Chapter 9 Ethics and sustainability Flashcards
2.1 Corporate social responsibility
CSR is a belief that a firm owes a responsibility to society and stakeholders. A firm with good CSR goes beyond its minimum contractual obligations to its stakeholders. This is also a wide concept, covering all stakeholder groups. CSR issues could include:
- Protecting the environment
- Staff welfare
- Customer welfare
- Using fair trade suppliers
- Charitable giving
3.1 Sustainability and ESG
Sustainability is becoming a more important issue to societies as a whole. This is a wide concept and is not limited to ‘green’ issues. There are three main types of issues to consider:
- Social: negative impact on society due to low pay, lack of diversity
- Environmental: pollution and climate change
- Economic: lack of economic growth, leading to fewer opportunities in the future and lower taxes to fund public spending
Organisations should consider how environmental, social and governance issues could affect their ability to create and maintain value.
3.2 Key definitions
Sustainability: ability to meet the needs of the present without compromising the ability of future generations to satisfy their own needs.
Impacts: considerations need to take place on the impact that a company has on the environment, such as waste and pollution.
Dependencies: considerations are also needed on how the environment, social and governance issues affect a company, such as a minimum wage and climate change.
Environmental cost: the cost of making sure that a company’s activities do not damage the environment or that any such damage is put right. These include:
- Conventional costs: such as the cost of raw materials
- Potentially hidden costs: such as those included within general overheads
- Contingent cost: costs to be incurred at a future date
- Image and relationship costs: such as marketing costs
Social cost: total cost to society of a new venture or project. A social cost-benefit analysis is recommended for new projects.
Environment management accounting: EMA attempts to highlight the costs associated with ESG for better reporting and decision making. This could be analysed further into environment activity based costing or some other techniques to identify the drivers of the costs.
Greenwashing: this occurs when a company makes false or misleading statements about their environmental credentials.
Double materiality: means considering the sustainability issues that affect financial risks (financial materiality) as well as issues that affect people and the environment (impact materiality).
3.2 ESG
ESG considers the environmental, social and governance issues on the enterprise value. environment issues relate to the natural environment and systems, including biodiversity loss, greenhouse gas emissions and climate change.
Climate change issues include the issues associated with transition to net zero. Climate change can also affect future estimated cash flows or values of assets. Social issues relate to the governance of companies and other investee entities, including board structure, pay and business ethics.
Governance issues relate to the governance of companies and other investee entities, including board structure, pay and business ethics.
Investors are increasingly expecting the companies they invest in to adopt objectives relating to ESG in addition to their financial objectives.
3.3 Role of accountants with ESG
Accountants can assist with ESG by:
- Mandatory reporting requirements: climate related disclosures are mandated for listed companies and accountants have a role in collecting and reporting this information
- Regulations: reviewing compliance with taxes
- Grants: assist with applying for grants and compliance with any conditions
- Assurance: compliance audits or audits of sustainability reports may be required
- Risk management: it is important to identify risks relating to sustainability when reviewing a scenario
- Strategy: when appraising strategies, assess the impact of the strategy on ESG
- Finance: investors prefer to invest in a company whose activities are environmentally and socially sustainable. Green finance may be available for some projects
- Governance: board has key oversight role ensuring the organisation monitors and manages ESG factors. A social and ethics committee should be set up.
- Performance management: companies with strong ESG practices tend to be lower risk and better financed long-term.
- Supply chain management: ensure other members of supply chain adhere to organisations ESG standards. Companies should perform supplier due diligence checks prior to commencing supply chain transactions
3.4 Performance management
Accountants need to advise on suitable metrics to measure performance and provide assurance to check compliance. Materiality analysis helps a company identify the most important sustainability related issues to focus on. The challenges with these metrics are:
- Lack of comparability: as companies can choose which ESG metrics they want to report on
- Difficult to measure outcomes: employee satisfaction
- Lack of assurance: not subject to a company’s normal assurance and control process
- Greenwashing
ESG ratings: they measure a company’s exposure to ESG risks and opportunities and determine its long-term sustainability. These ratings can influence finance and brand image. MSCI grade a company’s ESG risks within a range from CCC to AAA (AAA regarded as a company leading its industry in managing risks).
3.5 ESG disclosures
In the UK the CA2006 require quoted companies to report on environmental matters within the Strategic report section of their annual report. The report should include:
- The main trends and factors likely to affect the future development, performance and position of the company’s business
- Information about environmental matters, performance metrics, and stakeholder interests
Since 2021, the largest UK companies have been required to make a number of climate-related disclosures that follow the framework laid down by the Taskforce on Climate-related Financial Disclosures, the four categories that the disclosures should contain:
- Governance
- Strategy
- Risk management
- Metrics and targets
Methodology for the disclosures are provided in IFRS Sustainability Disclosures Standards. Best practice sustainability reporting should include:
- An overview of an organisation’s ESG strategy
- A description of the organisation’s ESG priorities, goals and metrics
- An evaluation of the organisation’s progress towards those goals
This could be disclosed in a standalone sustainability report or integrated within the annual report.
3.6 Natural capital
Natural capital: the natural assets that provide everyday resources and services.
Ecosystem services: the benefits to people from ecosystems, such as timber, pollination and mental health.
Abiotic services: the benefits from geological processes such as the supply of minerals, oil and gas. If organisations make decisions that have an impact on the natural assets, it could result in business risks such as legal action, or brand damage.
Valuing natural capital:
Many organisations are attempting to place financial values on natural assets they use. There are three key steps in the valuation process:
- Quantity resource use
- Understand how the resource use causes changes in the natural environment
- Value the impacts on people associated with these changes in the natural environment
When valuing natural capital it is important to consider the value perspective:
- Business value: assess how natural capital will impact the financial performance of the company
- Societal value: assess the significance of the entity’s natural capital on external stakeholders
The recognition of natural assets is included within the company’s integrated report.
3.7 Integrated report
An integrated report should explain how the organisation creates value, using both quantitative and qualitative information. There is no standard, but typical issues to cover include:
- Forward-looking information: how company creates value in the future
- Long-term performance: reflect longer-term consequences of decisions
- Non-financial information: give wider understanding of value creation
- Strategy: highlight the significance of reported figures and how they create value
A benefit of these disclosures is that is presents the image of corporate responsibility in formal communication by indicating the proposed sustainability policy.
