Enviromental Accounting

  The Strategic Governance Assessment Criteria  66

  The Human Capital Assessment Criteria  67

  The Stakeholder Capital Assessment Criteria  67

  The Environmental Assessment Criteria  69

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Enviromental accounting

Abstract

The growth in environmental accounting research and interest in the last few decades has experienced an optimistic time. Business is not an isolated island apart from the earth any more; the emergency of environmental accounting came from outside stakeholder at the end of 20 ^th century. Following with the rising sense of environment conservation no matter from the public or the companies/organizations, environmental accounting has been pushed to a central stage of nowadays business. This paper firstly provides a brief view of the current development of environmental accounting. Addressed with some questions, it further gives a review of recent research in this area from other scholars and seeks to answer if environmental accounting benefits both the public and business, how to put it into practice for different industries by looking into ten successful companies from “the global 100 list”, which provides the first hundred most sustainable companies in the world wide. The ten companies that I pick up are mostly in the UK despite for one in Finland and another in the US and cover three main industries like the retail industry, food and soft drink manufacturing industry, and tobacco and alcohol industry. Finally the paper concludes with a positive view that it is really good a thing for both sides and also practical despite of the considerable cost. The companies/organizations could be benefit from improving their efficiency and getting better control. The public could get a better and more sustainable living circumstance. But the problem of environmental accounting is its expensive cost, which makes middle or small size companies/organizations not be able to do it. However, there is always something to expect that the improvement of environmental accounting in the future will hopefully solve this problem and cut the cost down.

Key words: environment conservation, life-cycle assessment, ecological accounting

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Abbreviations

ACCA Association of Chartered Certified Accountants EHSV Environmental Health and Social Vice EPA Environmental Protection Agency EPD Environmental Protection Department FASB Financial Accounting Standards Board GRI Global Reporting Initiative GRIG Global Reporting Initiative Guidelines LCA Life-cycle Assessment ODS Ozone-depleting substance OECD Organization for Economic Co-operation and Development SRG Sustainability Reporting Guidelines UK United Kingdom UNCE United Nations’ Conference on the Environment UNCTAD United Nations Conference on Trade and Development USA United States of America WRI World Resources Institute

Chapter 1: Introduction

1.1 What is environmental accounting?

On the same basis as all accounting systems, environmental accounting presents an objective picture of the present situation and changes in the natural heritage,

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interactions between the economy and the environment, expenditure on preventive measures, environmental protection and the repair of environmental damage. “Environmental accounting aims at achieving sustainable development, maintaining a favorable relationship with the community, and pursuing effective and efficient environmental conservation activities.”(Caves, 1992, p.34) These accounting procedures allow a company or an organization to identify the cost of environmental conservation generated during the normal process of business, identify the benefit gained from such activities. It covers two different contexts. Environmental accounting can be used to provide insight on the interaction between the environment and a nation, or can be target to the activities of a company or an organization. This paper is mainly focus on the second realm. Environmental accounting is aimed to identify, measure and disclose the activities of a company or an organization based on its environmental conservation cost or economic benefit associated from environmental conservation activities and the company’s financial performance. The financial performance is supposed to be expressed in a monetary value. While environmental conservation benefits and organization’s environmental performance should be stated in physical units.

When the whole world experiences a rapid growth of industry and economic, unfortunately, the natural environment is terribly damaged at the same time. Nowadays, with the increasing awareness of the importance of environment, accounting is no longer just for the economic aspect or financial aspect. For example, the Global Reporting Initiative Guidelines (GRIG) defined their framework for reporting on 3 parts: the economic, environmental and social performance of an organization. (www.env.go.jp/en/ssee/eag02) Similarly, it can be seen in Accountancy and Business journal (Stikich, 1997), in which high lights that there are three aspects of core values of a modern sustainable business, one of them is environmental responsibility. In fact, a number of companies begin to reflect on and revise their corporate environmental responsibilities, not only because of the pressure and activity coming from non-governmental organizations and the growing sense of environmental issues by the

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general population, but using it as a part of their management strategies to specify measures for dealing with environmental issues and to internally carry out environmental conservation activities.

Moreover, advocated by many organizations like the United Nations, the World Bank, the Organization for Economic Co-operation and Development (OECD) and the European Union, environmental accounting is widely recognized as an essential tool of a sustainable development, which does not harm the planet’s resources needed for the future generations and the development on the earth.

1.2 Legalization

Regulation of environmental issues is growing rapidly in all countries of the world and keeping up to date. And even national legislation is becoming a specialized field in itself. With specific reference to disclose environmental liabilities, accountants today are required to follow the guidance enacted by the Financial Accounting Standards Board (FASB). According to the accounting principle stated in FASB Statement of Financial Accounting Standards No. 5, “accounting for contingencies”, which is issued in 1975, the contingent liabilities “arising from environmental cleanup costs” are required to be accounted and disclosed. This statement requests that “provision for a loss contingency be accrued and a liability recognized on the face of the financial statements when both of the following conditions are met: It is probable that an asset has been impaired or a liability has been incurred at the date of the financial statements; i.e., it is probable that a future event or events will occur confirming the fact of the loss; and the amount of the loss can be estimated reasonably.” It means that if the loss is reasonably possible and can be estimated reliably, the loss contingency must be reported, but only as a note to the financial statements. When there is only a tiny possibility of the occurrence of the future event, which might lead to loss; or the amount cannot be estimated reliably, there is no request of either an accrual or a note from FASB, but recommends a note in such circumstances. The FASB has also

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provided additional guidance regarding loss contingencies in FASB Interpretation No.14 “Reasonable Estimation of the Amount of a Loss”, in which it’s suggested that “the minimum amount of the range should be accrued, unless some amount within the range appears at the time to be a better estimate than any other amount within the range.”

Some countries have already set up the legislations on environmental accounting and reporting, such as Denmark, New Zealand and the Netherlands. (www.cei.sund.ac.uk/envrep/reports.htm) Some organizations have given a Reporting Guidelines, such as GRI. It mentioned, “Environmental reporting has traditionally been a voluntary method of communicating environmental performance to an organisations stakeholders.”

The Environmental Protection Agency (EPA) of USA identified more than 15,000 Protection Responsible Parties who should potentially responsible for the clean-up costs. A potentially responsible party is defined by EPA as any individual or company/organization who is potentially responsible for or contributed to the contamination problems at a Superfund site. It can include: “current owners or operators of facilities where hazardous substances have been deposited; owners or operators of facilities at the time hazardous substances were deposited; generators of hazardous substances deposited at facilities; transporters of hazardous substances to facilities; persons who arranged for disposal or treatment of hazardous substances at facilities.” (Jensen & Unger, 1991, p18)

The UK legislation involves such things as the EPA 1990, the Water Act 1990 and the Environment Act 1995. A new regime for Integrated Pollution Prevention and Control (Pollution Prevention and Control Act 1999) was implemented in 2000. As a result, companies are required to invest in pollution protection; invest in cleaner technologies; change processes and products; establish waste minimization programmes; review asset values; spend on waste treatment/disposal. Similarly, environmental legislation is

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supposed to be developed to support the policy of sustainable development, such as measures to reduce the emission of greenhouse gases. Wind the time back to the turn of the century, there were already some business implications like the nature of packaging was changing; packaging recovery/recycling schemes were needed; cost of waste treatment/disposal was rising; companies need to make more information available to the public; heavier industrial processes need to adopt environmental management practices. (Gray, R & J.Bebbington, 2001,p5)

1.3 Why do companies and organizations do it?

Considering the reasons for why companies and organizations carry out environmental accounting, there could be several causes, some of which are due to legislation, and some of which are voluntary simply because a company or organization wishes to improve it’s public image. These reasons are about to be discussed below.

1.3.1 External requirement: Legislation and accounting standards

As Professor Rob Gray said, “As well as generating consequences which may be interpreted as largely `positive', accounting is also implicated in many of the `negative' aspects of organisational life. For example, environmental damage can be shown to be inevitable given current accounting orthodoxy.”

(www.sussex.ac.uk/Units/gec/pubs/briefing/brf-gray.htm) The public and the government have the willing to be informed not only the positive side but also the negative side. In order to meet the needs of them, environment accounting is an inevitable trend. There is a discussion can be found from ACCA in appendix 1.

In addition, companies and some other organizations are required to have responsibility to stakeholders, such as consumers, business partners, investors and employees, when making use of environmental resources, i.e. public goods, for their business activities. Therefore, it’s a key process to disclose environmental accounting information to perform their responsibility to the stakeholders.

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1.3.2 Internal need: Benefit from doing environmental accounting

In carrying out environmental conservation activities, a company or other organizations can accurately identify and measure investments and costs that related to environmental conservation activities, therefore can prepare and analyze this data. The company cannot have a better acknowledgement of the potential benefit of these investments and costs, by only improving the efficiency of its activities, but environmental accounting also plays a very important role in supporting companies to make sensible decision. Consequently, environmental accounting helps companies and other organizations build their public trust and reputation and receive a fair assessment. It is mentioned in ACCA “companies should identify and communicate with their stakeholders, consider and act on their needs and involve them fully in corporate business”. Therefore, if a company wants to be more sustainable, it should consider to be more responsible to its stakeholders, such as show its environmental responsibility to them.

For example, the Body Shop strongly recommends its products from the view of environment protection. They emphasize the power that they are using to produce is “Ecotricity” which generated electricity from wind and solar power. And they are building new green energy sources to replace the conventional polluting kind of electricity that causes global warming. By switching to Ecotricity, the customers can use their electricity bill to help fight global warming. Body Shop successfully wins the popularity of the public by building their business on the basis of being environmental friendly. (http://www.uk.thebodyshop.com/web/tbsuk/values_pop.jsp)

1.4 Difficulties in carrying out

A big headache to practice environmental accounting is that it’s very expensive for companies and organizations to measure and report environmental items. Since it’s hard to measure environmental cost or benefit in monetary value. Moreover, from the Report of the Committee on the Environment Document 10071 announced 2004,it can

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be seen “An organization is exposed to reputation risk if it selectively chooses to publish only good news in its annual environmental report and appears to systematically exclude bad or neutral

performance”(www.evcp.chance.berkeley.edu/documents/Reports/documents/EnvCm teReport040427.pdf) It means that companies and organizations cannot only show the good news in their environmental report, but also have to expose the bad ones. Otherwise they may probably face a reputation risk. One the other hand, if they do disclose all the bad news in the environmental report, they might also be censured by public. For example Shell disclosed in its annual report in 2002 that after a slight decrease of emission to the air in 1998 and 1999, the number goes up again since 2000. (Appendix 2) And for some industry that has certain large negative impact on environment, like BT, one of the largest single purchasers of electricity in UK, buys 1.8% of the nation’s industrial energy and produces 100,000 tonnes of waste a year. (Rubenstein, D. B, 2005) Even though BT has taken some actions to deal with the problems, the negative impact on environment is still significant. However, under the current IT technology, in order to provide good communication service to public, the negative impact is unavoidable. There might be a problem comes out: these companies are doing a “good” thing, but get a “bad” result.

As estimated by the research of Rubenstein(2005), the clean-up cost of hazardous waste sites in all, the world is now likely facing at least a trillion dollar environmental obligation, for which society is trying to sort out responsibility, to determine who is going to pay for what. A key problem is that accountants of the world don’t really know how to account for clean-up costs and the related liabilities yet. As a result, investors are surprised to see undisclosed clean-up costs drain corporate resources. Environmentalists do not get a clear picture of how companies should meet their newly defined responsibilities. (www.accountancyage.com)

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1.5 Nowadays Situation

Even if there are some difficulties in environmental accounting’s implement, it’s very pleased to see that many Council of Europe members, such as the United Kingdom, France, Germany, Italy, and the Netherlands have studied and experimented with environmental accounting systems, and some cities and towns that are more directly accountable for the management and quality of their environments have done the same, mainly by using environmental indicators and adapting the methods developed to date to the urban sitting. (Giovanelli, C., 2004) The number of companies and organizations who disclose the information of environmental impacts of their activities in annual report keeps on growing recently. Although the annual report is designed primarily to report to investors upon the past activities and future plans, this increase in information disclosure can be contributed to a wide range of factors. The demand for environmental information comes from stakeholders who are interested not only in the short-term financial performance of a corporation but are also interested in its social impacts. And the wide range of the annual report readers asks for abundant information from it.

With regards of all of these that I mentioned above, this paper is going to concentrate on such questions as should environmental accounting be applied by all different kinds of companies and organizations, if it is a really good thing for both side of companies/organisations and the public? If so, how should different companies/organizations put it into practice? Addressed with these questions, there will be evidence supporting both sides of argument given in the following content.

Chapter2: Literature Review:

More than a decade ago, if a scholar wants to review the literature concerned on the relationship between accounting and the natural environment, he/she would have to bemoan. Because at that time, the research on environmental issues of accounting area is quite limited and only to a surface extent. Fortunately, the changes in last ten years

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turn the situation to be optimistic, more and more people and companies/organizations have been got involved in this area. Consequently, it would be easier for those of us who are tending to research in this issue.

2.1 Usefulness of environmental accounting:

2.1.1 Environmental accounting as a management tool:

Some scholars argue that environmental accounting tends to attract a strong interest as a management tool that could help companies make better business decisions and become more and more “eco-efficient.”

Briefly review from the case study to the US Company, Procter & Gamble (P&G), taken by the World Resources Institute (WRI). It indicates that P&G took the adage to a new level with its total cost assessment approach to evaluate its wasted reduction projects. Learning from doing it, P&G got to know that if an approach is cost-effective and driven by doing the right economic thing, it continues to drive down wastes and costs. From their experience, the first step was to “set up metrics and a process to measure the metrics by how P&G would measure cost and waste at sites.” “ What drove us to and where we are now was that we needed to figure out a way to link waste reduction efforts to the business”, said Michael T. Fisher, the director of P&G’s Environmental Controls Department. “The only way we could interest the business mangers in waste reduction was to show them that it could save money. That was almost five years ago, when we had a lot of very targeted waste reduction and pollution prevention opportunities, but nothing systemic. We wanted to start involving more people rather than just corporate staff.” He also emphasized that linking with financial people is critical. Although they may have a different way of thinking about things, the financial people are the ones to whom the company’s head would like to listen. It’s also important to create design for the future, institutionalize the approach to make it work for a long run, and make sure having the support and commitment from the top. (www.cdmeyer.com/allied/LEADART.htm)

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After four years, what are the results that P&G got? The costs per production unit were flat and slightly downward, in spite of rapid escalation of disposal costs. Fisher said P&G achieved significant waste reductions from this effort, 50% on a pounds per production basis. During the four years, P&G has learnt that the cost-effective solutions are sustainable; the clear measures will drive continuous improvement; clear cost and waste definitions are an essential requirement and pollution prevention projects have tree phases, and each phase requires different action plans. (www.cdmeyer.com/allied/LEADART.htm)

2.1.2 Environmental accounting as a sustainable development tool:

Above all, the “sustainable development” is defined as relating to development which “ meet the needs of the present without compromising the ability of future generations to meet their own needs” (Eden, 1996, p8) To answer the question, “can business and accounting be a part of the solution, which is to move our economic organizations back towards less unsustainable path?” addressed by some researchers. There is a study in which indicates that at present, conventional tools for economic analysis do not enable the decision makers using them to reliably know whether the environmental policies implemented are effective and what kind of impact economic policies they have got on the environment. With the regard to environmental cost in particular, the necessary expenses in order to maintain the natural resources at a certain level, as well as the start of reference period that was continues ignored from the economic analyses based on conventional accounting instruments, in 1992, the United Nations’ Conference on the Environment (UNCE) marked a crucial turning point by approving the action plan Agenda 21 on sustainable development, which introduced the concept of environmental accounting as a tool for implementing the policies in this area. Environmental accounting is therefore an essential tool for implementing the concept of sustainable development, which is a kind of development that doesn’t disserve the planet’s resources needed by the generations and continues development in the future. (www.egj.lib.uidaho.edu/egj13/shrode1.html) Over the last ten years, the increased

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impact of human activities on the environment at both local and global level has shown that, the environmental costs of development are not easily discounted factors any more, especially in the urban areas, so that it’s necessary to use a specific tool to measure and control them. Moreover, improved access to information has caused a rinsing demand of information on the environment by both sides of politicians and the public who are asking for better governance on environment. The environmental accounting system enables greater accountability of decision makers and different interest groups committed to a common sustainable development goal; regular environmental monitoring and proper environmental data usage at decision-making level with the regard to sustainable develop. (www.assembly.coe.int)

2.2 Influences brought by environmental accounting:

2.2.1 The influences to management accounting:

Generally speaking, management accounting is designed for internal purposes of companies and organizations. It addresses the “measurement of the costs and benefits of pursuing and ignoring corporate environmental protection.” (www.gla.ac.uk ) The additional revenues do not raise any special measurement problems; cost reduction and expected cost avoidance are often underestimated because of the need for greater environmental protection. Therefore the present method mainly focuses on the internal environmentally induced costs. Whilst external costs can also be relevant for companies, because they could become internal costs along with the time pass by. Opportunity costs of unrealized environmental protection are a special group of internal corporate environmental costs. The opportunity costs occur could due to the poor information management, or it could also due to the changing cost relations. For example, the increasing direct and indirect costs of environmental impacts and the decreasing costs of information management. (www.ask.com)

Depending on the perspective’s taken, the internal corporate environmental costs are defined in different ways: as costs of environmental protection or as costs directly and

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indirectly related to material and energy flows, which cause environmental impacts. According to the first point of definition, any kind of environmental protection will only cause an increase of costs. This doesn’t reflect reality and is in contrast with the concept of eco-efficiency. The second point shows that measures of environmental protection cause both costs and benefits. And the economic challenge is to find measures, which could reduce material and energy flows and could provide the net benefit as high as possible. In order to achieve this goal, a new approach to material and energy flow, the activity-based costing is proposed and discussed. Since “its relevance to improve eco-efficiency is placed on issues associated with the tracing of direct costs and the allocation of indirect environmental costs.”(Owen, 1999) Recognition of environmental costs and their appropriate allocation, as well as consideration of the opportunity costs of unrealized environmental protection can substantially change decisions by using contemporary investment appraisal techniques. (www.ask.com)

2.2.2 Influences to financial accounting and reporting

Environmental issues have also shaped financial accounting and reporting. The main purpose of especially considering environmental issues in accounting standards is to improve the usefulness of the information that is supplied to stakeholders, because the information is not equal for internal management and external stakeholders.

There are a number of major environmental issues in financial accounting indicated by previous researchers. Like when should environmental costs be capitalized and when should be expensed? How should environmentally induced expenses and environmentally related depreciation and devaluation of assets be taken into account? How should accountants treat the contingent environmental liabilities and tradable pollution permits? What environmental issues should be included in the Management’s Discussion and Analysis report?

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Most of these environmental issues are not clearly taken into account by the existing financial accounting standards, thus the economic consequences of environmental impacts are sometimes underestimated, which may reduces the motivation to improve corporate eco-efficiency. The fact that some environmental issues are taken into account, while some are not, could also lead to confusion and misunderstanding. As a result, these problems lead to awareness of the need to incorporate environmental issues in existing standards. (www.uni-lueneburg.de)

An approach to increase the transparency of the value that financial accounting provided is to develop relevant financial information by using cash-flow figures. Since these figures are less likely to be influenced by accrual accounting standards. (www.accaglobal.com) The advantage of adopting a shareholder value analysis is that the different effects of an environmental protection strategy and environmental protection measure can be weighted against each other and the total effect assessed. (www.commerce.adelaide.edu.au) Nevertheless, as long as external effects are not internalized, conventional financially management information systems are not so sufficient for those stakeholders who want direct information about the effects of corporate activities on the natural environment. Even merely from a financial perspective, no one could deny that the information on the environmental impacts caused by a company/organization is relevant.

The research runs from the interest in social accounting to the interest in environmental accounting investigates the statistical relationships of corporate environmental disclosures, corporate characteristics, environmental performance and financial performance. (Freedman and Stagliano, 1995) The growth in both environmental awareness and the impact of environmental matters on the financial statements has tended to provide further promotion for research in this area. Learnt form these literature, the financial performance is only loosely linked to environmental performance in all but it is the case that investors are interested in environmental issues

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only to the extent that it affects their financial well-being. A strand, which seems to increase the popularity in this area of financial statements, can be found in the early experiences with social accounting. There have been examples of what financial statements might look like if they reflect the environmental issues. (Huizing and Decker, 1992) like the environmental financial statements of Baxter Health Care (Bebbington and Tan, 1997), and Hydro’s experiment to define sustainable cost (Gray, 1996), expose both the limitation of current financial accounting theory and the difficulty of seeking the full range of environmental issues into a financial statement. However, there is a further related issue here. The financial statements have a dominant place in companies/organizations performance. Someone argues “their very primacy as the measure of organizational success and the way in which that measure is founded upon fundamental assumptions accountants make in their calculation of profit that is at the very heart of the causes, or at least implicated in those causes of environmental degradation” (Gray and Bebbington, 1993, p72) Most of accounting research inevitably takes the financial statements for granted and examines the environmental crisis. The financial statements are at the heart of the environmental problem. But through those researches, it offers no substantive challenge to environmental degradation.

2.3 Environmental reporting

Accounting researchers have seen a growth in environmental reporting by companies and organizations lately. The research in this area has been dominated initially at any rate; both nation specific studies and comparative studies have recorded an upward trend in environmental disclosure through the annual report and stand-alone environmental report. However, analyses of this phenomenon confirm that such reporting is “principally restricted to very largest companies and is country and industry variant.” (Pava and Krause, March, 1996) Research into environmental disclosure is developing rapidly with examinations of the impact of pressure group and other external forces (Deegan and Gordon, 1996), exploration of users needs, focus on

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