The Irish Auditing and Accounting Supervisory Authority (IAASA) contributes to ESMA’s activities in the accounting enforcement arena through its participation in the ESMA-sponsored European Enforcement Co-ordination Sessions (EECS). With responsibility for the coordination of supervision of almost 4,500 issuers listed on the regulated markets in the EEA preparing IFRS financial statements, EECS constitutes the largest regional accounting enforcers’ network with supervision responsibilities for IFRS.

1. Climate-related matters
2. Direct financial impacts of Russia’s invasion of Ukraine
3. Macroeconomic environment
4. Disclosures relating to Article 8 of the Taxonomy Regulation
5. NFRD: Reporting scope and data quality
6. Identification of alternative performance measures (APMs) and reconciliations.

Over the space of a short few years, climate-related matters have emerged as a key consideration in the preparation of financial statements. Similarly, green-washing, the disconnect between what companies say in their narrative reporting and what is reflected in the financial statements proper, has emerged as an area of focus for accounting enforcers. Stakeholders are increasingly seeking comprehensive information on companies’ climate responses.

ESMA reminds preparers, approvers and auditors to consider climate-related matters when preparing and auditing financial statements where those matters are material, even if accounting standards do not explicitly refer to climate-related matters.

Companies should be attentive to climate-related matters and their effects when providing a balanced and comprehensive analysis of the development and performance of the company’s business and of its position together with a description of the principal risks and uncertainties that it faces. ESMA believes that companies should consider whether the degree of emphasis placed on climate-related matters in the management report and the non-financial information is consistent with the extent of disclosure on how the risks and opportunities arising from climate matters have been reflected in the judgements and estimates applied in the financial statements.

ESMA notes that boilerplate disclosures stating that climate-related matters have been considered (e.g., in impairment tests) without further explanation as to how and to what extent they impact financial statements should be avoided. Where companies, especially those in exposed sectors, conclude that no material financial impact from climate-related matters on their operations and the measurement of their assets, liabilities and cash flows is expected, ESMA expects those companies to disclose: (i) the assessments performed, (ii) the judgements made, and (iii) the time horizon used to reach such a conclusion. Disclosures should be tailored to the specific circumstances of the specific company. ESMA encourages companies to include all information required to be disclosed under accounting standards on climate-related matters in one single note.

• impairment of non-financial assets,
• provisions, contingent liabilities and contingent assets, and
• power purchase agreements.

An important disclosure related to climate is that of transition plans which help users understand whether and how a company intends to modify its business model, operations and asset base towards a model that is compatible with the latest climate science recommendations.

The ESMA CEPs paper notes that increased transparency is necessary when companies prepare transition plans; some companies present ambitious climate goals without addressing how those goals were established, under which scenario they are developed, and the actions in place to achieve them. ESMA calls on issuers to provide company specific disclosures.

The ESMA CEPs paper directs companies’ attention to the requirements of the Non-Financial Reporting Directive (NFRD) and notes that companies should be aware that the general expectation from both users and regulators is in the direction of increased transparency on climate-related matters.

ESMA highlights some considerations for companies to bear in mind in the financial reporting impact of the war.

Separate presentation
The ESMA CEPs paper cautions against the separate presentation of the impacts of the war in the income statement; separate presentation may not give a fair presentation of a company’s financial performance and may be misleading to users’ understanding of the financial statements.

Therefore, ESMA urges companies to disclose, in the notes to the financial statements, qualitative and quantitative information on the significant impacts, the judgements and assumptions applied in the recognition, measurement and presentation of revenues, expenses, assets, liabilities, and cash flows.

Loss of control
ESMA notes that assessing whether control, joint control or significant influence has been lost requires detailed consideration of all facts and circumstances and the use of judgement is needed when assessing whether or not control, joint control or significant influence has been lost due to the war.

Discontinued operations
Some companies have presented exit plans concerning operations located in Russia and Belarus. In this context, ESMA urges caution regarding the classification of non-current assets held for sale and/or discontinued operations under IFRS 5 Non-current Assets Held for Sale and Discontinued Operations.

There should be clarity regarding any judgements made on the classification and measurement of assets and liabilities under this Standard. Companies should ensure that there is consistency between the disclosures provided in financial statements and in the management report.

Impairment of non-financial assets
ESMA expects that, because of the gas supply restrictions and potential rationing of energy to certain industries in connection with the Ukrainian/Russian war, companies should consider the impact of various energy price-scenarios and potential restrictions when performing their impairment test sensitivity analysis and disclose the key assumptions [paragraph 134(f) of IAS 36 Impairment of Assets].

The current macroeconomic environment, resulting from a combination of residual Covid-19-related effects, inflation, interest rate increases, deterioration of the business climate, geopolitical risks and uncertainties regarding future developments, pose significant challenges to companies and their operations.

Accordingly, the ESMA CEPs paper emphasis that companies must (i) assess the impacts that the macroeconomic environment and uncertainties have on their financial statements and incorporate those impacts in the financial statements (e.g., the ability to continue as a going concern and the impacts of energy costs on operations).

Some specific macroeconomic impacts are set out including:

Impairment of non-financial assets
Companies should ensure that potential indications of impairment are identified and responded to and should explain the impact of interest rate increases on impairment tests (e.g., changes in the weighted average cost of capital (WACC)). Companies should also consider adjustments to the range of reasonable possible changes in assumptions in their sensitivity analysis.

Employee benefits
Companies should ensure that the actuarial assumptions used reflect the current economic environment and are mutually compatible, including estimated future salary increases.

Revenue from contracts with customers
Companies should exercise caution before recognising an asset from the costs incurred to fulfil a contract in accordance with paragraph 95 (c) of IFRS 15 Revenue from Contracts with Customers in a context of strong inflation, as additional costs (e.g., rising raw material prices, energy costs, salary increases) may not be recovered. In addition, companies unable to reflect the increase of costs in the sale prices of services and goods may need to assess whether contracts have become onerous [IAS 37].

Financial instruments
Current macroeconomic developments highlight the importance of disclosures that enable users of financial statements to evaluate a company’s exposure to interest rate risks, commodity price risks and related liquidity risks in accordance with paragraph 31 of IFRS 7 Financial Instruments: Disclosures.

Expected credit losses (ECLs)
The current macroeconomic environment may pose challenges for the ECL models used by financial institutions due to a lack of experience in modelling such circumstances.

Therefore, to enable users of financial statements to understand the effect of credit risk on the amount, timing, and uncertainty of future cash flows, the ESMA CEPs paper highlights the need for financial institutions to provide transparency on the impact the changing economic environment has on the ECL calculation. In addition, ESMA notes the need for transparency when material adjustments (i.e., management overlays) are used in the measurement of ECLs.

2023 is an important year for the reporting under Article 8 of the TR as financial year 2022 is the first time non-financial undertakings are required to disclose both the taxonomy eligibility and the taxonomy alignment of their economic activities vis-à-vis the climate change mitigation and climate change adaptation objectives.

This disclosure includes those set out in the complementary climate delegated act (Delegated Regulation (EU) 2022/1214). In this context, the ESMA CEPs paper reminds companies that it is mandatory to use the templates in Annex II of the Article 8 Disclosure Delegated Act.

The ESMA CEPs paper notes that, to provide a comprehensive picture of the non-financial matters listed in Article 19a(1) and 29a(1) of the NFRD, a company reports on at least the same scope as that used for its financial reporting.

Those Articles require companies to disclose information on risks linked to their own operations, including those of their business relationships, products or services that are likely to cause adverse impacts. ESMA invites companies to consider reporting on a larger perimeter than that used for its financial reporting when this would be necessary to provide material information on non-financial matters.

To this end, ESMA recommends that issuers describe their supply and sales chains (suppliers, subcontractors, distributors, franchisees and other relevant third parties in the value chain) and clarify the extent to which they have covered these entities in their non-financial reporting.

Companies may consider reporting on their data collection processes and the due diligence performed by their board or other relevant internal decision-making bodies in relation to the data. In this regard, ESMA highlights the important role which robust information systems play for data collection and management.

The ESMA CEPs paper reminds companies:

• That some sub-totals included within the primary financial statements or in the notes (e.g., operating profit/loss, EBIT, EBITDA, and financial ratios) are within the scope of the ESMA Guidelines on Alternative Performance Measures (available at https://www.esma.europa.eu/press-news/esma-news/esma-publishes-final-guidelines-alternative-performance-measures) if those measures are included outside the financial statements.
• To provide reconciliations of the APM to the most directly reconcilable line item, sub-total or total presented in the financial statements of the corresponding period, separately identifying and explaining the material reconciling items.
• The definition and calculation of an APM should be consistent over time. Therefore, ESMA recommends that issuers use caution when making changes to APMs previously used and when presenting new APMs.

The ESMA CEPs paper provides useful guidance to preparers, approvers, and auditors of 2022 financial statements on areas that EU accounting enforcers will focus on when examining financial statements in 2023.

The ESMA CEPs paper should be read in conjunction with IAASA’s 2022 Observations paper (available at http://iaasa.ie/News/2022/IAASA-highlights-matters-for-companies-to-consider) which is addressed to companies falling within IAASA’s financial statement examination remit and may usefully be considered by a broader range of companies.

The ESMA CEPs paper is available at Microsoft Word – ESMA32-63-1320 Public Statement on the European Common Enforcement Priorities 2022 (europa.eu)

IAASA’s 2022 Observations document is available at http://iaasa.ie/Publications/Financial-Reporting-Supervision

The views expressed here are his own and do not necessarily reflect IAASA’s official positions.