«Published by the SIGMA Project, September 2003 SIGMA Project, 389 Chiswick High Road, London, W4 4AL SUSTAINABILITY ACCOUNTING GUIDE Contents ...»
Sustainability accounting tries to provide information in three different
3. Type of impact: is the impact environmental, social or economic?
The environmental, social and economic elements, are often thought of as the components of the ‘triple bottom line’ of sustainability reporting which can be
disaggregated into the Five Capitals Model in the following way:
The 5 Capitals Models is discussed in depth in the Sigma Guiding Principles.
These three distinct dimensions of the sustainability accounting framework are illustrated in Figure 1 as a three by two by two cube.
Figure 1: Sustainability Accounting in three dimensions
Almost inevitably, sustainability accounting currently deals with economic, environmental and social issues in relative isolation from each other. Attempts are being made to explore the inter-relationships between these three central pillars of sustainability (for example see the material in 6.2 on the Sustainability Assessment Model) but, with the possibility of some experimentation with integrated performance indicators (socio/economic or eco-financial), corporate progress towards sustainability is mainly measured in discrete chunks rather than as an integrated whole (Bebbington & Gray).
Also, much sustainability accounting practice currently treats the stocks and flows in relative isolation. A more complete approach is to recognise that changes in stocks are the results of in- and out- flows. There are almost no examples of reporting at this level of sophistication.
Traditional financial accounting only includes the internal stocks and flows of economic (and some social and environmental impacts) on the Balance Sheet and Profit and Loss account respectively – part of the front half of the cube.
Sustainability accounting seeks to explore all three dimensions by:
1. disaggregating the internal accounts to show costs and benefits relating to economic, social and environmental performance; and
2. extending the accounting boundary to consider the monetary value of external economic, social and environmental impacts.
Moving from financial accounting to sustainability accounting requires
adjustment and extension to the primary statements in the following ways:
• Restatement of the Profit and Loss Account to show how sustainability related costs and benefits can directly impact on the bottom line.
• Extension of the Profit and Loss Account to encompass the external costs and benefits to the environment, society and the economy which are not traditionally taken into account.
• Extension of the Balance Sheet to take a fuller account of the range of assets (including intangible assets such as brands, human capital or reputation as they relate to sustainability); and ‘shadow’ liabilities (including liabilities relating to sustainability risks) of the organisation.
Taken together these adjustments form the sustainability accounting framework which is illustrated in Figure 2. They provide a route map for the remaining chapters of this guide.
Figure 2: Overview of Sustainability Accounting The numbers against each part of the overview give the section in this guide where that approach is discussed.
5. Internal Flows: Role of the Profit & Loss Account
5.1 Current financial accounting practice Reporting an organisation’s financial performance over a period is encapsulated in the Profit and Loss account (P&L). Conventionally the P&L presents this information in a format of most interest and value to its shareholders. Table 1 provides a simple example of the presentation of a conventional P&L Account.
Table 1: A Conventional Profit and Loss Account
For many users of the financial accounts, the financial bottom line would be the Profit Before Tax.
Sustainability accounting recognises that the capacity of an organisation to generate wealth and value added is dependent not just on manufactured and financial capital, but also on human, social and natural capital. This means that payments to employees; environmental protection expenditures and community programmes can be re-investments in the organisation's assets and as such can contribute to positive wealth generation.
Re-statement of the financial information contained in the P&L Account can show the positive contribution that sustainability related programmes can make to wealth generation and value added. There are many different ways to re-state the financial information contained in the P&L Account. This guide
illustrates three different ways:
• Economic value added
• Environmental value added
• Social value added
5.2 Economic Value Added An Economic Value Added statement restates the financial flows in the P&L to show which different stakeholder groups benefited from those flows. It shows the economic value added to different stakeholders by the organisation’s activities.
Value Added Statements are an integral part of sustainability accounting as they enable organisations to focus on returns to wider stakeholders as well as shareholders. They can be used to allow sustainability targets to be defined in terms of how the wealth generated is to be shared amongst the various groups. They allow sustainability performance to be benchmarked over time and across different organisations and sectors.
The Economic Performance Indicators in the Global Reporting Initiative are derived from a simple Economic Value Added Statementii. A number of organisations are now regularly preparing and reporting using this format.
See for example BT, Novo Nordisk and South African Breweries (as illustrated in Table 2). Value added statements are normally produced on the basis of sales less cost of sales. Using cash receipts minus cash payments is a variant which can be susceptible to timing differences in cash flows. The SAB approach is cash flow based.
A more detailed pro forma of the economic value added statement is presented in Appendix 2.
Table 2: Economic Impacts: Value Added Statement for South African Breweries for the year ended 31 March 2002
An Economic Value Added statement, such as Table 2, by itself does not give the users of the accounts a full basis for understanding an organisation’s economic impact. Best practice with sustainability reporting would be to provide a relevant and objective interpretation of the disclosed figures.
5.3 Environmental Value Added The P&L Account can also be re-stated to draw out environmentally related costs and benefits which would otherwise remain hidden in the financial accounts. The presentation of company wide environmental costs and benefits is sometimes referred to as an Environmental Financial Statement (EFS).
The EFS is basically an aggregated cost-benefit statement that attempts to collate and report, in a single statement, total environmental expenditure and any associated financial savings achieved as a result of that expenditure over the particular accounting period under review. The statement aims to capture all relevant items of environmentally related expenditure, irrespective of which department or cost centre incurred them, and to match the expenditure with associated financial benefits or savings. Environmental costs may be investments in fixed assets (manufactured capital) or operational expenses.
Environmental benefits may arise from cost savings; environmental grants;
taxes avoided or revenues generated. Environmental taxes (e.g. landfill tax, climate change levy etc) to discourage poor environmental performance and tax breaks (e.g. enhanced capital allowance for energy efficiency investments) to reward good environmental practices are likely to become more common.
In other cases, some materials will become more costly or even banned for environmental reasonsiii.
The re-statement of environmentally related costs and benefits can be presented in a variety of different formats and levels (organisation-wide, by department, project or product). A detailed pro forma of an environmental financial statement is presented in Appendix 3.
An example of an EFS in practice is provided by Baxter Healthcare Corporation. They have produced and reported a company wide statement of environmental costs and benefits since 1995. The Company reports that their experience makes a powerful bottom line argument for environmentally responsible corporate behaviour that should appeal to companies that have yet to make environmental issues a priority. Table 3 presents the company wide statement of environmental costs and benefits for the years 2000 and 2001.
The Baxter approach requires an organisational commitment to a revised and expanded management accounting system which can identify not just environment related costs but also related benefits and the life-span of those benefits. Companies wishing to adopt the Environmental Value Added approach are advised to pilot the methodology at the facility or production unit level so that the practicality of the approach, and its benefits, can then be demonstrated (and sold) elsewhere in the organisation.
Forum for the Future has been working with a number of organisations in the private and public sectors to encourage them to account for the environmental costs and benefits of their environmental programmes. For example, the construction services company Carillion, prepared an Environmental Financial Statement for the Dartford and Gravesham hospital in Kent which was published in 2000 Environmental and Community Report (pages 26 and 27).
More recently, a statement of the costs and savings of selected environmental features of the Great Western Hospital in Swindon was prepared and published by CIRIA (2002).
For practical guidance on preparing an Environmental Financial Statement, see CIMA and Forum for the Future (2002). Also refer to Envirowise (a government programme offering practical advice to business) Using Environmental Management Accounting to Increase Profits: A Good Practice Guide, 2002.
5.4 Social Value Added The P&L Account can also be re-stated to draw out the costs and benefits of social policies and activities, including the values which drive the core business, that would otherwise remain hidden in the financial accounts. This is not the disbursement of internal flows to stakeholders (which is given in the Economic Value Added statement in section 5.2 above). Instead the Social Value Added statement is the economic value to the organisation of its social stance, through ethical policies and practices. The presentation of organisation wide socially related costs and benefits can also be referred to as a Social Financial Statement (SFS).
The first step in the preparation of a social value added statement is defining the scope and definition of benefits and costs related to an organisation’s social stance. One way forward is to ring-fence particular types of costs and benefits as ‘socially related’. Benefits would include additional sales from social/ethical price premium and additional business generated due to social/ethical reputation as well as costs avoided through reduced staff turnover, a beyond-compliance health policy and ethical supply chain management, for instance. The costs would include the extra expenditure related to social policies, in staff costs, supply chain management or through donations to the local community.
For this guide, we suggest that the boundaries be defined by ring-fencing particular types of costs and benefits as socially related. Over time it is important to build a common understanding on what should and what should not be included.
For example, should social expenditure include total expenditures on health and safety or only those expenditures beyond legislative compliance?
Should it include total expenditure on wages and salaries or just expenditures above sectoral averages? These issues are raised to identify the type of further work that is needed in this area.
Forum for the Future has pioneered the Social Financial Statement and has trialled it with some of its partners. A suggested pro forma for the Social Financial Statement is provided in Appendix 4. At present, there are no examples of organisations who have completed a full SFS but some organisations are beginning to collect information on certain aspects.
BT plc have made some first steps along the road of considering the benefits of Corporate Social Responsibility policies through their Customer Satisfaction Model. The Model uses consumer research, such as face-to-face interviews, to identify the factors that strongly correlate with changes in overall customer satisfaction: Products & Services; Contact & Experience; Price & Value, and Image/Reputation. Within the Image/Reputation driver the interview data allows BT to estimate that about 25% of its reputation is built on its CSR policies.
As the company says “Taking our model to the bounds of reasonable extrapolation, if BT were to cease all its CSR activities (i.e. cease treating employees with respect, ignore environmental issues, no longer emphasise the need to act with integrity, ceasing all non-profitable services and cancelling all community activities) then our customer satisfaction rating would drop by 10%” (European Business Forum magazine issue 11, autumn 2002 p65).
The BT Customer Satisfaction Model provides a case for the “underlying and long-term strategic importance of strong social responsibility reputation” for similar organisations. Although BT routinely considers customer satisfaction, they have not as yet decided to use the full model (from each component of each driver, through the drivers to the overall customer satisfaction) as a continuous management tool. Nor have they tried to make a further causal jump from movements in customer satisfaction driven by social policies to financial impacts such as turnover or profit. More detail on the BT model can be found on their Better World website under Investors.