheless decided to include this case study because of the benefits to be gained in the research from assessing such a mature and large renewable company with accompanying mature and extensive annual reporting.

6.2 Future research

A potential follow-up project is to compare the findings of this study with the figures and companies of similar companies published in relation to the financial year 2017. Additionally, the exploratory case study findings in this paper can be expanded with assessments of more energy companies. Also, the same research question could be used in regard of other industries, e. g. traditional car producers versus electric car producers. Another research focus could be to assess the application of the accounting standards applicable to the value of the farming land in the situation of traditional large-scale food production companies on the one hand and organic food companies on the other hand, in connection with the use of pesticides and fertilizers and their impact on the production capacity of the soil and the continued use of ground water.

Another option for future research is to further develop the environmental accounting framework as proposed by Evangelinos et al. (2015) by complementing the framework with recommendations offered in the TCFD Report (2017a, 2017b) and implementing them therein.

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  • Task Force on Climate-related Financial Disclosures. (2017a). Recommendations of the task force on climate-related financial disclosures [online]. Retrieved June 3, 2018 from: https://www.fsb-tcfd.org/wp-content/uploads/2017/06/FINAL-TCFD-Report-062817.pdf

  • Task Force on Climate-related Financial Disclosures. (2017b). Technical supplement – The use of scenario analysis in disclosures of climate-related risks and opportunties [online]. Retrieved April 26, 2018 from https://www.fsb-tcfd.org/wp-content/uploads/2017/06/FINAL-TCFD-Technical-Supplement-062917.pdf

  • Thislethwaite, J. (2015). The politics of experimentation in climate change risk reporting: The emergence of the climate disclosure standards board (CDSB). Environmental Politics, 24(9), 970–990.

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  • Vlachou, A. (2014). The European Union’s emissions trading system. Cambridge Journal of Economics, 38(1), 127–152. doi:

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  • Walter. (2017). Sustainability matters: Focus on your future today [online]. Retrieved February 2018 from https://corpgov.law.harvard.edu/2017/04/18/sustainability-matters-focusing-on-your-future-today/

  • Warwick, P., & Chew, N. (2012). The ‘cost’ of climate change: How carbon emissions allowances are accounted for amongs European union companies. Australian Accounting Review, 60(22), 54–76.

  • Yin, R. K. (2009). Case study research: Design and methods (4th ed.). Thousand Oaks, CA: Sage.

Footnotes

1

CDP is a not-for-profit charity that runs the global disclosure system for investors, companies, cities, states and regions to manager their environmental impacts. See: https://www.cdp.net/en

2

Car Carbon Tracker is an independent financial think tank that carries out in-depth analysis on the impact of the energy transition on capital markets and the potential investment in high-cost, carbon-intensive fossil fuels. See: https://www.carbontracker.org.

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  • Task Force on Climate-related Financial Disclosures. (2016). Phase I report of the task force on climate-related financial disclosures. [online]. Retrieved April 26, 2018 from https://www.fsb-tcfd.org/wp-content/uploads/2016/03/Phase_I_Report_v15.pdf

  • Task Force on Climate-related Financial Disclosures. (2017a). Recommendations of the task force on climate-related financial disclosures [online]. Retrieved June 3, 2018 from: https://www.fsb-tcfd.org/wp-content/uploads/2017/06/FINAL-TCFD-Report-062817.pdf

  • Task Force on Climate-related Financial Disclosures. (2017b). Technical supplement – The use of scenario analysis in disclosures of climate-related risks and opportunties [online]. Retrieved April 26, 2018 from https://www.fsb-tcfd.org/wp-content/uploads/2017/06/FINAL-TCFD-Technical-Supplement-062917.pdf

  • Thislethwaite, J. (2015). The politics of experimentation in climate change risk reporting: The emergence of the climate disclosure standards board (CDSB). Environmental Politics, 24(9), 970–990.

    • Crossref
    • Export Citation
  • Vlachou, A. (2014). The European Union’s emissions trading system. Cambridge Journal of Economics, 38(1), 127–152. doi:

    • Crossref
    • Export Citation
  • Walter. (2017). Sustainability matters: Focus on your future today [online]. Retrieved February 2018 from https://corpgov.law.harvard.edu/2017/04/18/sustainability-matters-focusing-on-your-future-today/

  • Warwick, P., & Chew, N. (2012). The ‘cost’ of climate change: How carbon emissions allowances are accounted for amongs European union companies. Australian Accounting Review, 60(22), 54–76.

  • Yin, R. K. (2009). Case study research: Design and methods (4th ed.). Thousand Oaks, CA: Sage.

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