Sustainability Accounting

The heart of sustainability accounting (also called Environmental Accounting) is resource management, the need for which may be illustrated by the following example. Imagine the inner workings of a gas engine. At rest the engine has two energy sources: a battery and fuel tank. Conceivably, the engine could simply run exclusively on the battery, though it would be sure to run out of power rather quickly. Instead, gas engines use the energy from the battery to tap the longer lasting fuel tank. Not only does this ensure the engine significantly longer run time, but it also conserves the battery’s charge for future, currently unforeseen need.

Unfortunately, socio-economic and political forces in the world today strongly encourage shortsighted, unsustainable resource consumption. At such consumption levels and patterns, we are sure to encounter a variety of crises sooner or later. To avoid crisis, these levels and patterns must be altered to reach sustainability while opportunity exists. As accounting has been labeled “the language of business,” it seems the proper vehicle to communicate knowledge with the goal of spurring environmentally sustainable activity throughout the world.

This article seeks to evaluate how financial accounting may increase such sustainability based on the premise that unsustainable activity, unchecked, will eventually crash, in this case, leading to worldwide economic, and potentially biological disaster. While the basic morality of preserving the condition of the biosphere for future generations is a valid topic, this discussion seeks to found itself on matters of fact for the sake of objectivity.

Going Concern

One of the basic fundamental assumptions driving recognition and measurement in financial statements is the notion of going concern, that an economic entity is presumed to continue operations for the foreseeable future (FASB Concept Statement 5). This phrasing indicates that sustainability is an issue of time, loosely quantified here as “the foreseeable future.” In practice, this term has come to mean “the near future” due to increased uncertainty and decreased urgency associated with the distant (albeit, often foreseeable) future. Thus, operations that cannot continue indefinitely are often ignored as a going concern, so long as such operations are classified as sustainable within the near future.

By contrast, at the foundation of sustainability accounting is the assumption of the indefinite continuance of man’s civilization on the earth. This underlying assumption points to one great implication—for civilization to continue as we know it, the condition of the earth must be stable. To reach such stability, we must understand our own impact on the planet. Consequently, under sustainability accounting, all costs affecting the ecosystem must be internalized and recognized.

Sustainability Cost

Complete internalization is reflected in the concept of sustainable cost—the “cost of restoring the earth to the state it was in prior to an organization’s impact (Lamberton, 2005).” Sustainable cost may be incorporated into existing financial accounting following the same accrual and matching principles. By subtracting the sustainable cost incurred in a given accounting period from the GAAP profit, we arrive at the entity’s sustainable profit or loss. In this way, sustainability accounting is really nothing more than a broader application of existing accounting principles with the view of the organizations impact on the planet’s limited resources.

Simple in theory, computing sustainable profit with accuracy and objectivity is next to impossible in practice because of the uncertainty involved in estimating sustainable cost. By the nature of entropy the environment cannot be returned to its previous condition once non-renewable resources have been exhausted, and restoration to a reasonably identical state incorporates so much subjectivity that pinning responsibility on one entity is infeasible. Scientists disagree on the impact of externalities, and macro-economic externalities (such as the true cost of depleting rain forests) cannot be priced using markets. Furthermore, the fact that the planet undergoes slow, constant change without human interference brings question into the validity of past conditions as a reference.

Sustainability accounting extends beyond profit/loss analysis and can also be used to portray the world’s resources in a balance sheet-like format. However, unlike most balance sheets, the world’s lists no liabilities. Rather, the earth’s balance sheet would be only a list of various resources, including fossil fuels and renewable energy, land, water, air, biodiversity, and others. Accordingly, this perspective of sustainability accounting is referred to as natural capital inventory accounting. An important aspect of this inventory of resources is the distinction between renewable and non-renewable resources. Also, waste byproduct of non-renewable resources is still a resource; only its usefulness has decreased through the entropic process.

The key problem with such accounting, again, is a question of scientific measurement. The amount of fossil fuels is unknown. The impact on human civilization of ecosystems and weather patterns is also unknown. However, this perspective is useful in identifying what we, as humans, have available to us at a given point in time, and thereby creates awareness of the need to maintain an ongoing stock of natural capital. Also implicit in such analysis is the notion that the total natural capital does not change. We may alter the planet’s mix of resources, but upsetting the balance between resource types is done at our own peril.

Practical Implementation

Given such uncertainty, sustainability accounting may appear to be impractical, and therefore, useless. However, just because many externalities cannot be accurately measured and internalized doesn’t mean the overall identification of an activity as unsustainable must be wasted. Under SFAC 5, as long as an activity’s unsustainability can be determined foreseeable, such unsustainability ought to be accounted for.

When accurate measurement is infeasible, one viable accounting solution may be to identify links between an entity’s activities and sustainability trends at the macroeconomic level. For example, we may not know the real cost of landfills. But we do know landfills are growing faster than the earth can reabsorb their contents, making current waste disposal unsustainable. We may not be able to quantify the earth’s oil deposits, but we do know they are currently being consumed faster than the slow geological process that replaces them. We may not know the exact effect of fossil fuel combustion on our biosphere, but we can easily assume that, at best, filling the atmosphere with carbon emissions is not beneficial.

Thus, by classifying the various activities of an entity as sustainable or not, we may make conclusions about the entity’s overall sustainability. One nagging question yet to be asked is how macroeconomic trends on a geological time scale influence companies now. Alone it is highly doubtful that any of these trends will have a direct, material impact on a company’s operations within the near future.

Consumer demand and governmental regulation can accelerate the immediacy of such trends. Growing popularity of the green movement pushes companies to meet the demand for environmentally sustainable production, and governments can implement laws changing the incentives of internalizing externalities overnight.

Specifically, government may influence the activities of economic entities in the following ways: 1. Establishing regulations on the legality of certain activities. 2. Creating tax incentives for corporations employing sustainable operations. 3. Facilitating increased consumer awareness of entities’ environmental sustainability.

In accordance with SFAS 5, Accounting for Contingencies, a corporation’s sustainable cost should be disclosed when the unsustainability of its operations is definitely foreseeable, as such foresight makes material, influential action by consumers and government reasonably possible. Such disclosure, along with qualification for favorable tax conditions could be based on a simple environmental sustainability audit in which the inputs and outputs of an entity’s operations are evaluated. An example of such an audit is follows this essay.

Conclusion

The need for sustainability accounting calls into question the adequacy of the current market’s ability to appropriately allocate resources over time. Interestingly, this method follows the same concepts as traditional financial accounting. The key difference is a broader perspective, evaluating the operations of an economic entity in relation to constraints dictated by the planet’s natural resources.

As the predominant means of economic communication, financial accounting may be effective in guiding worldwide economic stability toward environmental stability.

Other Resources

Atkinson, G. (2002). Measuring corporate sustainability. Journal of Environmental Planning and Management, 43(2), 235—244.

Builds on Pezzey, Pearce, Markandya, and Barbier’s definition of sustainable development, non-declining human well-being over time) to discuss the possibility of sustainable businesses, sectors, cities, etc. This article also explores the possibility of using full-cost accounting as the vehicle to bring about and measure such sustainability.

Lamberton, G. (2005). Sustainability accounting—a brief history and conceptual framework. Accounting Forum, 29, 7—26

Summarizes existing publications to define the following terms: sustainable cost, natural capital inventory accounting, input-output analysis, full-cost accounting, and triple bottom line (TBL) accounting. This article is presented in the context of historical background, and theorizes that the principal hold up in further implementation and adoption of sustainability accounting worldwide is the difficulty in objectively measuring negative externalities.

Lamberton, G. (2000). Accounting for sustainable development—a case study of city farm. Critical Perspectives on Accounting, 11, 583—602

Uses a case study to frame and illustrate sustainability from the following three perspectives:

1. Economic – long term viability of organizations
2. Ecological – focus on natural capital and environment preservation
3. Social – emphasis on intergenerational and intragenerational equity

Gray, R. and Milne, M.J. (2002). Sustainability Reporting: Who’s Kidding Whom? Chartered Accountants Journal of New Zealand

Theorizes that, based on the lack of progress toward sustainability observed between the world summits of 1992, 1997, and 2002, the future is not safe in the hands of business alone, otherwise world citizens might expect widespread adoption of environmental, social, and sustainability reporting from all businesses.

Elkins, P. (1999). European environmental taxes and charges: Recent experience, issues and trends. Ecological Economics, 31, 39—62

Summarizes many European governments recent increase of the use of environmental taxes and charges. The notion of shifting taxation focus away from labor usage to the use of environmental resources is discussed, along with its potential negative effects on competitiveness.

Lehman, G. (1996). Environmental accounting: pollution permits or selling the environment. Critical Perspectives on Accounting, 7, 667—676

Discusses the common viewpoint that assigning a cost to the environment through such actions as issuing pollution permits creates a disincentive for pollution, and argues that the primary effect of such actions only sells the environment.

Environmental Audit

The purpose of the environmental audit is twofold: first, to assess the environmental sustainability of an economic entity at a point in time for purpose of measuring progress and comparing contemporaries; and second, to lay out steps approaching absolute sustainability.

The framework for the audit is the sustainability of inputs and outputs:

Inputs (Resources)

• Energy

• • Rate dependence on fossil
  • Rate investment in renewable energy
• Materials
  • Evaluate replenishment of materials used.

Outputs

• Product (eventual waste)
  • Evaluate future usability/ recyclability
  • Evaluate environmental impact
• Immediate waste
  • Scrap
    • Evaluate future usability/recyclability
    • Evaluate environmental impact
  • Emissions
    • Evaluate environmental impact and volume produced in:
    • Energy release
    • Product material transformation

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