Financial accounting for the green transition

Policy makers will need to set ambitious goals and make sure companies do not delay or obscure climate disclosures with their reporting on how climate risks impact financial performance, assets, and liabilities.

Summary

TIME MIRROR wants to contribute to the green transition by encouraging a radical change in financial reporting by bringing the cost of the necessary future investments to achieve carbon neutrality into the present-day income statement and balance sheet. In the near future, this would also include an effective carbon pricing regime to bring the future costs of removing carbon into these accounts.

With governments around the world pledging to limit rising temperatures to 1.5C by 2050 and the Danish parliament committed to large scale reductions of CO2 emissions by 2030, fundamental societal changes will be required to deal with the climate challenge.

“TIME MIRROR is a new four-year project focusing on how companies and their stakeholders will need to radically change their current financial accounting in order to create incentives for the green transition,” says Thomas Riise Johansen, Professor at the Department of Accounting at CBS and project coordinator.

The goal of the project is to explore the role of accounting and reporting in dealing with climate risk, including encouraging Danish companies to achieve carbon neutrality. “Specifically, we aim to identify and provide insights into which actors and tools will be needed to better account for climate change challenges,” adds Professor Johansen.

TIME MIRROR wants to contribute to the green transition by encouraging a radical change in financial reporting by bringing the cost of the necessary future investments to achieve carbon neutrality into the present-day income statement and balance sheet. In the near future, this would also include an effective carbon pricing regime to bring the future costs of removing carbon into these accounts.

Creating incentives

“Some companies do include climate disclosures in financial reports, this disclosure is often only a narrative and somewhat disconnected from the hard-financial numbers that appear in the income statement, balance sheet and shown as key performance indicators,” says Professor Johansen.

The consequences of climate change are already creating physical and transition as well as financial risks, so better accounting will be crucial for financial performance, including how these risks may impact valuations and provisions in the balance sheet. In some cases, if they are ignored, it could in Johansen’s opinion threaten the survival of companies.

“The field of climate disclosure is occupied by a wide range of actors, and all of them are needed as we intend to map expert networks, analyse stakeholder positions and project how they may bring about a positive change,” Professor Johansen adds.

Taking responsibility

One of the biggest challenges for the project will be to convince all of the different actors to acknowledge that the green transition is not a short-term event for which low-hanging benefits can be gleaned.

“If we are serious then all involved would have to leave aside second order concerns and prioritise the main concern, climate change. As examples, this could be standard setters that opportunistically seek to promote their own standards, companies pursing short term profit goals or politicians unwilling to make decisions that are necessary for the long term but not popular in the short run,” says Professor Johansen.

Johansen argues that the challenge for accounting will not only be about measuring emissions, though there will be a need for strong and reliable measurements of greenhouse gas emissions which will have to be standardised across companies. It will also need companies to provide information on e.g. how business activities are changing, assets impairments due to climate risk, provisions for future costs and other disclosures to account for the strategies, activities as well as the cost of removing carbon externalities.

“The concerns about climate change have intensified and although there are great challenges to be overcome, I think this project will be able to highlight that there are also grounds for optimism,” concludes Professor Johansen.

The project involves a team of researchers from CBS and is a collaboration between the Department of Organization and Department of Accounting and funded by the Independent Research Fund Denmark.

Read more about Professor Thomas Riise Johansen