ACCA P4 Advanced Financial Management - 2010 - Study text

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Chapter 2: Impact of environmental issues on corporate objectives and governance

Countries that consume most environmental resources and create most

environmental damage relative to other countries are those with the highest

environmental footprint per head of the population.

1.2 Carbon neutrality

The effect on the environment of economic activities by individual companies may

be measured in terms of emissions of carbon-based pollutants, such as the release of

carbon dioxide into the atmosphere. (Carbon is only one of many different

pollutants of air, water and land, but carbon dioxide emissions into the atmosphere

have attracted extensive interest and concern.)

Some environmentally-conscious companies already measure their impact on

carbon pollution, and might have a stated environmental policy of being ‘carbon

neutral’.

Carbon neutrality exists when a company is able to counterbalance its use of carbon

products, and particularly its carbon dioxide emissions, with activities that reduce

the amount of carbon dioxide in the atmosphere such as growing trees or plants

(which absorb carbon dioxide from the atmosphere). Some companies have also

tried to reduce their impact on carbon dioxide pollution by switching to the use of

fuel and energy that does not involve carbon consumption.

Example

The Du Pont Corporation is an example of a large environmentally-conscious

company, which has stated as its mission the aim of seeking sustainable growth.

Du Pont listed some of the initiatives it has taken to create a sustainable business:

 Setting a target of zero waste generation and zero waste emissions

 Conserving energy and resources such as oil, coal, natural gas, water and

minerals

 Recycling materials to reduce the need for disposals

 Reducing packaging waste

 Making, using, handling and transporting materials safely and in an

environmentally-friendly way and in compliance with local regulations

 Managing land efficiently to increase habitats for wildlife

 Developing new products and processes that reduce the environmental risks.

1.3 Social footprint

A social footprint is the effect of economic activity on society and people. In general,

economic activity is seen as providing benefits for society, although some

companies are much more ‘people-friendly’ than others. Some companies, for

example, use child labour and/or pay subsistence-level wages to their workers.

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Companies might seek to measure the contribution of their activities towards

society in terms of:

 Total numbers employed or increase in the total number of employees

 The proportion of the total work force employed in different parts of the world

 The proportion of the total work force that is female or from different ethnic

groups

 Health and safety at work (for example, numbers of employees injured each year

per 1,000 of the work force).

Social ecologists argue that the environmental crisis has been caused by companies

seeking growth, profits and economic self-interest. Nothing fundamental has

changed. Companies are still trying to get bigger and more profitable, even though

they use environmental ideology to express their plans and ambitions. They argue

that the environmental crisis cannot be averted without a radical change in human

society.

1.4 Sustainability and environmental risk

For companies there are two aspects to environmental risk:

 There is reputation risk for companies that are considered serious polluters of

the environment and companies that are depleting the world’s natural resources.

Reputation risk is the risk that a company will acquire a bad reputation in the

eyes of the general public customers, and so be at a competitive disadvantage to

rival producers.

 There is also the risk that by continuing to use up natural resources and pollute

the environment, companies might not have a business that can be sustained

into the long-term future. Examples of concerns about sustainable business

development have included the consumption of the world’s fishing stocks by

fishing fleets and the destruction of hardwood forests by forestry companies.

One way in which companies might recognise their responsibility towards the

environment is to provide information about their environmental and social

footprints.

Many companies now produce a voluntary social and environmental report each

year (as a separate publication), or include comments on environmental issues in the

chairman’s statement of the chief executive officer’s report in the published annual

report and accounts. However, social and environmental reports often do not

include quantified information, and reports often concentrate on the ‘good’

environmental measures taken by the company and ignore the ‘bad’ polluting and

non-sustainable activities.

Chapter 2: Impact of environmental issues on corporate objectives and governance

Sustainability reporting and environmental audits

 Accounting and the economic model

 The need for objective environmental reporting

 Sustainability reports: triple bottom line reporting

 Environmental audits

2 Sustainability reporting and environmental audits

2.1 Accounting and the economic model

The capitalist system creates incentives for maximising wealth, and it is based on

the assumption that wealth can only be increased through continual economic

growth. This is the ‘economic model’ of society. As a result, growth-seeking

economic activities continue, in spite of growing concerns for the environment, and

recognition that continual growth in its current form cannot be sustained.

Accounting has developed in support of the economic model. Financial reporting

measures the consequences of a company’s activities in terms of the use of the assets

that it owns and the liabilities for which it has the direct responsibility for payment.

Current accounting practice does not allow companies to report the consequences of

their actions on external assets that it does not own, and the creation of liabilities for

which it does not have to pay directly.

Investment decisions by large companies are made using accounting techniques

such as discounted cash flow analysis, which focuses exclusively on economic

consequences of investment, and does not measure or evaluate the environmental

and social impact.

Financial reporting, management accounting and financial management have all

therefore supported the economic model of business.

2.2 The need for objective environmental reporting

In the past, companies ignored their consumption of natural resources such as air

and water because they assumed that supplies of these items were both limitless

and free. This is no longer the case. It can now be argued that whereas companies

are increasing economic wealth through growth and the search for profit

maximisation, society may well be getting poorer because of the damage that

economic activity is having on the environment and society

As companies have become increasingly aware of environmental issues, and begin

to accept that economic growth might not be sustainable, they have become more

interested in measuring sustainability and environmental impact.

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Traditional accounting methods do not provide for this type of measurement, and to

the extent that companies (and society) want environmental and social impacts to be

measured, traditional accounting is inadequate.

In order to help companies to set targets for achievement and assess their actual

performance, there should be measurement. Environmental and social effects

should be quantified, because managers find it easier to plan and control using

numbers than using more general qualitative assessments.

Some accountancy bodies, including the ACCA, are contributing towards efforts to

establish measurement and reporting systems for social and environmental issues,

to complement traditional financial reporting.

Alternative measurement and reporting systems that recognise the need for

economic activity to be sustainable have therefore been considered, although there

is as yet no widely-accepted standard measurement and reporting system.

2.3 Sustainability reports: triple bottom line reporting

Sustainability reporting in the form of ‘triple bottom line reports’ have been

developed as a method of presenting quantified and more objective information

about the social and environmental effects of a company’s activities.

The term ‘triple bottom line’ was ‘invented’ in 1994 by J Elkington. Its aim is to

encourage companies to recognise social and environmental issues in their business

models and reporting systems. This method of reporting is encouraged by the

Global Reporting Initiative (GRI), an internationally-recognised body that promotes

sustainability reporting.

The ‘triple bottom line’ gets its name because companies report their performance

not simple in terms of profit: they provide key measurements for three aspects of

performance:

 economic indicators

 environmental indicators, and

 social indicators.

Triple bottom line reporting is therefore providing a quantitative summary of a

company’s economic environmental and social performance over the previous year.

Economic indicators will include measurements relating to:

 sales revenue

 profits, earnings and earnings per share

 dividends per share

 global market share (as a percentage of the total market)

 in some industries, such as car production, units of sale worldwide.

Environmental indicators might include measurements relating to:

 reducing the ‘intensity’ of materials in products and services

Chapter 2: Impact of environmental issues on corporate objectives and governance

 reducing energy intensity

 minimising the release of toxic materials/pollutants

 improving the ability to recycle material

 maximising the use of renewable resources

 extending the life of a product

Example

One major global company using triple bottom line reporting reported its

environmental performance in terms of:

 global energy use, measured in thousand of GWh

 global carbon dioxide emissions, measured in metric tonnes

 production of non-recycled waste, measured in metric tonnes

 the number of manufacturing sites that had been awarded an ISO 14000

certificate (which is explained later).

The same company reported, as social indicators:

 its donations to communities and sponsorships, measured in US dollars

 diversity: the percentage of its employees who were female and the percentage

who came from minority groups

 the number of discrimination charges brought against the company during the

year

 employee satisfaction, based on a census of employee opinion

 the recordable injury rate per 1,000 employees.

Weaknesses in triple bottom line reporting

There are several weaknesses with triple bottom line reporting.

 There are no widely-established standards for triple bottom line reporting, and

no standard methods for measuring social and environmental impacts. It is

therefore difficult to compare the sustainability of one company with the

sustainability of another. (The work of the Global Research Initiative or GRI is to

standardise measurements for the triple bottom line. It has been publishing

Sustainability Reporting Guidelines since 1999. These were updated and

amended in 2002.)

 If the social and environmental measures are not subject to independent audit,

there might be doubts about the reliability of the data presented in a company’s

report.

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2.4 Environmental audits

A social and environmental audit, or simply an environmental audit, can have

several meanings.

 It can mean a formal audit of an environmental management system, to check

that the system operates effectively.

 It could be an internal check of a particular aspect of the company’s environment

management system, such as its system for measuring the environmental costs

of waste, or the methods used to measure the cost of site contamination at a

particular manufacturing site. This audit might be carried out by members of the

company’s own internal audit team (who might be an environmental expert

rather than an accountant).

 There may be a check on the company’s compliance with environmental and

social legislation and regulations.

 It could involve a verification of social and environmental information that will

be included in a published report, such as an environmental performance report.

 Similarly it might be a check on the accuracy of figures supplied by the company

to the government authorities responsible for environment regulation.

 It could also refer to the checks that the company’s external auditors need to

carry out on the company’s financial statements, as far as they relate to

environmental issues. For example, the introduction of new environmental laws

might have an impact on the impairment of non-current assets, and a failure by

the company to carry out environmental improvements required by law might

create a requirement to make an accrual for remedial costs or a provision for the

payment of a fine.

An international auditing practice statement has explained environmental audits as

follows:

Environmental audits ‘can be performed by external or internal experts…at the

discretion of the company’s management. In practice, persons from various

disciplines can qualify to perform “environmental audits”. Often the work is

performed by a multi-disciplinary team. Normally “environmental audits” are

performed at the request of management and are for internal use. They may address

various subject matters, including site contamination, or compliance with

environmental laws and regulations’ (IAPS 1010).

How can environmental audits contribute to environmental accounting?

At the moment there is no legal requirement in any country for environmental

audits. This type of audit is voluntary.

Similarly there is no legal requirement for environmental accounting, although

professional accounting bodies such as the ACCA are encouraging more research by

academics and practice by companies.

It seems quite possible, however, that environmental audits and environmental

accounting will both become more common, as companies become increasingly

aware of the problems of sustainability and sustainable growth, and include

Chapter 2: Impact of environmental issues on corporate objectives and governance

environmental objectives within their corporate strategy and investment decision-

making.

The development of environmental accounting and environmental auditing will

depend to a large extent on the development of environmental management

systems, and how soon more companies establish environmental management

systems. When environmental management systems are established:

 management needs reliable environmental information

 in general, managers prefer information in a quantified/measured form rather

than in qualitative and descriptive terms

 as environmental management systems develop, with measurement systems for

setting targets and monitoring performance, it seems likely that the need for

audits of the information system will be necessary, to reassure management that

the information systems are sound.

However, there still seems a long way to go before social and environmental

reporting rivals financial reporting (economic reporting) as the main method of

reporting by companies.

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Carbon trading

 Origins of carbon trading

 Features of the EU Emissions Trading Scheme

 The significance of carbon trading for companies and financial management

3 Carbon trading

3.1 Origins of carbon trading

The Kyoto Protocol to cut greenhouse gas emissions was agreed by the governments

of about 140 countries and came into force in 2005. (It runs until 2012.) It has not

been ratified by the United States or Australia.

In the European Union, the implementation of the Kyoto agreement has been in the

form of the European Emissions Trading Directive, which set out a framework for a

European Emissions Trading Scheme (EU ETS).

This is more commonly known as a carbon trading scheme, because the scheme

applies only to emissions of carbon dioxide (CO

) until 2007, although from 2008 the

trading scheme might be extended to the other five greenhouse gases.

3.2 Features of the EU Emissions Trading Scheme

The emissions trading scheme has two main elements:

 The governments of the EU countries are required to set a cap on total amount of

carbon dioxide emissions, by allocating ‘rights to pollute’ to individual

industrial sites/companies.

 The market is then allowed to trade in these ‘rights to pollute’, so that high

polluting companies can buy carbon trading ‘credits’ on the market, giving them

the right to go beyond their allocated pollution limit.

The EU ETS scheme is in two phases. In the first phase lasting until the end of 2007,

carbon dioxide emissions in the EU countries are limited or ‘capped’ for companies

in the power-generating and energy-intensive industrial sectors. Each country sets

its own total emissions limit for these industries and the government then allocates

‘free emissions allowances’ or ‘rights to pollute’ to companies. In the UK, the first

phase of the ETS applied to about 1,500 sites.

Companies are allowed to use their ‘free emissions allowances’, but in practice some

companies do not need all the allowances they have been given, and other

companies need to make more emissions than they are allowed.

 Companies with surplus allowances or ‘credits’ can sell them in a carbon trading

market, and companies needing more credits can buy them.

 The price for carbon credits depends on demand and supply.

 The market is fairly new, but there are specialist carbon credit traders who act as

intermediaries between buyers and sellers of credits.

Chapter 2: Impact of environmental issues on corporate objectives and governance

There is another aspect to the carbon trading market. Companies that invest in

projects that are environmentally friendly are given additional carbon credits by the

government. The companies receiving these additional credits can sell them in the

market.

Example

A company decides to build a wind farm. It receives carbon credits from the

government because the technology to generate power from the wind has a zero

carbon output.

This company does not need its carbon credits, because it does not produce any

carbon dioxide emissions. The company can therefore sell its carbon credits to

another company that does produce CO

emissions and needs to obtain more

credits.

The company building the wind farm is able to use the money it receives from

trading in carbon credits to help pay for the cost of its wind farm.

3.3 The significance of carbon trading for companies and financial

management

Government actions to reduce greenhouse gases have an impact on companies

affected by the regulations in their particular country. For many polluting

companies, the consequences are higher costs. Higher costs take the form of both

measures to reduce emissions and also the cost of buying carbon credits when

permitted limits will otherwise be exceeded.

For companies that will receive carbon credits for environmentally-friendly

investments, the system of carbon credits means that they can reduce their

investment costs by selling the credits they are given.

Criticisms of carbon trading

Critics of carbon trading argue that the only way to reduce greenhouse gas

emissions is through direct government action and regulation, and that the system

of offsetting and trading carbon credits has no effect on the total amount of

environmental pollution.

The scheme is also criticised on the grounds that some countries have been given

fairly ‘generous’ limits for carbon dioxide emissions (notably China and India) and

that in other countries the government has been too generous in awarding the free

emissions allowances.

The biggest difficulty for the Kyoto Protocol and measures to cut greenhouse gas

emissions has been the refusal of the United States to join the scheme. The US

government began discussions on greenhouse gas emissions in 2007, but has so far

not taken any direct action.

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ACCA P4 Advanced Financial Management - 2010 - Study text - Emile Woolf Publishing

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