WHAT YOU NEED TO KNOW ABOUT CARBON ACCOUNTING IN EUROPE

Big changes are coming to carbon accounting. Regulators around the world are tightening their directives as the impacts of climate change mount. It means more companies than ever will soon face intense regulatory scrutiny of their carbon footprints ― and with tight deadlines looming, it’s imperative that they put processes and resources in place immediately to ensure their compliance.

In Europe, 11,700 of the largest, exchange-listed companies, banks, and insurers will have to report their greenhouse gas emissions for the first time in 2025 because of the European Union’s Corporate Sustainability Reporting Directive (CSRD). These companies — with more than 500 employees each — were formerly covered by the Non-Financial Reporting Directive (NFRD), a predecessor of the CSRD that imposed broader, less stringent rules on environmental, social, and governance disclosure. Their 2025 reports will have to detail emissions from their 2024 fiscal years.

In 2025, companies not subject to the NFRD that meet two out of three of these criteria — more than 250 employees and/or €40 million in turnover and/or €20 million in total assets — will become subject to the CSRD. They will need to disclose their 2025 emissions in reports submitted in 2026. This could include EU subsidiaries of companies not based in the EU if they meet the criteria.

Ultimately, nearly 50,000 companies in Europe will be reporting as well as more than 10,000 non-EU companies and their European subsidiaries. In 2028, the CSRD takes effect for non-EU parent companies with €150 million annual revenues in the EU and at least one subsidiary or branch in the EU that conducts significant business. They must file their first report using 2028 emissions data at a consolidated group level (including non-EU activity) in 2029.

Listed small and midsize companies come under CSRD in 2026 and must report in 2027, but there is a provision allowing small and midsize enterprises to op-out until 2028.

CSRD and ESRS reporting essentials

The breadth and detail required by the CSRD framework can feel overwhelming, especially for companies that have not previously been subject to environmental disclosure. What should companies do to prepare for the 2025 deadline? And how can they continue to grow while also reducing their carbon footprints?

Companies will face an unprecedented level of data-intensive, highly granular reporting because of the CSRD and ESRS. Sustainability will essentially become a fourth factor for many finance functions to balance, alongside the traditional “buckets'' of revenue, cost, and capital.

Carbon accounting is also set to become a major factor in defining business risk as many companies begin to calculate carbon footprints using the Greenhouse Gas Protocol’s Scope 1, 2, and 3 definitions for the first time. CSRD disclosure is also based not just on a company’s carbon dioxide (CO2) emissions but rather on its total greenhouse gas emissions ― using CO2 equivalents. This metric represents the number of metric tons of CO2 emissions with the same global warming potential as one metric ton of another GHG.

In our experience, most companies are good at assessing emissions from their operations (Scope 1) and energy usage (Scope 2). The same cannot be said for Scope 3 emissions, which are trickier ― primarily because they involve emissions created outside the reporting company.

What makes Scope 3 harder

This category of emissions relates to those produced by a company’s entire supply chain ― both upstream emissions, most often involving suppliers from around the world, and downstream emissions, produced by customers’ use of products. This complicates calculations as disclosure is difficult to mandate, especially when dealing with suppliers outside of Europe. Without an accurate accounting of emissions, reducing them becomes that much harder. Yet Scope 3 emissions can make up as much as 90% of a company’s output in some sectors.

There are 15 separate categories to keep track of across the upstream and downstream value chains of a company’s products. The more components involved in producing a product, the more complex the Scope 3 emissions calculation becomes.

Take an automotive manufacturer: Cars can have up to 30,000 components, many of which come from emissions-generating suppliers upstream. Once the car rolls off the assembly line, it continues to generate emissions for as long as it’s in use. Even scrapping and recycling a vehicle creates GHG emissions, and all of these must be accounted for in great detail.

The CSRD will compel companies to substantiate both their baseline emissions and targets for emission reductions. In the run-up to the reporting deadlines, companies will be required to calculate their Scope 1, 2, and 3 emissions, as well as forecast how they will reduce them.

Getting ahead of the new carbon accounting rules

The first step is understanding what falls under the rules and when. They initially apply to large and exchange-listed, EU-based organizations, but by 2026 they will also compel many bigger EU subsidiaries of foreign companies to report. By 2029, non-EU parent companies of a certain size will also have to report.

Ideally, companies should start doing dry runs of their carbon accounting processes this year. This exercise can provide a dry run to test processes and ensure companies are ready for their first official reporting cycle. This is especially true for Scope 3 emissions — unless a company has fewer than 750 employees and can put off Scope 3 reporting until 2026.

Doing a mock Scope 3 calculation now will reveal to companies places in their supply chains where emissions can be avoided to help reduce emissions in subsequent years. This might mean switching to suppliers with lower carbon footprints or turning to suppliers closer to a company’s own operations to reduce transportation emissions. It may even involve substituting different raw materials.

How technology can help with emissions data

Given the tight deadlines, companies may require not only in-house resources but also external advice and tools. Technology — including artificial intelligence and machine learning — will be critical for speeding up data gathering and calculations.

Still, organizations should avoid jumping on the software bandwagon too quickly. Before bringing technology in, they must ensure that adequate processes are in place for working out their carbon footprints. Organizations with enterprise resource planning systems are at an advantage here, while those without will likely face a bigger transformation before they can calculate their footprint comprehensively.

Despite the tight deadlines, companies should not shy away from deploying a “prototype and learn” strategy to find the best possible approach for their specific supply chain. The same applies to selecting technology solutions to automate all or parts of the chosen process.

Reducing emissions while growing

Carbon accounting is not a one-off exercise, but an ongoing process of capturing and analyzing emissions to show targets are being met. That poses a new challenge for European companies, which will now need to understand the implications of their growth aspirations for emissions.

Typically, business growth equates to increased emissions. Our calculations show that business growth of just 2.7% a year between now and 2050 would double a company’s emissions. The challenge will be decoupling this relationship.

Despite the tight deadlines, companies should not shy away from deploying a “prototype and learn” strategy to find the best possible approach for their specific supply chain. The same applies to selecting technology solutions to automate all or parts of the chosen process.

Testing options

For example, digital twins could help explore the energy savings potential of moving operations closer to customers to cut down on shipping or relocating to a country with a highly decarbonized grid to reduce Scope 2 emissions.

A digital twin can also help model more sustainable product designs before they are adopted, as well as more energy-efficient manufacturing techniques.

Similar “abatement levers” can be applied downstream, for example, by simulating the impact of marketing more environmentally friendly, but potentially higher-cost, products.

The future of carbon accounting

Investors and even financial institutions are already beginning to redirect capital away from fossil fuels and high-emission industries toward sustainable alternatives, or they are at least raising the cost of capital for companies with substantial carbon footprints. This trend looks set to increase as the investment community attempts to tweak portfolios to reduce their own exposure to climate change.

Besides placating regulators and the financial community, companies must also consider pressure from the media and public to cut emissions. This is particularly true as the devastating impacts of climate change become more apparent.

The latest Edelman Trust Barometer shows that the public does not believe business is doing enough to fight climate change. The effect of this opinion is already being seen, with rising numbers of consumers switching to brands they think are working harder to reduce their carbon footprints.

The growing urgency of climate change means carbon accounting will be with us for the foreseeable future, with demands for disclosure and aggressive emissions reduction only getting louder. Over time, we expect carbon accounting to become as mainstream as financial accounting — and as important for judging a company’s sustainability. It’s therefore imperative for businesses to understand fully the strategic and business implications of the CSRD and other new rules of business — and to act on them as soon as possible.