SEC’s Low Bar for Climate Accounting Disclosures Vexes Industry

A little known provision of the SEC’s sweeping climate plan that calls on companies to tally how extreme weather events and the transition to clean energy could impact their financial performance has drawn strong opposition from accountants and auditors, including the Big Four firms.

Much of the controversy around the proposed rule has focused on the need for companies to detail the pollution emitted by customers and vendors, but requirements that they tally the financial impact of floods, droughts and other climate risks on every financial statement line item causes the most heartburn for auditors and accountants.

If climate issues affect 1% of any line in the balance sheet, income statement, or cash flow statement, companies would have to disclose the dollar figure and explain how they calculated it, according to the agency’s March proposal. That’s a lot of detail, affecting everything from revenue to inventory and cost of goods sold. And it kicks in at a threshold much lower than what the market generally thinks of as constituting “materiality,” the legal concept that governs what companies have to reveal as important to the average investor.

“Everyone’s scratching their heads around it,” said Maura Hodge, ESG audit leader at KPMG LLP.

The unease surrounding the 1% disclosure proposal is not lost on the SEC’s top accountant, Paul Munter, who has pledged to assess all feedback and recommend potential changes to the agency as it drafts final rules. Companies fear that, without changes, they’d be forced to clog their annual financial statements with pages of new disclosures packed with trivial details.

Few believe the provision is workable as is. Accounting firms, trade groups, and businesses ranging from United Parcel Service Inc. to Dell Technologies Inc. have pleaded for relief in comment letters to the SEC. They say the regulator will have to make changes, simplify it, or scrap it before finalizing the larger climate change reporting rules.

Tough Calls

Companies also would have to make judgments about what exactly makes an event or transaction related to climate.

If an early season snowstorm knocks out power at a factory, companies would have to determine whether it’s a climate change-related cost, or just a freak weather event. Transitioning to hybrid delivery trucks might be viewed as a climate-related move, or simply a cost-savings measure.

“You start to put it together and start to realize how tricky some of those judgments are, especially when you’re starting from scratch,” said Marc Siegel, Ernst & Young LLP’s ESG reporting leader and former member of the Financial Accounting Standards Board.

A company can’t just plug in numbers in a footnote and call it a day. Anything it reports must be documented, and that documentation has to be robust enough to meet internal control requirements.

“It becomes a little more clear as to why there was so much pushback,” Siegel said.

The SEC’s plan would link corporate climate-related risks back to company financials, so that companies gave specific, numerical details, as opposed to vague descriptions. The agency has defended the proposed 1% disclosure threshold, saying a bright-line standard would provide more consistent corporate climate-risk disclosures than giving companies leeway via a principles-based approach. A set threshold also would reduce “the risk of underreporting,” it said.

It got a taste of how large companies assessed the materiality of climate-related expenditures last year when it sent dozens of letters asking them to explain how climate risk plays out in their financial statements and to disclose more costs.

The vast majority of the companies said the costs were not financially material yet. Several of the companies—including Target Corp., Cisco Systems Inc., and Las Vegas Sands Corp.—described expenses like installing LED lights or upgrading refrigeration systems that represented a fraction of overall expenditures. In their letters, they told the SEC that spending 1% or 3% of capital expenditures on these items wasn’t material to them.

Changes Coming?

The SEC may be open to ideas on how to make the disclosures workable.

Its Office of the Chief Accountant is wading through feedback and trying to come up with a recommendation to the regulator “that will result in meaningful improvements to information for investors but at a manageable cost-benefit trade off,” Munter said at a financial reporting conference in early November.

SEC staffers were weighing whether to reconsider the 1% threshold or require companies to make the disclosures when they deem them to be material, without requiring a numerical threshold, Munter told reporters after his public remarks.

Such a move reflects requests from the large accounting firms. Deloitte & Touche LLP in a comment letter to the agency questioned whether detail was even useful to investors. “The commission could instead require companies to disclose the impact of severe weather events and transition activities as they do for other disclosure requirements—in the context of the financial statements as a whole and consistent with the SEC’s established materiality definition,” the Big Four firm wrote in May.

Robert Herz, who chaired the Financial Accounting Standards Board from 2002 to 2010, said he didn’t believe the final SEC climate rules would include the numerical disclosures as they are currently written.

“I’d be surprised if that remained in that form,” Herz said. “They probably will have some kind of footnote disclosure of the impacts that are included in the financial statements, but I don’t know about the 1%.”