ENVIRONMENTAL ACCOUNTING: EMERGING ISSUES OF …



ENVIRONMENTAL ACCOUNTING: EMERGING ISSUES OF THEORY AND PRACTICE

Geoff Wells

In the practical world of business, environmental accounting has been, until recently, a relatively minor matter of internal costs. It has related to a straightforward management and management accounting issue: how to identify and capture environmental costs, with a view to minimising them. In the course of the last decade, however, the theory and practice of environmental accounting has taken it well beyond the boundaries of this exercise. Environmental accounting is now seen not only as a core business issue, but as raising fundamental questions of accounting theory, and even of challenging the foundations of accounting and of the theory of business itself. This paper attempts to trace the outlines of this trajectory, and suggests some possible research strategies directed to exploring these issues further.

At a first level of analysis, it is clear that environmental impact and management is increasingly seen as relevant to all the major divisions of modern corporate practice, including marketing, operations, and finance. It now figures as a major component of corporate strategy. The emphasis is moving away from the impact of environmental factors on the cost burden, to the strategic opportunities becoming available as the result of a sea-change in the marketplace. This change has been lead by a transformation of consumer sentiment, particularly in Europe: environmental legislation and regulation; media reporting of environmental damage; consumer concerns over environmental safety and health; consumer preferences for environmentally friendly products and services; an upsurge in community awareness and understanding of environmental issues and implications, from a wide educational base; all are well established trends, particularly in Northern Europe, but, to different degrees, in most major developed and developing markets.1

It is a trend that is discernible even in countries that historically have largely ignored the environmental dimension of government policy, such as China: faced with catastrophic degradation of soil and water, on a vast scale, the Chines government is beginning to incorporate environmental dimensions in major policy initiatives, including those that regulate corporate practice, in the new environment of WTO accession. Interestingly, this is a trend that is less well developed in North America, where the underlying cultural belief in the intrinsic beneficence of science and technology, and of the corporations who use them, is apparently highly resistant to evidence to the contrary. Even in the US, however, the natural foods sector has been growing, admittedly on a small base, at more than 30% per year over the past decade; and American corporations are coming to terms with the fact that they cannot, with impunity, ignore consumer preferences for environmentally safe and friendly products and services, even manufacturing processes. Monsanto presents perhaps the most spectacular example of the consequences of American hubris, in its attempt to export genetically-modified seed stocks to Europe, whose consumers, and therefore whose national governments, have been fiercely resistant to such products—a miscalculation (or culpable myopia) which even now, after a fruitless expenditure of millions of public relations dollars, and its takeover and corporate relegation by Pharmacia, Monsanto still seems unable to understand or accept.

To put it bluntly, a modern company ignores the environmental dimensions of its business at its peril. Accounting theory and practice now has to reflect that new reality.

Cost efficiencies are, nevertheless, still central to the way in which companies think about the environment. There is nothing unreasonable in such a focus. Once systematic analysis of business operations and processes is undertaken, it generally becomes clear that environmental costs are a far greater percentage of total costs than had been realised. Typically, this underestimation is a consequence of lazy accounting practice. Overhead accounts become general dumping grounds for costs that are out of the ordinary, or difficult to classify (in my experience, accountants are not, as a rule, comfortable in having habitual practice challenged, and in having to think things through from first principles). Environmental costs are scattered across overhead accounts, and, because they are not consolidated and appropriately classified, are not even identified for what they are. As a result, they cannot be effectively managed. Thus the financial returns potentially available from waste reduction, energy conservation, raw material initiatives, through identification of lower polluting materials or reprocessing, or lifecycle cost reductions are typically not captured, or captured only partially.

An example of a systematic attempt to capture internal costs and benefits arising from its environmental programme comes from Baxter International, a US company producing, developing and distributing medical products and technologies, with annual revenues in excess of US$5 million. In 1995 Baxter developed an Environmental Financial Statement, the purpose of which was to report on “the total of financial costs and benefits that could be attributed not only to the environmental programme itself but to the environmentally beneficial activities across the corporation.” This financial statement identifies costs associated with the company’s environmental programmes, such as pollution controls, waste disposal, remediation and clean-up; savings, through cost reductions from the prior year to the report year; and a line item called ‘cost avoidance’ relating to additional costs other than the report year’s savings that were not incurred, but would have been incurred in the report year if the waste reduction activity had not taken place. The environmental bottom line is then calculated as the sum of savings and cost avoidance less costs—in Baxter’s case, a healthy surplus. Note, however, that the focus of the analysis is entirely internal—the entity assumption is maintained, and no external environmental impacts of the business is considered—but it does demonstrate that by explicitly considering environmental dimensions of a business, and by capturing its impact in the accounting structure, actual cost savings can be made.2

It should be noted that intangible cost reductions are even less likely to be identified and secured. Present outlays to avoid future expenses, such as landfill, clean-up, customer boycotts, product recalls, and regulatory infractions, are not common practice because conventional financial analysis doesn’t support them. Relatively few companies have begun to think about the potential upheaval in their cost profiles and cost reduction strategies in the carbon emissions caps and trading environment that is rapidly approaching. BP Amoco is a notable example to the contrary: for the past several years it has been adopting in its global operations strategies to maximise cost efficiencies and capture competitive advantage in this new environment.

Risk management and liability reduction is an associated arena of environmentally-directed business strategy. Resource depletion, product liabilities, pollution, and waste can generate significant contingent liabilities for rectification, legal defence (against class actions, for example), fines, and penalties. There is no question that the legislative and regulatory component of the societal framework within which contemporary business functions is targeting fundamental aspects of business operations—processes which may have funded a company’s profitability for decades—and is being administered more strictly. Penalties for infractions are being raised across the world, as society’s expectations of company performance become greater and less prepared to countenance environmental damage. The most notable example of this liability, of course, is Exxon Corporation’s Alaskan oilspill, which cost more than US$ 3.5 billion in clean-up, fines, environmental mitigation, and monitoring and subsequently more than US$5 billion in punitive damages claims by commercial fishers and native Alaskans. Closer to home, the BHP Ok Tedi copper mine has turned a mountain into a basin, and flushed 70 million tonnes of waste a year down the river system to sea. In the process, the riverbed has filled up with sediment, flooding up to 2000 square kilometres (the size of greater Sydney), wiping out its rainforest canopy, ruining the subsistence plots and destroying the wildlife of the region. The land and watercourses of the lower Ok Tedi river have become a heavy-metal toxic waste dump. It remains to be seen whether the $80 million settlement of the class action launched on behalf of the Ok Tedi villagers will be the end of the matter, as the company jettisons its holding in the operation into a Singapore trust for the benefit of the 30,000 villagers affected in both livelihood and health; one would have to be sceptical.3

Clearly, when one attempts to manage and report on risks of this magnitude, the tools of risk management and financial modelling are manifestly inadequate. That is the result of an almost total lack of comprehension of the enormous costs of miscalculating the environmental risks, with their associated physical and social consequences.

As an example of what might be called the progressive corporate view of environmental performance, we might look to this statement, taken from the oil and gas industry—an industry which, more than most, has been faced with the realities of environmental challenges:

Oil and gas companies cannot continue to achieve financial success without also achieving environmental excellence, and they cannot achieve environmental excellence by evaluating and rewarding performance based strictly on short-term financial indicators. Environmental performance, environmental multiplier, and international environmental taxes will help oil and gas companies integrate environmental performance into their management evaluation and rewarding systems. For many oil and gas companies, current performance appraisal process only incorporates a fraction of all environmental costs. The less tangible, hidden, indirect costs such as potential legal liability, future regulatory compliance, and the economic consequences of changes in corporate image linked to environmental performance, are largely ignored. When evaluating management performance, a company must consider total costs, including all internal and external environmental costs. To do otherwise can lead to poor environmental decisions which eventually will adversely affect the company's long-term profitability.4

Again, however, note that the emphasis of such a comment is on the entity, rather than on its social context. “Total costs” here means total costs to the entity, not total costs produced to both entity and society. We may have an uneasy feeling that, particularly when dealing with such vast environmental and social impacts as those of Exxon Valdez and BHP Ok Tedi, the entity assumption that is fundamental to accounting theory has become comprehensively breached; an observation to which we will return.

In recent years, and increasingly in contemporary business, environmental strategies offer not just cost reductions but competitive advantages in the market. As noted, this is the result of a sustained and deeply-based upsurge of consumer sentiment in favour of environmentally friendly products, services, and processes. That it is deeply-based is now well confirmed: recent market research undertaken in Europe on consumer attitudes to genetically-modified food, for example, has demonstrated that consumer resistance to these products has its roots in fundamental beliefs and attitudes—about family health, about the nature of science, even about the nature of life itself—which are simply not amenable to manipulation through standard advertising and promotional techniques. In this consumer environment, demand has emerged for the production and delivery of green products and services, and green labelling and marketing are part of a company’s differentiation strategies. One has only to walk into a UK supermarket to verify this trend: products are labelled with an array of environmental classifications, extending even to the processes by which they are produced—animal welfare or sustainable agriculture production. In textiles, the newly introduced European Ecolabel, driven by government regulation, places strict requirements on the entire lifecycle of the product: in woollen fabric and garments, for example, limitations on the residues of pesticides and chemicals in greasy wool (unprocessed wool); required standards for dissolved solids in scouring effluent (cleaning the wool); even standards of shrinkproofing in the yarn and fabric, to conserve garment use and minimise disposal volumes. At present, such environmental marketing strategies command a premium in the retail market. Experience suggests, however, that these products will become commoditised, and then the advantage for environmentally friendly products will be simply access to market. Without it a company will not even be able to enter the competitive arena.

In this context, the costs associated with meeting environmental standards are seen in an entirely different light. These are no longer unavoidable costs of doing business, to be allocated as overheads, along with accountants and executives, to business centres and products. They are product linked—direct costs—a central component of the cost of goods sold, feeding directly into the calculation of gross profit. As such, they are managed as a central business focus by margin analysis, across the range of products and markets. Environmental considerations thus move from the margins of the business into its core segments of operations, finance, and marketing; they become not part of the business environment, but a central part of the business itself. The focus of the analysis has still not moved outside the entity—the only environmental costs considered are those incurred by the entity—but the entity’s enterprise has been penetrated by the environment, of which now, in the pursuit of competitive advantage, it is necessary to take account.

Let us now come back to the question of external environmental impacts; or, for that matter, external social impacts (Ok Tedi demonstrates how interdependent these are). It is clear from the foregoing account that there may well be costs incurred by the impacts of the operations of the business that are not met, either now or in the future, by the company itself. That is, they are costs picked up by the society at large. In large part, this is due to limitations in conventional accounting and costing rules, which in turn have their foundation in financial accounting theory, with its underpinnings in political economy theory. Some of these limitations are as follows5:

1) Financial accounting focuses on the information needs of those parties involved in making resource allocation decisions about the entity—predominantly stakeholders with a financial interest in the entity. This limits access to information by people who are impacted outside the financial parameters of the entity; that is, the public at large.

2) The basic principle of materiality has tended to preclude the reporting of environmental information, given the relative difficulty of identifying and quantifying some categories of environmental costs and benefits.

3) Measurability is an associated limitation. The recognition criteria of financial accounting require an item to have a cost or other value that can be measured financially and reliably. Most attempts to assign value to external environmental impacts move quickly into estimates, with their associated controversies concerning methodology.

4) In financial accounting expenses are defined to exclude the recognition of any impacts on resources that are not controlled by the entity, unless fines or other cash flows result. This is because the notion of expenses is linked to the notion of reduction of assets; and assets are defined in terms of future economic benefits controlled by the entity.

5) Conventional accounting does not account for the full cost of production because it assigns no monetary costs to the consumption of natural resources such as air, water and land fertility. Social costs and related benefits are ignored.

6) Accounting rules may penalise environmentally responsible behaviour. Unless this behaviour is reflected in a higher price for its products, it may result in a lower net profit and lower earnings per share.

7) Conventional accounting does not have a mechanism for recording green assets, or their consumption; monitoring the use of green assets; distinguishing between the costs of renewable and non-renewable resources; or providing accounting incentives for protection of the environment.

The net result of these deficiencies of conventional accounting—the structure by which, in the current environment, we evaluate the performance of companies and their management—mean that if an entity were to progressively degrade the quality of water in its vicinity, with the resulting decimation of associated flora and fauna, then to the extent that no fines or other related cash flows were incurred, reported profits would not be directly impacted. In fact, the performance of such an entity could well be portrayed as very successful. This is hardly hypothetical: business practice worldwide abounds with such examples. As has been well, if emotionally, said:

. . .there is something profoundly wrong about this system of measurement, a system that makes things visible and which guides corporate and national decisions, that can signal success in the midst of desecration and destruction.6

There have been some attempts—one would have to say, in the current corporate environment, courageous attempts—to develop new accounting approaches that might begin to internalise the external environmental impacts of an entity. In one way or another, all such approaches represent themselves as “full-cost accounting”. Here are two examples.7 Ontario Hydro, a North American electricity distributor (now Hydro One), pioneered a “damage function” approach. The damage function was calculated by techniques using market prices to estimate monetary values from those impacts, such as crop losses, that are traded in the market; and using “willingness to pay for”, or “willingness to accept”, changes in environmental quality, for impacts that are not explicitly traded in the market. These estimates were combined with environmental modelling techniques to consider potential damage to the environment. Physical impacts were then assigned monetary value through economic valuation techniques. However, while impacts external to the entity were recognised and valued, they were not fully internalised into the company’s accounts, but presented in parallel.

A more radical approach has been offered by BSO/Origin, a Dutch computer consultancy organisation. For some years the company provided environmental accounts, which placed a monetary value on the external environmental costs of the company’s operations. Its methodology used two methods: actual damage costs; and, where these are not available, or difficult to come by, prevention costs, as an approximation to the real costs, using studies of sustainable shadow pricing. Not content, however, with simply reporting these costs, in parallel with the company’s accounts, BSO/Origin deducted the total of these costs (which it called “extracted value”) from operating income to give what was then defined as “sustainable operating income”. Carried through to the bottom line, the new result becomes “sustainable net income.”

It is interesting to note that the demand for full-cost accounting arose as a consequence of, or in parallel with, the world-wide rise of the notion of sustainability. The most-quoted definition of sustainability is that of The Brundtland Report, issued by the World Commission of Environment and Development in 1987. There sustainable development was that defined as “. . .development that meets the needs of the present world without compromising the ability of future generations to meet their own needs.” This lead to a concern with not only inter-generational equity, but intra-generational equity; in other words, a concern with globally conceived social justice—an important component of subsequent environmental accounting theory with which, however, I will not attempt to deal here. The Brundtland initiative was followed in 1992 by a European Earth Summit, which released a document called Towards Sustainability. This document, called for, among other things, “a redefinition of accounting concepts, rules, conventions and methodology so as to ensure that the consumption and use of environmental resources are accounted for as part of the full costs of production and reflected in market prices”—a tall order, one may feel, in the contemporary business environment, however admirable in spirit. However, this document made the crucial connection between sustainability and environmental accounting which has governed radical critiques since that time.

Whether this has been a helpful link is open to question. “Sustainability” is one of those concepts, like “freedom”, which commentators think they intuitively understand, but which, on closer examination, has widely different interpretations. It has been noted that the decade that followed the Brundtland Report has done little to clarify the concept of sustainability: it has been estimated that there are more than 5000 definitions now circulating in the literature. One recent commentator noted, “Sustainable development is a term that everyone likes, but nobody is sure of what it means (at least it sounds better than ‘unsustainable development’).” In response, it has been argued that although there is a conspicuous lack of consensus on the exact definition of sustainability, it carries a core meaning which is substantive and important, in the same way that principles like ‘democracy’ are widely defined and implemented, but used sensibly in discourse.8

While granting the validity of this argument for some purposes, it doesn’t work for accounting. Accounting concepts need to be sufficiently defined to allow, and measure, uniform practice. The kind of difficulty one can encounter is illustrated by the NZ-based Landcare Ltd. approach to full cost accounting, which is explicitly linked to sustainability, through the following definition:

. . .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.9

The problem with this definition, to anyone educated in the elements of biology, is that the biosphere (itself difficult to define) is a dynamic system, which follows a development trajectory. One would have to reframe the definition to include:

. . .the amount an organisation must spend to put the biosphere at the end of the accounting period back into the state it would have been in without the operations of the company during the accounting period.

This in turn would require sophisticated modelling and measurement at a level which is only now taking its first, tentative steps (for example, the modelling of the complex global land, water, and atmosphere systems associated with global warming). It sounds a promising approach conceptually, but it is, to all intents and purposes, useless in practice.

One other observation on the theoretical challenges to financial accounting theory as it attempts to meet the demands of environmental externalities. It seems to me one could argue as follows: if it is to be required that company’s should internalise the costs of their operations on society at large (as in environmental and social impacts); and that financial statements reflecting these costs are a truer representation of the company’s value: why should one therefore not require similar treatment of benefits to the society at large of the external impacts of the company’s operations, and similar financial treatment of these benefits in the company’s accounts? For example, would one want to measure the social benefit of employment, which would be far greater in a large company than in a small one? Or the multiplier effect in the economy of a company’s transactions with suppliers? And so on. Without having analysed it very fully, it does seem to me that this is a question that may have to be answered, if approaches to full cost accounting of external environmental impacts are to be logically consistent. And the answer may lead to a re-configuration of the very idea of a business. I will return to this notion in a moment.

Let me turn now to a case study which nicely illustrates the main issues associated with environmental accounting, as I’ve laid them out here. A major Australian wool-processing company (which shall remain nameless, for commercial-in-confidence reasons) has been looking at the way it is handling in its accounts environmental aspects of its operation. Wool processing is a dirty business. Essentially it involves taking wool in its raw state—termed ‘greasy wool’—and washing it with various detergents and chemicals, then treating it in various ways for specific fibre performance. There are two primary processes: combing and carbonising. Both are directed to getting large contaminants, such as burrs, out of the wool: the first process is, as the name implies, by physically combing the wool; the second, used on the dirtier parts of the wool, such as skirtings, locks, bellies, and so on, employs acid, which carbonises these solids to make them easier to eliminate. Effluent from scouring (which is common to both processes) and from carbonising is treated, and then, when it reaches the regulatory level of TDS, is allowed down the drain. At the site of this particular processor, some of this effluent is first diverted to a large composting project, which is currently under development and testing. It is the second of these processes, carbonising, that has been the focus of some initial work in environmental accounting.

In looking closely at the carbonising process, the following environmentally-related accounting observations have been made:

Clearly anything one wants to do to advance environmental accounting requires underpinning in the measurement of materials. However, only approximately 50% of key materials flows in the carbonising process are currently measured. Moreover, these measurements are captured in KPI reports, but are not currently costed.

Most of the environmental measurement currently occurring is at the plant level. There has been no attempt to drive measurement through to the product level (‘types’). Different product types require different inputs of: water, detergent, sodium carbonate, hydrogen peroxide. These are determined by looking at the previous ten or so runs of that type, and the outcomes of these runs. Flow down the drain therefore varies in composition from product to product. This is measured as Total Dissolved Solids (TDS) before it is released to the drain. If the TDS measure is too high, the flow from the plant is recycled back through the plant, with the expectation that different wool types will dilute it. When the TDS measure is at the level allowed, it is released to the drain.

The impact of running types that generate high TDS loads is thus increased water flow and increased energy usage. However, data on the relationship between product batches and water usage is collected but has not been analysed or costed. In addition, electricity is only measured for the plant as a whole.

Secondly, if one wants to link ‘waste’ and ‘environmental impact’, the definition of waste becomes important. From one point of view, ‘waste’ would be any output from the plant that has no commercial value, and must therefore be disposed of with maximum cost and environmental efficiency. Note, however, that under this view, ‘waste’ may change as commercial conditions change. Thus woolgrease was of no commercial value a decade ago and had to be burnt; now it is a product in its own right, earning significant revenue. The same may shortly apply to compost: if the compost process reaches the required specifications, it has been calculated that this plant (one of the largest wool processing plants in the world) would generate sufficient material to compost the entire Barossa Valley vineyards every year.

At the same time, it is legitimate to question whether, just because a product has commercial value, it is free of environmental impacts. One would want to be sure, for example, that the kind of compost produced here did not itself generate environmental negatives when applied to agricultural or horticultural enterprises.

Here therefore are some key questions that arise from this analysis:

a) What elements of the manufacturing process contribute most to the cost handling the TDS load? Have the costs of all elements been captured? What does this imply for materials measurement, for costing, and for bringing these costs to book? (This is an example of what we may call Level 1 analysis, in which the focus of the environmental accounts is exclusively on capturing, appropriately classifying, and therefore reducing manufacturing costs.)

b) What product types contribute most to the cost of handling the TDS load? (This is an example of Level 2 analysis, where the environmental accounting begins to impact marketing and selling decisions. Here a better understanding of costs by product may lead to a revision of gross margins, and a change in the marketing and selling strategies by product and market.)

c) If one looks at by-product sales, what is the best way of understanding the costs of producing them (at present, for example, woolgrease is assumed to have no cost of production)? Will this change as the commercial value of outputs changes over time? (This too is an example of Level 2 analysis. But it is intriguing, and raises some challenging questions. Could one, for instance, conceive of a commercial environment where the main product resulting from wool processing was not wool, but wool grease—with the clean wool fibre becoming a waste product of no commercial value that must be disposed of? What would be the trajectory of the accounts, including the environmental accounts, in tracking this kind of fundamental change in the identification of manufactured products?)

d) How can one best account for the potential impact of external costs—for example, in the drain discharge, or in possible risks associated with the by-products, wool grease and compost? (This is an example of Level 3 analysis, where the question of externalities looms uncomfortably large—is becoming, in fact, a ‘stay-in-business’ issue—yet is not in any way being captured in the current accounting or projections.)

Finally, as noted above, the introduction of the Ecolabel may require a re-examination and reconfiguration of the manufacturing process. The Ecolabel criteria set levels of certain components of the effluent from scouring, and these criteria incorporate other standards relating to chemical residues in the greasy wool. In addition, the Ecolabel criteria prohibit the use of some manufacturing processes, such as the use of chlorine in shrinkproofing, while still setting standards for the shrinkproof qualities of the processed fibre. Irrespective of the actual environmental impacts of its manufacturing processes, the company will now have to meet these environmental standards in order to maintain access to its European market.

All this is simply to demonstrate that the kinds of issues that are arising in environmental accounting, and about which the academic accounting establishment is busying itself—very real challenges to contemporary business practice. As noted above, these are issues that have penetrated all the main segments of the business—here, specifically, operations, marketing, and finance—and have become part of the strategic landscape within which the company operates. Ultimately they may even play the major part in determining whether the company stays in this business, or not.

Let us turn, finally, to two research directions which seem to me to arise from this analysis. The first concerns what has been termed “value based management”. This is the view that “all companies, especially publicly owned companies, should be managed to create as much wealth as possible.”10 This equates to managing for maximum shareholder value, which in turn is held to generate the maximum economic benefit for the society of which the company is a part:

Managers create shareholder value by identifying and undertaking investments that earn returns greater than the firm’s cost of raising money. When they do this, there is an added benefit to society. Competition among firms for funds to finance their investments attracts capital to the best projects, and the entire economy benefits.11

There is, as we will see, reason to challenge the view that shareholder value and value to society are inherently linked. However, let us for the moment work within the framework which accepts that economic results are the primary outcome by which a company is to be evaluated; a view expressed with characteristic pungency by Drucker, nearly four decades ago:

Economic performance. . .is the specific function and contribution of business enterprise, and the reason for its existence. It is work to obtain economic performance and results.12

The implementation of this dictum in modern best practice is widely agreed to be value based management (VBM). This approach holds that the real economic value of a firm’s business, whether it is completely reflected in the firm’s stock price or not, is equal to the discounted value of expected future cash flows accruing to the shareholders. Conventional GAAP principles, it is argued, are not designed to reflect value creation, and cannot therefore be used effectively in managing for increased value: accounting earnings do not equal cash flow nor do they reflect risk; they don’t reflect the opportunity cost of equity nor consider the time value of money. In consequence, a business can appear to be (may well be, in my experience) profitable in the conventional accounts, yet at the same time be destroying economic value. Various discounted cash flow (DCF) methods have been developed for analysing the expected future cash flows of a business: these include free cash flow (promoted by McKinsey), economic value added (developed by Stern Stewart), and cash flow return on investment (developed by the Boston Consulting Group). These methods are far from uncontroversial: there is continuing debate on the correlation of DCF valuations with stock price, and on the significant management challenges associated with driving VBM through an organisation. Nevertheless, they represent the ground on which modern management is conducted. Moreover, discounted cash flows and the use of net present value calculations are becoming commonplace in the external reports of companies. Accounting standards in Australia enable the disclosure of discounted cash flow information.

A first research question might therefore be: can discounted cash flow methods capture the various dimensions of environmental business issues outlined above? In June (2001) the European Commission produced guidelines on the recognition, measurement, and public disclosure of environmental issues in the annual accounts and reports of companies in the European Union. These guidelines focus on monetary information and accept discounted cash flow and net present value as appropriate measurement methodologies for environmental issues. There are at least two important challenges to such an approach. The first is that the numbers to which the DCF methods are applied are not historical: they are projected numbers, and they arise from a comprehensive and detailed view of what the business will look like over the next five or ten years. The valuation is only as good as the projections; and, as any executive worth his or her salt will tell you, projections are hard to do well. There is a systematic method for developing a view of the shape of the future business: this is termed “scenario analysis”13. With respect to environmental issues, it will include predictions of the likely trajectories of regulation and legislation, environmental technology, the evolution of physical systems, consumer sentiment and the form of demand, and so on. I repeat, this is very challenging, and most companies won’t take it on. But without it being done, and done well, DCF valuation techniques don’t have much validity. That will apply as much to environmental matters as it does to any part of the business.

A further challenge arises from the discounting component of DCF methods. The EC guidelines allow the present value measurement of environmental liabilities, even if these liabilities will not be settled in the near future. However, it has been pointed out that discounting the value of future liabilities in effect discriminates against future generations. The structure of the numbers directs management attention, and therefore resources, to environmental impacts that will occur in the immediate or short-term future. It thus appears to contradict the basic notion of sustainability, which, as we have seen, in its most widely accepted form looks for “. . .development that meets the needs of the present world without compromising the ability of future generations to meet their own needs.” The question that presents itself is therefore whether there is something in the particular character of environmental issues associated with business which precludes the use of DCF methods in managing these issues, or whether DCF tools can be developed to meet this challenge successfully.

Both challenges are important and require systematic resolution. Given the promising record of DCF approaches in management, it is reasonable at least to begin with the assumption that they can be met. Moreover, it should be noted that major companies, particularly in the resources sector, are urgently seeking such methods in order to manage their businesses, and their stakeholder relations, more effectively. Working with members of this department, this is a research and consulting direction I intend to pursue.

Behind this sits—or perhaps, lurks—a second research question that has the potential to overturn the fundamental assumptions about business within which one is here functioning: I refer to the entity assumption. The nature of the business, or accounting, entity, and its relationship to the society in which it functions is, as we have observed, critical to the way in which the environmental impacts of business are handled. The main accounting theory which attempts to deal with this relationship is Legitimacy Theory. Under this theory, there is held to be a social contract between a company and the society in which it operates. The social contract expresses the expectations of the society, the criteria which a business has to meet in order to be seen as legitimate:

Society. . .provides corporations with their legal standing and attributes and the authority to own and use natural resources and to hire employees. Organisations draw on community resources and output both goods and services, and waste products, to the general environment. The organisation has no inherent rights to these benefits, and in order to allow their existence, society would expect the benefits to exceed the costs to society.14

This position is encapsulated in the phrase “license to operate”, which is now found used with increasing frequency—and, one might observe, with widely differing results in business practice—in company reports.

The implications of this position, it seems to me, are very great, and its treatment in the literature is less than convincing. It is, of course, a central entry point for critical accounting theorists. I have some sympathy for these forays. I am not myself a Marxist, having some thirty years ago concluded that Marxist theory has fundamental, and irretrievable, flaws; but such critiques, it must be said, do tend to raise disquieting questions that seem to demand resolution. Simply put, environmental issues in accounting and finance practice and theory logically force an analysis of the nature of business itself, and of the society in which it operates. I have been exploring the idea that an important component of what is needed to further the analysis may be a theory of business. This is to be distinguished from the economic theory of the firm, or the financial accounting theory of the business entity. Such a theory would start from the axioms associated with a commercial transaction, and attempt to construct logically the structure of contemporary business. It may be that with such a conceptual structure in place these deeper questions—which we recognise but tend to push to one side, as too difficult, or perhaps too threatening—can be moved towards some kind of resolution. However, the consequences of such a logical resolution, for the current disciplines of accounting and of management, may well be, I would warn, intellectually provocative—that, at least, is the hope.

BIBLIOGRAPHY

Bebbington, Jan and Gray, Rob, “Seeing the wood for the trees: Taking the pulse of social and environmental accounting”, Accounting, Auditing & Accountability Journal, Vol. 12, no. 1, pp. 47-51.

Burritt, Roger and Lodhia, Sumit (2001), “Green-hand economics”, Charter, vol. 72 no. 11, pp52-53.

Deegan, Craig (1999), “Triple bottom line reporting: A new reporting approach for the sustainable organisation”, Charter, Vol. 70 No. 3, pp. 38-40.

Deegan, Craig (1999), “Implementing triple bottom line performance and reporting mechanisms”, Charter, Vol. 70 No. 4, pp. 40-42.

Deegan, Craig (2000), Financial Accounting Theory, McGraw-Hill Book Company Australia Pty Limited, Roseville, NSW.

Drucker, Peter F. (1964), Managing For Results, HarperBusiness Books, HarperCollins, New York.

Gray, R. and Bebbington, J. (1992), “Can the grey men go green?”, Discussion Paper, Centre for Social and Environmental Accounting Research, University of Dundee, UK.

Martin, John D. and Petty, J. William (2000), Value Based Management, Harvard Business School Press, Boston, Massachusetts.

Mathews, M.R. (1993), Socially Responsible Accounting, Chapman and Hall, London.

McTaggart, James M., Kontes, Peter W., Mankins, Michael C., The Value Imperative, The Free Pres, New York.

Parker, Lee D. (2000), “Green strategy costing: Early days”, Australian Accounting Review, Vol. 10 No. 1, pp. 46-55.

Pheasant, Bill (2002), ‘Life After Ok Tedi’, Australian Financial Review Magazine (March 2002)

Rigby, Dan, Howlett, David, and Woodhouse, Phil (2000), “A review of indicators of agricultural and rural livelihood sustainability”, Research Project No. R7076CA, UK Department for International Development, London.

Schwartz, Peter (1996), The Art Of The Long View, Australian Business Network, St. Leonards, NSW.

Unerman, Jeffrey (2000), “Methodological issues—Reflections of quantification in corporate social reporting content analysis”, Accounting, Auditing & Accountability Journal, Vol. 13 No.5, pp.667-680.

1 Parker (1977)

2 Deegan (2000), pp. 335-337.

3 Pheasant (2002), pp. 25-31.

4 Tinius and Wang (2001)

5 Deegan (2000), pp. 306-310; Parker (1977), p.48.

6 Gray and Bebbington (1992), p.6.

7 Deegan (2000), pp.338-343.

8 Rigby, Howlett and Woodhouse (2000), p.5.

9 Gray and Bebbington (1992), p.15, quoted in Deegan (2000), p.344.

10 McTaggart, Kontes, and Mankins (1994), p.7.

11 Martin and Petty (2000), p.3.

12 Drucker (1964), p.xi.

13 Schwartz (1996).

14 Mathews (1993), p.26.

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