Financial Accounting Theory
Craig Deegan
Chapter 9
Extended systems of accounting—the
incorporation of social and environmental factors
within external reporting
Slides written by Craig Deegan and Michaela
Rankin
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PPTs t/a Financial Accounting Theory 2e by Deegan
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Learning objectives
• In this chapter you will be introduced to
– various perspectives of the responsibilities of business
– explanations of the relationship between organisational
responsibility and organisational accountability
– various theoretical perspectives that can explain why
organisations might voluntarily elect to provide publicly
available information about their social and environmental
performance
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Learning objectives (cont.)
– some recent initiatives in social and environmental
accounting
– the concept of sustainable development and how
organisations are reporting their progress towards the
goal of sustainable development
– the relationship between sustainability and eco-efficiency
and eco-justice issues
– some of the limitations of traditional financial accounting
in enabling users of reports to assess a reporting entity’s
social and environmental performance
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Introduction
• In recent years there has been increasing
discussion about sustainable development and
triple bottom line (TBL) reporting
– TBL reporting is reporting that provides information about
the economic, environmental and social performance of
an entity
• Represents a departure from sole economic focus
that was traditional in external reporting
• A review of the Global Reporting Initiative’s
Sustainability Reporting Guidelines provides
insight into the types of social, environmental and
economic information that could be disclosed in a
sustainability report
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Introduction (cont.)
• The terms sustainability reporting and TBL reporting
are often considered to be synonymous
• Strictly speaking, however, sustainability reporting
would require more than just TBL reporting and it
would question three separate ‘bottom lines’ given
sustainability would require social, economic and
environmental aspects to be considered together
• Sustainability reporting would also address
specifically how current activities are impacting the
abilities of future generations to satisfy their own
needs. Current TBL reports do not address such
issues
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Responsibilities of business
• Moves to provide information about social and
environmental performance, whether through
sustainability or TBL reports, implies management
of these organisations consider they have an
accountability for social and environmental
performance, as well as economic performance
– not a view held universally
• Increasing community pressures for organisations
to make a commitment to sustainable business
practices, and corporate reporting is tending to
respond to this pressure
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Responsibilities of business (cont.)
• If sustainability becomes part of the expectations
held by society, it must—consistent with legitimacy
theory—become a business goal
• Providing information about social and
environmental performance will increase the trust
a community has in the organisation
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Sustainability
• Brundtland Report placed sustainability on the
business worldwide agenda
• Sustainable development defined as
‘… development that meets the needs of the
present world without compromising the ability of
future generations to meet their own needs’ (World
Commission on Environment and Development,
1987)
• Inter-generational and intra-generational equity
central to the agenda
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Sustainability (cont.)
• Should organisations be responsible for the
sustainability of their business practices?
• Will they embrace this responsibility in the
absence of specific legislation?
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How does an entity determine its
responsibilities?
• What do its relevant stakeholders consider
business responsibilities to be?
• Based on personal judgement of the management
involved as to who are the relevant stakeholders
• Has implications for the information disclosed
• Perceived responsibility and accountability go
hand in hand
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Accountability
• The duty to provide an account (not necessarily
financial) or reckoning of those actions for which
one is held responsible
• Two responsibilities or duties
– responsibility to undertake certain actions
– responsibility to provide an account of those actions
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To whom is business responsible?
• Many organisations making public statements that
responsibilities extend beyond shareholders to
encompass communities in which they operate
and society as a whole
• If sustainability embraced then responsibility also
owed to future generations
• If an organisation accepts a responsibility for the
sustainability of its business practices, then it
should produce an account of its responsibilities—
it should provide a sustainability report
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Stages of sustainability reporting
• Stage 1: Why report?
– relates to management’s motivations
• Stage 2: To whom to report—who are the
stakeholders?
– tied to motivations—if motivations are based on
managerial reasoning then disclosures could be aimed at
powerful stakeholders
• Stage 3: What to report?
– involves dialogue with identified stakeholders
• Stage 4: What format for the disclosures?
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Stage 1: Why report?
• Different accounting theories will provide
alternative explanations about why an entity might
decide to report social and environmental
information
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Theories to explain ‘why report?’ social
and environmental disclosure
• Legitimacy Theory and social contract
– disclosures linked to providing evidence that entity is
complying with the expectations of society
• Stakeholder Theory
– disclosure depends on expectations of powerful
stakeholders if the managerial perspective of stakeholder
theory is embraced
• Accountability Model
– an acceptance of a responsibility to report
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Theories to explain ‘why report?’ social
and environmental disclosure (cont.)
• Institutional Theory
– organisations will adopt particular practices because of
institutional pressures
• Positive Accounting Theory
– disclosure depends on positive wealth implications
 consider submission of the Business Council of Australia
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‘Why report?’ and its links to views about
the responsibility of business
• Consider the views of Milton Friedman—reporting
is not about responsibilities; rather, it is about
enhancing business profitability
• A broader view of business responsibilities would
accept that regardless of the impacts of
profitability, stakeholders have a right to know
about the social and environmental implications of
an organisation
• Where do we think corporations sit in terms of the
above views?
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Differing views of business responsibility
• Friedman
– rejected the view that corporate managers have any
moral obligations
– responsibility to increase profits as long as stays within
the rules
– this view often held by the media—applauds profitable
organisations
• Alternative view
–
–
–
–
–
organisations earn their right to operate in the community
artificial entities that society chooses to create
organisations do not have an inherent right to resources
consequently accountable to society for how it operates
societal expectations may exceed profitability
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Stage 2: To whom to report?
• If managers overwhelmingly motivated by the
desire to increase shareholder value then reporting
will be aimed primarily at satisfying the
expectations of powerful stakeholders
• If we adopt a broader ethical perspective then
disclosures would be aimed at stakeholders
impacted by the operations of the entity—but still
cannot address all information needs, so some
prioritisation will be necessary
• It is emphasised that the decision to whom to
report to is directly related to the previous issue of
‘why report?’
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Stage 3: What to report?
• First of all, establish that there is a demand for
information
• Identify information needs through dialogue with
stakeholders
• Negotiate a consensus among competing
stakeholder needs and expectations
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Stage 4: How to report?
• Conventional financial accounting does not appear
to provide a foundation for social and
environmental disclosures
• Triple bottom line reporting is an alternative,
although it is not the same as sustainability
reporting. A true sustainability report would
consider such issues as the carrying capacity of
the eco-system, impacts on future generations and
so forth
• An attempt can also be made to place a cost on
the externalities of business
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How to report? Limitations of traditional
financial accounting
• For the following reasons, financial accounting is
not seen as a useful vehicle for promoting social
and environmental disclosures
• Financial accounting focuses primarily on the
information needs of those involved in resource
allocation decisions. By contrast, sustainability
concerns all stakeholders
• The notion of ‘materiality’ tends to preclude the
reporting of social and environmental information,
given the difficulty in quantifying costs
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How to report? Limitations of traditional
financial accounting (cont.)
• Reporting entities frequently discount liabilities to
present value, which tends to make future cleanup expenditures appear trivial
• Financial accounting adopts an entity assumption
where the entity is treated as distinct from its
owners and other stakeholders
– transactions not directly impacting the entity are ignored
– ignores externalities caused by the reporting entity, some
relating to social and environmental implications of the
entity’s operations
– sustainability and the ‘entity assumption’ are mutually
exclusive
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How to report? Limitations of traditional
financial accounting (cont.)
• Expenses are defined to exclude the recognition of
any impacts on resources not controlled by the
entity
• Externalities caused by the entity cannot be
reliably measured, and so typically are not
recognised given the recognition criteria provided
in such documents as the IASB Framework
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How to report? Triple Bottom Line
Reporting
• Triple bottom line reporting refers to the disclosure
of information about the social, economic and
environmental performance of an entity
• But … is the bottom line metaphor appropriate—
can social and economic impacts be measured
through a ‘bottom line’?
• Seems to indicate that we must manage all the
bottom lines in a similar manner—appropriate?
• Seems to suggest that social, economic and
environmental performance are separate to one
another—not really the case in practice
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How to report? Relevance of measures
such as GDP
• Performance of governments is related to outputs
of systems of national accounts
– e.g. gross domestic product (GDP)
• Does not consider issues of resource efficiencies
or equities with how resources are distributed
• Experiments taking place to ‘green’ GDP
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How to report? The Global Reporting
Initiative
• Global Reporting Initiative (GRI) established 1997
• The GRI Sustainability Reporting Guidelines is the
most comprehensive framework for ‘how to report’
that is currently available
• Third version—G3—released in 2006
• Made up of various ‘core’ and ‘additional’
performance indicators
• Not mandatory and hence many organisations are
selective about what information they select for
disclosure
• Apart from the GRI, a number of other
organisations have produced reporting guidelines
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Social auditing
• Purpose of social auditing is for an organisation to
assess its performance in relation to society’s
requirements and expectations
• Results form the basis of an entity’s publicly
released social accounts, which in themselves are
often incorporated into a triple bottom line or
sustainability report
• Consider the Body Shop’s social impact report
which is based on their social audit
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Social Auditing Standards
• Released in 1998 by the Council on Economic
Priorities (US body)
– SA8000
– focuses on issues associated with human rights, health
and safety, and equal opportunities
• In 1999 ISEA launched standard AA1000
– concerned with the processes of setting up and operating
social and ethical accounting and auditing systems
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Monetising environmental costs and
benefits
• As we have already discussed, financial
accounting typically ignores environmental
impacts, therefore experimental approaches to fullcost profit calculation are being developed
• Market prices do not reflect the scarcity of
resources involved or harm resources cause
• Perception that all costs associated should be
reflected in the price of the good
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Monetising environmental costs and
benefits (cont.)
• If done comprehensively this would involve some
life-cycle analysis
– consideration of the inputs and outputs from raw material
acquisition to disposal
• Often referred to as ‘true prices’
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Baxter International
• Approach most conservative of those considered
• Ignores any externalities caused by the business,
and only includes costs and benefits directly
related to cash flows
• Attempts to demonstrate that by explicitly
considering the environment, actual cost savings
can be made
• Still applies the usual ‘entity assumption’
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BSO/Origin
• Place a notional value on the environmental costs
imposed on society
• This value is then deducted from profits (calculated
using financial accounting methods) to determine a
measure referred to as ‘sustainable operating
income’
• Although consider many externalities, ignores
many eco-justice considerations required to
pursue sustainability
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Landcare Ltd
• Seeks to determine the notional costs that would
be incurred if the organisation was to have zero
environmental impact
• Sustainable cost: the amount which must be spent
to put the biosphere at the end of the accounting
period back into the state it was at the beginning
• Sustainable cost calculation involves two elements
– costs required to ensure inputs have no adverse
environmental impacts
– costs required to remedy any environmental impacts that
arise
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Watercare services
• Identifies the additional costs that would need to
be incurred if the organisation was to meet the
social and environmental standards that it believes
are appropriate
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Concluding comments
• Social and environmental reporting is a rapidly
evolving area
• Only 15 years ago, almost no companies were
producing social and/or environmental reports
• Now many large listed companies are providing
such reports
• As concerns for social justice and environmental
protection increase we can expect this form of
reporting to continually evolve
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