You won’t see your accountant in the next superhero movie or hear about one on the local news, but it’s not a stretch to say the accounting profession and its standards are changing what we report about our economy, and in turn, changing the way businesses impact the environment. The accounting profession is tackling some of the biggest issues at the forefront of society through sustainability reporting – most notably greenhouse gas (GHG) emissions. It’s not every day that you hear about accountants saving the world, but that’s exactly what Peter Bakker, the president of the World Business Council for Sustainable Development said in June of 2012 when he addressed the United Nations Conference on Sustainable Development in Rio de Janeiro. He made the claim “accountants would save the world”, and he meant it. He subsequently wrote, “To get all businesses involved in solving the world’s toughest problems, we must change the accounting rules”. So the rules need to be changed, but which ones should be changed, and what should they say?
“To get all businesses involved in solving the world’s toughest problems, we must change the accounting rules”
It is easy to point to a company’s income, assets and liabilities to measure economic performance, but what about their social and environmental capital? There is no question that companies benefit from social and environmental capital, but it is not a line item on a company’s financial statement that stakeholders can use to make decisions, and it is up to the accounting professions to set the standards for measuring and reporting the GHG information to key stakeholders - investors, creditors, business managers, and regulators. For example, two companies produce the same product, have the same quantity of outputs, and charge the same price for their product, but one company has significantly less GHG emissions as a by-product of their production. While their financial statements may appear identical, both of these companies do not offer the same value to consumers or the world as a whole. It is apparent that reporting this social and environmental capital is useful to the stakeholders, but without a comprehensive set of guidelines and rules, GHG emission reporting will not offer the reliability and relevance needed to account for and manage the social and environmental responsibility of a company. What Peter Bakker referred to was the establishment of accounting rules that would help quantify their GHG emissions, while standardizing the subsequent reporting of companies’ GHG inventory.
In 2010, Ford Motor Company made a decision to reduce carbon dioxide emissions – the most significant of the six main greenhouse gasses – by 30% on a per-vehicle basis by the year 2025. While this was an achievable goal, Ford’s internal GHG inventory team was tasked with measuring its current GHG emissions against its performance target, but had no clear answers as to how to measure the company’s GHG emissions. The team considered what emission factors should be used in the process, how to account for subsidiary companies’ emissions, and if their method of accounting for GHG emissions would even be credible to company stakeholders. The team at Ford Motor Company could not come to any real conclusions on how to measure its GHG emissions, and they turned to the accounting profession for help. The Ford Motor Company case is not unique, and the accounting profession must take steps to help companies quantify and report on their GHG inventories. Companies cannot fix what cannot be measured, so what can the accounting profession do to help quantify an entity’s GHG emissions? What are the boundaries of emission reporting? What standards can be set to help control these GHG emissions? If accountants and standard setters are to incorporate environmental responsibility into corporate reporting, there must be standards set that will address the questions in the Ford Motor Company case.
The Growing Need for GHG Accounting:
Before the accounting profession can address the GHG inventory problem, it’s important to understand why the need for GHG accounting has emerged over the past decade. At the forefront of sustainability reporting is the key issue of climate change, where GHG emissions from human activities are the most significant drivers of climate change. Extreme and unpredictable weather conditions – floods, droughts, rapid glacial melting, and rising sea levels – are among the major climate change challenges for business operations, and could have an adverse impact on business operations by disrupting supply chains, and in turn, could have a domino effect on global commerce. Climate change has environmental, social, and economic risks, and measuring, reporting, and verifying these risks have become a huge challenge for businesses and governments. As concerns over climate change increase, governments, regulators, investors, and stakeholders are calling for a greater corporate reporting of GHG information. In order for businesses and governments to take mitigating action against climate change, a clear understanding of greenhouse gas sources is required, along with the ability to monitor mitigation strategies and their impacts.
With heightened scrutiny by the insurance industry, company shareholders, and environmental regulators, a company’s GHG exposure is increasingly becoming a management issue. Stakeholders want more information incorporated into corporate reporting, more specifically, they are not just interested in how much money is being made, but how a business is making its money. Business managers must understand how a company makes its money – by exploiting or conserving the environment – so that they can manage their impact on the environment and track progress towards performance goals. According to the Carbon Disclosure Project’s 2015 climate change report, incentives for employees that help businesses meet energy efficiency or carbon pollution goals have risen by 34% from 2010 to 2015. Greenhouse gas accounting and reporting can provide the information that is important for solid business management decision making, and can drive increased materials and energy efficiency as well as the development of new products and services that reduce a company’s GHG inventory. In turn, this can lead to a reduction in production costs or help differentiate a company in an increasingly environmentally conscious marketplace. Business managers can use GHG accounting to manage a company’s vulnerability to future government legislation, future lawsuits, and shifts in consumers' perceptions towards heavy emitters.
"Many investors are critically assessing the climate risk in their portfolios, leading to select divestment from more carbon-intensive energy stocks—or, in some cases, from the entire fossil fuel complex" - Paul Dickenson, Executive Chairman of the Carbon Disclosure Project
Capital markets are also becoming more interested in receiving reliable and comprehensive information about climate change risks and opportunities for investing. Paul Dickenson, Executive Chairman of the Carbon Disclosure Project, a leading organization on GHG emission reporting of major corporations, says “Many investors are critically assessing the climate risk in their portfolios, leading to select divestment from more carbon-intensive energy stocks—or, in some cases, from the entire fossil fuel complex”. This can be further evidenced by how credit rating agencies such as Standard & Poor’s have incorporated environmental and climate risks into their corporate credit ratings. According to a report published by Standard & Poor’s, there were 299 cases in which a corporate rating was influenced or revised due to environmental or climate risks, of which 80% of these cases were influenced in a negative direction as a direct result of environmental or climate risks.
Investors and creditors are also interested in how businesses are positioned relative to their competitors with the possibility of environmental disaster or emerging regulation. In March of 2015, Morgan Stanley concluded that “sustainable investments have usually met, and often exceeded, the performance of comparable traditional investments … on both an absolute and risk-adjusted basis, across asset classes and over time”. In response to the new demands for information on environmental risk, an increasing amount of companies are including some kind of sustainability reports within their corporate reporting. These may be broader environmental and sustainability reports, or stand alone GHG emission reports.
GHG emissions accounting not only aims to report emissions for a single entity, but also for an entire country. Over the past decade, governments from all around the world are taking steps to mitigate GHG emissions by introducing policies that provide incentives for business to reduce or offset their emissions – from emissions trading programs to tax credit incentives. Reporting GHG emissions as an aggregate of a country is particularly important on a government level where 192 countries recently signed the Paris Agreement, an agreement designed to mitigate global GHG emissions. The Paris Agreement requires each country to be responsible for reporting its own GHG emissions every 5 years and track progress against their contributions. Understanding a country’s GHG emissions will help prioritize mitigation strategies, but there needs to be a standardized reporting and measuring method in place to fully account for and manage GHG emissions. This kind of accounting will be critical to the success of the Paris Agreement, and critical to the ability to control GHG emissions and hold countries accountable.
Businesses, investors, and nations all must understand their positions with GHG emissions to ensure the success of business operations, stakeholder’s investments, and the sustainability of our environment. As a result of government initiatives and the increasing concerns of stakeholders, businesses need to manage their GHG risks if they are to demonstrate compliance with government regulations, meet the informational demands of key stakeholders, and adapt to future environmental policies created by regulators. With the growing need for GHG inventory reporting comes an opportunity for accountants and standard setters to create and implement a framework that allows for the measurement, reporting, and verification of GHG inventories.