The IFRS Interpretations Committee (IFRIC) has issued an agenda decision explaining how to assess whether an entity’s commitment to reduce or offset its greenhouse gas (GHG) emissions gives rise to a liability in a specific scenario.
This agenda decision may prove useful for preparers, especially as entities come under increasing legislative and stakeholder pressure to respond to the climate emergency and start to make ‘net zero’ or similar climate-related commitments.
The fact pattern
In 20X0, a manufacturer of household goods publicly states that it will:
- gradually reduce its annual GHG emissions, reducing them by at least 60% compared to current levels by 20X9; and
- offset its annual remaining emissions in 20X9 and subsequently by purchasing carbon credits (verified removals of carbon) and retiring these from the carbon market.
In support of its public commitment, the entity publishes its transition plan that:
- explains how it will change its manufacturing methods between 20X1 and 20X9 to achieve the 60% reduction in annual emissions by 20X9;
- states the entity will invest in more energy-efficient processes, purchase more renewable energy and replace existing petroleum-based inputs and packaging materials with lower-carbon alternatives in order to meet its emissions reduction targets.
The question
Does the entity have a constructive obligation as a result of its public statements? If so, does this give rise to a provision that must be recognised at the time the entity publicly states its commitments?
The IFRIC’s observations and conclusion
A two-part test was applied by the IFRIC in responding to the query.
1. Is there a constructive obligation?
The first thing to consider is whether the entity’s public statement creates a constructive obligation. While AASB 137 Provisions, Contingent Liabilities and Contingent Assets states that an entity can create an obligation through its actions (such as publicly making a statement), such actions must create a valid expectation that the entity will discharge the responsibilities it has accepted for it to be considered a constructive obligation.
In this scenario, assessing whether the entity’s public statement is sufficiently specific to create a valid expectation that the entity will fulfill its commitments as announced, will involve judgement. The specific facts and circumstances (which may change over time) will need to be considered, including the nature of the statement and whether it is supported by formally approved and sufficiently detailed plans.
Only if it is assessed that there is a constructive obligation will the second part of the test need to be considered.
2. Does the constructive obligation give rise to a provision?
A constructive obligation does not automatically result in a liability. For a provision to be recognised, the following criteria must be met:
- a present obligation as a result of a past event must exist;
- it is probable that an outflow of cash or other resources will be needed to settle this obligation; and
- the related amount must be capable of being reliably estimated.
Assuming a constructive obligation exists because of the entity’s public statement, the IFRIC concluded:
- No provision is required in 20X0 when the entity makes the statement. At this point, there has been no past event that triggers a present obligation. Simply stating a commitment is not an event that creates a present obligation. The event that creates a present obligation is the event to which the statement applies, and such an event has not occurred at the time the entity states its commitment. Importantly, the costs that will be incurred to reduce the entity’s annual GHG emissions and to offset the greenhouse gases it emits from 20X9 and beyond are costs that it will need to incur to operate in the future. The obligations for these costs do not exist independently of the entity’s future actions.
- Only when the entity emits the greenhouse gases that it has committed to offset will it have a present obligation because of a past event (the past event being emitting greenhouse gases). An obligation arises at this point (i.e. 20X9 and beyond) to acquire carbon credits to offset these emissions.
At the time the provision is recognised in 20X9, a corresponding debit is recognised as an expense rather than an asset, unless such an amount gives rise to, or forms part of, the cost of an item that qualifies for recognition as an asset in accordance with IFRS Accounting Standards.