Talal Abu-Ghazaleh, president, The Arab Society of Certified Accountants, c/o Talal Abu Ghazaleh International, 23 Wadi El Nil Street, P.O. Box 96, Imbaba 12411, Mohandesseen City, Egypt.
Abstract ...
This article surveys the development of “environmental auditing”, especially regarding the accounting profession’s responsibility for— and responsiveness to —serving the public interest. Work carried out to develop environmental accounting guidelines by the UNCTAD-sponsored Working Group on International Standards of Accounting (ISAR) is described. The implications of introducing environmental accounting include the need to make changes in education and training, work with other international standard-setting bodies; and re-examine some of the profession’s fundamental concepts and standards.
Introduction:
The impact of the environment on the accounting profession can be summed up in one phrase, “environmental accounting”. This phrase is now established in the vocabulary and scope of the accounting profession, if not yet wholly then in its practice. Put simply, the profession can no longer ignore the demands that organizations account for the impacts of their operations on the environment rather immediately or potentially, in the longer term. Environmental accounting will be defined more precisely below, but first we will look at some of the reasons that have led to this upsurge of interest in the environment
The Public Interest:
The accounting profession has long recognized that it is paramount to be seen to serve the public interest. This is not entirely selfless, of course. It is highly unlikely that the activities of any profession will be restricted solely to its members. The counting profession has its particular functions, largely concerned with auditing specific types of organizations. Until very recently the “public interest” was seen in a very narrow context by accountants. It was primarily concerned with the owners or shareholders of large private sector corporations, and with others who deal with them in a direct financial way such as lenders (bankers) and suppliers (creditors). However, in recent years the concept of public interest has been widened substantially to encompass other interested parties such as employees, the state, and the public at large.
The term “stakeholder” is often used to describe this wider group of interested parties. While this term may have superseded “shareholder” in the press, PR publications, speeches, annual reports and so on, there is little doubt that for the accounting profession the dominant parties in relation to accounting and auditing standards are still shareholders and lenders. The movement by the profession to serve a much wider constituency and develop appropriate standards had progressed very slowly. Occasionally, the slow pace of evolution has been accelerated due to natural events or other occurrences which bring about revolutionary change, and this has happened in the case of the environment.
Public concern about the environment, brought about by the often disastrous consequences of atmospheric pollution, oil spills, chemical and other toxic waste discharges and the potentially lethal impact of global warming, has made society at large much more conscious of the need to protect and safeguard the environment. As a result of these concerns, combined with the activities of dedicated and vociferous pressure groups, governments at the national, regional and international levels have introduced legislation (often with punitive sanctions if the law is broken) designed to control and restrict many organizations are able to do.
The performance of corporations, particularly multinationals, is increasingly being judged not on financial results alone but also in regard to social and ethical issues, among which the environment ranks as high as any. Potential liabilities arising from environmental damage have to be faced up to. Accidents with environmental consequences, such as the Exxon-Valdez disaster have brought home the scale of damages which could be faced, as has the realization that actions in the past such as poor management of toxic waste disposal could lead to civil and criminal actions in the future. Environmental issues have become an important variable in the equations used by financial analysts and other investors to determine the risk associated with investment - the higher the risk, the higher the cost of capital. Faced with such a scenario, there were increasing demands for some form of reporting on and accounting for the environment. However, what and how it was reported had no structure, form or consistency from one period to another or from one organization to another. What was needed was a more disciplined and professional approach to environmental accounting, i.e. a framework providing standard performance indicators and principles for measuring, reporting and verifying them.
This immediately brought the matter into the domain of the accounting profession. Its reaction was, regrettably, slow and hesitant. Fortunately, the challenge was taken up elsewhere. It is to the great credit of the Intergovernmental Working Group of Experts on International Standards of Accounting (ISAR), sponsored by the UN Conference on Trade and Development (UNCTAD), which it took this issue on board. To date, ISAR’s contribution, although relatively modest in volume, has been impressive. It is currently the undoubted leader in the field of determining standards for environmental accounting.
The Work of ISAR:
Since the late 1980s, the United Nations has done a considerable amount of work related to environmental accounting issues through its various committees. ISAR took up the topic of environmental accounting in 1989. In its first survey on the subject, it discovered that there were no accounting standards specific to environmental issues. Some corporations did not consider environmental information necessary for the fair presentation of financial statements. Others, which were faced with sizeable environmental costs and were measuring them at least for internal management purposes, were looking for guidelines for external reporting of these costs.
In 1991, ISAR formulated its first guidance on environmental disclosure in financial statements. This was followed by two comprehensive surveys. In l992, and in 1994, revealing that disclosure of environmental information that was qualitative, descriptive, biased and difficult to compare was still the order of the day— the very antithesis of good accounting practice. The most comprehensive work was presented in a position paper adopted by lSAR in February, 1998. The main chapter, “Recommendations Adopted by the Intergovernmental Working Group of Experts on International Standards on Accounting and Reporting,” although not authoritative, provides guidelines for best practices in accounting for environmental transactions and events. These recommendations are based on two reports submitted to the UNCTAD. The first report,”Accounting and Reporting for Environmental Liabilities and Costs within the Existing Financial Reporting Framework,” was prepared by David Moore, Doctor of Research Studies at the Canadian Institute of Chartered Accountants. The second, “Linking Environmental and Financial Performance: A Survey of Best Practice Techniques,” was prepared by Roger Adams, Head of Technical Services and Research at the Association of Chartered Accountants in the UK.
Some of the basic recommendations of the ISAR position paper are:
1. Environmental costs should be charged to income in the period in which they are identified, unless they meet the criteria for recognition as an asset. Environmental costs comprise the costs of steps taken, or required to be taken, to manage the environmental impact of an enterprise’s activity in an environmentally responsible manner, as well as other costs driven by the environmental objectives and requirements of the enterprise.
2. Environmental costs that relate to a prior period should not be treated as prior period adjustment unless there is a change in accounting policy or unless there was a fundamental error.
3. Environmental costs should be capitalized if they meet the following conditions:
(a) They increaser the capacity, or improve the safety or other assets.
(b) They reduce or prevent environmental contamination.
(c) They conserve the environment.
4. Environmental liabilities should be recognized when there is an obligation on the part of the enterprise to incur environmental costs. An obligation does not have to be legally enforceable for a liability to be recognized. It could be a constructive obligation. A constructive obligation is one that can be created, inferred or constructed from the facts in a particular situation rather than being legally based, or that arises from ethical or moral considerations, and that an enterprise has little or no discretion to avoid. ISAR’s definition has considerably widened the scope of environmental liability for accounting purposes.
5. When there is difficulty in estimating an environmental liability, the best possible estimate in the range should be provided. In the rare situation where an environmental liability cannot be estimated, disclosure should be made of the existence of such a liability along with the reasons why an estimate cannot be made.
6. Expected recoveries from third parties should not be netted against environmental obligations. These items should be reported separately: the latter as a liability; the former as an asset.
7. Disclosure should be made o the types of items that are identified as environmental costs.
With respect to the measurement of environmental liabilities that will be paid over a long period of time and that relate to future site restoration, closure, and removal of long-lived assets, ISAR proposes a number of approaches. These include:
(a) The “present value” approach, which ISAR considers to be the preferred approach. Under this approach the liability is measured at the present value of the estimated future will be needed. The discount rate to be used should be at risk-free rare, such as the rate of government securities.
(b) The “current cost” approach, which ISAR considers to be the acceptable alternative. Under this approach the liability should be measured at the estimated cost of performing the required activities in the current period.
(c) The “anticipated expenditures” approach, which ISAR does not support. Under this approach, anticipated expenditures over the life of the related operations are based on an estimate of the undiscounted cash outflows that will eventually be required.
ISAR’s work continues, of course. Its current and medium-term program covers such topics as linking environmental and financial performance, recommendations for additional disclosures to flow through the annual reports of listed companies, standardized environmental performance indicators, and a framework of genetic environmental performance indicators based on Agenda 2l eco-efficiency principles.
The Accounting Profession -Quo Vadis?
The increasing pressure to account for the environment along with the success of ISAR’s work, has at last awakened the word-wide accounting profession to the need to get involved and to realize that environmental accounting is not just a fad which will pass as time goes by, but something which will increasingly impact upon the profession.
The work of the accounting profession in preparing, reporting and verifying financial and other information can be conveniently classified into three areas: financial accounting, management accounting and auditing. \
Financial accounting deals primarily with the preparation of financial and other information for external use and is often described as reporting on management. Management accounting deals with the preparation of financial and other information for internal use, and is again often described as reporting on management. Audit is concerned with verifying the correctness and fairness of the information disclosed in financial statements. While it is predominately associated with financial accounting (the credibility of such financial statements would disappear if management were able to report what, and ho they wanted as opposed to what had actually happened), it is taking on an ever increasing role within management accounting as well.
Environmental accounting has been and will be increasingly impacting upon all three areas. The major influence to dare has been on financial accounting, via the reporting of environmental costs and liabilities. As we have seen, significant progress has been made in this area. But with management accounting and internal decision making more and more attention being paid to the benefits vs. the costs of eco-efficiency - both short-term and long term. Energy saving and waste management schemes can benefit both the environment and the organization which implements them. Similarly, what happens at the end of a project lifetime is now as important as what happens at the beginning, and investment appraisal has to take account of this change. Major investment in the oil industry, for example, almost always requires an environmental impact survey prior to commencement. Such a survey often looks at what will be required to protect the environment, not only during the project lifetime but also at the end, so that the site is returned to what it was and at the very least, in the same condition. Information that cannot be objectively tested and verified lacks credibility. Therefore, audit principles also need to be able to be applied to environmental accounting. There needs to be an audit trail which can be followed in order to derive and check the basis of the figures in any environmental accounting report.
Will the accounting profession be able to cope? Or will it be left to some other group or profession to shoulder these responsibilities? I believe the former, but unless the profession adapts then I fear the latter. What does this adaptation require?
There is a need to review the profession’s educational and training programs, not only to ensure that environmental accounting forms part of the curriculum but also to see what new skills, if any, are required for accountants and auditors. We cannot, of course, expect accountants to be specialist environmentalists. In many cases they will have to call on the expertise of others, as indeed is already happening in many areas of accounting. Nevertheless, they will need a much better understanding of environmental auditing, evaluation of long-term impacts, reassessment of environmental provisions, expected recoveries, decommissioning provisions, constructive obligations, contingent environmental liabilities and the capitalization of environmental costs, to name just a few. Such an educational review is timely, as most national professional accounting societies will be examining their current curriculum in light of the development, also by ISAR, of a model curriculum for a Global Accounting Qualification.
The accounting profession is going to have to consider how it can work more closely with other major standard-setting bodies, and to accept that in the area of the environment it cannot continue to hold the view that it is the sole master in its own house when it comes to accounting standards.
Environmental performance is too important for this. Other bodies such as the International Organization for Standardization (ISO), which has already issued guidelines on environmental performance evaluation (ISO 14001), will have to be included in the standard-setting process.
Corporate freedom in this area is going to be increasingly restricted as rules and standards for external reporting are developed. In the case of internal reporting, while the application of management accounting techniques has demonstrated that many environmentally conscious projects (e.g. in energy efficiency) produce net economic benefits for the enterprise as well, there will undoubtedly be may others which do not and which will be seen as simply increasing costs with no apparent benefit for the specific enterprise. It will be incumbent on the profession, through its audit arm, to report on compliance with standards and contracted obligations.
An accounting and reporting framework is required that provides standard performance indicators, and the principles and standards for measuring and reporting them. Environmental accounting should not be regarded as a simple add-on to what exists at present.
There is a need to consider traditional accounting parameters in order to determine their suitability for the new demands placed on them. The first two steps in the accounting process are recognition and measurement. Before any accounting can take place, we need to recognize that an economic event has taken place which will affect the financial statements that are required to be prepared. Once recognition takes place, we need to be able to measure this event or, to use the accounting term, “value” it.
There are quite strict accounting rules concerning the recognition and measurement of economic events. However, accountants have long been accused of allowing the second step to determine the first, i.e. of only recognizing what they can measure and never recognizing what they cannot. Whether these accusations are justified is not relevant here. What is relevant is that no environmental impact can be ignored, as current accounting rules for measurement are not applicable. The rules, or standards, for recognition and measurement will need to be re-examined, and adapted/amended if required. The challenge of environmental accounting is to bring about meaningful disclosure within accounting practices and standards. If existing practices and standards do not enable us take up the challenge, then, rather than withdraw, the profession has to consider what accounting practices and standards would enable it to do so.
Environmental accounting must be seen as both a challenge and an opportunity: an opportunity for the profession to consolidate its position and reputation as the custodian of rigorous management information systems.
• UNEP Industry and Environment, January — March 1999