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Accounting May Be ‘Blind Spot’ as SEC Mulls Climate Reporting

Aug. 23, 2021, 8:45 AM

Coming soon: SEC rules for public companies to report the impacts of climate change and progress toward climate goals.

Already here, and not to be ignored: accounting requirements that capture some details, like the financial effects of a commitment to going carbon-neutral or phasing out energy-sucking machinery and equipment.

While the Securities and Exchange Commission’s reporting rules—expected by early fall—grab headlines, the existing financial reporting requirements must still be followed, say practitioners, standard-setters, and regulators themselves. And the SEC is paying attention.

“There’s so much attention being given to reporting requirements in the future,” said Eric Knachel, partner in the professional practice group at Deloitte & Touche LLP. “Potentially overlooked is the requirements today.”

No U.S. accounting rule spells out how to account for climate change or environmental impact. But many rules require judgments and assumptions that contemplate environmental considerations, Knachel said.

“Companies can have a blind spot around that,” he said.

The SEC in the spring warned about these potential blind spots. At a conference in May, an agency official said the SEC was scrutinizing how companies account for climate-related risks based on current U.S. generally accepted accounting principles (GAAP). Lindsay McCord, chief accountant for the Division of Corporation Finance, highlighted accounting rules for asset retirement, environmental obligations, and loss contingencies as potential areas for review.

The Financial Accounting Standards Board flagged even more issues in voluntary guidance it released in March. The accounting standard-setter reminded companies and organizations about existing rules that could require businesses to consider the effects of material issues related to environmental, social, and governance matters, even if the rules don’t explicitly state it.

Some industries—such as companies subject to environmental regulations—may be more affected than others, the rulemaker said.

“Companies have it more on their radar if they’re a manufacturer that has environmental considerations; they might have it baked in,” said R. Charles Waring, director at Eisner Advisory Group LLP. “Environmental aspects may not be front or center for others.”

The accounting rules largely capture financially significant issues like environmental or regulatory changes that would cause big swings in estimates versus the broader climate-related risks the SEC is considering, Waring said.

“That’s a totally different ballpark,” he said.

FASB itself acknowledges that its accounting standards don’t cover everything investors demand. The financial accounting standards cover items that can be measured or have journal entries, versus the broader issues the SEC is tackling. Here are some highlights of what exists already in U.S. GAAP, according to FASB.

ASC 275, Risks and Uncertainties: Requires organizations to share risks and uncertainties that could significantly affect—in the near term—amounts they report in their financial statements. If an environmental matter is material and happening soon, a company needs to describe it in its financial statement footnotes.

ASC 350, Property, Plant and Equipment: Calls for measuring long-lived assets like buildings, machinery, and equipment at their historical cost. The value of the asset gets depreciated, or written down, in financial statements over time. Where ESG comes into play: If more energy efficient machines or equipment gain market popularity or new environmental regulation force a company to change, that decreases the value of the assets. Decreased value means faster writedowns.

Subtopic 410-20 and Subtopic 410-30, Asset Retirement and Environmental Obligations: Requires organizations to consider regulatory, legal, and contractual obligations when accounting for things like land contamination remediation or accounting for fines, such as for failing to meet emissions targets. If a business has to shut down, or retire, a big-ticket asset like a toxic waste storage facility or an offshore drilling platform, it creates an asset retirement obligation. This obligation is a liability recorded in the financial statement.

Subtopic 450-20, Contingencies—Loss Contingencies: U.S. GAAP requires companies to report potential fines and penalties as contingencies when a loss is “probable and reasonably estimable.” The standard outlines how to make the assessment.

ASC 330, Inventory: Stockpiles of raw materials and finished goods have to be measured. A regulatory change or consumer taste for more environmentally sound or sustainably sourced products could reduce the value of a warehouse full of energy inefficient machines.

To contact the reporter on this story: Nicola M. White in Washington at nwhite@bloombergtax.com

To contact the editors responsible for this story: Jeff Harrington at jharrington@bloombergindustry.com; Kathy Larsen at klarsen@bloombergtax.com