While traditional accounting may not be considered one of the more exciting areas of business, in the transition to a more sustainable economy, social impact accounting is definitely where it’s at in a lot of ways. Find out why.

It’s not lost on me that, as a business consultant, my most recent posts have discussed topics that might not be considered mainstream or steadfast business ideas, but are nonetheless urgently important, such as paradoxical thinking for business leaders and the transition to an economy that calls for more humanity in the business world. But, trust me, as someone with three business degrees and over 25 years of professional experience, I have extensive knowledge and skills in practicing mainstream business – that is to say, I know my way around everything from financial statements to strategy analyses. With that said, I thought today I would return to one of the most steadfast of steadfast topics in business: accounting.

While traditional accounting may not be considered one of the more exciting areas of business, in the transition to a more sustainable economy, social impact accounting is definitely where it’s at in a lot of ways (I credit my appreciation of this to my accounting professor at the London School of Economics (LSE), Julia Morley). The reasons for this are not immediately obvious, but are, once again, urgently important because it is here where discussion, debate and dialogue is happening about how we can effectively account for people and planet in a business context. And since financial results are the global standard for signalling the value of a business to capital markets, the real effects of impact accounting are (as they say in the business) material.

In the context of our changing world, traditional accounting has come under fire recently for failing to reflect the environmental and social position of companies, which can exert significant influence on the underlying value of their businesses from both a risk and long-term competitive advantage perspective. It is this increasing lack of relevancy that has prompted the massive shift in traditional accounting disclosures to now include environmental, social and governance (ESG) related issues.

But the seismic nature of the shift has meant that it’s not been without controversy. Even though 1) profit is a social construct, making it redefinable and 2) accounting is an evolving social practice meant to accurately reflect the times, the introduction of ESG disclosures has prompted criticisms that question the magnitude of ESG related risks and the legitimacy of social impact accounting results. These are, from my perspective, irrational criticisms aimed at maintaining the status quo in the face of clear and indisputable social and environmental upheaval (more about my deeper thoughts on this in my next blog post).

Personally, I align with the more rational and contiguous perspective that social impact accounting is a natural and necessary evolution in the practice of accounting that must, from a planetary perspective, be mandated and given the same opportunity as today’s prevailing Generally Accepted Accounting Principles (GAAP) were given to be refined, standardized and accepted into the global business world.

Today, in practice, these shifts have resulted in mandatory disclosures related to greenhouse gas (GHG) emissions (global), gender pay gaps (EU, UK, Canada, Iceland) and board diversity (EU, UK, Canada, US) as a way to report on externalities and mitigate financial risks for investors. While challenges have been posed to these new requirements, causing some of them to be scaled back, the demand for accountability to stakeholders has also prevailed in some cases. For example, in the US when a judge stated that it was not in the Securities and Exchange Commission’s (SEC) purview to force US companies to have diverse boards, the SEC responded by asserting that most investors believe that diverse boards result in better corporate governance and financial results. The SEC requirement therefore necessitates disclosure, not necessarily diverse boards, to send accurate signals to the market and protect investors.

The implementation of ESG disclosures has also led to the proliferation of ESG rating agencies and methodologies, resulting in uncorrelated ratings and poor data quality in general. There is a strong need for consolidation and standardization in the sector to allow for alignment around definitions and measurements, benchmarking and comparison. This is the process that the Financial Accounting Standards Board (FASB) is responsible for in its ongoing stewardship of US GAAP and this type of intersubjective consensus building is even more important in social impact accounting because of the challenges associated with assigning monetary values to social and environmental metrics. 

While social impact accounting is still very much evolving as a practice, it is maturing. This can be seen in the increasing demand for external third-party assurances in the sector, whether from one of the big four auditing firms or specialist agencies like Carbon Trust. So, given all of this, in measuring ESG issues, is it better to be “roughly right rather than precisely wrong?” This is exactly the question posed to me and my cohorts at LSE by Professor Morley, to which I emphatically agreed. Our current brand of capitalism has caused market failures, which have led to significant negative externalities – impacts that result from the activities of a firm that are borne by third parties – such as the global climate crisis, (Unerman et al., 2018, p. 497). These kinds of externalities have arisen in part because our current systems, including the traditional financial accounting system, don’t motivate profit-focused firms to take them into account (Le Grand & Roberts, 2021, p. 2). By reflecting the social and environmental impacts of producing goods and services, however, sustainability accounting motivates for-profit firms to take the public good into account by responsibly managing environmental and social capital to create long-term value (SASB, 2017). Therefore, while sustainability accounting is currently somewhat imprecise, it is so critically important to the public good it is necessary to evolve the practice rather than not do it at all.

In fact, we are starting to see the influence of this reasoning being reflected in capital markets, with stock market prices reacting to material ESG information that can affect a company’s fundamentals and financials – see the “ESG Market Cap Impacts Are Real” article found on my Resources for Business page. And as the ESG reporting field continues to evolve and get more precise, it will also drive important innovations in our economy. For instance, in September 2019, Serafeim et al. introduced the concept of impacted weighted financial accounts (IWA) to monetarily value impacts and incorporate them into financial statements, allowing for an integrated view of a company’s financial, social and environmental performance to support comparability and actionability, (2019). And when impact reporting is integrated into our existing accounting systems, it will unlock new innovations, business models and approaches to governance (SASB, 2017) focused on mobilizing our economy to prioritize the public good and improve our society (Serafeim et al., 2019). I discuss one such business model, shared value, in my recent post about what the transition to the new economy looks like for traditional businesses.

The bottom line (as they say) on social impact accounting is that it is a natural and necessary evolution in the practice of accounting in response to our changing world. These changes, from the global climate crisis to economic inequality, have in large part been caused by our current brand of capitalism, which incentivizes a short-term view on resource allocation. On the other hand, sustainability accounting motivates for-profit firms to responsibly manage environmental and social capital to create long-term value, thereby considering the public good and helping to reduce current crises and inequalities.

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Sources:

1. Unerman, J., Bebbington, J. & O’Dwyer, B. (2018). Corporate Reporting and Accounting for Externalities. Accounting and Business Research, 48(5), p. 497 – 522.
2. Le Grand, J. & Roberts, J. (2021). Hands, Hearts and Hybrids: Economic Organization, Individual Motivation and Public Benefit. LSE Public Policy Review, 1(3), p. 1 – 9.
3. Sustainability Accounting Standards Board (SASB). (2017). SASB Conceptual Framework. http://sasb.ifrs.org/wp-content/uploads/2019/05/SASB-Conceptual-Framework.pdf
4. Serafeim, G., Zochowski, R.T. & Downing, J. (2019). Impact-Weighted Financial Accounts: The Missing Piece for an Impact Economy. White Paper, Harvard Business School, Boston, MA.