Financial Acco
Financial Accounting
unting Theory
Theory
Craig Deegan
Craig Deegan
Chapter 9
Chapter 9
Extended systems of accounting
Extended systems of accounting——thethe
incorporation of social and environmental factors
incorporation of social and environmental factors
within external reporting
Learning objectives
Learning objectives
•• In this chapter you will be In this chapter you will be introduced tointroduced to
–
– various perspectives of the responsibilities of businessvarious perspectives of the responsibilities of business
–
– explanations of the relationship between organisationalexplanations of the relationship between organisational
responsibility and organisational accountability
responsibility and organisational accountability
–
– various theoretical perspectives that can explain whyvarious theoretical perspectives that can explain why
organisations might voluntarily elect to provide publicly
organisations might voluntarily elect to provide publicly
available information about their social and environmental
available information about their social and environmental
performance
Learning objectives
Learning objectives
•• In this chapter you will be In this chapter you will be introduced tointroduced to
–
– various perspectives of the responsibilities of businessvarious perspectives of the responsibilities of business
–
– explanations of the relationship between organisationalexplanations of the relationship between organisational
responsibility and organisational accountability
responsibility and organisational accountability
–
– various theoretical perspectives that can explain whyvarious theoretical perspectives that can explain why
organisations might voluntarily elect to provide publicly
organisations might voluntarily elect to provide publicly
available information about their social and environmental
available information about their social and environmental
performance
Learning objectives (cont.)
Learning objectives (cont.)
–
– some recent initiatives in social and environmentalsome recent initiatives in social and environmental
accounting
accounting
–
– the concept of sustainable development and howthe concept of sustainable development and how
organisations are reporting their progress towards the
organisations are reporting their progress towards the
goal of sustainable development
goal of sustainable development
–
– the relationship between sustainability and the relationship between sustainability and eco-efficiencyeco-efficiency
and eco-justice issues
and eco-justice issues
–
– some of the limitations of traditional financial some of the limitations of traditional financial accountingaccounting
in enabling users of reports to
in enabling users of reports to assess a reporting entity’sassess a reporting entity’s
social and environmental performance
Introduction
• In recent years there has been increasing
discussion about sustainable development and triple bottom line (TBL) reporting
– TBL reporting is reporting that provides information about the economic, environmental and social performance of an entity
• Represents a departure from sole economic focus that was traditional in external reporting
• A review of the Global Reporting Initiative’s Sustainability Reporting Guidelines provides
Introduction (cont.)
• The terms sustainability reporting and TBL reporting are often considered to be synonymous
• Strictly speaking, however, sustainability reporting would require more than just TBL reporting and it would question three separate ‘bottom lines’ given sustainability would require social, economic and environmental aspects to be considered together • Sustainability reporting would also address
specifically how current activities are impacting the abilities of future generations to satisfy their own needs. Current TBL reports do not address such
Responsibilities of business
• Moves to provide information about social and environmental performance, whether through
sustainability or TBL reports, 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
• Increasing community pressures for organisations to make a commitment to sustainable business
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
Sustainability
• Brundtland Report placed sustainability on the business worldwide agenda
• Sustainable development defined as
‘… development that meets the needs of the
present world without compromising the ability of future generations to meet their own needs’ (World Commission on Environment and Development, 1987)
• Inter-generational and intra-generational equity central to the agenda
Sustainability (cont.)
• Should organisations be responsible for the sustainability of their business practices? • Will they embrace this responsibility in the
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
Accountability
• The duty to provide an account (not necessarily financial) or reckoning of those actions for which one is held responsible
• Two responsibilities or duties
– responsibility to undertake certain actions
To whom is business responsible?
• Many organisations making public statements that responsibilities extend beyond shareholders to
encompass communities in which they operate and society as a whole
• If sustainability embraced then responsibility 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 motivations—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?
Stage 1: Why report?
• Different accounting theories will provide
alternative explanations about why an entity might decide to report social and environmental
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
Theories to explain ‘why report?’ social
and environmental disclosure (cont.)
• Institutional Theory
– organisations will adopt particular practices because of institutional pressures
• Positive Accounting Theory
– disclosure depends on positive wealth implications
‘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
• A broader view of business responsibilities would accept that regardless of the impacts of
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
– responsibility to increase profits as long as stays within the rules
– this view often held by the media—applauds 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
Stage 2: To whom to report?
• If managers overwhelmingly motivated by the
desire to increase shareholder value then reporting will be aimed primarily at satisfying the
expectations of powerful stakeholders
• If we 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 to whom to
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
• Triple bottom line 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
How to report? Limitations of traditional
financial accounting
• For the following reasons, financial accounting is not seen as a useful vehicle for promoting social and environmental disclosures
• Financial accounting focuses primarily on the information needs of those involved in resource allocation decisions. By contrast, sustainability concerns all stakeholders
• The notion of ‘materiality’ tends to preclude the reporting of social and environmental information, given the difficulty in quantifying costs
How to report? Limitations of traditional
financial accounting (cont.)
• Reporting entities frequently discount liabilities to present value, which tends to make future clean-up expenditures appear trivial
• Financial accounting adopts an entity assumption where the entity is treated as distinct from its
owners and other stakeholders
– transactions not directly impacting the entity are ignored – ignores externalities caused by the reporting entity, some
relating to social and environmental implications of the entity’s operations
• Expenses are defined to exclude the recognition of
any impacts on resources not controlled by the
entity
• Externalities caused by the entity cannot be reliably measured, and so typically are not
recognised given the recognition criteria provided in such documents as the IASB Framework
How to report? Limitations of traditional
financial accounting (cont.)
How to report? Triple Bottom Line
Reporting
• Triple bottom line reporting refers to the disclosure of information about the social, economic and
environmental performance of an entity
• But … is the bottom line metaphor appropriate— can social and economic impacts be measured through a ‘bottom line’?
• Seems to indicate that we must manage all the bottom lines in a similar manner —appropriate? • Seems to suggest that social, economic and
How to report? Relevance of measures
such as GDP
• Performance of governments is related to outputs of systems of national accounts
– e.g. gross domestic product (GDP)
• Does not consider issues of resource efficiencies or equities with how resources are distributed
How to report? The Global Reporting
Initiative
• Global Reporting Initiative (GRI) established 1997 • The GRI Sustainability Reporting Guidelines is the
most comprehensive framework for ‘how to report’ that is currently available
• Third version—G3—released in 2006
• Made up of various ‘core’ and ‘additional’ performance indicators
• Not mandatory and hence many organisations are selective about what information they select for
Social auditing
• Purpose of social auditing is for an organisation to assess its performance in relation to society’s
requirements and expectations
• Results form the basis of an entity’s publicly
released social accounts, which in themselves are often incorporated into a triple bottom line or
sustainability report
• Consider the Body Shop’s social impact report which is based on their social audit
Social Auditing Standards
• Released in 1998 by the Council on Economic Priorities (US body)
– SA8000
– focuses on issues associated with human rights, health and safety, and equal opportunities
• In 1999 ISEA launched standard AA1000
– concerned with the processes of setting up and operating social and ethical accounting and auditing systems
Monetising environmental costs and
benefits
• As we have already discussed, financial accounting typically ignores 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 should be
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
Baxter International
• Approach most conservative of those considered • Ignores any externalities caused by the business,
and only includes costs and benefits directly related to cash flows
• Attempts to demonstrate that by explicitly
considering the environment, actual cost savings can be made
BSO/Origin
• Place 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
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