30 January 2014 – The Sustainability Accounting Standards Board in the US came out of Harvard and the Kennedy School of Government and is backed by Bloomberg Philanthropies and the Rockefeller Foundation. The Australian Bureau of Meteorology has published a guide on environmental accounting. And in Denmark companies are required to report on corporate social responsibility, or explain why not.
Why is sustainability accounting important?
Think of the old mantra: what gets measured gets acted on.
Sustainability accounting is critical now because the system is struggling to come to terms with a world that’s become more fragile. And we need changes to accounting to measure markets that are now more volatile. Take a look at the markets over the last week – the old systems aren’t working anymore.
The Sigma Project, run by the Association of Chartered Certified Accountants in the UK, with the Co-Operative Bank and Co-Operative Insurance, says sustainability accounting is the way to measure real costs. Unfortunately, companies don’t use it when they report earnings, leaving investors in the dark.
“In a market-based system people are influenced by the pricing signals that are available. If prices do not include all the costs and benefits, then how can the market give the signals which allow for the most appropriate economic, social and environmental decisions?
“For example, petrol emissions from transport contribute to acid rain, climate change, as well as adverse health effects arising from a reduction in air quality. These environmental and social impacts generate real costs to society now and in the future. However, they are not reflected in the price of fuel.
“These externalities are not wholly borne by the person purchasing the petrol and driving the car. Externalities may also be positive: the car may be performing any number of tasks that lead to benefits to wider society (an ambulance, a truck transporting recycling material, a family visiting relatives).
“There are means of bringing external environmental impacts within the control boundary of an organisation. Mechanisms such as taxes, levies or compliance costs internalise the cost of the environmental impacts so they are being recognised by the conventional financial accounting system, and earnings are reduced as a result. It remains true, however, that the extent of such internalised costs is rarely reflected in terms of financial statement disclosures. Residual, non-internalised costs, both environmental and social, remain unrecognised and continue to represent a hindrance to fully effective resource allocation.”
Writing for the Institute of Chartered Accountants, Karen McWilliams says that between 60-80 per cent of coal, oil and gas reserves of publicly listed companies would be “unburnable” if the world was to successfully limit the global temperature change to two degrees.
The result: a massive over-valuation of these reserves. As Carbon Tracker, a not for profit initiative, says, this not only represents a systemic risk to the environment. It can also damage financial markets. The assets in public companies would be over-valued and that means you can’t believe what’s on the balance sheet.
“The Association of Chartered Certified Accountants and Carbon Tracker have found that reporting standards as they are currently applied to the fossil fuels sector would struggle to recognise the warning signs of the systemic risks of climate change,’’ McWilliams writes.
“Markets need to become more climate literate and investors need more complete, forward-looking and integrated information on emissions and fossil fuel reserves to better understand their exposure to climate change risks.
“The accounting challenge which arises from this relates to the carrying value of fossil fuel reserves, which are typically based on associated costs, rather than current value. Although impairment can be applied, where the expected value may not be realised, there don’t seem to be allowances made for the reasonable assumption that demand for fossil fuels will decline in the future.”
Still, the push to develop sustainability accounting standards is gathering momentum. The International Integrated Reporting Committee is currently piloting its methodology for companies to produce one combined financial, environmental and governance report, not just the financials.
As the IIRC says studies show that 80 per cent of an organisation’s value is “hidden” in non-financial assets, such as research and development, technology, patents, and intellectual property, not showing up in traditional financial reports.
“Integrated reporting requires an integrated business strategy that creates value by balancing short-term gains with long-term strategy and investment,” says the IIRC.
Needless to say, it’s the accountant’s role to identify those non-financials.
At the same time, Accounting Today reports that the Sustainability Accounting Standards Board and the International Integrated Reporting Council signed a memorandum of understanding pledging to collaborate more closely to advance corporate disclosures of sustainability efforts to investors.
The person behind a lot of this is Jean Rogers the founder and executive director of SASB which developed out of the Harvard University Initiative for Responsible Investment at the Kennedy School of Government.
The SASB is gaining clout. It has a staff of 30, a budget of $5.8 million, 150 advisors and over 1000 corporate and investor participants in the standards-setting process to date representing over $13.9 trillion in assets under management and $5.7 trillion in market capitalisation.
A look at the SASB website shows that it’s developing sustainability standards for sectors including healthcare, financials, technology and communication, non-renewable resources, transportation, services, resource transformation, consumption, alternative energy and infrastructure. Standards in each sector are being developed by experts in standards development, securities law, environmental law, metrics and accounting.
SASB supporters include Bloomberg Philanthropies and the Rockefeller Foundation.
Rogers argues that sustainability metrics build trust in the financial sector in a way that other initiatives can’t.
As she writes in Green Biz, the only way to rebuild trust in financial institutions is to identify comparable data on how they are managing environmental, social and governance. This data gives them the social licence to operate.
“The social licence to operate enjoyed by the financial sector can be traced back to ancient times, when temples commonly served as banks. Governance issues, determined by SASB research to be among the most material of ESG issues for the sector, have the potential to shake public trust in the near-sacred institutions in this sector.
“Governance is made particularly complicated by the concentration of large players intertwined in multiple roles. Banks, for example, are often on several sides of the same transaction — as principal investor, advisor and provider of debt financing. This leads to potential conflict of interest, systemic risk and regulatory compliance.”
The Australian Bureau of Meteorology has published a guide on environmental accounting designed to help policy makers, scientists and accounting practitioners develop environmental accounts. It is working with key partners, particularly the Australian Bureau of Statistics and the Department of the Environment, to develop an environmental accounting platform.
It says accounting can easily be expanded into the equipment and weather forecasts.
The bureau says:
“Accounting is a long-established and well understood format for organising information with built-in checks and balances. It is used for tracking value through time and space. While national accounts report on the economy, on the whole measures of human, social, and natural capital do not register in these accounts.
“Fortunately, advances in theory and practice across many disciplines, along with advances in information technology, are allowing accounting methods to be applied to the environment and ecosystems, providing a broader frame of reference for policy.
“Improved accounting of changes in environmental assets, over both the short- and long-term, will enable us, as Australians, to better measure the status of their environment and the quality of their stewardship of the country’s land, air, and water resources. This knowledge will enable more efficient investment decisions and improved environmental management.”
University of Tasmania research finds that sustainability accounting would have a key role in local government, the coal face of planning decisions. Unfortunately, most accountants aren’t yet across this discipline. They have some way to go.
The study says:
“Accountants themselves need to engage more in issues of sustainability if they are to broaden their involvement and role in sustainability accounting. This can only come if accountants are aware, understand and fully appreciate the value of sustainability accounting and reporting.
“This lack of understanding was highlighted in the study with 30.9 per cent of respondents indicating that accountants are not used in sustainability reporting due to a lack of expertise. This result sends a clear signal to both the accounting profession and the accounting education system that there is a need for re-education and re-training of accountants if accountants are to play a leading role in sustainability reporting.”
The chief executive of the Global Reporting Initiative Ernst Ligteringen says governments should play a key role making sustainability accounting part of the financial reporting process.
“There needs to be better quality of information and more generally available information for this information to be systemically useful to markets. The decision to report or not has an impact beyond the company – it has an impact on markets.
“Imagine if you said you were no longer going to give financial information to markets – there would be an outcry, because markets can’t work without information. If we want markets to take account of environmental and social factors that influence companies’ blended value it is no different. Markets need information to be able to do this. Failing to share this information undermines a well-functioning market.”
He says there is a role for governments here and cites the new rules in Denmark where companies are required to report on corporate social responsibility, or explain why not.
Sustainability accounting in Denmark would be the next step. Governments and accountants will play a bigger role in sustainability accounting over the next decade. Watch this space.