The climate challenge is global. We all live on the same blue planet. In the fight against climate change and global warming, we can all play our part personally, but accountants can also make a difference professionally.

“It’s crucial that we use our unique position as advisers to business and policymakers to make the case for sustainability,” urged Michael Izza, ICAEW CEO. “Chartered accountants bring practical skills like measurement and management to the table and can work with business to build green policies into their working practices.” 

The profession deployed both practical and technical skills when chartered accountants recently joined academics, environmentalists and others for a virtual ICAEW-hosted workshop to explore ‘sustainable cost accounting’ (SCA). The idea behind SCA is to merge accountancy and sustainability reporting and is the brainchild of Professor Richard Murphy FCA. Put simply, SCA aims to put the estimated cost of transitioning to net-zero carbon emissions on to the balance sheet and give this greater prominence in determinations of whether an entity is a going concern. 

As we head towards a net-zero world, the definition of solvency and the traditional capital maintenance concept may need to evolve. “Historically, the focus of going concern has been on the availability of financial capitals to settle liabilities as they fall due and to date this has been a valid approach. In the future, being a going concern should not be based solely on the ability to settle financial liabilities; the business should also have to demonstrate that it can be a net-zero carbon emitter,” the professor explained at the workshop.

Quantifying risk

Murphy suggests mandatory SCA for the biggest organisations. This would require an entity to show how it will manage the consequences of climate change: preparing a plan for how it aims to become a net-zero carbon emitter by a specified date by eliminating carbon from its own processes and its supply and customer chains. The plan would need to be fully costed (using best current estimates and prices) and recorded in the accounts as a liability, with progress towards stated aims annually reappraised, reported on and then audited.

“I am deeply worried about the view that accounting and sustainability should not overlap,” he said, referring to the IFRS Foundation’s intention to establish an International Sustainability Standards Board. The Foundation plans to build on work done by the Task Force on Climate-related Financial Disclosures (TCFD), and other sustainability reporting frameworks (of which there are many), to accelerate convergence by developing global sustainability standards. These will operate in parallel with International Financial Reporting Standards.

“The numbers need to be in the primary financial statements, not in a disclosure footnote,” said Murphy. “I don’t think the IFRS and TCFD approach will create sufficient pressure for business change.” He favours accounting for the costs of progress towards net-zero carbon emissions through the financial reporting framework and standards (and in a way that does not require carbon to be ‘priced’), rather than through any of the existing or emerging non-financial reporting frameworks and standards, a trend that seems to be the prevalent direction of travel. 

Currently, organisations can treat some of the cost of their carbon emissions as an ‘externality’- a cost they do not financially incur, despite it being caused by production or consumption of a product or service that they provide. 

As governments across the globe approach their net-zero carbon emissions deadlines, individuals and organisations will need to take actions that reduce the amount of carbon entering the atmosphere, rather than externalising some carbon consequences of doing business and becoming carbon neutral by buying carbon credits or offsets. SCA is intended to address this issue in what Murphy describes as the least complicated way possible. 

Owning carbon emissions

On the road from carbon neutrality to net zero, every organisation will need to adjust its business model to move away from emitting carbon – and own the costs. SCA may offer an approach that enables this, by making the sustainability of company actions and outcomes – and reporting on this – more meaningful. So, after reading Murphy’s paper, How Sustainable Cost Accounting Works virtual workshop attendees explored SCA and some of the associated technical and practical challenges by considering three big questions:

1. Is it possible to estimate the costs of removing carbon from an organisation and how should this be reflected in the financial statements?
2. Would it be possible to account for this cost using existing accounting standards? If so, which areas of the financial statements would create the biggest challenges and where are the pinch points?
3. If changes to financial reporting were needed, could this be achieved by amending individual standards, or would it be necessary to create a new standard or make fundamental changes to the conceptual framework?

Unsurprisingly, each of these questions prompted dozens more. There were too many to share here, but they are being used to help frame some of ICAEW’s 2021 workstream on climate change. 

More questions than answers

There were discussions about how far an entity’s liability for carbon might extend and how to source customer and supplier information for estimates and provisions. “Obtaining granular empirical data on the costs of removing carbon is a huge task, particularly with existing technologies,” noted a statistics expert. The consensus seemed to be that reflecting – in financial statements – the costs of becoming and being a net-zero carbon emitter is not impossible, but that more guidance will be needed to deliver clear, consistent and comparable reporting. 

Liabilities, estimates and provisions continued as themes in discussions around the second question on SCA. Challenges were identified, for example, around how impairment tests are done and how to come up with a reliable estimate over a long period of time. So, the need for some regulatory intervention and revisions to international accounting standards (such as IAS 36 Impairment of Assets, and IAS 37 Provisions, Contingent Liabilities and Contingent Assets) was anticipated. “If an entity has a liability for carbon, over what period? What are the responsibilities and contract boundaries?” asked one accountant. How will a past event trigger a present obligation? At what stage is a constructive obligation created? 

Going concern loomed large. As well as identifying difficulties in obtaining the information for SCA to determine whether an entity has achieved net-zero carbon emissions, there were also concerns that applying SCA could render some organisations unsustainable.

But Murphy says that SCA is not about closing down businesses that are ‘carbon insolvent’: “The company would have to address the issue, so that their solvency might be restored”. For example, suspending dividends or raising additional capital could help to fund the transition to net zero.

Accelerating action

There was debate about whether SCA could best be achieved by creating a new financial reporting standard, amending existing standards, or both. But there was consensus on the need for overarching guidance, either way. Fundamental change to the conceptual framework was not anticipated, although this might become necessary if rules on discounting are changed. Some workshop attendees felt that something completely new, such as SCA, might be counterproductive “as the existing direction of travel is good”. 

Jake Green, Chair of ICAEW’s Financial Reporting Committee, noted during the workshop: “We are seeing a real step change in investors’ expectations of reporting on the potential impact of climate change.” Others felt that SCA may not go far enough and, in the pursuit of global environmental sustainability, we may need to focus on carbon emissions and on other impacts a company is having on the planet. Meanwhile, ICAEW will continue its explorations of sustainability initiatives, such as SCA, to help chartered accountants rise to the climate challenge. 

About the author
Alison Dundjerovic, Director, Technical Strategy Talent, ICAEW