DeeganFAT4e_PPT_ch09

9-1Copyright © 2014 McGraw-Hill Education (Australia) Pty Ltd PPTs to accompany Deegan, Financial Accounting Theory 4e

FINANCIAL ACCOUNTING THEORYCraig Deegan

Slides written by Craig Deegan

CHAPTER 9Extending corporate accountability: the incorporation of social and environmental factors within external reporting


Learning objectives9.1 Have some knowledge of the history of social and

environmental reporting.

9.2 Be aware of the meanings attributed to social, environmental, sustainability and triple bottom line reporting.

9.3 Be aware of various, and sometimes competing, perspectives about the responsibilities of business.

9.4 Be able to provide an explanation of the relationship between organisational responsibility and organisational accountability.

9.5 Be aware of the relationship between accounting and accountability.

continued


Learning objectives (cont.)9.6 Understand the various decision phases pertaining to

sustainability reporting (these being: why report? to whom to report? what to report? how to report?).

9.7 Be aware of various theoretical perspectives that can explain why organisations might voluntarily elect to provide publicly available information about their social and environmental performance.

9.8 Be aware of some research that explores stakeholders’ demand for, and reaction to, social and environmental information.

9.9 Be able to explain the concept of sustainable development and be able to explain how organisations are reporting their progress towards the goal of sustainable development.

continued


Learning objectives (cont.)9.10 Have some knowledge about the global problem of climate

change and be aware of some issues associated with accounting for climate change.

9.11 Be able to identify some of the limitations of traditional financial accounting with respect to enabling users of reports to assess a reporting entity’s social and environmental performance.

9.12 Be aware of the organisation known as the Global Reporting Initiative (GRI) as well as have knowledge of the GRI’s Sustainability Reporting Guidelines.

9.13 Understand the meaning of ‘integrated reporting’ and be aware of the reporting guidance being developed by the International Integrated Reporting Committee (IIRC).

continued


Learning objectives (cont.)

9.14 Understand some of the problems associated with accounting for the externalities being generated by an organisation.

9.15 Understand the meaning of, and the reason for undertaking, social audits.

9.16 Be aware of how various corporate governance mechanisms can be used to improve an organisation’s social and environmental performance.

9.17 Understand the role of personal social responsibility in addressing ongoing social and environmental issues confronting society and the planet.


Introduction• In recent years there has been increasing focus

upon sustainable development and sustainability reporting

• Sustainability reporting (and CSR reporting) represents a departure from the economic focus that was traditional in external reporting

• A review of the Global Reporting Initiative’s Sustainability Reporting Guidelines provides insight into the types of social, environmental and economic information that could be disclosed in a sustainability report

continued


Introduction (cont.)

• The terms ‘sustainability reporting’, ‘Corporate Social Responsibility Reporting’ and ‘Triple Bottom Line (TBL)’ reporting are often considered to be synonymous

• Strictly speaking however, sustainability reporting would require more than simply providing information against social, environmental and economic indicators

• Sustainability reporting would also address how current activities are impacting the abilities of future generations to satisfy their own needs


What is Corporate Social Responsibility (CSR)?• There will be different views about the meaning of CSR. The

general view is that an organisation that embraces CSR is considering the interests of a broader group of stakeholders rather than just shareholders alone

• A useful definition of CSR is provided by the Commission of European Communities (Promoting a European Framework for Corporate Social Responsibility, 2001, p. 6):

…a concept whereby companies integrate social and environmental concerns in their business operations and in their interaction with their stakeholders on a voluntary basis.

Being socially responsible means not only fulfilling legal expectations, but also going beyond compliance and investing more into human capital, the environment and the relations with stakeholders.


CSR reporting• CSR reporting is a process whereby an organisation

publicly discloses information about its interactions with, and impacts upon, the various societies and environments in which it operates.

• The nature of this reporting can vary widely between organisations, and across time.

• In part, the variations in reporting across different organisations will be due to different perspectives of accountability being embraced (that is, different views about who the organisation is responsible to, and for what aspects of performance it is responsible for).


CSR reporting and sustainability reporting• CSR reporting includes ‘social reporting’ and ‘environmental

reporting’.

• Social reporting and environmental reporting are both also considered to be components of ‘sustainability reporting’.

• Sustainability reporting would also include reporting about economic performance.

• Sustainability reporting is defined in the GRI Sustainability Reporting Guidelines (2011) as:– a broad term considered synonymous with others used to

describe reporting on economic, environmental, and social impacts.

• Any consideration of sustainability reporting requires a definition of sustainable development. Sustainable development was defined in the Brundtland Report (1987) as development that has the aim of:– Ensuring the needs of today’s world are met while at the same

time ensuring that the ability for future generations to meet their own needs is not compromised.


Social reporting• Social reporting – which is a component of

CSR/sustainability reporting – provides information about such things as:

– labour practices and decent work performance (e.g. occupational health and safety, training and education, diversity and opportunity);

– human rights performance (e.g. non-discrimination, freedom of association and collective bargaining, child labour and indigenous rights); and

– product responsibility performance (e.g. customer health and safety).


Environmental reporting• Environmental reporting – also a component of

CSR/sustainability reporting – could include the provision of information about such items as:• materials usage;

• energy usage;

• water usage;

• emissions, effluents and waste;

• compliance with environmental regulations; and

• use and impact of transport.


Sustainability reporting• As we have already indicated, sustainability reporting involves

the production of information about the social, environmental, and economic performance of an organisation.

• The leading guidance document on sustainability reporting is the Sustainability Reporting Guidelines issued by the Global Reporting Initiative (GRI).

• GRI (2013) defines sustainability reporting as:

…the practice of measuring, disclosing, and being accountable to internal and external stakeholders for organizational performance towards the goal of sustainable development. ‘Sustainability reporting’ is a broad term considered synonymous with others used to describe reporting on economic, environmental, and social impacts (e.g. triple bottom line, corporate responsibility reporting). A sustainability report should provide a balanced and reasonable representation of the sustainability performance of a reporting organization—including both positive and negative contributions.


Responsibilities of business• Moves to provide information about social and

environmental performance, whether through reports that are labelled as sustainability or CSR reports (or similar), implies management of these organisations consider they have an accountability for social and environmental performance, as well as economic performance– not a view held universally

• There is increasing community pressures for organisations to make a commitment to sustainable business practices, and corporate reporting is responding to this pressure

continued


Responsibilities of business (cont.)

• If sustainability becomes part of the expectations held by society, it must—consistent with legitimacy theory—become a business goal

• Providing information about social and environmental performance will increase the trust a community has in the organisation


How does an entity determine its responsibilities?• What do its relevant stakeholders consider

business responsibilities to be?

• Based on personal judgement of the management involved as to who are the relevant stakeholders

• Has implications for the information disclosed

• Perceived responsibility and accountability go hand in hand


Accountability• This is a very important concept in terms of the profession of

‘accounting’ and CSR

• The concept of accountability and the practice of accounting should be considered together

• The broader our notion of ‘accountability’, the broader the types of ‘accounting’ that we would embrace

• If we believe we are only accountable to our shareholders (a shareholder primacy perspective), then we might restrict our accounting to ‘financial accounting’


Accountability (cont.)

• However, if we accept that we have an accountability to a broader group of stakeholders for aspects of performance that include social and environmental aspects, then we are likely to disclose information about our social and environmental performance

Accountability can be defined as the duty to:1 undertake certain actions (or to refrain from taking

actions) in accordance with the expectations of a group of stakeholders; and

2 provide a reckoning or account of those actions to the stakeholders


Side issue: are students of accounting sufficiently taught about ‘accountability’?

• So, accountability is central to the practice of accounting

• But how many students are exposed to an examination of ‘corporate accountability’ as part of their accounting education?

• Logically, how can you study ‘accounting’ without firstly exploring ‘accountability’ and its link with accounting?


To whom is business responsible?• Many organisations are making public statements

that their responsibilities extend beyond their shareholders to encompass communities in which they operate and society as a whole

• If sustainability is truly embraced then responsibility is also owed to future generations

• If an organisation accepts a responsibility for the sustainability of its business practices, then it should produce an account of its responsibilities—it should provide a sustainability report


Stages of sustainability reporting• Stage 1: why report?

– relates to management’s motivations

• Stage 2: to whom to report—who are the stakeholders?– tied to managerial motivations for reporting—if motivations

are based on managerial reasoning then disclosures could be aimed at powerful stakeholders

• Stage 3: what to report?– involves dialogue with identified stakeholders

• Stage 4: what format for the disclosures?We will consider each of these stages in turn.


Stage 1: why report?• Different accounting theories will provide alternative

explanations about why an entity might decide to report social and environmental information

• We should remember that most social and environmental reporting is voluntary (an interesting issue in itself given the high level of regulation for financial reporting), therefore we can use various positive theories to explain or predict the voluntary decision to report

• As we appreciate, different theories make different assumptions and therefore will tend to give different explanation of the reporting phenomena


Theories to explain ‘why report?’ social and environmental disclosure• Legitimacy Theory and social contract

– disclosures linked to providing evidence that entity is complying with the expectations of society

• Stakeholder Theory– disclosure depends on expectations of powerful stakeholders

if the managerial perspective of Stakeholder Theory is embraced

• Accountability Model– an acceptance of a responsibility to report

continued


Theories to explain ‘why report?’ social and environmental disclosure (cont.)

• Institutional Theory– organisations will adopt particular practices – including

disclosure practices – because of institutional pressures

• Positive Accounting Theory– disclosure depends on positive wealth implications

consider submission of the Business Council of Australia on pages 423 and 425 of the text


‘Why report?’ and its links to views about the responsibility of business• Consider the views of Milton Friedman—reporting is not about

responsibilities; rather, it is about enhancing business profitability

– ...there is one and only one social responsibility of business, to use its resources and engage in activities designed to increase its profits as long as it stays within the rules of the game, which is to say, engages in open and free competition, without deception or fraud

• A broader view of business responsibilities would accept that regardless of the impacts on profitability, stakeholders have a right to know about the social and environmental implications of an organisation

• Where do we think corporations sit in terms of the above views?


Differing views of business responsibility• Friedman

– rejected the view that corporate managers have any moral obligations– stated that ‘the business of business is business’– responsibility to increase profits as long as stays within the rules– this view often seems to be held by the media which appears to

applaud profitable organisations

• Alternative view– organisations earn their right to operate in the community– artificial entities that society chooses to create– organisations do not have an inherent right to resources– consequently accountable to society for how it operates– societal expectations may exceed profitability


Differing views of business responsibility (cont.)• Anita Roddick, founder of the Body Shop, made the following

statement (2007):

In terms of power and influence, you can forget the church, forget politics. There is no more powerful institution in society than business, which is why I believe it is now more important than ever before for business to assume a moral leadership. The business of business should not be about money, it should be about responsibility. It should be about public good, not private greed.

• Consider how Roddick’s view contrasts with Milton Friedman or with the statement made by the Business Council of Australia (2005). The BCA stated:

The litmus test for any activity or responsibility is whether the performance of that activity or responsibility can reasonably be seen to be contributing to the growth of shareholder value.


Stage 2: to whom to report?• If managers are motivated by a desire to increase

shareholder value then reporting will be aimed primarily at satisfying the expectations of powerful stakeholders

• If, by contrast, managers adopt a broader ethical perspective then disclosures would be aimed at stakeholders impacted by the operations of the entity—but still cannot address all information needs, so some prioritisation will be necessary

• It is emphasised that the decision about to whom to report is directly related to the previous issue of ‘why report?’ One cannot be considered in isolation from the other


Stage 3: what to report?• First of all, establish that there is a demand for

information

• Identify information needs through dialogue with stakeholders

• Negotiate a consensus among competing stakeholder needs and expectations


Stage 4: how to report?• Conventional financial accounting does not appear to

provide a foundation for social and environmental disclosures

• Reporting various social, environmental and economic indicators (also referred to as TBL reporting) is an alternative, although it is not the same as sustainability reporting. A true sustainability report would consider such issues as the carrying capacity of the eco-system, impacts on future generations and so forth

• An attempt can also be made to place a cost on the externalities of business


How to report? Limitations of traditional financial reporting• To this point we have talked about CSR reporting and

associated motivations for reporting—but what frameworks should we use? Should we use our traditional financial reporting approaches?

• As accountants, we are familiar with generally accepted financial accounting practices. Do these practices hinder corporate accountability?

continued


How to report? Limitations of traditional financial reporting (cont.)• For a number of reasons to be discussed below, our financial

reporting practices are not terribly useful for reporting CSR information. Some of the problems relate to:– the objective of general purpose financial reporting;– considerations of materiality;– the definition of the elements of financial reporting;– the practice of discounting future cash flows;– issues of reliable measurement and probability; – focus on short term results; and– the entity assumption.

We will now consider each of these issues in turn


The objective of general purpose financial reporting

• IASB Conceptual Framework, paragraph OB2 states:– The objective of general purpose financial reporting is to provide

financial information about the reporting entity that is useful to present and potential investors, lenders and other creditors in making decisions about providing resources to the entity. Those decisions involve buying, selling or holding equity and debt instruments, and providing or settling loans and other forms of credit.

• No explicit consideration is given to the needs of a broader group of stakeholders or to the provision of information that is non-financial in nature

• In terms of the information needs or expectations of other stakeholders, paragraph OB 10 of the IASB Conceptual Framework further clarifies the issue by stating:– Other parties, such as regulators and members of the public other

than investors, lenders and other creditors, may also find general purpose financial reports useful. However, those reports are not primarily directed to these other groups.


Considerations of materiality• Materiality as applied by financial accountants

may not be a relevant criterion for the disclosure of social and environmental performance data

• Social and environmental performance is quite different from financial performance and typically cannot be quantified in monetary terms


Definition of the elements of financial reporting• The way we define the elements of accounting acts to exclude

the recognition of many social and environmental costs and benefits

• For example, the IASB Conceptual Framework currently defines an asset as:

A resource controlled by the entity as a result of past events and from which economic benefits are expected to flow to the entity.

• ‘Control’ is a central attribute of the asset definition. If a resource is not controlled by an organisation, then it cannot be considered to be that organisation’s asset (meaning that its consumption or use will not be considered to be an expense of the reporting entity)

continued


Definition of the elements of financial reporting (cont.)• For financial reporting purposes, expenses are defined as

follows (IASB Conceptual Framework):

expenses are decreases in economic benefits during the accounting period in the form of outflows or depletions of assets or incurrences of liabilities that result in decreases in equity, other than those relating to distributions to equity participants.

• Again, given that the recognition of assets relies upon control, then environmental resources such as air and water are shared and not controlled by the organisation and hence, cannot be considered to be assets. Therefore, their use and/or abuse are not considered ‘expenses’ from a financial reporting perspective

continued


Definition of the elements of financial reporting (cont.)• Further, the way we recognise expenses means that many actions

which create social costs actually have positive benefits for reported profits

• For example, if we slash jobs, it will reduce wage expenses and increase profits. Yet at the same time, social costs in terms of the unemployed will increase—but these would be treated as externalities and not recognised by the reporting entity

• Similarly, if an organisation releases greenhouse gases without financial penalty (for example, it does not incur carbon taxes), then this will have no negative impact on reported profits, but will nevertheless contribute to global warming. This accounting anomaly occurs because the atmosphere is not ‘controlled’ by the reporting entity and therefore its use, or abuse, is not an expense of the entity (as no ‘asset’ has been consumed)


The discounting of future cash flows• There is a general requirement (e.g. IAS 37) that liabilities that

are payable beyond 12 months must be discounted to their present value. This is in accordance with general economic theories that promote the discounting of future cash flows

• However, the implication is that it can make the future obligations—such as obligations for site remediation—almost disappear because of the discounting

• Therefore, there may be little discouragement to undertaking activities now that create remediation obligations many years later. Current costs are effectively being ‘discounted away’ and effectively shifted to future generations

• Hence, this is another instance where our traditional ways of doing financial accounting do not necessarily sit well with quests towards sustainability


Issues of ‘reliable measurement’ and ‘probability’

Pursuant to the IASB Conceptual Framework, the recognition of the elements of financial reporting (these being assets, liabilities, income, expenses, equity) requires that:

a. it is probable that any future economic benefit associated with the item will flow to or from the entity; and

b. the item has a cost or value that can be measured with reliability.

Many environmental costs and related obligations cannot be measured reliably and their probability is often questioned. Some researchers have argued that issues associated with ‘probability’ and ‘measurability’ are used opportunistically by organisations to justify not recognising various environment-related obligations


Focus on short term results• As we would appreciate, the focus of the media is typically on the

annual, or perhaps at times on the half-yearly and quarterly, financial results of an entity

• As accountants, we do tend to emphasise short-term (annual) performance through our practices of dividing the life of the asset up into somewhat artificial periods of time

• Managers are also often rewarded in terms of measures of performance such as annual profits

• This can have the effect of discouraging us from making long-term investments in new technologies (including those that will provide longer-term social and environmental benefits)

• This acts to dissuade us from investment expenditure in more sustainable modes of operation that might not generate positive financial results for many years


The entity assumption• The entity assumption is a cornerstone of financial reporting

• It requires the ‘accounting entity’ to be treated separately from its owners, other organisations, and stakeholders

• Therefore, if something does not directly impact the organisation itself in terms of its financial position or financial performance, then it is ignored by financial accounting

• This is not consistent with moves towards sustainable development which requires organisations to consider their impacts on the environment and current and future communities

• So concluding this section on the limitations of generally accepted accounting principles … are generally accepted accounting principles the right vehicle for ‘broad-based accountability’. Arguably not. But, what is better?


How to report? The Global Reporting Initiative• Whilst there is no regulation requiring organisations to

produce a stand-alone sustainability (or CSR) report, many organisations do

• By far, the most commonly used framework adopted on an international basis is the Sustainability Reporting Guidelines released by the Global Reporting Initiative (GRI).

• The Global Reporting Initiative (GRI) was established in 1997

• The GRI Sustainability Reporting Guidelines is the most comprehensive framework for ‘how to report’ that is currently available


The GRI Sustainability Reporting Guidelines

• We now have version 4 (referred to as G4) which was released in 2013.

• The Sustainability Reporting Guidelines are supplemented by Sector Supplements, which contain indicators for individual industry sectors.

• The GRI Guidelines are presented in two parts, these being:

– Reporting Principles and Standard Disclosures

– Implementation Manual

continued


The GRI Sustainability Reporting Guidelines (cont.)• These parts are freely available on the GRI’s website. The

first part of the Guidelines, the Reporting Principles and Standard Disclosures, contains Reporting Principles, Standard Disclosures, and the criteria to be applied by an organisation to prepare its sustainability report ‘in accordance’ with the Guidelines. Definitions of key terms are also included

• The second part of the Guidelines, the Implementation Manual, contains explanations of how to apply the ‘Reporting Principles’, how to prepare the information to be disclosed, and how to interpret the various concepts in the Guidelines. References to other sources, a glossary and general reporting notes are also included

continued


The GRI Sustainability Reporting Guidelines (cont.)• Organisations that apply the guidelines, and that make a specific

claim to be ‘in accordance’ with the Guidelines, are required to select one of two ‘in accordance options’.

• This represents a significant change from the previous version of the Guidelines. Previously the GRI had established a self-assessment system wherein organisations could rank themselves from A to C on the basis of the extent to which the guidelines have been adopted.

• Reflecting the new approach, page 8 of the G4 Sustainability Reporting Guidelines states:– The Guidelines offer two options for an organization to prepare its

sustainability report ‘in accordance’ with the Guidelines. The two options are Core and Comprehensive. These options designate the content to be included for the report to be prepared ‘in accordance’ with the Guidelines. Both options can apply for an organization of any type, size, sector or location

continued


The GRI Sustainability Reporting Guidelines (cont.)• Organisations that are applying the GRI Guidelines are required to

produce what are referred to as ‘standard disclosures’ – which are divided into general standard disclosures and specific standard disclosures. They are also and are required to disclose information relating to various performance indicators. The general standard disclosures relate to:

– Strategy and Analysis;– Organizational Profile; – Identified Material Aspects and Boundaries; – Stakeholder Engagement; – Report Profile; – Governance; and – Ethics and Integrity.

• The specific standard disclosures relate to:– Disclosures on Management Approach; and – Indicators.

continued


The GRI Sustainability Reporting Guidelines (cont.)• The Disclosures on Management Approach referred to above

(under the specific standard disclosures) is intended to give the organisation an opportunity to explain how the economic, environmental and social impacts related to material Aspects are managed

• The sustainability performance indicators which are required to be disclosed pursuant to the guidelines are organised under the categories of: – economic performance,

– environmental performance and

– social performance (with the social indicators being further subdivided into labour practices

and decent work performance indicators, human rights indicators, society indicators, and product responsibility performance indicators)


Integrated reporting• Another relatively recent development to the CSR

reporting arena is integrated reporting

• Initially, looked like a very exciting project

• The International Integrated Reporting Committee (IIRC) was created in 2010 and is a joint Initiative of The Prince’s Accounting for Sustainability Project (A4S) and the GRI

• The aim was initially identified as:– to create a globally accepted framework which brings

together financial, environmental, social and governance information in a clear, concise, consistent and comparable format —put briefly, in an ‘integrated’ format

continued


Integrated reporting (cont.)• The website (www.theiirc.org) identifies the mission

of the IRRC:…. create the globally accepted International <IR> Framework that elicits from organizations material information about their strategy, governance, performance and prospects in a clear, concise and comparable format. The Framework will underpin and accelerate the evolution of corporate reporting, reflecting developments in financial, governance, management commentary and sustainability reporting. The IIRC will seek to secure the adoption of <IR> by report preparers and gain the recognition of standard setters and investors.

Hmmmmm ….. What about other stakeholders??

continued


Integrated reporting (cont.)• According to the IRRC website, objectives for an integrated

reporting framework are to:– support the information needs of long-term investors, by showing

the broader and longer-term consequences of decision-making;

– reflect the interconnections between environmental, social, governance and financial factors in decisions that affect long-term performance and condition, making clear the link between sustainability and economic value;

– provide the necessary framework for environmental and social factors to be taken into account systematically in reporting and decision-making;

– rebalance performance metrics away from an undue emphasis on short-term financial performance (e.g. ‘profits’); and

– bring reporting closer to the information used by management to run the business on a day-to-day basis.

continued


Integrated reporting (cont.)• The IIRC released its Consultation Draft of the International <IR>

Framework in April 2013. The intention is to release a completed framework in 2015

• The draft framework released as part of the Consultation Draft is a principles-based document rather than being one that stipulates lists of required disclosures

• A review of the Consultation Draft reveals a number of interesting (and some worrying) aspects to the guidelines, some of which are discussed below. According to page 8 of IIRC (2013), Integrated Reporting is defined as:

– A process that results in communication by an organization, most visibly a periodic integrated report, about value creation over time.

• The above definition is interesting because the focus seems to be on ‘value creation’ rather than on accountability. This will be of concern to many people who had hoped that the emphasis of Integrated Reporting would be to increase the transparency of companies to a broad group of interested stakeholders – many of which are not directly interested in ‘value creation’ continued


Integrated reporting (cont.)• The IIRC also emphasises the centrality of ‘materiality’ to the

reporting process. IIRC (2013, p. 21) states:– An integrated report should provide concise information that is

material to assessing the organization’s ability to create value in the short, medium and long term.

– A matter is material if, in the view of senior management and those charged with governance, it is of such relevance and importance that it could substantively influence the assessments of the primary intended report users with regard to the organization’s ability to create value over the short, medium and long term.

• When we consider the intended audience of integrated reports, IIRC (2013, p. 8) states:– An integrated report should be prepared primarily for providers of

financial capital in order to support their financial capital allocation decisions.

• Oh no! We have the same ‘shareholder primacy’ perspective being applied yet again!! Is this really the right approach to adopt in the pursuit of sustainability?

continued


Integrated reporting (cont.)• A particularly interesting aspect of the Consultation Draft is that it

makes reference to six different types of capitals. According to IIRC (2013, p. 11):

– All organizations depend on various forms of capital for their success. In this Framework, the capitals comprise financial, manufactured, intellectual, human, social and relationship, and natural, although this categorization is not required to be adopted by organizations preparing an integrated report.

– the capitals are stores of value that, in one form or another, become inputs to an organization’s business model. They are increased, decreased or transformed through the activities and outputs of the organization in that they are enhanced, consumed, modified, destroyed or otherwise affected by those activities and outputs

for example, an organisation’s financial capital is increased when it makes a profit, and the quality of its human capital is improved when employees become better trained

continued


Integrated reporting (cont.)• In relation to changes in capital, it is further stated (IIRC, 2013, p. 12):

– Although organizations aim to create value overall, this may involve the diminution or destruction of value stored in some capitals, resulting in a net decrease to the overall stock of capitals.

• Natural capital (the environment) is defined in the Consultation Draft as (IIRC 2013, p. 13):

– All renewable and non-renewable environmental resources and processes that provide goods or services that support the past, current or future prosperity of an organization. It includes:

air, water, land, minerals and forests biodiversity and eco-system health.

• Again, there are some broader philosophical issues to consider. As we can see from the above definition of ‘natural capital’, the environment seems to be considered on the basis to which it supports ‘past, future or current prosperity of an organisation’. Many people would question whether the environment should be considered in such an organisation-centric manner.

• Referring to the environment as part of ‘capital’ also seems to promote a view that it can be ‘drawn down’ to support growth in other capitals.

continued


Integrated reporting (cont.)• Again, there are some broader philosophical issues to consider

• As we can see from the above definition of ‘natural capital’, the environment seems to be considered on the basis to which it supports ‘past, future or current prosperity of an organisation’

• Many people would question whether the environment should be considered in such an organisation-centric manner. Is not this one of the very reasons that the planet has the environmental and social problems that it currently has?

• Referring to the environment as part of ‘capital’ also seems to promote a view that it can be ‘drawn down’ to support growth in other capitals. Again, this view that the environment can justifiably be utilised and degraded in exchange for economic gains is a major contributory factor to our current global problems

continued


Integrated reporting (cont.)• We could provide further comment on the IIRC Consultation

Draft as released in 2013 but suffice it to say that the draft will be disappointing to many people who initially hoped that integrated reporting would provide improvements in the social and environmental accountability of corporations

• Like the GRI’s Sustainability Reporting Guidelines, the draft IIRC Framework has also explicitly adopted various financial reporting conventions (including materiality – which in the <IR> document is linked to ‘assessing the organization’s ability to create value’, reliability, completeness, consistency, comparability)

• Coupled with this, and as already noted, the IIRC also notes that 'an integrated report should be prepared primarily for providers of financial capital in order to support their financial capital allocation assessments' (IIRC, 2013, p.8)

continued


Integrated reporting (cont.)• This primary focus on the information demands of capital

providers, the linkage of materiality to ‘creating value’, and the adoption of key financial reporting conventions does not, at least in the minds of some concerned parties, indicate that the future of <IR> provides much hope in terms of extending the accountability of organisations in terms of the various non-financial aspects of their operations

• Again, the adoption of key financial reporting conventions counters any real likelihood of providing a useful framework for broad-based accountability

• There are also concerns that the process being undertaken by the IIRC has already been captured by large scale corporate interests who see this form of reporting as being more about enhancing corporate value, rather than increasing transparency

continued


Externalities—what are they and how do we report them?• A ‘true’ sustainability report would disclose information about

various social and environmental ‘costs’ including those relating to externalities

• An externality can be defined as an impact that an entity has on parties that are external to the organisation where such external parties did not agree or take part in the actions causing, or the decisions leading to, the cost or benefit

• Externalities can be positive or negative• Prices paid for goods and services typically do not reflect

externalities, meaning that the cost of many products is ‘understated’

• Government intervention can occur so as to place a cost on externalities—for example, carbon taxes. This acts to internalise some costs that were previously unrecognised


Monetising environmental costs and benefits – accounting for externalities• As we have already discussed, financial accounting

typically ignores social and environmental impacts, therefore experimental approaches to full-cost profit calculation are being developed

• Market prices do not reflect the scarcity of resources involved or harm resources cause

• Perception that all costs associated with the production of goods or services (including use of ‘the environment’) should be reflected in the price of the goods or services – the practice of ‘under-pricing’ the environment leads to over use and damage to the environment

continued


Monetising environmental costs and benefits (cont.)

• If done comprehensively this would involve some life-cycle analysis– consideration of the inputs and outputs from raw material

acquisition to disposal

• Often referred to as ‘true prices’


A ‘sustainable cost’ calculation

• A number of researchers are attempting to develop approaches to place a cost on the social and environmental impacts of organisations – still very experimental

• For example, Gray and Bebbington (1992, p.15) state:

– … sustainable cost can be defined as the amount an organisation must spend to put the biosphere at the end of the accounting period back into the state (or its equivalent) it was in at the beginning of the accounting period. Such a figure would be a notional one, and disclosed as a charge to a company’s profit and loss account. Thus we would be presented with a broad estimate of the extent to which the accounting profits had been generated from a sustainable source … our estimates suggest that the sustainable cost calculations would produce the sort of answer which would demonstrate that no Western company had made a profit of any kind in the last 50 years or so.


Alternative approaches to social and environmental reporting—the example of Baxter International

• We have suggested that generally accepted financial reporting principles are not very useful in increasing corporate accountability. As an alternative framework we have introduced the GRI Framework,

• It is also useful to consider various innovative approached being adopted by certain organisations.

• One such approach is that taken by Baxter International – See page 466 of textbook

• Approach is innovative but still reasonably conservative

• Ignores any externalities caused by the business, and only includes costs and benefits directly related to cash flows

• But attempts to demonstrate that by explicitly considering the environment, actual cost savings can be made

• Still applies the usual ‘entity assumption’


BSO/Origin• Places a notional value on the environmental costs

imposed on society

• This value is then deducted from profits (calculated using financial accounting methods) to determine a measure referred to as ‘sustainable operating income’

• Although consider many externalities, ignores many eco-justice considerations required to pursue sustainability


Landcare Ltd• Seeks to determine the notional costs that would be

incurred if the organisation was to have zero environmental impact

• Sustainable cost: the amount which must be spent to put the biosphere at the end of the accounting period back into the state it was at the beginning

• Sustainable cost calculation involves two elements– costs required to ensure inputs have no adverse

environmental impacts

– costs required to remedy any environmental impacts that arise


Watercare services• Identifies the additional costs that would need to be

incurred if the organisation was to meet the social and environmental standards that it believes are appropriate

• Interesting approach to reporting – see pages 469 to 471 of the textbook


PUMA• From 2012 it commenced producing its Environmental Profit &

Loss (E P&L) account wherein it places a financial value on its use of 'natural capital'.

• The E P&L seeks to quantify not only PUMA's direct environmental impacts, but those of its suppliers too. The methodology relies heavily upon the use of various estimation techniques.

• See pages 465 and 466 of the textbook

• From the discussion of some of the alternative reporting approaches we should understand that reporting information about corporate social and environmental performance can be an interesting exercise wherein some level of experimentation is to be encouraged


Climate change• We will now move our focus on to the important social

and environmental issue of Climate Change

• Climate change represents one of the biggest risks to the planet (and to businesses)

• Climate change occurs because of an effect referred to as the ‘greenhouse effect’

• The ‘greenhouse effect’ describes how natural gases in the earth’s atmosphere allow infrared radiation from the sun to warm the earth’s surface. These gases prevent heat escaping from the earth’s atmosphere. Human actions are increasing the concentrations of these gases, creating global climate change

continued


Climate change (cont.)

• There are various accounting issues here, for example:– How do we account for (measure) emissions?

– How do we account (financially) for assets and liabilities associated with schemes such as ‘cap-and-trade’ schemes?


Cap-and-trade schemes• Cap-and-trade schemes are designed as a market-based approach

to dealing with carbon emissions

• The concept of an emission trading market is based on giving carbon a price per tonne so that products can be more fully costed and the costs of emissions be internalised

• Under a cap-and-trade system (such as the European Union Emissions Trading Scheme), ‘allowances’ or ‘credits’ are used to provide incentives for companies to reduce emissions by assigning a monetary value to pollution

• The ‘cap’ phase of the program begins when a government or regulatory body establishes an economy-wide target for the maximum level of specific emissions permitted by companies in a specified time frame. Then, a specific number of emissions allowances equal to the national target are allocated (or auctioned) to participating companies based on a formula that generally includes past emissions levels


Cap-and-trade schemes (cont.)• The ‘trade’ aspect of the program occurs when a company’s

actual emissions are greater or less than the amount covered by its owned allowances. Companies that emit less than their target will have excess allowances; those that exceed their target must acquire additional allowances. Additional (or excess) allowances can be purchased (or sold) directly between companies, through a broker, or on an exchange. Excess allowances can often be 'banked' and used to satisfy compliance targets in subsequent years

• A cap-and-trade system acts to internalise costs that would otherwise be treated as externalities and therefore, ignored by financial accounting (refer to previous slides on externalities and the definition of the elements of financial reporting)


Accounting for assets and liabilities arising from a ‘cap-and-trade’ system

• There will be numerous financial accounting issues associated with cap-and-trade systems

• For example, should the emission rights be considered as intangible assets?

• Decisions also need to be made about such issues as:

– how the emission rights shall be measured?

– Whether increases and decreases in the value of emission rights (for example, their fair value) should be recognised in profit or loss?

– how and when to account for impairments of emission rights?

– When to recognise expenses associated with emissions?

– Whether the value of emission rights granted by government should be included within income in the period of granting, or systematically recognised as revenue over the compliance period?

– When to recognise liabilities when emissions exceed the permits that are held? continued


Accounting for assets and liabilities arising from a ‘cap-and-trade’ system (cont.)

• Previous lectures/chapters have explored factors that would motivate managers to support or lobby for particular accounting methods

• Previous lectures/chapters have also explored theories to explain what might motivate regulators to support particular accounting approaches


Cap-and-trade schemes: some other issues• At a more general level, does it make sense to use a cap-and-trade

system to combat climate change?

• We can also reflect upon the European Union Emission Trading Scheme – which is an example of a cap-and-trade scheme

• To many people, this appeared to be a strange situation of using the very instrument that created the problem (the market) to then try to solve the problem

• This issue aside, the prices of the ‘pollution rights’ have fluctuated widely thereby creating much uncertainty for organisations considering whether to invest in cleaner technologies, or to buy pollution rights

• For example, the price of a permit to emit a tonne of carbon dioxide hit a peak of €32 in April 2006 but hit a recent record low of €2.81 per tonne in April 2013

• There are also the issues associated with having a ‘right to pollute’ being considered as an asset that sits in a balance sheet – that does look strange, doesn’t it?


Accounting for actual emissions• Apart from accounting issues associated with placing valuations on

emissions rights, and so forth, there are also accounting issues associated with measuring actual physical emissions

• Various frameworks have been developed to measure emission levels and offsets, one such framework being the Greenhouse Gas Protocol.

• Emissions are often reported in three categories:

– Scope 1—Emissions directly occurring from sources owned or controlled by the organisation (e.g. from company owned vehicles)

– Scope 2—Indirect emissions generated in the production of electricity and consumed by the organisation

– Scope 3—Other indirect emissions that are a consequence of the activities of the institution but occur from sources not owned or controlled by the organisation (e.g. emissions related to air travel)


Social auditing• In this lecture and in a previous lecture we explored the need for

organisations to be aware of, and to comply with, community expectations

• A Social audit involves stakeholder-based engagement with the aim of determining whether the organisation is perceived to be operating in accordance with stakeholder expectations and where improvements in performance are considered necessary

• The results of a social audit will often form the basis for information presented in a Social Report, or in the social reporting component of a Sustainability Report

• Organisations can do social audits to try to ensure that they are maintaining high ethical standards (for example, consider The Body Shop’s use of social audits), or they can be used after social problems have already become known (e.g. consider Nike’s early use of social audits)


Examples of social auditing standards• Released in 1998 by Social Accountability International

– SA8000

– focuses on issues associated with human rights, health and safety, and equal opportunities

• In 1999 the Institute for Social and Ethical Accountability launched the standard AA1000

– concerned with the processes of setting up and operating social and ethical accounting and auditing systems

– currently, the AA1000 series consists of: The AA1000 Accountability Standard (AA1000APS) provides a framework for an

organisation to identify, prioritise and respond to its sustainability challenges.

The AA1000 Assurance Standard (AA1000AS) provides a methodology for assurance practitioners to evaluate the nature and extent to which an organisation adheres to the Accountability Principles.

The AA1000 Stakeholder Engagement Standard (AA1000SES) provides a framework to help organisations ensure stakeholder engagement processes are purpose driven, robust and deliver results.


The role of corporate governance in improving corporate social and environmental performance

• Whilst a great deal of this lecture has focused on externally-oriented issues, such as public reporting, we will conclude the lecture by briefly considering internal factors – in particular – corporate governance

• If an organisation is serious about maintaining high levels of social and environmental performance, then its corporate governance system should reflect this aim


The role of corporate governance in improving corporate social and environmental performance (cont.)

• Governance mechanisms might include:– stakeholder engagement mechanisms (such as routine social

audits);– board structures that include environmental managers;– implementing a rigorous environmental management accounting

system;– environmental policies that are clear and well communicated;– executive rewards linked to sustainability-related KPIs (we could

perhaps question an organisation’s commitment to sustainability if we found that senior managers were rewarded solely on the basis of financial performance-related KPIs);

– policies of social and environmental evaluation for all major capital investment decisions;

– waste management policies; and– supply-chain audits.


Personal social responsibility• Whilst this lecture has focused on CSR, we should not ignore our own

responsibilities – our personal social responsibilities (PSR)

• We all make choices that will either increase or decrease our own contribution to various social and environmental outcomes

• Rather than relying solely on CSR and/or the government, we must also consider PSR which would require ongoing judgments, such as the necessity for particular travel and the mode of travel being used, how much energy we consume, how much waste our activities are generating, how social and environmental responsibilities were embraced by the suppliers of our clothing, and so forth

• The emphasis here is that tackling important issues such as climate change and poverty alleviation requires ‘the community’ to also embrace the need for change and not to simply rely upon (or blame) organisations for the necessary improvements

• One can also argue for PSR on the grounds that asking for CSR becomes a way of ‘passing the buck’—evading personal responsibility for ‘doing good’

continued


Personal social responsibility (cont.)• As Chandler (2010) states:

– Let’s get beyond the idea that firms are inherently evil. Such a perspective does not absolve firms of responsibility, but recognises that for-profit organizations add considerable social value in producing products and services that are in demand. It also recognizes that the relationship between firms and society is symbiotic and, as a result, the responsibility to ensure social responsible outcomes is shared. In the same way that we deserve the politicians we vote for, we also deserve the companies we purchase from.

• Whilst this is all pretty obvious, how many of us actually embed PSR considerations in the various decisions we make?

• Further, how do accounting and business lecturers embed considerations of PSR within the courses they teach? What’s our experience with this?

– arguably, because business educators have an audience of future business leaders it is even more important that they try to increase consciousness about the role of individual choice in addressing social and environmental issues and problems


Concluding comments• Social and environmental reporting is a rapidly

evolving area

• Only 20 years ago, almost no companies were producing social and/or environmental reports

• Now many large listed companies are providing such reports

• As concerns for global warming, social justice and environmental protection increase we can expect this form of reporting to continually evolve

• It is an exciting area of accounting to be involved with!

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