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Accounting for New Forms of Value

Note: This article is excerpted from The New Entrepreneurial Leader: Developing Leaders Who Shape Social and Economic Opportunity (Berrett-Koehler Publishers 2011).
In the 1990s, when managers at Hewlett-Packard (HP) recognized that the soldering lead used in the company’s manufacturing process was toxic, they voluntarily initiated R&D projects to develop nontoxic, nontarnishing, and nonoxidizing alternatives. In 2006, when the European Union passed the Restriction of Hazardous Substances Directive, HP was in compliance; this earned good will from regulators that resulted in a voice in future regulation of the industry, and it opened European markets for new services from HP (Nidumolu, Prahalad, Rangaswami 2009).
 
Here’s another real-world example: In 2004, Costco Wholesale beat Wall Street’s expectations, posting a 25 percent profit and 14 percent sales growth. The market responded with a 4 percent decline in Costco’s stock price because analysts were concerned about Costco’s strategy of paying high wages relative to its competitor, Wal-Mart. Costco paid its workers well and achieved lower employee turnover, higher sales per square foot, and lower wages per dollar of sales than Wal-Mart did, yet Wall Street didn’t appreciate Costco’s human resource strategy and failed to reward it for its socially and economically responsible approach to employee compensation (Holmes and Zellner 2004).
These two real-world examples highlight the complexity that arises when organizations and their leaders begin to manage in a way that integrates social, environmental, and economic value creation (which we will refer to as SEERS). Why did these companies, both of which embarked on voluntary social and environmental activities, experience different reactions to their laudable efforts? It is because the links among these three components are not always direct. Social and environmental sustainability may yield economic sustainability, but there is no straight line connecting social and environmental efforts to cost savings, higher profitability, or favorable stock market responses, as the Costco story illustrates.
With this in mind, our discussion below aims to offer business leaders a better sense of the practical role accounting can (and can’t) play in organizations eager to pursue a more comprehensive approach to value creation.

The Role of the Accounting Profession in SEERS

Traditionally, society (investors, creditors, unions, government agencies, and other stakeholders) relied on external accounting reports to provide financial information about profit-seeking organizations’ return to investors and lenders and their stewardship of entrusted assets. External financial statements are considered key to the existence of financial markets, as they help ensure that capital flows to the most efficient and effective firms (Financial Accounting Standards Board 2010; International Financial Reporting Standards 2010). Nonprofits and NGOs, which pursue a social mission through their operations, also rely on traditional financial statements to discharge their fiduciary responsibilities to stakeholders.
With the push for greater corporate accountability, many external organizations are asking for sustainability data to be included in a single report, preferably with audited financial statements included in the annual report (Eccles and Krzus 2010). Some organizations have begun experimenting with “full-cost accounting” and “triple-bottom line reporting.” When sustainability data are included in accounting documents, external auditors are responsible for their evaluation if the data conflict with knowledge they have gained during the audit process. The use of external auditors is presumed to lend some credibility to the sustainability data and their collection, although often external auditors do not have the technical expertise to do so.
In response to the push for sustainability, some external groups are developing metrics and certification methods (such as Leadership in Energy and Environmental Design [LEED], organic food standards, B corporations, and the Dow Jones Sustainability Indices) that are applied to companies in an industry or across industries. Unfortunately, the verification of these metrics is usually limited to a review of the data-gathering method and does not extend to the content of the specific metrics reported. There are obviously numerous challenges and inconsistencies with engaging in triple-bottom line reporting.

Why Is the Accounting Profession Hesitant to Engage a SEERS Approach?

The accounting profession’s conceptual framework establishes decision usefulness as the central criterion for accounting information. To have decision usefulness, data are to be both relevant (providing timely predictive or feedback value) and reliable (meaning the information can be verified, has representational faithfulness to what it purports to measure, and is neutral) (Financial Accounting Standards Board 2010; International Financial Reporting Standards 2010).
For the accounting profession to engage SEERS metrics, the data must likewise be both relevant and reliable; yet because there is no agreement on the metrics regarding SEERS, the relevance of the data is questionable. Moreover, because the data that organizations provide are often suspect, the reliability also is questionable. For accountants to incorporate SEERS and sustainability metrics into a predictive model of analysis and reporting, a number of industry-wide issues must be resolved. First, the accounting profession must develop suitable criteria to support practitioners’ evaluation of SEERS data. Practitioners need these criteria to ensure that the data are measurable, complete, and free from bias. Second, and perhaps more importantly, accountants and entrepreneurial leaders must gain knowledge of SEERS and its associated financial and nonfinancial issues. They also must be knowledgeable about how to leverage the data to compile an informed, credible SEERS report. With this knowledge, entrepreneurial leaders will lead the way in building sustainability reporting that supports SEERS.
Outside the United States, some accounting professionals are examining how to combine sustainability metrics with existing financial data to improve reporting. Some improvements have been made to establish unbiased methods for systematically collecting, reporting, and ensuring the reliability of sustainability metrics and for developing external reports that explain how sustainability links to the organization’s strategy and goals. In other instances, sustainability performance metrics are tracked to specific roles and responsibilities and are included in the organization’s internal performance management systems.
To help meet external reporting challenges, the International Accounting Standards Board issued, in December 2010, a nonbinding practice statement that allows management to provide a historical and prospective commentary on its financial statements that adds context. The practice statement did not preclude the reporting of nonfinancial metrics (such as sustainability and environmental data) in the commentary but required management’s statements to abide by the International Financial Reporting Standards conceptual framework (IFRS 2010).
Although the accounting profession may be making some progress on considering sustainability, it is not moving quickly. As educators, we are focused on how to use our current understanding of accounting practices to develop business leaders who are considering these complex accounting issues and are using their knowledge to act their way into feasible solutions that provide relevant and reliable data. If we are able to develop accountants and entrepreneurial leaders who have this world view, these individuals, in their privileged position as information providers, will be better positioned to lead their organizations to define, measure, and assess SEERS efforts.
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References 

Financial Accounting Standards Board. 2010. Conceptual Framework: Statement of Financial Accounting Concepts No. 8. September. http://www .fasb.org/cs/BlobServer?blobcol=urldata&blobtable=MungoBlobs&blobkey=id&blobwhere=1175821997186&blobheader=application/pdf.

Eccles, R. G., and M. P. Krzus. 2010. One Report: Integrated Reporting for a Sustainable Strategy. Hoboken, NJ: John Wiley and Sons.

Holmes, S., and W. Zellner. 2004. “The Costco Way.” Businessweek, April 12. http://www.businessweek.com/magazine/content/04_15/b3878084_ mz021.htm

IFRS Foundation. 2010. “IASB Publishes IFRS Practice Statement on Management Commentary.” December 8. http://www.ifrs.org/News/ Press+Releases/Management+Commentary+Practice+Statement.htm.

Nidumolu, R., C. K. Prahalad, and M. R. Rangaswami. 2009. “Why Sustainability Is Now the Key Driver of Innovation.” Harvard Business Review 87 (9): 56–64. http://hbr.org/2009/09/why-sustainability-is -now-the-key-driver-of-innovation/es.

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