Revenue, Carbon and the Sustainability Report
Larkspur plc reports under IFRS and is preparing its first sustainability report alongside its 20X5 financial statements. Larkspur has committed to net zero by 2040 and reports Scope 1, 2 and 3 emissions. Scope 3 emissions (purchased goods and use of sold products) represent 82% of total emissions and are estimated using industry-average factors rather than supplier-specific data. The company has also set an internal carbon price of £60 per tonne, which it uses to appraise capital projects but does not reflect in its financial statements. A large customer has begun requiring carbon disclosures as a condition of contract. The finance director argues that the sustainability report is 'marketing' and should not be connected to the financial statements, and that the carbon price should be disclosed only if it becomes a legal obligation.
1. Critically evaluate the FD's position on the relationship between the sustainability report and the financial statements, with reference to the concept of connectivity.
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The FD's position is not sustainable.
Connectivity. The sustainability report and the financial statements are not separate documents describing separate realities. They describe the same entity. The concept of connectivity requires that information in the sustainability report be consistent with the financial statements, and that the two be linked through shared assumptions, boundaries and time horizons. Where they conflict, users lose confidence in both.
Specific linkages in this case.
- Scope 3 and revenue. The customer's contractual carbon requirement is a commercial risk that may affect future revenue, contract terms and impairment of assets. That is relevant to the financial statements (IAS 36 cash flows, IFRS 15 contract terms) and must be described consistently in both.
- Internal carbon price. The £60/tonne price is used in capital appraisal. If it is not reflected in the financial statements, the financial statements' cash-flow assumptions and the sustainability report's transition plan are inconsistent. Either the carbon price is a genuine assumption used in impairment testing (and should be disclosed under IAS 36), or it is not - but the two reports cannot silently disagree.
- Net zero commitment. A public net-zero target can create a constructive obligation if the entity has created a valid expectation that it will act. Whether it meets the definition of a liability under IAS 37 is a judgement, but the commitment must at least be disclosed and explained.
- Assumptions and estimates. The use of industry-average factors for 82% of emissions is a material estimation uncertainty. It must be disclosed, with the method, the proportion estimated and the sensitivity. Presenting it as precise would be misleading.
Conclusion. The sustainability report is not marketing. It is a report to users on matters that affect the entity's prospects, and it must be connected to the financial statements. The FD's approach would create an accountability gap and expose the company to credibility risk with the customer and with investors.
2. Advise on the disclosure and governance response to the estimation uncertainty in Scope 3 and to the carbon price, and explain the risks of 'greenwashing'.
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Scope 3 estimation uncertainty.
- Disclose the method. State that Scope 3 is estimated using industry-average factors, identify the categories (purchased goods, use of sold products) and the proportion of total emissions (82%) that is estimated rather than measured.
- Disclose the limitations. Industry averages may not reflect Larkspur's actual supply chain; they can over- or under-state emissions. Explain why supplier-specific data is not yet available and the plan and timeline to obtain it.
- Sensitivity. Provide a range or scenario analysis showing how total emissions would change under alternative factors. This is the sustainability equivalent of IAS 1 estimation-uncertainty disclosure.
- Consistency. Ensure the emissions figures used in the sustainability report are the same as any used in financial estimates (e.g. carbon-price-based impairment assumptions).
Carbon price.
- If the £60/tonne price is used in capital appraisal and impairment testing, it is an assumption underlying the financial statements and should be disclosed (IAS 36.134 requires disclosure of key assumptions).
- If it is not used in the financial statements, the sustainability report must say so and explain the difference, otherwise the two reports are inconsistent.
- A carbon price is not a liability merely because it is used internally. A liability arises only when there is a present obligation (legal or constructive) from a past event. The FD is right that an internal price alone does not create a liability - but wrong to conclude it is therefore irrelevant to disclosure.
Greenwashing risks.
- Selective reporting. Emphasising the 18% measured emissions while underplaying the 82% estimated is misleading.
- Aspiration presented as achievement. A 2040 net-zero target is a commitment, not a result. Presenting it alongside current performance without distinguishing the two is a classic greenwashing pattern.
- Unsupported claims. Claims about carbon-neutral products or supply chains must be substantiated; unsubstantiated claims create regulatory and reputational risk.
- Governance response. Establish internal controls over sustainability data equivalent to financial controls; obtain independent assurance (limited or reasonable) over the emissions data; establish a board-level sustainability committee with clear accountability; and ensure the audit committee oversees the connectivity between the two reports.