Eye on ESG disclosures

Across the globe, efforts to put more emphasis on environmental, social and corporate governance (ESG) matters in financial statements are gaining momentum. Here’s an overview of the current ESG guidance in the United States and whether the Financial Accounting Standards Board (FASB) plans to expand the financial reporting guidance related to these matters.

Sustainability disclosures

Sustainability encompasses a broad range of nonfinancial issues that may affect a company’s financial condition and performance. For example, it may include environmental issues, such as the size of the company’s carbon footprint, efforts to replace fossil fuels with renewable energy sources and overall use of natural resources. Or it may cover social issues, such as workplace, health and safety, and consumer product safety risks. Media attention on these external threats has increased public awareness and prompted concerns about how sustainability issues could impact value or increase a company’s risk of litigation.

The Securities and Exchange Commission (SEC) doesn’t specifically require companies to provide investors with information about environmental issues. But some information related to these risks must be disclosed under U.S. Generally Accepted Accounting Principles (GAAP) in the following sections of a company’s financial statements:

Description of business. This disclosure describes the business and that of its subsidiaries, including information about its form of organization, principal products and services, major customers, competitive conditions and costs of complying with environmental laws.

Legal proceedings. This disclosure briefly explains any material pending legal proceedings in which the company, any of its subsidiaries and any of its property are involved. It includes disclosure of environmental litigation arising under any federal, state or local regulations regarding the discharge of materials into the environment or protection of the environment.

Risk factors. These disclosures highlight the most significant factors that make an investment in the company speculative or risky.

Management’s discussion and analysis (MD&A). These disclosures enable investors to see the company’s liquidity, capital resources and financial results through the eyes of management. Here, companies must identify known trends, events, demands, commitments and uncertainties that are reasonably likely to have a material effect on financial condition or operating performance.

In addition to these disclosures, some companies voluntarily issue separate sustainability reports that cover a broad range of nonfinancial issues. Unfortunately, without uniform sustainability reporting standards, these reports can be very inconsistent.

Investor concerns

Some investor groups believe that ESG disclosures aren’t being sufficiently used in the United States. They believe that the FASB could be missing an opportunity to put more emphasis on climate reporting and other sustainability matters in GAAP financial statements.

The Financial Accounting Standards Advisory Council (FASAC) is the advisory board for the FASB. FASAC meetings provide the FASB with an opportunity to obtain and discuss the views of a diverse group of individuals from varied business and professional backgrounds.

At the December 2020 FASAC meeting, some investor groups said that sustainability disclosures around the world vary significantly — and they expressed concerns that the United States could be left behind if they don’t expand their disclosure requirements. They also suggested that the FASB work alongside the International Accounting Standards Board (IASB) to develop consistent rules for ESG reporting.

FASB agenda

The Financial Accounting Foundation (FAF), the trustee organization of the FASB and the Governmental Accounting Standards Board, issued a survey on September 9, 2020. The survey was designed to gain input about the FAF’s strategic plan for the next three to five years, and it included questions about whether the FAF should create a new board, separate from the FASB and GASB, to develop ESG and other nonfinancial reporting standards.

Survey responses were due by September 25, 2020. As of this writing, the results of the survey haven’t been published on the FAF’s website, and the sustainability reporting theme hasn’t been pushed or raised during public meetings.

In general, the FASB has veered away over the years from pushing too far into sustainability reporting matters. If the FAF were to take up the matter, they would need to consider other bodies, such as the nonprofit Sustainability Accounting Standards Board (SASB). The SASB’s mission is to establish “industry-specific disclosure standards across ESG topics that facilitate communication between companies and investors about financially material, decision-useful information. Such information should be relevant, reliable and comparable across companies on a global basis.”

Stay tuned

Attention to ESG reporting is expected to grow under the Biden administration. If your company isn’t currently reporting these matters in its financial statements, it may be time to beef up your disclosures or consider issuing a separate sustainability report. Contact your trusted Hood & Strong advisor for more information.