Accounting for Sustainability

Reminders Before Lecture

• Topic 10 is the last topic: Accounting for Sustainability.
• Next week's lecture will be a revision lecture, covering all topics from the course.
• The revision lecture will include a practice question session. This part will not be recorded.

Final Exam Details

• The final exam is in person and invigilated.
• Permitted items: calculator and pen.
• Question types: essays, calculations, etc.
• Practice set will be released next week, Monday before the lecture.
• Test is scheduled on a Wednesday afternoon.
• Central examinations team handles permissions for the final exam, not the lecturer.

Topic 10: Accounting for Sustainability

• Sustainability involves prolonging the use of, reducing, or eliminating resources consumed in achieving objectives.
• Key aspects:
  • Intention to prolong resource use.
  • Reduction or elimination of resource consumption (recycling, reusing).
• Sustainability practices impact: lowering consumption for environmental preservation and cost structures of organizations.
• All decisions have cost implications.

Role of Management Accounting in Sustainability

• Evaluate benefits versus costs of sustainability initiatives.
• Organizations want to capitalize on the benefits of sustainability.
• Benefits are not free; there are associated costs.
• Management accountants investigate sustainability-related investments.
• Sustainability decisions require inputs and information for well-informed decision-making.
• Management accounting enables businesses to assess if benefits outweigh costs.

Sustainability Defined

• Any pursuit or practice that prolongs the use of, reduces, or eliminates resources being consumed in performing transactions to achieve an individual or organizational objective.
• There is an intention to prolong as resources are viewed as limited.
• The goal is to stretch benefits to different periods.
• There is also reduction or elimination of resource consumption.

Delta Airlines Case

• Delta Airlines plans to invest 1,000,000,000 over ten years to become a carbon-neutral carrier.
• This involves:
  • Retiring and replacing older aircraft.
  • Improving flight operations.
  • Decreasing fuel use.
  • Reducing cargo.
• Management accountants help map out the goal into realistic, practical, actionable terms, and look at costs and benefits.
• Ultimately, it's a cost-benefit consideration.

Sustainability and Profitability

• Firms don't have to sacrifice profits for sustainability.
• Management accounting provides analysis to accomplish profit-directed objectives while ensuring sustainability.
• Research shows sustainability can coexist with organizational performance.
• Framework by Epstein and Roy explains how sustainability leads to long-term corporate financial performance.
• Sustainability performance includes:
  • Workforce diversity.
  • Environmental impact.
  • Bribery, corruption.
  • Community involvement.
  • Ethical sourcing.
  • Human rights (labor working conditions).
  • Product safety.
  • Product usefulness.
• Sustainability related initiatives include:
  • Employee motivation.
  • Customer preference for sustainable products.
• These lead to:
  *Loyal customer base
  *Motivated and driven workforce
  *Profitability

Sustainability Performance

• Companies perform life cycle assessments and environmental social benchmarking.
• Better sustainability performance is indicated by:
  • Percentage of companies owned by minority groups.
  • Percentage of women in senior positions.
  • Working hours versus wages.
  • Emissions.
• Stakeholder reactions include:
  • Improved company image.
  • Product development.
  • Market share increase.
  • Credit rating.
  • Awards.
• Long term performance is based on:
  • Return on investment.
  • Return on capital.
  • Economic value added.

Aligning Sustainability with Profitability

• Corporate and business unit strategy is the beginning point.
• Sustainability performance encompasses various aspects beyond the environment.
• Actions related to sustainability reflect in stakeholder perceptions.
• Employees are motivated by good working conditions and benefits.
• Customers prefer businesses using sustainable products.
• Community and government reactions matter.
• Sustainability initiatives can have a ripple effect, indirectly contributing to profitability.
• Even with costs, sustainability investments can translate into something directly or indirectly contributing to profitability in both the long and short run.

Value Proposition and Sustainability

• Communicating sustainability information to consumers translates into profitability.
• Consumers are becoming more conscious of sustainability.
• People are willing to pay a premium for sustainability.
• Sustainability can be aligned with corporate financial performance.
• There is a trickle-down effect.

External Costs

• Organizations knowingly or unknowingly cause the incurrence of costs owing to second and third-order effects of their actions.
• These are unintended consequences, often indirect.
• They are not captured in the price of goods.
• Accounting captures direct and indirect costs that are largely internal.

Examples of External Costs

• Company pollutes a river in a rural community.
• Profit and loss statements cannot capture the financial impact of the pollution.
• Pollution impacts the quality of life.
• Quantifying the cost to the community is difficult.
• Even if organizations are fined, the cost to the people inhaling polluted air remains unaddressed.

Production Costs and External Costs

• Typical production cost of a garment:
  • Direct materials: 4.50
  • Direct labor: 2.30
  • Overhead: 1.50
  • Production cost: 8.30
  • Selling and admin: 2.50
  • Full cost: 10.80
• Example of external costs:
  • Crime rates increased from $10,000,000 in thefts to $12,000,000 in thefts per year.
  • School attendance rates dropped 12% due to less parental supervision, increasing social welfare payments from $15,000,000 to $18,000,000 per year (a $3,000,000 increase).
  • Strong fumes in the river cause chemical extraction costs of $9,000,000 per year.
  • Key local fauna have vacated, affecting tourism by $1,000,000 in lost sales per year.
• Total external costs come out to $15,000,000 or $7.50 per garment in other words. So the total true cost per garment is effectively $18.30 (including external costs)

Sustainability Value Chains

• Given the significant impact of external costs, sustainability value chains have been developed.
• This involves incorporating sustainability into the value chain, from cradle to grave.
• Example: Unilever Hindustan integrates sustainability in raw material sourcing, manufacturing, distribution, consumer use, and disposal.

Unilever Hindustan's Value Chain

• Raw Materials: 19 tea states certified with Rainforest Alliance.
• Manufacturing: 28% reduction in carbon dioxide from energy, 31% reduction in water usage.
• Distribution: 6,800 climate-friendly hydrocarbon refrigerant-based retail freezers.
• Consumer Use and Disposal: Packaging design efficiency aims to reduce potential waste; initiatives to remove all PVCs from packaging.
• Sustainability reports are segregated in terms of climate, nature, plastics, and livelihood, with long-term ambitions and short-term goals.
• Sustainability indicators align with the triple bottom line approach.

Developing Sustainability Indicators

• Businesses need to identify target levels of performance and performance indicators.
• Accounting helps generate numbers to align targets for sustainability versus performance indicators.
• Accounting helps motivate behaviors to achieve performance.
• The Seven step checklist is used for developing KPI's:
  • Identify a company's strategic imperatives.
  • Identify broad operational categories that relate to these strategic imperatives.
  • Select financial and operating information that helps us chart the categories.
  • Assess relationships between the information selected to create performance indicators for categories.
  • Identify levels of performance for indicators.
  • Identify performance indicators and define adequate rewards for their attainments.
  • Identify feedback systems to manage success or failure in attaining indicators.

Sustainability Indicators

• Example: BHP (a mining company) monitors sustainability reports.
• Five aspects of sustainability: safety, health, community, climate change, environment.
• Each aspect has targets, performance indicators, and commentary.
• Example Target: Zero work related fatalities for safety.
• This is like a scorecard, assessing performance with a focus on sustainability.
• Some companies would have sustainability reports included in their annual reports.

Sustainability Assurance

• To ensure the reports are correct, reports have begun to be examined by hired individuals.
• Big four companies can provide. However, other professionals such as engineers are also hired to do the job.
• With consumer paying close attention makes transparency and accuracy more prevalent to ensure decisions are based on facts.

Triple Bottom Line Reporting

• Traditional financial statements focus on profit (the common bottom line).
• Triple bottom line considers people and the planet.
• A triple bottom line approach considers economic, environmental, and social perspectives.
• Triple bottom line elements include:
  • Economic performance
  • Socially responsible outcomes
  • Environmental awareness of actions

Economic, Social, and Environmental Factors

• Economic: Profit, wages, taxes, expenses, share data, imports, exports.
• Social: Employment, health and safety, labor standards, donations, childcare, opportunities provided to employees.
• Environmental: Greenhouse gas emissions, energy use, water use, spills, material use, recycling, waste transport.
• It is a contemporary approach for looking at the business with holistic point of view.

Environmental Costs

• Prevention costs: Implementing a filtration system to remove chemical spillage into a river stream is undertaking a preventive measure that eliminates the possibility of future environmental pollution.
• Appraisal costs: Qantas might invest a few hundred thousand dollars to implement electronic monitoring systems that measure fuel emissions of its aircraft as they age.
• Internal failure costs: In November 2011, Orica's chemical plant experienced an ammonia leak. If employees had to be hospitalized owing to the leak, internal failure costs are the costs incurred by Orca to rehabilitate and cover the medical expenses of these employees.
• External failure costs: Approximately $40,000,000,000 in terms of cleanup bill was incurred by BP for the Gulf Of Mexico oil spill.
• Sophisticated environmental management programs have higher percentage of prevention and appraisal costs relative to internal and external failure costs.

Environmental Cost Management

• Organizations need to balance the cost of failure against the investment into problem prevention or appraisal.
• It will take careful weighing with reasonable decisions and past experiences.

Reminders:

• Test 2, if you need to see papers, consult your tutor.
• Reach out to your tutor if you have issues with the marks for your group assignments because they were the ones marking them.
• Revision Lecture next Week, and for first 20-30 minutes, the first part would be recorded. Tips will be provided on how to take the test without recordings.