ACC-ACF 3100 Advanced Financial Accounting

ACC-ACF 3100 Advanced Financial Accounting

Topic 3 Corporate Social Responsibility

•       LO 1: Appreciate the alternative perceptions about the role of ‘accounting’ and about the accountability and social responsibility

•       LO 2: Explain sustainable development

•       LO 3: Explain social-responsibility reporting

•       LO 4: Discuss the limitations of conventional financial accounting in relation to the recognition of social and environmental costs and benefits

•       LO 5: Understand the four-step approach to corporate reporting

•       LO 6: Discuss different perspectives on what motivates organizations to present social and environmental information

•       LO 7: Understand the different theories (legitimacy and stakeholder theories) that help explain why companies voluntarily provide social and environmental information → Motivation to prepare sustainability report

•       LO 8: Understand some basic feature of GRI, IR, UN Sustainable Development goals, full cost accounting

•       LO 9: Climate change reporting and its issues

•       LO 10: where to next with CSR reporting

LO 1: Different views of Business Responsibility

Milton Friedman: Saw the responsibility of business to use resources to increase profits as long as it stays within the rules → The business of business is business

• Alternative view: Managers should manage the organization for the benefit of all stakeholders, noy just those with control over scarce resources → entity has a responsibility for its social and environmental performance then accountants should provide an account of social and environmental performance

LO 2: Explain sustainability development

• Development that meets the needs of the present without compromising the ability of future generations to meet their own needs

LO 3: Social Responsibility Reporting

Social-Responsibility Reporting (which includes Social Reporting and Environmental Reporting*): the provision of information about the performance of an organization in relation to its interaction with its physical and social environment

• Known by many other names/acronyms:

Ø TBL (triple bottom line)

Ø ESG – environmental, social and governance

Ø CSR – corporate social responsibility

Ø Environmental reporting

Ø Social reporting

Ø Environmental accounting

Ø Environmental reporting

• Social Responsibility Reporting:

Ø Boarder group of stakeholders not just shareholders; e.g. local communities; customers, suppliers, employees, creditors, government, and even future generations;

Ø Organization’s perspective about its accountability

• Social Reporting

Ø Interaction with the local community

Ø Level of support for community projects

Ø Level of support for developing countries

Ø Level of support for employees within the supply chain

Ø Health and safety record

Ø Training, employment and education programs

• Environmental Reporting

Ø Emissions of greenhouse gases

Ø Water usage

Ø Release of effluents into water courses

Ø Results with respect to minimizing waste

LO 4: Limitation of financial accounting in relation to sustainability report

(E) The entity assumption

Ø (F) The focus on the information needs of stakeholders with a financial interest

Ø (S) The focus on short-term results

Ø (E) The exclusion from expenses of the impacts on resources not controlled by the entity

Ø (M) The mechanics of debit and credit

Ø (M) The recognition criteria of measurability and probability

Ø (M) The concept of materiality

Ø (D) The practice of discounting liabilities

Some of the perceived limitations of traditional financial accounting, which acts to exclude these externalities, include:

1) the focus on the information needs of stakeholders with a financial interest

• In the Conceptual Framework the objective of general purpose financial reporting is: to provide financial information about the reporting entity that is useful to existing and potential investors, lenders and other creditors in making decisions about providing resources to the entity

• Such a definition has the effect of denying or restricting access to information by those parties or individuals who are affected in any way that is not financial

2) the mechanics of debit and credit

• The double entry system does not work for ‘one-side transactions’

• One-sided transactions arise in the case of externalities where costs are imposed upon parties external to the entity but there is no direct resource outflow or consumption by the organization

• Unless there is some agency to which calculated ‘costs’ are ultimately required to be paid, or the reporting entity explicitly accepts that it either has a legal or constructive obligation to ultimately transfer resources then, for externalities, there simply will not be a balancing credit entry to be made

3) the entity assumption

• Financial accounting adopts the entity assumption, which requires an organisation to be treated as an entity distinct from its owners, other organisations and other stakeholders

• According to the entity assumption, if a transaction or event does not directly affect the entity, the transaction or event is to be ignored for accounting purposes. This means that the externalities caused by reporting entities will typically be ignored, and that performance measures (such as profitability) are incomplete from a broader societal (as opposed to a ‘discrete entity’) perspective

• Arguably, any moves towards accounting for sustainability would require a modification to, or a move away from, the entity assumption

4) the exclusion from expenses of the impacts on resources not controlled by the entity

• Expenses are defined as: decreases in assets or increases in liabilities that result in decreases in equity, other than those relating to distributions to holders of equity claims

• An understanding of expenses requires an understanding of assets.

• An asset is defined as: a present economic resource controlled by the entity as a result of past event

• The recognition of assets therefore relies upon control. Environmental resources such as air and water are shared and not controlled by the organisation and hence cannot be considered to be assets.

v For example, imagine that an entity destroys the quality of water in its local environment, thereby killing all local sea creatures and coastal vegetation. Under conventional financial accounting, if the entity incurs no fines or other related cash flows as a result of its actions, no externalities would be recognised.

5) the focus on short-term results

• As accountants, we tend to emphasise short-term (annual) performance through our practices of dividing the life of the asset up into somewhat artificial periods of time

• Managers are also often rewarded in terms of measures of performance such as annual profits

• This can have the effect of discouraging us from making long-term investments in new technologies (including those that will provide longer term social and environmental benefits)

6) the recognition criteria of measurability and probability

• For a transaction or event to be recognised within the financial statements there is a requirement within the Conceptual Framework that:

v the definition of the respective element of accounting be satisfied (the elements being assets, liabilities, income, expenses and equity), and that

v the information about the respective element be considered both relevant (which requires consideration of factors such as ‘existence uncertainty’ and assessments about the probabilities of the related outflow or inflow of economic benefits) and ‘representationally faithful’ (which requires consideration of factors such as ‘measurement uncertainty’)

• Evidence suggests that many liabilities—particularly those related to the environment—are ignored, often on the basis that they are too difficult to verify.

7) the concept of materiality, and

• According to paragraph 2.11 of the Conceptual Framework, Information is material if omitting, misstating or obscuring it could reasonably be expected to influence decisions that the primary users of general purpose financial reports make on the basis of those reports, which provide financial information about a specific reporting entity.

• Unfortunately, this has meant that if something cannot be quantified (as is the case for many social and environmental externalities), it is generally not considered to be ‘material’ and therefore does not warrant separate disclosure

• This implies that ‘materiality’ (as used by accountants) might not be a relevant criterion for the disclosure of social and environmental performance data8) the practice of discounting liabilities

• In respect of liabilities, there is a general requirement that liabilities to be repaid in more than 12 months should be discounted to their present value

• While discounting liabilities to their present value makes good economic sense (indeed it is not questionable that a dollar in the future is worth less than a dollar now), it does not necessarily make good ecological sense because it effectively downplays the importance of the future clean-up This may encourage some entities to undertake activities that will damage the environment but that will not need to be remedied for many years