Hints to tutorial answers from Chapter 9 (Week 10 tut questions; will be discussed in week 11)

Emerging issues in Accounting:

Tutorial questions: 9.1, 9.2, 9.5, 9.10, 9.11, 9.21 and 9.24.
Additional Question: 9.19:
Student critical thinking question: Please see the task at the end of document.

9.1 What has the environment got to do with accounting ?

Answer:
To answer this question we need to first consider how we would define accounting. If
our definition of accounting is limited to providing information about the financial
performance of an entity to individuals who have a financial interest in the
organisation then we might argue that the environment has limited relevance to
accounting. This is true except if particular cash flows relate to the use or abuse of the
environment (for example, fines for misuse, clean-ups of contaminated sites etc).

However, once we accept that organisations are accountable for not only their
economic, but also their social and environmental performance then the role of
accounting in fulfilling this accountability becomes relevant. In this sense we are
directly relating the practice of accounting with the notion of accountability. In doing
so we can rely on the perspective of accountability provided by Gray, Owen and
Adams (1996, p.38), this being the duty to provide an account (by no means
necessarily a financial account) or reckoning of those actions for which one is held
responsible.

Hence, adopting this broader perspective which links accounting with accountability
we can argue that if stakeholders expect an organisation to take certain actions (or
perhaps, to refrain from taking particular actions) then that organisation has a
responsibility to provide information (an account) to enable others to determine
whether the expectations have been met. Therefore, if we accept that many people
within society expect an organisation to be accountable for its environmental
performance (and to act responsibly) then the role of the accounting system should
become apparent. Accounting does not have to be confined to the provision of

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financial accounting alone, and the audience should not be narrowly defined as just
including shareholders.

9.2: What is accountability and what is its relationship with (a) accounting and
(b) an organisations responsibility ?

Answer:
We can refer to the definition of accountability provided by Gray, Owen and Adams
(1996, p.38), this being:

The duty to provide an account (by no means necessarily a financial account) or

reckoning of those actions for which one is held responsible.

According to Gray, Owen and Adams, accountability involves two responsibilities or

duties, these being:
(a) the responsibility to undertake certain actions (or to refrain from taking
actions); and
(b) the responsibility to provide an account of those actions.

In relating accountability to accounting we need to consider what we actually mean

by ‘accounting’. There is no definitive definition of accounting but perhaps we can
describe accounting as the process of providing information to various stakeholders to
allow those stakeholders to assess various aspects of the entity’s performance and
position for the purposes of making various decisions about the entity (inclusive of
whether they will support the entity through providing labour, investment capital,
consuming the entity’s products, and so on).

Traditionally, accounting has been considered to be a process of providing

information about financial performance and position to parties that have a direct
financial interest in the organisation—but this is an extremely restricted perspective of
accounting. In a sense, accounting provides the mechanism through which
accountability can be performed or exercised. Since different managers will have
different perspectives about what is expected of them from their various stakeholders,
different entities will develop different accounting systems (for example, some

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 organisations develop systems that can generate social and environmental
performance reports, while others do not).

In considering the relationship between accountability and organisational

responsibilities, we can say that the two are directly linked. An organisation has a
responsibility to provide an account (that is, it has an accountability) of its activities to
enable others to determine whether the entity has been acting in the manner in which
it is expected to act. Gray, Owen and Adams (1996) developed an ‘accountability
model’ to explain the relationship. They consider that accounting and the act of
reporting is responsibility driven, rather than demand driven. The view is that people
have a right to be informed about certain facets of an organisation’s operations. By
considering rights, it is argued that the model avoids the problem of considering
users’ needs and how such needs are established. The role of corporate reporting
under this perspective is to inform society about the extent to which actions for which
an organisation is considered responsible have been fulfilled.

9.5: Do conventional financial accounting practices, principles and definitions

encourage corporations to adopt sustainable business practices ? Explain your
answer.

Answer: Conventional financial accounting practices discourage us from embracing

sustainable business practices. There are a number of reasons for this as follow:

1. The objective of general purpose financial reporting, as noted in the IASB

Conceptual Framework for Financial Reporting, is to provide information to present
and potential investors, lenders and other creditors to assist them in their resource
allocation decisions. Other stakeholders who are making decisions unrelated to the
allocation of resources are not directly considered.

2. The accountants’ notion of materiality also tends to preclude the reporting of

social and environmental information.

As highlighted in Gray, Owen and Adams (1996), another issue that arises in financial
accounting is that reporting entities frequently discount liabilities, particularly those

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that will not be settled for many years, to their present value. This tends to make
future expenditure less significant in the present period. This has particular relevance
to future ‘clean-up costs’ and remediation costs. Discounting liabilities can tend to
make them immaterial in the current period and therefore not presented in the balance
sheet – that is, discounting can effectively make the liabilities ‘disappear’ and appear
as not being material or important enough for reporting.

3. Financial accounting adopts the ‘entity assumption’, which requires the

organisation to be treated as an entity distinct from its owners, other organisations and
other stakeholders. If a transaction or event does not directly impact upon the entity,
the transaction or event is to be ignored for accounting purposes. This means that the
externalities caused by reporting entities will typically be ignored, thereby meaning
that performance measures (such as profitability) are incomplete from a broader
societal (as opposed to a ‘discrete entity’) perspective.

4. In financial accounting and reporting, expenses are defined in such a way as to

exclude the recognition of any impacts on resources that are not controlled by the
entity (such as the environment), unless fines or other cash flows result. For example,
under the International Accounting Standards Board’s conceptual framework (as
discussed in chapter 6), expenses for financial reporting purposes are defined as:

… decreases in economic benefits during the accounting period in the form of

outflows or depletions of assets or incurrences of liabilities that result in
decreases in equity, other than those relating to distributions to equity
participants. (Paragraph 4.25b)

An understanding of expenses therefore requires an understanding of assets. Assets are

defined as resources ‘controlled by the entity as a result of past events and from which
future economic benefits are expected to flow to the entity’ (paragraph 4a, emphasis
added). The recognition of assets therefore relies upon control, and hence environmental
resources such as air and water, which are shared and therefore not controlled by the
organisation, cannot be considered as ‘assets’ of that organisation. Thus their use, or
abuse, is not considered as an expense.

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5. There is also the issue of ‘measurability’. For an item to be recorded for financial
accounting purposes it must be measurable with reasonable accuracy. As paragraph
4.38 of the IASB Conceptual Framework for Financial Reporting states:

An item that meets the definition of an element should be recognised if:

(a) it is probable that any future economic benefit associated with the item
will flow to or from the entity; and
(b) the item has a cost or value that can be measured with reliability.

Trying to place a value on the externalities caused by an entity often relies on

various estimates and ‘guesstimates’, thereby typically precluding their recognition
from the financial accounts on the basis of the potential inaccuracy of the
measurement.

6. General purpose financial reporting also requires us to break the life of the
organisation (which could be deemed to be indefinite) into smaller periods, such as
yearly (or quarterly, or half-yearly) periods. We are then required to calculate the
profit for each period. Focusing on yearly periods can act to discourage the
managers of the organisation from taking a longer term perspective
(particularly, perhaps, if they are paid bonuses that are linked to annual profits).
By contrast, a consideration of sustainability would require us to take a longer
term focus.

Taken together, the above limitations of financial accounting do tend to indicate that
financial accounting practices do not provide encouragement to corporations to
embrace sustainable business practices.

9.10: What is stakeholders’ engagement? Why might it be important to the

success of the organisation?

Answer:

Stakeholder engagement obviously relates to ‘engaging’ stakeholders and involves

discovering what really matters to the key stakeholders, providing them with feedback
on corporate strategies and performance, and identifying what and how things can be

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 changed. This also includes monitoring and managing stakeholder contributions and
satisfaction levels.

One way of engaging stakeholders is through undertaking periodic social audits. A

policy of undertaking periodic social audits should arguably be included within an
organisation’s corporate governance policies. Companies often do not understand
their stakeholders well and, as a result, many do not even try to encourage their
participation in shaping the future of the company. The long term success of an
organisation requires knowing, anticipating and responding to stakeholder
expectations and changes therein.

9.11:

(a) One negative externality identified might be the organisation’s contribution to

climate change, and the stakeholders affected would include current and future
generations, as well as various animals and plant life that might be negatively
influenced by rising land and sea temperatures, and rising sea levels. A positive
externality might include positive social benefits generated by the organisation’s
products. For example, if the organisation provided leisure or health-related
products then this might contribute to the level of physical and mental health in
the community, which in turn will reduce health costs being incurred within
society.

(b) Generally speaking, positive and negative externalities would not directly impact
on the organisation’s income and expense, and therefore profits. This is generally
because of accounting conventions such as the entity principle and because of the
way we define the elements of financial accounting. As an example, if we emit
greenhouse gases, and we are not taxed or fined for such emissions, then we will
not record any expenses despite the potential contribution to climate change. In
large part this is because we do not recognise the atmosphere as a resource of the
organisation.

(c) This will be a matter of opinion. As indicated in Chapter 9, there is a view that
measures of performance, such as accounting profits, provide a very restricted

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 measure of performance. Effectively, an understanding of the measure ‘profit’ –
and its limitations as a measure of performance – is only possible if we really
understand the contents of the various accounting standards, and importantly, the
aspects of ‘performance’ that are ignored by generally accepted accounting
practices. To achieve a more comprehensive understanding of organisational
performance, interested stakeholders should not only consider the financial
statements of the organisation but also other available information, such as that
included within CSR or sustainability reports.

9.21: Of what relevance to the accounting profession is sustainable development ?

Answer: While it is true that many accountants would not have given any consideration
to the notion of sustainable development, it is nevertheless an issue that is of direct
relevance to the accounting profession. Moves towards sustainable development
(accepted by many to be a global imperative) require new systems of providing
information—and accountants are very well placed to be involved with this.

In many countries, issues associated with sustainable development have led to the
introduction of various community-based initiatives. For example, the requirements
being introduced around the world to measure and report carbon-related emissions.
Accountants are getting involved in measuring, reporting and verification issues
associated with carbon emissions. They are also getting involved with issues
associated with the recognition and valuation of tradeable pollution permits, such as
those generated in cap-and-trade schemes.

As sustainable development becomes more of a priority and concern for the

community, it is expected that there will be increased demand for information about
entities’ social and environmental performance (two components of sustainability, the
other one being financial/economic performance), and firms will be expected to react
to this concern or else risk being in breach of their ‘social contract’. Accountants are
already reacting to this increasing demand. Throughout the world professional
accounting bodies have established taskforces to address the issues and the major

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accounting firms (for example, the ‘Big 4’) typically have special divisions which
consider social and environmental accountability and reporting issues.

As a further indication of the relevance of sustainability-related issues to the

accounting profession, many accounting education programs within universities and
other educational institutions are explicitly considering social and environmental
issues.

9.24: Evidence shows that the business entities or business associations typically
make submission to government which argue in favour of maintain voluntary
status of social and environmental performance reporting. That is, they typically
oppose the introduction of legislation to require them to report information about
their social and environmental performance. Why do you think that this is the
case?

Answer:
A number of chapters in the textbook provide reasons why management typically
prefers to be able to select its own methods of accounting, rather than being subject to
mandated reporting requirements. Some arguments are based on an efficiency
perspective, while other arguments are based on an opportunistic perspective. If
we are to adopt an efficiency perspective, perhaps management prefer to have the
option to select those methods of reporting which best reflect the underlying social
and environmental performance of the entity, rather than having particular methods
imposed upon them.
From an opportunistic perspective, perhaps the managers would rather have the
option to select those disclosures which provide the most favourable position of the
organisation’s social and environmental performance. Currently, the reporting of
social and environmental performance information is overwhelmingly voluntary.
While many entities state that they are embracing the ‘Global Reporting Initiative’s
Sustainability Reporting Guidelines’, evidence indicates that many organisations
select those items of disclosure within the GRI Guidelines which provide the most
favourable representation of the organisation’s performance—consistent with an
opportunistic perspective.

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Additional question:

9.19:
It has been argued by some authors that the concept of the triple bottom line is
severely restricting as; firstly, the term bottom line conveys the impression of
something which can be measured in a single number. The economic profit figure is
the summation, in a common currency, of all the income and expenses figures over a
period of time. Brown, Dillard and Marshall (2005) demonstrate that it is highly
problematic, and probably impossible in practice, to reduce all environmental impacts,
or all social impacts, to a common currency.

Secondly, the economic bottom line is commonly understood among managers as

being a metric which should be maximised. Brown, Dillard and Marshall (2005) argue
that it is difficult to apply this objective of maximisation to nature. While there could
be agreement on maximising a factor such as biodiversity, there is no commonly
accepted understanding of what this might mean and how it could be measured. Even
more problematic, is knowing which social metric should be maximised. Thus,
attempting to equate the notion (and management) of the bottom lines of social and
environmental with the more conventional economic bottom line is not possible in
practice. Therefore attempting to report upon, or manage, all three bottom lines in a
common manner is not appropriate.

Thirdly, the three separate bottom lines - the economic, social and environmental are
also interconnected. Doing environmentally right activities for a company such as
creating less pollution is also good for the health and well-being of people in the
society which will also lead to less health costs for the society. So these three bottom
lines are inter-connected. It will therefore be difficult to measure these bottom lines
separately.

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 Hence, from the above discussion, it is questionable whether triple bottom line
reporting can lead to separate and meaningful bottom lines for social, environmental
and economic performance.

Student critical thinking question:

Please read the articles posted in the canvas on Climate change and sustainability reporting
made by ISSB. Discuss your tutor what you feel sustainability law truly represents stakeholders
value or shareholders value ? Do you think it is contravening to the theme of Sustainable
Development ?

Look at the following commentary from London School of Economies, and try to understand
what is double materiality in the sustainability reporting and why it matters ?

https://www.lse.ac.uk/granthaminstitute/news/double-materiality-what-is-it-and-why-does-it-
matter/

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