Does Corporate Environmental Accounting Make Business Sense?

DOES CORPORATE ENVIRONMENTAL ACCOUNTING MAKE BUSINESS SENSE? Seakle K.B. Godschalk Tshwane University of Technology, South Africa Abstract: Businesses do not operate in a vacuum. They are subject to legal requirements and industry practices; they require resources to manufacture products and/or render services; they operate in an environment from which they draw their resources and which may be affected by their activities; and they operate in a community from which they draw their work force and which may also be impacted by their activities. Corporate environmental accounting is one of the tools that can be used by businesses to address these challenges. For an organisation to apply environmental accounting it must make business sense. Implementing environmental accounting may require resources. Therefore, a business must weigh up the benefits and costs thereof. This paper discusses the four elements of corporate environmental accounting, i.e. environmental management accounting, environmental financial accounting, environmental reporting and environmental financial auditing. The potential benefits that can be derived from each of these elements are discussed. Many benefits can be reaped from implementing different elements of corporate environmental accounting. Some benefits enhance internal efficiency and competitive advantage, whilst others enhance legitimisation and stakeholder relations. This paper also argues that for the full benefits of corporate environmental accounting to be reaped the elements of environmental accounting should be integrated with each other and in the day-to-day business of an organisation. The linkages and interactions among the elements of corporate environmental accounting as well as the linkages between corporate environmental accounting and the broader business processes of the company are discussed based on a diagrammatic model.

1.

INTRODUCTION

Businesses do not operate in a vacuum. They are subject to legal requirements and industry practices; they require resources to manufacture products and/or render services; they operate in an environment from which they draw their resources and which may be affected by their activities; and they operate in a community from which they draw their work force and which may also be impacted by their activities. In order to do all this, businesses need a “license to operate”, not only from the authorities but also from all their stakeholders. This comprehensive approach to business was the basis for the Triple Bottom Line (TBL) concept (Elkington 1994) or sustainable business. Corporate environmental accounting is one of the tools that can be used by businesses to address these challenges. Although the term “Environmental Accounting” is sometimes used at different levels and for different components, for purposes of this chapter corporate environmental accounting is meant to comprise four main elements, i.e. environmental management accounting, environmental financial accounting, environmental reporting and environmental financial auditing. The relationship between these elements is shown in Fig 1, and will be discussed in more detail in Section 7.

Environmental management accounting

Environmental financial accounting

Environmental financial auditing

Environmental reporting

Fig 1. The elements of corporate environmental accounting.

For an organisation to apply environmental accounting to its fullest extent it must make business sense. Implementing environmental accounting may require resources, particularly in the initial stages. Therefore, a business must weigh up the benefits and costs thereof. However, caution should be exercised in such costbenefit assessment, as many environmental and other factors may not easily lend themselves for quantification. One must also be careful not to focus on financial benefits only. One can even ask the question: should we überhaupt try to rationalise implementation of environmental management measures by pointing out business benefits? Should business not implement these measures because they are socially obliged or expected to do so in terms of a normative approach (Bebbington 1997)? Whether one would only want to follow the normative approach or not, identifying business benefits from environmental accounting might help to persuade business people, who tend to think mostly in bottom-line terms, to consider the implementation thereof. Corporate environmental accounting is an element of corporate environmental management. Therefore, benefits derived from corporate environmental accounting are closely related to benefits derived from corporate environmental management. Reaping benefits from corporate environmental accounting is a dynamic concept. Some elements of environmental accounting may have more prominent benefits than others. Benefits derived from environmental accounting can be internally [e.g. efficiency and competitive advantage] or externally [e.g. stakeholder] orientated (Hart 1995). All benefits identified may not necessarily be available for all role players. However, the benefits discussed below have all been identified in some situations and may be available for companies depending on circumstances. The availability of benefits may also change over time or depend on the phase of implementation of corporate environmental accounting. Madsen & Ulhøi (2003) found that Danish companies that had implemented environmental measures in an early stage, had exhausted the ‘low-hanging fruit’. They now had to focus on more substantive and expensive changes or technologies that would require longer pay-back time. This paper will first briefly discuss some theoretical perspectives, followed by a detailed discussion of the various elements of corporate environmental accounting and the benefits that each one may provide. Finally it will be discussed how these elements can be linked into an integrated approach to corporate environmental accounting in support of sustainable business.

2.

SOME THEORETICAL PERSPECTIVES

Without going into a detailed theoretical discourse it is necessary to identify some of the more pertinent theoretical frameworks that are relevant for the discussion of benefits derived from corporate environmental accounting. These include Legitimacy Theory, Stakeholder Theory and Porter’s Hypothesis. These various theoretical perspectives are not necessarily mutually exclusive, but could be considered supplementary to each other (Gray et al. 1995). 2.1 Legitimacy Theory Early developers of the concept of legitimacy theory were Shocker and Sethi (1974, cited by Patten 1992) and Preston and Post (1975, cited by Patten 1992). Lindblom (1994 cited by Buhr 2002) was the first to apply the concept of legitimacy theory to environmental reporting. The basic tenet of legitimacy theory is that companies cannot continue to exist and thrive if their beliefs and methods are contrary to those of the society in which they operate. This implies that there is some form of ‘social contract’ between the company and its society. If an organisation cannot justify its continued operation, then in a sense the community may revoke its ‘’contract’ to continue its operations. It then looses its ‘licence to operate’. In order to ensure that society continues to view the company’s activities as congruent to its own, the company should disclose its activities. 2.2 Stakeholder Theory Freeman (1984) made a persuasive case that systematic managerial attention to stakeholder interests is critical to firm success. Donaldson and Preston (1995) made important conceptual contributions to this concept, which form the basis of current research in the field. Berman et al. (1999) developed two models on stakeholder management, namely:




The Strategic Stakeholder Management model. The nature and extent of managerial concern for a stakeholder group is viewed as determined solely by the perceived ability of such concern to improve financial performance.




The Intrinsic Stakeholder Commitment model. Firms are viewed as having a normative [moral] commitment to treating stakeholders in a positive way, and this commitment is, in turn, seen as shaping their strategy and impacting their financial performance.

Berman et al.’s (1999) research did indicate support for the first model but failed to find support for the second model. 2.3 Porter’s hypothesis Traditionally, responding to environmental challenges has been seen as a no-win proposition for business, with the related expenditure seen as a net cost. However, in 1991 Porter posited that stricter environmental regulation would lead to innovative approaches that would enhance competitiveness (Porter 1991, Porter and Van der Linde 1995) – Porter’s hypothesis. Porter’s view was critiqued by various authors (Walley and Whitehead 1994, Palmer et al. 1995 and Maxwell 1996) as being too simplistic. Wagner et al. (2001) moderated Porter’s hypothesis and developed a model in which the traditionalist view and Porter’s hypothesis were combined. The moderated Porter hypothesis forms the key concept for this paper, i.e. that companies implementing corporate environmental accounting will perceive at least some benefits from doing so.

3.

ENVIRONMENTAL MANAGEMENT ACCOUNTING

Environmental management accounting (EMA) can be broadly defined as “the identification, collection, analysis and use of two types of information for internal conventional and environmental decision making:  physical information on the use, flows and destinies of energy, water and materials (including wastes) and  monetary information on environment-related costs, earnings and savings” (UN Division for Sustainable Development 2001: 4). It is critically important that both physical and monetary information is tracked, as both provide a basis for decision-making. The physical information should preferably be measured per unit production to eliminate any effects of changes in production volumes. Although the monetary information is important to assess the financial impact, it is subject to price fluctuations, which could neutralise underlying changes in physical units. The actual use of physical units is also a strong indication of the impacts of the activities on the environment. The application of EMA is strongly linked to the concepts of cleaner production and ecoefficiency (Schaltegger & Sturm 1990, Schaltegger and Wagner 2006). Many environmental costs are hidden away in overhead accounts and line managers are often not even aware of them. Studies such as those undertaken by the World Resources Institute have shown that these costs can be substantial. The six case studies presented in the WRI study show that for certain products and facilities, environmental costs can account for 20 per cent of total costs (Ditz et al. 1995). As overheads are allocated to the various cost centers on a basis that normally bears no relation to actual environmental causal relationships, these environmental costs may be incorrectly allocated. This might result in wrong product line and pricing decisions, as well as inappropriate investment decisions that affect the profitability of the business. Getting these environmental costs out of the magical box of overheads and into the cost centers where they belong, the company will be able to make better product and pricing decisions, enhancing its profitability. A typical example is that of Spectrum Glass. Hazardous waste generated by one particular product, ruby red glass, was responsible for the bulk of hazardous waste generated by the company. Because waste management costs were allocated across the board, ruby red glass was cross-subsidised by the other products and appeared to make a profit. In fact, it was making a loss (Ditz et al. 1995).

EMA focuses on identifying the major environmental cost drivers. This can include raw materials used, environmental resources such as water and energy used, waste that is generated or pollution that is caused. By focusing on these cost drivers and their underlying processes, a company may be able to effect substantial cost savings whilst optimising its business processes. Following a robust process re-engineering project in which environmental management accounting was used as one of the tools, Girsa, a chemical company in Mexico, tripled production, reduced CO2 emissions from 3.9 to 0.65 tons per ton of output, waste-water from 13.7 to 1.5 cubic meters per ton of production, and solid waste from 69.8 to 5.3 pounds. An investment of US$20 million in environmental efficiency improvements yielded US$30 million in savings. From a major source of controversy the plant has turned into a model of corporate citizenship that the local community is proud of (Thorpe & Prakash-Mani 2003). EMA is also linked to Life Cycle Analysis. The planning for the largest portion of overhead costs is done during the product’s design phase (Julian and Nel 2003: 22). Therefore, by following a life cycle approach and changing designs and processes at an early stage, substantial cost reductions during the operating and disposal phases may be effected. Hart (1995) found that the return on pollution-prevention projects averaged better than 60% whereas it was estimated that end-of-pipe pollution-control projects lost on average 16% for every dollar spent. EMA aims at minimizing wastage of resources used. In this way a more sustainable use of environmental resources is effected, ensuring the continued access to and use of these environmental resources, and the environment from which they are drawn. Procurement costs of wasted resources and waste management costs are reduced. It also prevents overloading of waste management infrastructure. Muraurer Bier in Austria, over the period 1995-2000, was able to effect a 19% reduction of fresh water use, a 30% reduction of fuel oil use and a 32% reduction in wastewater generated per unit product, for a total saving of US$186,000 (International Federation of Accountants 2005: 68). Raytheon, an electronics and aerospace company located in the USA, has used EMA to support a supply chain initiative with both financial and environmental benefits. This initiative resulted in a 92% reduction in scrap costs, a reduction of inventory turnover time from 3-4 months to 1 week, and a reduction of the purchase order cycle time from 3-7 days to 2 days (International Federation of Accountants 2005: 63). Compliance with environmental legislation is enhanced as the costs of non-compliance are clearly identified. In addition, clean-up costs and liabilities for clean-up of pollution and claims for other environmental damage caused are reduced. EMA will also reduce compliance costs as authorizations will be more readily granted to environmentally well-managed companies than to environmentally negligent companies. Environmentally related fees, taxes and fines will similarly be reduced. As a result of introducing a ‘green accounting system’ the UK Environment Agency achieved a 53% reduction in carbon dioxide emissions between 1998/99 and 2002/03 (International Federation of Accountants 2005: 59). The INCO nickel refinery in Wales achieved a 65% reduction in effluent charges (Benn and Probert 2006). Currently, external costs caused by the organisation, and that are born by society, are often ignored. Such external costs can, of course, by the stroke of a pen be internalised by means of stricter regulation and taxes (Howes 2004). Companies should, therefore, benefit by timeously identifying such external costs and managing the reduction thereof before they might be forced to back-engineer solutions by future external pressure or legislation. In the long run a preventive approach is much cheaper than a reactive approach. In a survey of 614 US companies King & Lenox (2002) found that the prevention of waste did lead to financial gain, but end-of-pipe treatment did not. Implementing environmental management accounting may result in a variety of benefits, including but not restricted to reduced use of input materials and reduced generation of output waste and pollution, increased efficiency, enhanced compliance, more effective product and price decisions, and even improved stakeholder relations. Overall this may lead to increased competitive advantage.

4.

ENVIRONMENTAL FINANCIAL ACCOUNTING

Environmental financial accounting [EFA] aims at ensuring that environmental revenue and costs, assets and liabilities are clearly reflected in the financial statements of the company in accordance with applicable

legislation and accounting standards. This component of environmental accounting is primarily driven by international accounting standards. The main users of the financial statements are the shareholders of the company, investors and regulating authorities. Other users include the multitude of other stakeholders such as employees, creditors, customers, suppliers, neighbouring communities and environmental interest groups (International Accounting Standards Board 2004). EFA can assist in the identification of environmentally related revenue, costs, assets and liabilities thereby enhancing compliance with legislation, Generally Accepted Accounting Practices [GAAP] and the International Financial Reporting Standards [IFRSs]. The Sarbanes-Oxley Act of 2002, promulgated following several serious accounting and corporate governance scandals, is a typical example of such legislation in the USA, and has a profound effect on environmental corporate governance. Several International Accounting Standards (IASs) explicitly refer to environmental costs, assets or liabilities. These include IAS 37 on Provisions, contingent liabilities and contingent assets, IAS 16 on Property, plant and equipment, IAS 38 on Intangible assets and IAS 2 on Inventory. Of particular importance is IAS 37 that deals with the accounting for provisions and contingent liabilities for repair of environmental damage, environmental rehabilitation and clean-up and other closure costs. The implications of other IASs on environmental accounting must be deduced by applying the underling principles. Several International Financial Reporting Interpretations specifically address environmental issues: IFRIC 1 on Changes in existing decommissioning, restoration and similar liabilities, IFRIC 5 on Rights to interests arising from decommissioning, restoration and environmental rehabilitation funds, and IFRIC 6 on Liabilities arising from participating in a specific market – waste electrical and electronic equipment. Aspects that currently receive attention in terms of formulating environmentally related accounting standards, interpretations or guidance are the Accounting for Heritage Assets under the Accrual Basis of Accounting [discussion paper issued by the International Public Sector Accounting Standards Board on 28 February 2006]], as well as Emission Rights Trading [IFRIC 3 on Emission Rights released by IFRIC in December 2004 but withdrawn by the International Accounting Standards Board in June 2005 to allow a wider assessment of the issues at stake]. Changes in these standards can have profound impacts on the bottom line of companies. In-depth knowledge of these standards and requirements, and pre-active management of the issues addressed by these standards will reduce the impact thereof (Carpentier et al. 2003, Repetto et al. 2002). The issuing of the US Financial Accounting Standards Board Interpretation No 47 (FIN 47) on Accounting for Conditional Asset Retirement Obligations that became effective on 1 January 2006 has caused a flurry of reactions, even recalling Enron sized implications (Rogers 2006). Where US companies were previously not obliged to disclose liabilities for environmental disposal and clean-up obligations if it was improbable that such obligations would be enforced or would result in litigation against the company, this has changed with FIN 47. This could result in disclosures amounting to billions of dollars of environmental liabilities previously undisclosed. Li and McConomy (1999) found that Canadian companies with strong environmental commitment were able to adopt new environmental accounting standards quicker than companies with less environmental commitment, thereby enhancing credibility and reducing litigation risk. Making adequate provisions for environmental liabilities also prevents the company from going bust or suddenly developing a serious cash flow problem. Timely identification of and planning for these events enables the company to incorporate these issues in its strategic planning. Evidence in support of a view that environmental disclosures as such enhance market valuation of a company seems to be inconclusive (Cormier and Magnan 1997). However, it could be argued that companies that consistently report on environmental matters in their financial statements, be it good or bad news, create confidence in investors and creditors. This may lead to improved market ratings and enable access to capital on easier terms. Freedman and Stagliano (1991) found that companies with better environmental disclosure track records experienced less decline in market valuation following the introduction of more stringent environmental legislation, than companies with poorer disclosure practices. Proper EFA results in a better reflection of the financial performance and situation of an organisation, which enhances the quality of decision-making by those stakeholders who base their decisions on the financial statements of an organisation.

5.

ENVIRONMENTAL REPORTING

Environmental reporting in this context refers to reporting on environmental issues in addition to prescribed disclosures in the financial statements. Environmental reporting has been the subject of extensive development over the past decades and is affected by many factors. Proper environmental reporting enhances compliance with legislative requirements for disclosure of environmental information. Countries such as Denmark, Norway, The Netherlands, Australia and Sweden (Monaghan 2004), Canada and the USA (Repetto et al. 2002) require by legislation disclosure of certain environmental information. The EU Modernisation Directive (2003/51/EC) and the Integrated Pollution Prevention and Control Directive (96/16/EC) require the disclosure of certain environmental issues by listed or larger organisations, while non-EU countries such as Australia and Japan also have regulatory requirements in this regard (KPMG 2005). It is expected that the recommendations in the King II report (Institute of Directors 2002), that contains extensive guidance on environmental reporting, will be incorporated in company legislation in South Africa in the years to come. Reports on corporate governance invariably include sustainability or triple-bottom-line [environmental, social and economic] reporting. Environmental reporting also enhances compliance with GAAP and the IFRSs. Several stock exchanges have introduced voluntary systems for environmental reporting based on which socially responsible investment indices have been developed. These include amongst others the FTSE4Good indices, the Dow Jones Sustainability Index (DJSI) (Howes 2004), and the Johannesburg Stock Exchange Socially Responsible Investment Index (Newton-King 2004). “Increasingly, the quality of a company’s environmental management is being seen as an indicator to the outside world of the overall quality of its management” (Howes 2004: 107). Therefore, to be incorporated in any of these sustainability indices enhances the rating of a company in the eyes of investors, and, therefore, its share price. On the other side, the UK government has instituted a policy of ‘naming and shaming’ those companies that do not yet report on environmental, ethical and social issues (Howes 2004). The most widely accepted best practice for environmental reporting are the Global Reporting Initiative (GRI) guidelines (Cerin 2002, Edwards et al. 2002, KPMG 2005). The 3rd version of the GRI guidelines was launched in Amsterdam in October 2006 (Global Reporting Initiative 2006). Companies who voluntarily produce reports in reference to or in accordance with the GRI guidelines are seen as well managed companies. It is important that environmental reports should primarily report on environmental performance rather than on environmental management systems and processes as such. Research has shown that companies with formalised environmental management systems, in general, did not perform significantly better than those without (Monaghan 2004). Overemphasising process rather than performance is a real risk that detracts from the value of environmental reports, and can often fail to reach the real objectives (Doane 2004). Proper environmental reporting builds confidence among shareholders and other stakeholders. The public image of companies with effective environmental reporting will probably have the advantage over the image of companies that either neglect environmental reporting altogether or make it a formality rather than honest and open reporting. The Co-operative Bank in the UK is proof that one has not to be big to produce good environmental reports. Its Partnership Report has received numerous commendations over the past few years, including best sustainability report in the UK, best environmental report in the UK and best social report in the UK. The effect of its philosophy of open and honest environmental reporting is evident in a much lower than average staff turnover. Since launching the Co-op’s partnership approach in 1997, the number of customer accounts has increased by over 30% and the bank’s profitability has doubled. An international survey by Echo Research has found that the Co-operative Bank is one of the five most trusted companies worldwide (Monaghan 2004). Several other benefits of environmental reporting have been mentioned in literature, including legitimising activities, distracting attention from other areas, boosting corporate image, preventing the promulgation of mandatory reporting regimes, building up expertise in advance of regulation, enhancing share price, political benefits, risk reduction, competitive advantage, enhancing accountability, informing the public, forestalling disclosure by others, and building reputation (Clarke and Gibson-Sweet 1999, De Villiers 1998, Gray et al.

1993). Environmental reporting also offers the opportunity for extensive stakeholder involvement in the identification and monitoring of environmental performance indicators, thereby enhancing transparency, accountability and stakeholder relations. The positive role of environmental reporting in internal motivation and acting as a catalyst has also been mentioned (Hedberg and Von Malmborg 2003).

6.

ENVIRONMENTAL FINANCIAL AUDITING

Environmental financial auditing focuses on the environmental aspects in the financial statements, and should not be confused with environmental management systems audits, that are also often called environmental audits. International Audit Practice Statement [IAPS] 1010 The consideration of environmental matters in the audit of financial statements (IAASB 1998) provides guidance in this regard. The verification/assurance of environmental reports might be undertaken by auditors but is not part of the mandatory financial audit. It is an integral part of the environmental reporting process and is as such not included in the discussion in this section. Environmental financial auditing checks the financial statements for legal compliance, compliance with generally accepted accounting practices as well as compliance with best practices on environmental corporate governance. The Sarbanes-Oxley 2002 Act specifically requires independent financial auditors to verify that public companies have sufficient controls and procedures to identify, assess, measure and report conditional asset retirement obligations [section 404]. A major contribution of environmental financial auditing could be to identify potential environmental risk areas that could jeopardise the continued existence of an organisation as an ongoing business, either by government sanctions, irreparable reputational damage or excessive cost (Cormier and Magnan 1997). If no or insufficient provision has been made for environmental liabilities, companies have been known to go bankrupt, of which Enron is but one of the most visible examples. This function of the environmental financial audit could prevent companies from going bust by timely identification of such liabilities, and the insistence on proper provision for these liabilities. There appears to be some evidence that stakeholders attribute more credibility to environmental information if it is presented in the financial statements (Tilt 1994). This is most likely due to the fact that the financial statements are subject to regulatory audits. The main benefits of environmental financial auditing lie in ensuring compliance, identifying risks and lending credibility.

7.

INTEGRATED ENVIRONMENTAL ACCOUNTING FOR SUSTAINABLE BUSINESS

Sustainable business can only be maintained if resources are used efficiently and sustainably, operations are carried out within the confines of compliance, and the impact of its activities on the social and physical environment is considered in an integrated way. This will ensure that the “licence to operate” will remain in place. After having realised that it had lost its “licence to operate” due to severe community disturbances in its area of operations in Nigeria, Shell had to put a considerable amount of money into community development activities in order to regain its “licence to operate” (Shah 2004). Environmental accounting in all its facets contributes considerably to the above-mentioned factors supporting sustainable business. However, to realise the full potential benefit from environmental accounting a company should implement all its components in an integrated way. It should become an integral part of their doing business. “Experience suggests that the best way to ensure that a given corporation fully addresses the TBL agenda [and thereby reaps its full benefits, SG] is to build the relevant requirements into its corporate DNA from the very outset. ……. The center of gravity of the sustainable business debate is in the process of shifting from public relations to competitive advantage and corporate governance – and, in the process, from the factory fence to the boardroom”, says the founder of the TBL concept (Elkington 2004: 6).

Lee and Ball (2006) found that those companies in the Korean chemical industry that displayed the highest commitment by top management to environmental issues, that realised the strategic importance of such issues and achieved the best operational performance from implementing green strategies were considered leading companies in the industry, not only in terms of environmental management but in respect of management and performance in general as well. Managing these issues at the strategic level as an integral part of the business clearly gave those companies a competitive advantage. Ernst Winter & Sohn, a manufacturer of diamond tools, as early as 1972 declared environmental protection as one of its corporate aims. It implemented the so-called Integrated System of Environmentalist Business Management (the Winter Model), addressing a comprehensive range of environmental measures. Although not mentioning environmental accounting as such, their model contained several elements of environmental accounting, particularly regarding environmental management accounting and environmental reporting. This successful approach was adopted by many companies in Germany and abroad. Winter already recognised financial benefits from these activities, including direct cost savings, and reduced liabilities (Winter 1988). Being aware of their environmental costs (and benefits) can assist the company’s management in its forward strategic planning, and, consequently, help to reduce the company’s exposure to future environmental risks and liabilities. Without adequate and appropriate systems to identify and account for such costs, it is unlikely that companies will be able to meet the future expectations of their customers, shareholders and the requirements of a more stringent regulatory environment and environmentally aware society. ‘First movers’ will clearly have an advantage (Howes 2004, Nehrt 1996, 1998). The intangible benefits of environmental accounting in terms of brand value and confidence among shareholders and other stakeholders, are not always easy to quantify. As a result some companies inadequately recognise the long-term value of intangible benefits of environmental accounting. This leads them to ignoring the benefits altogether as not material enough to bother with. In the process companies deny themselves the opportunity of realising the real benefits of environmental accounting to the full extent. “More work clearly needs to be done on demonstrating the linkage between the intangible benefits of operating more sustainably and competitive advantage, this being the ‘missing link’ that is most likely to make analysts engage more systematically” (Porritt 2004: 61). The four components of environmental accounting are closely linked. As a matter of fact, there should be a golden thread linking these components and the business processes of the company. Berry and Rondinelli (1998) made a strong case for proactive corporate environmental management [which includes corporate environmental accounting, SG] and suggested ways in which integration could be promoted. The linkages and integrative aspects are illustrated in Fig 2.

Business strategy Risk management

Financial statements

Environmental management accounting

Environmental financial accounting

Operational processes

Environmental reporting

Financial audits

Environmental financial auditing

Verification/ assurance

Sustainability reporting

Fig 2. Integrative linkages between elements of corporate environmental accounting and between corporate environmental accounting and business processes. [Internal linkages are illustrated by single arrows, linkages between environmental accounting and other business processes are illustrated by block arrows.] During the environmental management accounting process all the major environmental issues will be identified and analysed. Inputs into operational processes, risk management and business strategy will be given. Inputs will also be received from these processes for consideration of environmental implications. Specific environmental objectives and targets will be formulated and action plans will be implemented and integrated in the business plans. This will include any aspects that have to be addressed, in order to comply with legislation and accounting standards, in the financial statements. The EMA phase will form the basis of the company’s environmental program. During the environmental financial accounting process those aspects for which disclosure is required by regulation or accounting standards, will be identified and their inclusion in the EMA process will be ensured. Those aspects will be accounted for according to the relevant standards, and will be incorporated in the company’s financial statements. The bulk of environmental information, which might not be required by regulation or accounting standards, will be incorporated in the company’s environmental report. The environmental report will in many cases form an integral part of the sustainability report. The process of compiling the environmental report will in itself also serve as a monitoring mechanism for the relevance of and progress with environmental programs under the EMA process. Third party verification of environmental reports might take place in this phase. However, a major challenge remains the bridging between financial and physical/environmental data, as we are speaking of two different language systems here. This is even recognised by the GRI guidelines: “Despite the growing overlap between sustainability and financial reporting, the greatest challenge in bridging financial and sustainability reporting lies in translating economic, environmental, and social performance indicators into measures of financial value. …… New methodologies are required to link performance in the economic, environmental, and social dimensions to financial performance” (Global Reporting Initiative 2002: 71). During environmental financial auditing environmental accounting compliance is checked and potential risks identified. This is included in the mandatory audit report. Feedback from this phase is used to upgrade environmental financial accounting. It is also used to feedback into the EMA phase and for addressing issues in the business’ risk management process.

If the various elements of environmental accounting are not linked, it will lead to disjointed actions that address the environmental challenges in a piecemeal manner. Proper integration in business strategies will also be hampered and environmental management will be considered a fringe activity for ‘greenies’. The involvement of stakeholders in the various components of environmental accounting may act as catalyst to enhance integration.

8.

CONCLUSION

The above discussion of the benefits that can be derived from implementing various elements of corporate environmental accounting seems to corroborate the various theoretical posits discussed in section 2. The legitimacy of a company can be enhanced if it identifies and addresses environmental issues that affect the interests of various stakeholders, and if it by reports on these actions. In doing so the company ensures that its activities are in congruence with societal norms. Non-congruence has placed the future viability of some companies in jeopardy. [Legitimacy theory] Stakeholder involvement and feedback has proven to be of much value to many companies. Companies that were controversial scapegoats could be turned around to become models of corporate citizenship by cooperating with their various stakeholders. The impact of proper environmental management on the image of companies has been confirmed in many cases. Environmental accounting is an integral part of proper environmental management. Stakeholder relations can be improved by either reducing impacts on them (e.g. surrounding communities) or enhancing the benefits they receive from improved performance (e.g. shareholders). [Stakeholder theory] The many benefits that have been identified and experienced by a wide variety of companies under widely varying circumstances confirm that at least in its moderated manner Porter’s hypothesis holds true. EMA definitely improves efficiency and compliance, and can lead to cost reductions and improved decisionmaking. The overall effect of these impacts would be to improve competitiveness, by enhancing costefficiency or the company’s image and customer relations. Further studies might prove that Porter was closer to the truth than his critics would concede. [Porter’s hypothesis] It is clear that each element of corporate environmental accounting can generate its own benefits for a company. The benefits of some elements are more internally orientated and enhance efficiency and competitive advantage [eg environmental management accounting]. Others such as environmental reporting are more externally orientated and enhance legitimacy and stakeholder relations. Of course, not all companies will reap all these benefits. Circumstances and predetermined enabling conditions differ from company to company. However, companies interested in implementing or improving corporate environmental accounting will find at least some of these benefits coming their way. It is also clear that environmental management accounting and environmental reporting offer more visibly prominent benefits than environmental financial accounting and auditing. However, for a company to reap the most benefits from corporate environmental accounting it should use the powers of synergy and develop a system of integrated environmental accounting. This is the best way to ensure the proper integration of corporate environmental accounting in all its components in the company’s business processes. It is possible that environmental accounting may become standard practice as a result of future regulation. Companies that have already implemented a system of integrated corporate environmental accounting will then clearly have a first mover advantage.

REFERENCES Adams C, Frost G and Webber W (2004) Triple Bottom Line: a review of the literature in Henriques A and Richardson J The Triple Bottom Line: Does it all add up? London, Earthscan 17-25

Bebbington J (1997) Engagement, education and sustainability: a review essay on environmental accounting Accounting, Auditing and Accountability Journal 10.3: 365-381 Benn S and Probert J (2006) Incremental change towards sustainability in Schaltegger S and Wagner M Managing the business case for sustainability Sheffield, Greenleaf Publishing 542-552 Berman SL, Wicks AC, Kotha S and Jones TM (1999) Does stakeholder orientation matter? The relationship between stakeholder management models and firm financial performance Academy of Management Journal 42.5: 488-506 Berry MA and Rondinelli DA (1998) Proactive corporate environmental management: a new industrial revolution Academy of Management Executive 12.2: 1-13 Buhr N (2002) A structuration view on the initiation of environmental reports Critical Perspectives on Accounting 13: 17-38 Carpentier CL, Patterson Z and Malthouse J (2003) Environmental Disclosures in Financial Statements: New developments and Emerging Issues New York City, Commission for Environmental Cooperation Cerin P (2002) Communication in corporate environmental reports Corporate Social Responsibility and Environmental Management 9.1 46-66 Clarke J and Gibson-Sweet M (1999) The use of corporate social disclosures in the management of reputation and legitimacy: a cross-sectoral analysis of UK top 100 companies Business Ethics: a European Review 18.1: 5-13 Cormier D and Magnan M (1997) Investors’ assessment of implicit environmental liabilities. An empirical investigation Journal of Accounting and Public Policy 16.2: 215-241 De Villiers CJ (1998) The willingness of South Africans to support more green reporting South African Journal of Economic and Management Sciences, NS 1.1: 145-167 Ditz D, Ranganathan R and Banks D (1995) Green Ledgers: Case Studies in Environmental Accounting, Washington DC, World Resources Institute Doane D (2004) Good intentions – bad outcomes? The broken promise of CSR reporting in Henriques A and Richardson J The Triple Bottom Line: Does it all add up? London, Earthscan 81-88 Donaldson T and Preston LE (1995) The stakeholder theory of the corporation: concepts, evidence, and implications Academy of Management Review 20: 65-91 Edwards P, Birkin F and Woodward D (2002) Financial comparability and environmental diversity: an international context Business Strategy and the Environment 11.6: 343-359 Elkington J (1994) Towards the sustainable corporation: win-win-win business strategies for sustainable development. California Management Review 36.2: 90-100 Elkington J (2004) Enter the Triple Bottom Line in Henriques A and Richardson J The Triple Bottom Line: Does it all add up? London, Earthscan 1-16 Freeman RE (1984) Strategic management: a stakeholder approach. Englewood Cliffs, NJ: Prentice Hall Freedman Mand Stagliano AJ (1991) Differences in social-cost disclosures: a market test of investor reactions Accounting, Auditing & Accountability Journal 4.1: 68-83 Global Reporting Initiative (2002) Sustainability Reporting Guidelines (2nd version) Global Reporting Initiative (2006) Sustainability Reporting Guidelines (3rd version) Gray R, Bebbington J and Walters D (1993) Accounting for the environment New York: Markus Wiener Gray R, Kouhy R and Lavers DS (1995) Corporate social and environmental reporting: a review of the literature and a longitudinal study of UK disclosure Accounting, Auditing & Accountability Journal 8.2: 47-77

Hart SL (1995) A natural-resource-based view of the firm Academy of Management Review 20.4: 986-1014 Hedberg C-J and Von Malmborg F (2003) The Global Reporting Initiative and corporate sustainability reporting in Swedish companies Corporate Social-Responsibility and Environmental Management 10.3: 153-164 Howes R (2004) Environmental cost accounting: coming of age? Tracking organizational performance towards environmental sustainability”, in Henriques A and Richardson J The Triple Bottom Line: Does it all add up? London, Earthscan 99-112 Institute of Directors (2002) King Report on Corporate Governance for South Africa 2002, Johannesburg, Institute of Directors International Accounting Standards Board (2004) Framework for the preparation and presentation of financial statements in International Financial Reporting Standards, vol 1A 19-46 International Auditing and Assurance Standards Board (1998) International Audit Practice Statement 1010: The consideration of environmental matters in the audit of financial statements International Federation of Accountants (2005) International Guidance Document: Environmental Management Accounting Julian FW and Nel C (2003) Managerial Accounting, vol 1 (2nd edition) Centurion, Imprenta King A and Lenox M (2002) Exploring the locus of profitable pollution reduction Management Science 48.2: 289-299 KPMG (2005) KPMG International survey of corporate responsibility reporting 2005 Amsterdam, KPMG Global Sustainability Services Lee KH and Ball R (2006) Achieving sustainable corporate competitiveness in Schaltegger S and Wagner M Managing the business case for sustainability Sheffield, Greenleaf Publishing 378-397 Li Y and McConomy BJ (1999) An empirical examination of factors affecting the timing of environmental accounting standard adoption and the impact on corporate valuation Journal of Accounting, Auditing & Finance 14.3: 279-319 Lindblom CK (1993) The implications of organisational legitimacy for corporate social performance and disclosure Paper presented at the Critical Perspectives on Accounting Conference, New York Madsen H and Ulhøi JP (2003) Have trends in corporate environmental management influenced companies’ competitiveness? Greener Management International 44.winter: 75-88 Maxwell JW (1996) What to do when win-win won’t work: environmental strategies for costly regulation Business Horizons 39.5: 60-63 Monaghan P (2004) Put up or shut up in Henriques A and Richardson J The Triple Bottom Line: Does it all add up? London, Earthscan 142-154 Nehrt C (1996) Timing and intensity effects of environmental investments Strategic Management Journal 17.7: 535-547 Nehrt C (1998) Maintainability of first-mover advantages when environmental regulations differ between countries Academy of Management Review 23.1: 77-97 Newton-King N (2004) Sustainable Development Investments in The Enviropaedia 2004 266 Palmer K, Oates WE and Portney PR (1995) Tightening environmental standards: the benefit-cost or the no-cost paradigm? Journal of Economic Perspectives 9.4: 119-132 Patten DM (1992) Intra-industry environmental disclosures in response to the Alaskan oil spill: a note on legitimacy theory Accounting, Organizations and Society 17.5: 471-475 Porritt J (2004) Locating the government’s bottom line in Henriques A and Richardson J The Triple Bottom Line: Does it all add up? London, Earthscan 59-69

Porter ME (1991) America’s green strategy Scientific American 264: 168 Porter ME and Van der Linde C (1995) Toward a new conception of the environment-competitiveness relationship Journal of Economic Perspectives 9.4: 97-118 Repetto R, MacSkimming A and Isunza GC (2002) Environmental Disclosure Requirements in the Securities Regulations and Financial Accounting Standards of Canada, Mexico and the United States New York City, Commission for Environmental Cooperation Rogers G (2006) A looming environmental Enron? Environmental Finance December 2005 – January 2006 21 Schaltegger S and Sturm A (1990) Ökologische Rationalität Die Unternehmung 44.4: 273-290[available only in German] Schaltegger S and Wagner M (2006) Managing and measuring the business case for sustainability. Capturing the relationship between sustainability performance, business competitiveness and economic performance in Schaltegger S and Wagner M Managing the business case for sustainability Sheffield: Greenleaf Publishing 1-27 Shah R (2004) What a fine mess! Moving beyond simple puzzle-solving for sustainable development in Henriques A and Richardson J The Triple Bottom Line: Does it all add up? London, Earthscan 89-98 Shocker AD and Sethi SP (1974) An approach to incorporating social preferences in developing corporate action strategies in Sethi P (ed) The unstable ground: corporate social policy in a dynamic society Mellville: 67-80 Thorpe J and Prakash-Mani K (2003) Developing value. The business case for sustainability in emerging markets Greener Management International 44(winter): 17-32 Tilt CA (1994) The influence of external pressure groups on corporate social disclosure: some empirical evidence Accounting, Auditing and Accountability Journal 7.4: 47-72 United Nations Division for Sustainable Development (2001) Environmental Management Accounting: Policies and Linkages. Wagner M, Schaltegger S and Wehrmeyer W (2001) The relationship between the environmental and economic performance of companies: what does theory propose and what does empirical evidence tell us? Greener Management International 34: 95-108 Walley N and Whitehead B (1994) It’s not easy being green Harvard Business Review 72.3: 46-52 Winter G (1988) Business and the Environment Hamburg, McGraw-Hill

ACKNOWLEDGEMENTS I want to acknowledge the comments received from two anonymous referees on an earlier draft of this paper. Their inputs contributed to the enhancement of the final product. However, I remain in the final instance accountable for the content of this paper. -------------------------------------------

[Published as Chapter 13 in Environmental Management Accounting for Cleaner Production, edited by Prof Stefan Schaltegger, Martin Bennett, Prof Roger Burritt and Dr Christine Jasch. Springer 2008: 249-265]