CIA 3003:ACCOUNTING THEORY AND PRACTICE

Special Issues in Financial Accounting &

Reporting: Sustainability and Environmental
Reporting

Semester 1, 20192020
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OUTLINE
•  Definition of sustainability
•  Corporate accountability
•  Conventional versus Social & Environmental Accounting (SEA)
•  Sustainability Reporting :
•  Evolution of Sustainability Reporting
•  Motivations for Sustainability Reporting
•  Global Reporting Initiative
•  Integrated Reporting
 Introduction
•  In recent years there has been increasing focus upon
sustainable development and sustainability reporting
•  Sustainability reporting (and CSR reporting) represents a
departure from the economic focus that was traditional in
external reporting
•  A variety of terms are used for sustainability reporting.
•  For example corporate social reporting, triple bottom line
reporting, environmental reporting, shared value etc.
•  Sustainability reporting is the most common term.
•  All refer to impacts that business has on society and the
environment and vice versa
Sustainability reporting
•  Sustainability/Sustainable development:
o  development that meets the needs of the present without
compromising the ability of future generations to meet their
own needs (Brundtland Report)
•  Strictly speaking however, sustainability reporting would
require more than simply providing information against
social, environmental and economic indicators
•  Sustainability reporting would also address how
current activities are impacting the abilities of future
generations to satisfy their own needs
Sustainability Accounting and Reporting
•  Two fundamental issues:
o Firstly, development is not just about bigger profits and
higher standards of living for a minority. It should be
about making life better for everyone.
o Secondly, development should not involve the destruction
or the irresponsible exploitation of the natural
resources, nor should it engage in environmental pollution.
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Sustainable Business Practices

Sustainability

A business practice that is

economically viable, socially
responsible and
environmentally friendly is
usually regarded as being
sustainable.

Sustainable Economic
Triple Bottom Line Values
Accountability
•  This is a very important concept in terms of the profession of
‘accounting’ and CSR

•  Accountability can be defined as the duty to:

o undertake certain actions (or to refrain from taking actions)
in accordance with the expectations of a group of
stakeholders; and
o provide a reckoning or account of those actions to the
stakeholders

•  The concept of accountability and the practice of accounting

should be considered together
Accountability (cont.)
•  The broader our notion of ‘accountability’, the broader the
types of ‘accounting’ that we would embrace

o  If we believe we are only accountable to our shareholders

(a shareholder primacy perspective), then we might restrict
our accounting to ‘financial accounting’
o  However, if we accept that we have an accountability to a
broader group of stakeholders for aspects of performance
that include social and environmental aspects, then we are
likely to disclose information about our social and
environmental performance
To whom is business responsible?
•  Many organisations are making public statements that their
responsibilities extend beyond their shareholders to
encompass communities in which they operate and society
as a whole

•  If sustainability is truly embraced then responsibility is 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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Why is there a need for environmental and

social accounting ?
§  If ignored they can have major adverse impacts
on financial performance
§  E.g. rectifying pollution, possible claims for
compensation by parties adversely affected, reduced
sales due to adverse publicity.
§  Information on these areas can compensate for
some of the limitations of traditional financial
accounting.
 Conventional versus Social &
Environmental Accounting (SEA)
Conventional Accounting
•  Methods or procedures generally
applied by accounting practitioners.
•  The accounting practitioners in
performing the reporting function
should follow existing accounting
conventions/principles that apply to
the given situation.
•  The accounting conventions/principles
have been traditionally developed and
discussed through a conceptual
framework.
•  Main objective is to maximize the
financiers wealth in the secondary
belief that society at large will benefit
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Social and environmental accounting
•  SEA generally covers the issues of
social accounting, responsibility
and environmental matters. Its
focus is on how corporate activities
affect employees, the local community,
the consumer and the natural
environment (Owen et al., 1994).
•  SEA is an extension of disclosure into
non-traditional areas such as providing
information about employees,
products, community service and
the prevention or reduction of
pollution (Mathews, 1997)
•  Primarily voluntary in nature
How to report? Limitations of traditional financial
reporting
•  For a number of reasons to be discussed below, our financial
reporting practices are not terribly useful for reporting CSR
information. Some of the problems relate to:
•  the objective of general purpose financial reporting;
•  considerations of materiality;
•  the definition of the elements of financial reporting;
•  the practice of discounting future cash flows;
•  issues of reliable measurement and probability;
•  focus on short term results; and
•  the entity assumption;
The objective of general purpose financial reporting
•  IASB Conceptual Framework, paragraph 1.2 states:
•  The objective of general purpose financial reporting is to provide
financial information about the reporting entity that is useful to
present and potential investors, lenders and other creditors in making
decisions about providing resources to the entity. Those decisions
involve buying, selling or holding equity and debt instruments, and
providing or settling loans and other forms of credit……

•  No explicit consideration is given to the needs of a broader group

of stakeholders or to the provision of information that is non-
financial in nature

•  In terms of the information needs or expectations of other

stakeholders, paragraph 1.10 of the IASB Conceptual
Framework further clarifies the issue by stating:
•  Other parties, such as regulators and members of the public other
than investors, lenders and other creditors, may also find general
purpose financial reports useful. However, those reports are not
primarily directed to these other groups.
Considerations of materiality
•  Materiality as applied by financial accountants may not be
a relevant criterion for the disclosure of social and
environmental performance data
•  Social and environmental performance is quite different
from financial performance and typically cannot be
quantified in monetary terms
 Definition of the elements of financial
reporting
•  The way we define the elements of accounting acts to exclude the
recognition of many social and environmental costs and benefits

•  For example, the IASB Conceptual Framework currently defines an asset

as:
A present economic resource controlled by the entity as a result of past events.
An economic resource is a right that has potential to produce economic benefits.

•  ‘Control’ is a central attribute of the asset definition.

•  If a resource is not controlled by an organisation, then it cannot be considered to be that
organisation’s asset (meaning that its consumption or use will not be considered to be an
expense of the reporting entity)
Definition of the elements of financial reporting (cont.)
•  For financial reporting purposes, expenses are defined as
follows (IASB Conceptual Framework):
expenses are decreases in assets, or increases in liability,
……..other than those relating to contributions from equity claims.

•  Again, given that the recognition of assets relies upon control,

then environmental resources such as air and water are
shared and not controlled by the organisation and hence,
cannot be considered to be assets.
•  Therefore, their use and/or abuse are not considered ‘expenses’
from a financial reporting perspective
 Definition of the elements of financial reporting (cont.)
•  Further, the way we recognise expenses means that many actions which
create social costs actually have positive benefits for reported profits
•  For example, if we slash jobs, it will reduce wage expenses and increase
profits. Yet at the same time, social costs in terms of the unemployed will
increase—but these would be treated as externalities and not recognised by
the reporting entity
•  Similarly, if an organisation releases greenhouse gases without financial
penalty (for example, it does not incur carbon taxes), then this will have no
negative impact on reported profits, but will nevertheless contribute to
global warming.
•  This accounting anomaly occurs because the atmosphere is not ‘controlled’ by
the reporting entity and therefore its use, or abuse, is not an expense of the
entity (as no ‘asset’ has been consumed)
The discounting of future cash flows
•  There is a general requirement that liabilities that are payable beyond
12 months must be discounted to their present value.
•  This is in accordance with general economic theories that promote the discounting of
future cash flows
•  However, the implication is that it can make the future obligations—
such as obligations for site remediation—almost disappear because of
the discounting
•  Therefore, there may be little discouragement to undertaking activities
now that create remediation obligations many years later.
•  Current costs are effectively being ‘discounted away’ and effectively shifted to future
generations
•  Hence, this is another instance where our traditional ways of doing financial
accounting do not necessarily sit well with quests towards sustainability
 Focus on short term results
•  As we would appreciate, the focus of the media is typically on the annual,
or perhaps at times on the half-yearly and quarterly, financial results of an
entity
•  As accountants, we do 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)
•  This acts to dissuade companies from investment expenditure in more
sustainable modes of operation that might not generate positive financial
results for many years
The entity assumption
•  The entity assumption is a cornerstone of financial reporting

•  It requires the ‘accounting entity’ to be treated separately from its

owners, other organisations, and stakeholders
•  Therefore, if something does not directly impact the organisation itself
in terms of its financial position or financial performance, then it is
ignored by financial accounting
•  This is not consistent with moves towards sustainable development
which requires organisations to consider their impacts on the
environment and current and future communities
•  So concluding this section on the limitations of generally accepted
accounting principles … are generally accepted accounting principles
the right vehicle for ‘broad-based accountability’. Arguably not. But,
what is better?
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Other limitations of conventional accounting- Externalities

•  An externality can be defined
•  as an impact that an entity has on parties that are external to the organisation
where such external parties did not agree or take part in the actions causing, or
the decisions leading to, the cost or benefit
•  Externalities can be positive or negative
•  Prices paid for goods and services typically do not reflect
externalities, meaning that the cost of many products is
‘understated’
•  Government intervention can occur so as to place a cost on externalities—for
example, carbon taxes. This acts to internalise some costs that were previously
unrecognised
•  Greater responsibility should be borne by the free economy
enterprise for the indirect consequences of their activities.
Example, ways to control pollution at reasonable costs should
be found.
•  In this regard, rather than measuring only an individual firm’s
contribution to shareholders’ wealth, emphasis was also to be given to
the measurement of an individual firm’s contribution to society and
the quality of life.
Why are externalities typically ignored?
Definition of elements
•  Assets and expenses defined
based on the notion of control
•  Eg: rivers are not assets,
reduction in the quality of
rivers are not expenses
•  Matthews(1993)-the effects of
business decisions on
communities cannot be
recognized and
environmental effects of
externalities are defined out
of existence
Adoption of entity concept
•  Entity concept: organization
and its owners are treated as
a separate entity
•  If a transaction does not
directly impact on an entity,
the transaction is ignored for
accounting purposes
•  Hence externalities will be
ignored which implies that
performance measures are
incomplete from a broader
social perspective
Other Limitations of conventional accounting

•  It does not give sufficient insights into risks other

than financial risks.

•  Issues with dealing with intangibles (intellectual

knowledge, quality of human resources, changes in
reputation, organisational culture, product
obsolescence, changes in legislation).
Conventional vs Non-Conventional
Accounting (SEA)
CONVENTIONAL ACCOUNTING

Users
Management
Economic Accounting Financial
Investors
events entity descriptions
Bankers
Creditors

Users (include also)

Other events- e.g. Externalities Other Society
Social and descriptions Labour
environmental Community
Future Generations

SOCIAL AND ENVIRONMENTAL ACCOUNTING

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 Corporate social responsibility reporting
(CSRR) in Malaysia
•  CSR reporting has been mandatory since 2007.
•  The reporting followed the guidelines recommended by Bursa
Malaysia CSR Framework
1.  Market place-disclosure on conducting business responsibly ie: activities to
encourage the supply chain to support sustainability
2.  Work place – disclosure on human resource policies ie: activities to support
high standards of recruitment, development of employees
3.  Community – disclosure on activities that positively impact local communities
4.  Environment- disclosure on activities aimed at conserving environment
•  In October 2015, Bursa Malaysia launched a new Sustainability
Framework, comprising amendments to the Listing
Requirements and the issuance of a Sustainable Reporting
Guide and Toolkit
•  PLCs are required under the Listing Requirements to disclose a
narrative statement of their material economic, environmental and social
risks and opportunities in their annual reports.
 Corporate social responsibility reporting (CSRR) in
Malaysia
•  Key Dead lines by market capitalization(Source: https://www.pwc.com)
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Corporate social responsibility reporting (CSRR) in Malaysia, cont

Mandatory to provide a separate report description of the CR activities

as set out in Part A of Appendix 9C. If none, must provide a statement
to that affect (Paragraph 9.25 MMLR)
Monetary fine (RM 1 mil) can be imposed for noncompliance. (Para 16)

There is no reporting requirement for other companies including Small

and Medium Enterprises (SME).
Fact: SME contributes 99.2% of total business establishment and 32%
of GDP, 59% of employment and 19% of exports. (Year 2010)
SME cannot be expected to compile extensive and comprehensive
disclosure due to insufficient resources.
According to a report by ACCA: Out of 500 SMEs surveyed only 16
(3.2%) published for environmental perspective and 7 (1.4%) for social
perspective through their corporate website.
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Corporate social responsibility reporting (CSRR) in Malaysia, cont

Para 253 (3) Act 777: “…may include a business review according to
ACT 777 Part II of Fifth Schedule…”
C.A 2016 Part II of 5th Schedule: Para 2(d)
Information about environmental matters, company’s employee and
social and community issue.

Malaysia has developed a Malaysian Standard for Social

Responsibility based on ISO 26000 which taken care of SIRIM
Berhad.

SIRIM Berhad has established a Technical Committee on Social

Responsibility (TC on SR).
Global trend on sustainability reporting
•  Increasing trend towards mandatory sustainability
requirements
•  Denmark:
•  Danish Act of 16 December 2008 requires Denmark’s state owned
public companies and large listed to include their ESG activities or
justify the absence of this information.
•  Norway:
•  White paper titled Corporate social responsibility in a global economy
introduces provisions requiring large companies to provided information
regarding what they do to integrate sustainability considerations
•  United States:
•  The US Environmental Protection Agency proposed a mandatory Green
House Gas reporting rule, which became effective on 29 December
2009.
•  It requires reporting of GHG emissions by facilities that emit GHGs
Guidelines for sustainability reporting
•  There have been various attempts to create a
sustainability reporting framework that would lead to more
consistent and comparable disclosure across companies.

•  The Sustainability Accounting Standards Board (SASB)

has developed a range of standards to assist US
companies provide disclosures adequate to meet
10‐K and 20‐F requirements.
Guidelines for
sustainability reporting
•  The best known frameworks are the
Sustainability Accounting Guidelines
put together by Global Reporting Initiatives (GRI)

•  Global Reporting Initiative:

•  Launched in 1997 as an initiative to develop a globally accepted
reporting framework to enhance the quality of sustainability
reporting.
•  A joint initiative of the Coalition of Environmentally Responsible
Economies (CERES) and the United Nations Environment Program
(UNEP).
•  The aim is to enhance transparency, comparability and clarity,
amongst other principles.
Guidelines for sustainability reporting
•  Global Reporting Initiative:
•  Sustainability reports based on the GRI Framework can be used to
demonstrate :
•  organizational commitment to sustainable development,
•  to compare organizational performance over time, and
•  to measure organizational performance with respect to laws, norms,
standards and voluntary initiatives’.
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Integrated Reporting Framework

•  A recent initiative designed to improve sustainability reporting and to
integrate sustainability reporting more closely with financial and
governance reporting.
§  Developed by the International Integrated Reporting Council.
•  Formed by the merger of the Prince of Wales’ Accounting for
Sustainability Project (A4S) and Global Reporting Initiative (GRI).
•  IIRC members represent a cross‐section of society.
•  Including non-governmental organisations (NGO) and
intergovernmental organisations (IGO).
•  The council has no regulatory powers but provides guidance in this
area.
Sustainability reporting
•  International Integrated Reporting Council (IIRC):
•  The mission is:
•  ‘to establish integrated reporting and thinking within mainstream
business practice as the norm in the public and private sectors’.

•  In 2013, the International Integrated Reporting

Framework (International <IR> Framework) was
developed.
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Integrated Reporting
•  An integrated report is a concise communication about
how an organization’s strategy, governance, performance
and prospects, in the context of its external environment,
lead to the creation of value over the short, medium and
long term. (www.integratedreporting.org)
•  Recognises that companies are more than financial entities but
rather a system coordinating the management of financial, people,
intellectual, property rights, equipment, customer and supplier
relations, community support and ethical cultures.
•  Essentially:
•  Linking corporate strategy to the current and future
environments that the company faces.
•  Reporting on the relation of the preceding to economic,
environmental and social dimensions.
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Integrated Reporting
§  Traditionally accounting has said progress means
increases in money capital other than through
transactions with the owners.
§  New concept says the business has to maintain financial,
manufactured, intellectual, human, social and
relationships and natural capital before it is clear that
progress has been made.
§  Companies have to assess each capital and decide what
is significant for their business
§  They then have to identify measures which reflect
important items and install systems that reliably capture
the relevant information
 Integrated reporting capitals
•  Financial – the traditional monetary measure.
•  Manufacturing – this is the system of producing
goods and services for customers and would include
manufacturing facilities and inventory, but also
includes equipment, etc. used by an accounting
firm to supply services.
•  Intellectual capital -includes the knowledge base
of the firm which supports current and projected
operations and may include items such as systems
and patents.
 Capitals continued
•  Human capital - is the investment in employees in terms
of training, experience; and commitment to the goals of the
organisation.
•  Social and relationships - capital involves maintaining
good relationships with the community in which it operates,
customers, suppliers, etc.
•  Natural capital - involves the environment, ecosystems,
proven raw material bodies (e.g. oil, gas, coal, uranium
reserves).
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Benefits of Sustainability reporting

Enable benchmarking
Signal competitiveness
against competitors

Benefits

Enhance brand value

Increase transparency
reputation and legitimacy
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Benefits of Sustainability
reporting,cont

Embedding sound corporate Improved management of risk through

governance and ethics systems enhanced management systems and
throughout all levels of an organisation. performance monitoring.

Benefits

Formalising and enhancing Attracting and retaining competent staff

communication/interaction with key by demonstrating an organisation is
stakeholders such as the finance sector, focused on values and its long-term
suppliers, community and customers. existence.
Theories on Sustainability Reporting (why report)
•  Legitimacy theory:
•  Based on the notion of a social contract.
•  This means that an organisation must appear to consider the rights of the public at
large, not just its shareholders.
•  Argues that organisations can only continue to exist if the society in which they
operate recognises they are operating within a value system that is consistent with
society’s own.
•  Disclosures linked to providing evidence that entity is complying with the
expectations of society
•  Disclosure on social issues may be used to educate the public, change perceptions,
manipulate perception by deflecting to other issues

•  Stakeholder theory:
•  Stakeholder theory considers the relationship with discrete stakeholders rather than
society as a whole
•  Proposes that organizations have an obligation to consider how their operations
affect stakeholders and should not just concentrate on maximising profits
•  Ethical branch states that organizations should treat all their stakeholders fairly
•  Managerial branch proposed as a mechanism to explain how stakeholders might
influence organizational actions
•  The extent to which an organization will consider its stakeholders will relate to the power or
influence of these stakeholders
•  Social disclosure is dialogue between company and its stakeholders
Theories on Sustainability Reporting (why report)

•  Institutional Theory
•  organisations will adopt particular practices – including disclosure
practices – because of institutional pressures

•  Positive Accounting Theory

•  disclosure depends on positive wealth implications
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Summary
•  Sustainability reporting is a rapidly evolving area
•  As concerns for global warming, social justice and
environmental protection increase we can expect this form
of reporting to continually evolve
•  Motivations an entity might embrace sustainable
development practices.
•  Commonly used guidelines for sustainability reporting and
how they can assist corporate reporting of sustainability
performance.
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Discussion
1)  Discuss the limitations of conventional accounting in
capturing CSR information. Group 5
2)  What motivates companies to provide sustainability
reports? Discuss the motivations based on Hahn and
Kuhnen (2013). Group 6
3)  Discuss theories commonly used in empirical studies of
sustainability/CSR ? Discuss the evolution towards and
future of sustainability reporting in Malaysia. Group 7
4)  What is Integrated Reporting? Discuss the move
towards Integrated Reporting both globally and within
Malaysia. Group 8