Impact of climate-related risks on the balance sheet



Impact of climate-related risks on the balance sheet

A company’s balance sheet gives an overview of the company’s financial conditioners. PICTURES | CASE

Climate-related risks refer to the potential negative impacts of climate change on an organization.

There are two categories of climate-related risks. The first category is that of physical risks, which arise from changes in weather and climate. Examples of physical hazards include severe droughts, floods, rainfall, wildfires, and the effects of rising temperatures and loss of biodiversity.

The second category is transition risks, which arise from the transition to a low-carbon economy. They include technological, market, reputational, legal and regulatory risks.

Although many organizations have made net zero commitments and transition commitments to manage these risks and take advantage of opportunities, the war in Ukraine will have an immediate and short-term impact on the timelines of net zero commitments and decarbonization efforts. globally, as more fossil fuel is pumped in to deal with the unfolding global energy crisis.

However, some share the view that the duration and contained scope of the war will have a mid- to long-term effect on global net zero transition timelines and programs.

Climate-related physical and transition risks could impact an organization’s balance sheet (assets and liabilities) and business activities in the short, medium and long term.

Impact assessment

Organizations should start performing impact assessments on the effects of climate-related risks on their balance sheets. It should be part of an organization’s response to the overall risks posed by climate change to the organization and to society as a whole.

The use of climate scenario analysis, a process that identifies a range of scenarios that provide a variety of possible future climate conditions and the organization’s impact and response, is a welcome addition to this assessment.

These assessments will allow the organization to understand the effect of climate-related risks on specific assets and liabilities of the organization.

Organizations would also understand the immediate and long-term effects of these climate-related risks on their business operations and performance.

For example, organizations may identify stranded assets that are not yielding an economic return to the organization due to changes associated with transitioning to a low-carbon operation before the end of the asset’s economic or useful life. ‘asset. Organizations in an economy contribute to emissions that directly or indirectly affect climate change.

However, certain aspects of the economy create significant emissions such as electricity, mobility (road, aviation, rail, maritime), agriculture, forestry, waste (disposal, incineration and treatment), buildings (heating and cooking) and industry (steel, cement, chemical and mineral extraction and refining).

Therefore, understanding an organization’s position and the scope of its emissions through an impact assessment will allow the organization to properly plan for its future, long-term competitiveness, and sustainable growth.

Balance sheet review

Some of the balances that organizations should consider in the balance sheet include an assessment of the impairment of investments held in a subsidiary, joint venture and associates taking into account the effect of climate-related risks on forecasting assumptions such as growth and cash flow.

The recoverability of receivables and loans highly exposed to climate-related risks could affect the value of these assets and the measurement of credit risk. Organizations must also ensure that they maintain adequate provisions to cover decommissioning obligations associated with the retirement of assets.

Useful lives and residual values ​​of intangible assets, property, plant and equipment and equipment owned by organizations should be reviewed and possibly revised based on the impact of climate-related risks.

Insurance companies, for example, should take into account the increased frequency and magnitude of insured events as well as an accelerated time frame for an insured event to occur when measuring their insurance liabilities in due to climate-related risks.

Awodumila is an Associate Director at PwC Kenya. An author who writes and speaks widely on topics related to corporate reporting


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