Chapter 35

1. Chapter 35 Accounting for corporate social responsibility

2. Objectives of this lecture • Understand and appreciate the various issues associated with social-responsibility reporting, including: • alternative perceptions about the social responsibility of business • what social-responsibility reporting is • how social-responsibility reporting relates to financial reporting • the possible linkages between social and environmental performance and financial performance • the linkage between social and environmental risk and business risk • the regulatory requirements for disclosure of social performance

3. Objectives (cont.) • Understand and appreciate the various issues associated with social-responsibility reporting, including (cont.): • the regulatory and industry requirements for disclosure of environmental performance • the trend towards sustainability reporting • the extent to which Australian organisations currently disclose information about their social and environmental performance • user demands and market responses to the disclosure of social-performance and environmental-performance information • theoretical perspectives on what motivates organisations to present social and environmental information

4. Objectives (cont.) • Understand and appreciate the various issues associated with social-responsibility reporting, including (cont.): • some of the limitations of conventional financial accounting in relation to the recognition of social and environmental costs and benefits • some of the various frameworks for social-performance and environmental-performance reporting • the issue of climate change and its relevance to society, to the environment, and to accounting

5. Introduction to social-responsibility reporting • Traditionally business entities perceived to be responsible for their financial performance and that the principal stakeholders were the owners (shareholders) • Views are changing; it is becoming accepted that entities also have responsibilities to a broader group of stakeholders (e.g. local communities, customers, suppliers, employees, creditors, government and even future generations) • Entities now being held responsible for their social and environmental as well as their financial performance • With the changes in expectations about responsibilities of corporations we would expect to find a change in the expectations about corporate accountabilities • Changes in expectations about accountabilities in turn should lead to changes in corporate accounting

6. Definition of social-responsibility reporting • Environmental and social reporting represent components of the broader form of reporting known as ‘social-responsibility reporting’ (SRR)—also known as Corporate Social Responsibility (CSR) Reporting • SRR can be defined as ‘the provision of information about the performance of an organisation in relation to its interaction with its physical and social environment’ • This includes interaction with local community; level of support for community projects; level of support for developing countries; health and safety record; training, employment and education programs; and environmental performance

7. Social, environmental and triple-bottom-line reporting Social reporting • is a component of social-responsibility reporting • provides information about an organisation’s interaction with, and associated impacts on, particular societies Environmental reporting • is the communication of environmental performance information by an organisation to its stakeholders Triple-bottom-line reporting • provides information about the economic, environmental and social performance of an entity • The view being that an organisation must address each of these three ‘bottom lines’ in order to survive

8. Differing views of business responsibility Friedman • Rejected the view that corporate managers have any moral obligations • Considered that the responsibility of business was to use resources to increase profits as long as it stays within the rules (to engage in open and free competition, without deception or fraud)

9. Differing views of business responsibility (cont.) Alternative view (to Friedman) • Managers should manage the organisation for the benefit of all stakeholders, not just those with control over scarce resources • Accounting does not have to be restricted to ‘financial’ performance • Need also to consider whether responsibility is owed to future generations (sustainability)

10. Accountability • An organisation’s perspective of its accountability will directly impact on the information (accounts) it elects to provide • If an organisation considers it only has a responsibility for its financial performance, then it will fixate on financial accounts • Historically, this restricted view of accountability has dominated • However, if an organisation believes it has an accountability for its social and environmental performance, then it will provide social and environmental accounts/reports

11. Accountability (cont.) A definition of ‘accountability’ Accountability involves two responsibilities or duties, these being: 1. the responsibility to undertake certain actions (or to refrain from taking actions), and 2. the responsibility to provide an account of those actions

12. Regulation of public social and environmental reporting • Reporting about social and environmental issues within annual report remains predominantly voluntary • AASB 116 Property, Plant and Equipment requires the cost of an item of property, plant and equipment to include the initial estimate of the costs of dismantling and removing the item and restoring the site on which it is located • Section 299(1)(f) of the Corporations Act requires details in the Directors’ Report of performance in relation to any specific environmental regulation to which it is subject • AASB 137 Provisions, Contingent Liabilities and Contingent Assets. Obligations relating to environmental performance could be considered to be either included in ‘provisions’ or ‘contingent liabilities’, depending upon the circumstances

13. General reporting requirements • No other annual report requirements that relate specifically to environmental performance or environmentally related expenditures or obligations • Note general reporting requirements • True and fair financial statements (s. 297 of the Corporations Act) • Material contingent liabilities to be disclosed in note to accounts (AASB 137) • More stringent regulations in other countries

14. Other reporting requirements • National Greenhouse and Energy Reporting Act 2007 • Corporate groups that meet the NGER threshold must report their greenhouse gas emissions, energy consumption, energy production, and other required information • National Pollutant Inventory • Requires details to be provided by certain entities about emissions to air, water and land of a defined list of substances where such releases or emissions exceed a specified threshold • Australian Greenhouse Challenge (voluntary) • ASX Corporate Governance Council’s Corporate Governance Principles and Recommendations

15. Why the lack of reporting requirements? • Financial reporting is heavily regulated • Social and environmental reporting is subject to very minimal regulation • Recent government inquiry concluded that it is best to leave social and environmental disclosures to the control of corporations—‘let the market decide’ • It would appear that regulators have embraced a ‘shareholder primacy’ approach to corporate reporting

16. Limitations of traditional financial accounting • Focuses on information needs of stakeholders with a financial interest • ‘Materiality’ precludes reporting of social and environmental information and recognition criteria • Adoption of the entity assumption • Exclusion from expenses of any impacts on resources not ‘controlled’ by the entity • Focus restricted to stakeholders with a financial interest in the entity • Impact of discounting liabilities to present value

17. Industry and government initiatives • Mining companies initially led the way in producing stand-alone social and environmental reports and ‘sustainability’ reports • Other Australian industry codes and environmental reporting • Global Reporting Initiative’s Sustainability Reporting Guidelines—enjoy dominant position internationally at social and environmental level • To date no conceptual framework exists for environmental reporting; disclosure based on perceptions of information needs of particular stakeholder groups • Disclosure of social and environmental information often based on reports that have been acknowledged as representing ‘best practice’, i.e. they have been recognised by an award

18. Other international initiatives to assist corporate social and environmental performance • Global Compact • Voluntary initiative to encourage organisations to adopt 10 principles in the area of human rights, labour, environment and anti-corruption • Equator Principles • Applying the Principles, financial institution signatories attempt to ensure that the projects they finance will be developed in a socially responsible manner that reflects high environmental standards • International Organization for Standardization • Developed a set of standards against which organisations can voluntarily be assessed against

19. Other international initiatives to assist corporate social and environmental performance (cont.) • Carbon Disclosure Project • Organisations wishing to publicly report their greenhouse gas emissions and climate change strategies can do so through the CDP • Accountability AA1000 Series • Developed a number of standards that organisations can voluntarily adopt to increase the sustainability of their actions • Greenhouse Gas Protocol • Tool for quantifying greenhouse gas emissions

20. Social and environmental reporting practices 2011 International Survey by KPMG notes: • Ninety-five per cent of the 250 largest companies in the world (G250 companies) now report on their corporate responsibility (CR) activities, two-thirds of non-reporters are based in the US • Traditional CR reporting nations in Europe continue to see the highest reporting rates, but the Americas and the Middle East and Africa region are quickly gaining ground. Only around half of Asia Pacific companies report on their CR activities • In the 2011 KPMG study, Australia ranked 23rd out of 34 countries surveyed (compared to 14th out of the 22 countries surveyed in 2008), with 57 per cent of the top 100 companies in the sample producing a stand-alone corporate responsibility report (up from 45 per cent in 2008, 23 per cent in 2005, 14 per cent in 2002 and 5 per cent in 1996)

21. Social accounting • Aims to assess the impact of an organisation or company on people both inside and outside of it • Widely promoted in 1970s • Re-emerging from mid- to late 1990s • Process whereby an enterprise can account for its performance against its social objectives and then report on that performance • Results of social audit form basis of publicly released social accounts • Provides details of where improvements are necessary

22. Assurance of reports • Just as there is a demand for external reviews (audits) of financial reports, we would expect to find a demand for third party assurance of social and environmental reports • Quality of assurance work remains low relative to financial statement audits • Improvements needed

23. Diversity in reporting approaches • Approaches adopted to disclosing social and environmental information vary greatly • Checklist approach • Target-based reporting • Eco-balance approach • Full-cost approach incorporates environmental costs and benefits into profit calculations

24. Motivations for social and environmental reporting Many organisations voluntarily elect to publicly disclose information about their social and environmental performance Rationale • Influence the perceived legitimacy of the organisation • Manage particular (perhaps powerful) stakeholder groups • Increase wealth of shareholders and managers of the organisation • Belief on the part of managers that the entity has an accountability to provide information • To forestall efforts to introduce more onerous disclosure regulations

25. Stakeholder demands for and reactions to social and environmental information • A number of studies have addressed stock market reactions to the disclosure of social information • Underlying theory used in this research is the efficient markets hypothesis • Banking and insurance institutions have become key users of social and environmental information, particularly about environmental performance • Another growing source of demand for social and environmental information is the growing ethical investment market (ethical funds)

26. Link between social and environmental performance, financial risk and financial performance • Reasons why social and environmental performance can affect financial performance • Consideration of ‘Community Licence to Operate’—organisations to contribute to society and not harm environment, otherwise can lose customer, employee, and community support • An example of the potential damage to a company’s share price from an environmental disaster is the major oil spill in the Gulf of Mexico which made world news in 2010. The damage to BP’s share price was severe. After trading in a range of around US$60 per share on the New York Stock Exchange in the months leading up to the spill, the shares plunged below US$30 as news of the leak emerged

27. Climate change • Climate change is an environmental issue that is increasingly being seen as likely to have major impacts on the planet • ‘Greenhouse effect’ occurs when natural gases in the earth’s atmosphere allow infrared radiation from the sun to warm the earth’s surface • These gases prevent heat escaping from the earth’s atmosphere • One important greenhouse gas is carbon dioxide, which is believed to represent approximately 75 per cent of Australia’s greenhouse gas emissions

28. Climate change (cont.) • For many years companies have treated the atmosphere as a ‘free good’ and have released emissions with no direct implications for reported profit or loss • The introduction of carbon taxes and emissions trading schemes in some parts of the world has meant that many organisations will now have to internalise aspects of the environmental impacts of their business that were previously ignored • The philosophy behind the introduction of carbon taxes and related regimes is that, if organisations are required to pay for the amount of pollution they create (which would otherwise be treated as an externality), this will have behavioural implications

29. Emission trading schemes and related climate change accounting techniques • The existence of emission trading schemes relies upon giving carbon a price per tonne so that products can be more fully costed • Under a ‘cap-and-trade’ system, ‘allowances’ or ‘credits’ are used to provide incentives for companies to reduce emissions by assigning a monetary value to pollution • In the European Union (EU), each carbon allowance permits the holder to emit one tonne of CO2 • Over time, it is expected that the amount of permits (or units) made available will be reduced by the government in line with the quest to reduce carbon emissions

30. Cap-and-trade system • The ‘trade’ aspect of the program occurs when a company’s actual emissions are greater or less than the number of allowances it holds • Companies that emit less than the number of permits they hold will have excess allowances; those that exceed the number of permits they hold must acquire additional allowances • Additional (or excess) allowances can be purchased (or sold) directly between companies, through a broker, or on an exchange • Excess allowances can be ‘banked’ and used to satisfy compliance requirements in subsequent years

31. Accounting for assets and liabilities associated with a cap-and-trade system • While there is no definitive guidance, it appears from international experience that the following financial accounting approaches would be acceptable within the Australian context to account for the related financial assets and liabilities associated with a cap-and-trade system: • Any emission permits or rights that have been allocated to a reporting entity shall be considered to be intangible assets and can be recognised at their fair value (market value) at allocation date

32. Accounting for assets and liabilities associated with a cap-and-trade system (cont.) • Permits recognised under either method are subject to periodic impairment tests • The difference between the price paid and fair value of permits received from the government is initially reported as deferred income and then systematically recognised as revenue over the compliance period regardless of whether the allowances are held or sold • Increases in fair value of permits are reported in shareholders’ equity and decreases in fair value are recognised in profit or loss to the extent they exceed the revaluation surplus

33. Accounting for assets and liabilities associated with a cap-and-trade system (cont.) • As greenhouse gases are emitted, the reduction in the value of any emission right or permit would be recognised as an expense • Should organisations emit at levels beyond their permits, the related financial obligation would be of the nature of a liability • There should be no netting of assets and liabilities related to emissions

34. Accounting for emissions • Earlier in this lecture we discussed various initiatives that have been developed to enable an organisation to measure its emissions (e.g. the Greenhouse Gas Protocol) • Emissions tend to be divided into three categories: Scope 1, Scope 2 and Scope 3 emissions: Scope 1 Those emissions directly occurring from sources that are owned or controlled by an institution, including combustion of fossil fuels; mobile combustion of fossil fuels in vehicles owned/controlled by the institution; and fugitive emissions.

35. Accounting for emissions (cont.) Scope 1 (continued) Fugitive emissions result from intentional or unintentional releases of greenhouse gases, for example the leakage of hydro-fluoro carbons from refrigeration and air conditioning equipment Scope 2 Indirect emissions generated in the production of electricity consumed by the institution Scope 3 All the other indirect emissions that are a consequence of the activities of the institution, but occur from sources not owned or controlled by the institution

36. Integrated reporting • A significant recent development in CSR reporting is the push towards integrated reporting—something which could take a number of decades to be properly developed • The International Integrated Reporting Committee (IIRC) was created in August 2010 (see http://www.integratedreporting.org/) and is a joint Initiative of The Prince’s Accounting for Sustainability Project (A4S) and the Global Reporting Initiative (GRI) • According to the website of the IIRC, the IIRC's remit is to create a globally accepted framework for accounting for sustainability: a framework which brings together financial, environmental, social and governance information in a clear, concise, consistent and comparable format—put briefly, in an ‘integrated’ format

37. Summary • The lecture has considered various issues associated with social-responsibility reporting • Social-responsibility reporting relates to the provision of information about various facets of an organisation’s social performance, including information about its environmental performance, health and safety records, training and education programs, support of the local community, etc. • Provision of information about an entity’s social performance (unlike financial reporting) is largely unregulated—corporate social disclosures within annual reports are often provided on a voluntary basis—many researchers have undertaken studies to explain the various motivations driving corporate management to make such disclosures

38. Summary (cont.) • Consideration of social-responsibility disclosures requires consideration of the social responsibilities of business—various perspectives on the social responsibility of business have been considered in this lecture; some limit the responsibility of business to a responsibility to investors, other broader perspectives include a responsibility to a range of stakeholder groups • Also considered in the lecture is an overview of various research studies on the practice of environmental-performance reporting

39. Summary (cont.) • Researchers will rely on a particular theoretical perspective to develop their arguments and to explain the results of their work—researchers can select from among many competing theories to explain accounting-related phenomena, often the selection of a theory is tied to the values and beliefs of the researcher • Typical accounting theories addressed in this lecture include: • Positive Accounting Theory • Legitimacy Theory • Stakeholder Theory • The theory currently being embraced by many researchers into social-responsibility reporting is Legitimacy Theory • Advocates of a Legitimacy Theory perspective propose that the way in which an organisation operates and what information it elects to disclose will depend on management’s perspectives on what the community considers to be appropriate for the organisation

40. Summary (cont.) • An overview of various environmental-reporting research studies has also been provided—these typically show that the amount of environmental-performance reporting is increasing, is improving in quality and can frequently be explained as a strategy used to legitimise the ongoing operations of an organisation • Research indicates that various user groups (e.g. shareholder and various interest groups) demand information about corporate environmental performance • Financial accounting is not an all-encompassing measure of performance of an organisation—it typically disregards the social and environmental impacts/performance of an entity’s operations; reasons for omission including the accountant’s concept of materiality as well as the accounting definition of assets and expenses

41. Concluding thought… Only after the last tree has been cut down, Only after the last river has been poisoned, Only after the last fish has been caught, Only then will you find out that money cannot be eaten (Cree Indian saying)