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Several companies today have committed themselves into becoming sustainable enterprises. They have discovered that by shifting their corporate strategy towards sustainable thinking this could harvest potential benefits. Yet one of the key challenges they face is that of tracking and measuring their progress towards Sustainability and communicating it to both internal and external stakeholders (Fiksel et al, 1999). To facilitate this action, organizations have sought to integrate Sustainability measures into their daily operations and systems thereby addressing both financial and non-financial aspects of performance. This has been done through the creation of policies, Sustainability management systems and in some instances, Sustainability or environmental reports to stakeholders (Searcy, 2009).
In their attempt to try to embed this concept into the day-to-day operations of their company, managers have adopted a Sustainability Accounting approach. This is a useful tool that enables companies to identify cost savings and efficient resources, and integrates social and environmental improvements with financial opportunities. It also helps to identify certain risks and allows companies to benchmark their performance with best practice (Stanger, 2004). Sustainability Accounting must incorporate social and environmental disclosures to increase stakeholder value and improve internal decision-making (Gray, 2006). In doing so, it supports the triple bottom line (TBL) framework, which, according to Savitz (2006), 'captures the essence of sustainability by measuring the impact of an organization's activities on the worldâ€¦including both its profitability and shareholder values, and its social, human and environmental capital.'
The TBL therefore is an accounting framework that goes beyond the traditional way of using profit and shareholder value or return on investment as performance measures, but also encompasses environmental and social aspects (Slaper and Hall, 2011). All these approaches, which in principle argue the same thing, have laid the foundations for the design of a Sustainability Management Accounting System (SMAS) which is aimed at improving the identification, cost allocation and analysis of social and environmental impact costs. This leads to better management decisions and better environmental and social disclosures (Petcharat et al, 2010). In view of this, Sustainability Accounting has been recognized as a salient tool to achieve Sustainability goals across various types of organizations, whether or not they aim for profit.
2.2 SUSTAINABILITY MANAGEMENT ACCOUNTING SYSTEM
2.2.1 OVERVIEW OF SUSTAINABILITY MEASUREMENT
Back in 1997, Elkington developed the Triple Bottom Line concept in attempt to measure Sustainability. Yet it has been argued that there is no single harmonized unit of measurement for economic, environmental and social performance. Economic performance is the easiest to measure since profits are used as a measurement basis but how do companies measure the social capital or environmental health of a business? According to Slaper and Hall (2011), some have argued that all the dimensions of the triple bottom line should be translated into money as a common measure, including the social and environmental impacts. Yet this leads to value incompatibility. Another measure they proposed is the use of an index that would be universally accepted and allows good comparisons between companies. However an element of subjectivity still remains when it comes to weighting the index components. One other suggested approach is to allow each Sustainability measure to stand alone rather than use monetary measures or indices. Yet Slaper and Hall argued that this could lead to 'proliferation of metrics'. Despite the lack of a universal standard measure for the three dimensions of the TBL this can still be beneficial because the chosen measures will reflect the different needs of the entity.
A series of indicators have been used for measurement. Practical examples of economic indicators used are income and expenditure, job growth and company size while environmental indicators measure the influences of natural resources for example electricity and fossil fuel consumption or the carbon footprint. Social indicators commonly used include education measurements, quality of life and well-being, poverty levels and client retention rates (Slaper and Hall, 2011). These are translated into useful environmental and social Key Performance Indicators (KPIs) keeping in mind the idea that 'what you cannot measure you cannot manage' (Rath, 2011). Moreover, to facilitate environmental and social cost measurement for decision-making, it is clear that an effective Management Accounting framework is needed (Petcharat et al, 2010).
2.2.2 ENVIRONMENTAL MANAGEMENT ACCOUNTING
Environmental Management Accounting (EMA) is a sub-category of Environmental Accounting which provides information that is useful for internal decision-making whilst supporting external environmental disclosures provided through Environmental Financial Accounting (EFA) (Petcharat et al, 2010). It also considers issues such as choosing environmentally-aware suppliers and the effect of non-compliance with environmental regulations (Irons, 2010). According to UNDSD (2001), EMA measures both physical quantities such as energy, water and wastes, and monetary amounts such as environmental costs or savings. Identifying such costs could be a tedious process since historically they have been 'hidden away' as overheads making it difficult to accurately measure them (IFAC, 2005). EMA assists with allocating environmental costs to the individual products, and the UNDSD (2003) advocates the use of four management accounting techniques for doing so, namely Activity Based Costing (ABC), Life-Cycle costing, input/output flow analysis and flow cost accounting (Irons, 2010). The most popular techniques are ABC, which translates environmental costs into cost drivers after allocating them to cost centers, and Life-cycle costing which outlines the environmental costs from the initial stage of product development to the completion and delivery stage of the product. The concepts and practices in EMA therefore allow more accurate management of environmental costs.
2.2.3 SOCIAL MANAGEMENT ACCOUNTING
Similar to EMA, Social Management Accounting (SMA) is a sub-category of Social Accounting which is concerned with the identification and measurement of social costs for internal decision-making, thereby supporting external social performance disclosures (Petcharat et al, 2010). Most businesses today claim that their most valuable asset is their people. Therefore they are continuously seeking ways of how to 'put the customer first' without compromising employees working conditions (CGMA, 2012). In doing so, they have attempted to record social costs like employee turnover or customer dissatisfaction, as overheads rather than product costs, to integrate them into decision-making (Hazilla and Kopp, 1990). However, not much has been done about measuring social costs given the complexity of the process in capturing them. Thus Social Accounting has not been successfully implemented. Nevertheless, human capital, knowledge, technology, intellectual property and customer relationships are regarded as potential drivers of value and measures of such drivers are required (CGMA, 2012).
2.2.4 FULL COST ACCOUNTING APPROACH
Past practice has shown that treating social and environmental costs as overheads has made such costs less controllable and removed the product managers' responsibility over them. In response to this a Full Cost Accounting alternative has been promoted thereby factoring in social, environmental and other costs as product costs.
Environmental costs can be private costs for which the firm is directly responsible and affect profits directly, or societal costs which affect the rest of society but for which the firm is not necessarily held liable. In a study carried out by the U.S Environmental Protection Agency (1995), environmental costs were classified as shown in Figure 2.1 overleaf.
Figure 2.1: Environmental costs and measurement classification
Agency U.S.E.P.A. (1995). An Introduction to Environmental Accounting as a Business Management Tool: Key concepts and terms. [Online] Available from: http://onlinelibrary.wiley.com/doi/10.1002/cbdv.200490137/abstract [Accessed: 4 November 2012]. Remove URL and do it the proper way!
Conventional costs are the normal raw material, labour and capital equipment costs used which are important for decision-making. Hidden costs are those that cannot really be accounted for directly for example voluntary or regulatory costs which include training, R&D and feasibility studies. Contingent costs are those that are expected to be incurred at some point in the future for example future compliance costs, economic loss damages and remediation costs. Relationship/image costs are certain intangible costs that tend to affect the perceptions of employees, customers, management and the community. They may affect forward-looking decisions. Lastly, societal costs are externalities that can include environmental degradation or adverse effects on human beings.
Given this breakdown of environmental costs (including social costs), one question still remains, namely that of how costs are assigned from the intangible social and environmental attributes. In his study, Conway-Schempf (online) outlines four main methods of doing this. These are:
Direct Method: Here the market price of resources is used directly for measurement.
Hedonistic Price Approach: here one seeks to associate changes in the price of a resource to differences in environmental quality and discover the price consumers are willing to pay.
Contingent Valuation: this involves directly asking people the price they are willing to pay for an environmental benefit and how much they would be compensated if such benefit is lost. This would then help arrive at the price.
User Cost Approach: this method attempts to analyze the total costs of an activity including opportunity costs.
The above methods allow for social and environmental costs to be incorporated in the price of a particular activity. As a result, 'Full cost pricing attempts to ensure that the costs are paid by the users rather than by society at large' (Conway-Schempf, online).
Despite all this there might still be difficulty in estimating the environmental and social costs since it involves subjectivity. Also it is hard to achieve consistency in measurement methods among companies and it is not so easy to set prices which include social and environmental cost elements in a competitive market. Companies need to be motivated in applying full cost accounting since in the presence of budgetary constraints they normally attempt to reduce costs rather than increase them.
2.2.5 PUTTING IT ALL TOGETHER
In their study, Petcharat et al (2010) developed a holistic model that combined the concepts of Environmental Management Accounting and Social Management Accounting to help measure social and environmental costs within a Sustainability Management Accounting System (SMAS). This aided in identifying and measuring both types of costs making it easier to allocate them to individual products. By following these concepts, companies could portray themselves as sustainable enterprises thereby enhancing their reputation. Figure 2.2 depicts how these three major concepts in a SMAS are interlinked within a theoretical framework. The more these concepts are efficiently applied, the stronger the SMAS therefore the middle circle would be larger. Correct application of the SMAS then drives the company to disclose environmental and social issues in the form of a triple bottom line report which will add value in the eyes of the stakeholder (Berkel, 2003).
Figure 2.2: Sustainability Management Accounting System concepts
Petcharat, N. & Mula, J.M. (2009) Identifying System Characteristics for Development of a Sustainability Management Accounting Information System: Towards a Conceptual Design for the Manufacturing Industry. 2009 Fourth International Conference on Cooperation and Promotion of Information Resources in Science and Technology. [Online] 56-64. Available from: http://ieeexplore.ieee.org/lpdocs/epic03/wrapper.htm?arnumber=5361815. [Accessed: 4 nov
2.3 SUSTAINABILITY DISCLOSURE & ASSURANCE
We currently live in a world of permeable boundaries between businesses, individuals and the outside world, where 'it seems that nothing is private' (CGMA, 2012). Most companies are therefore being required by stakeholders to increase their transparency on Sustainability actions. Investors are pressuring companies to disclose measurable and reliable non-financial information to assist them in their investment decisions. It has been realized that the absence of credible and reliable reporting on environmental and social performance mitigates the chance for companies to increase competitive advantage and risk losing major customers as well as the trust of the public (Nieland, 2011). This explains why over the last few years, Sustainability reporting initiatives have increased at a dramatic rate. In fact, according to CorporateRegister.com, the number of global companies issuing Sustainability reports escalated from around eight-hundred in 2000 to over four-thousand five-hundred in 2010 (Nieland, 2011).
2.3.1 REPORTING GUIDELINES AND REGULATION
Sustainability reporting worldwide is largely considered to be a voluntary initiative (Boynton, 2010). Yet in some cases, such reporting has been promoted further by adopting certain regulations. An example is the EU Fourth Company Law Directive that requires companies to disclose information on social and environmental aspects of their operations in order to 'provide an understanding of their development, performance or position' (European Commission, 2011). It has also become common practice for certain companies to become certified with International Organization for Standardization (ISO) to improve the efficiency of their operations by integrating 'environmental regulations into the management system' (Bugelli, 2011). The most commonly used Environmental Management System (EMS) is ISO 14000 and the European Union's Eco-Management and Audit Scheme (EMAS). For more detail about these, refer to Appendix 1.
In a study carried out by Ioannu and Serafeim (2012) in which they explored the consequences of mandatory Corporate Sustainability reporting, it was discovered that the social responsibility of business leaders tends to increase following the adoption of mandatory Sustainability regulations. They also proved that companies in this scenario give more priority to Sustainability practices and improve their managerial credibility. Also, countries with stronger regulation enforcement tend to experience more of these effects. Nevertheless, it is a fact that if regulation is not in any way synchronized with a number of metric frameworks, this poses a major challenge (Boynton, 2010). Voluntary or regulatory reporting requirements can therefore be synchronized within a framework and triggered by initiatives like the Global Reporting Initiative (GRI).
The GRI, which is a non-profit making organization, set up a number of guidelines that served as the world's most widely-used reporting framework and can be applied by companies in various sectors. Its mission is to convert Sustainability reporting into a 'mainstream business activity'. The GRI framework outlines a set of principles which ensure that reported information is of good quality. It also includes disclosures about performance indicators and guidance on technical topics while allowing companies to set the level at which they have applied the GRI reporting framework, to ensure that the needs of all stakeholders are met (GRI, 2011). It emphasizes that 'Sustainability reporting is a living processâ€¦' and 'â€¦should fit into a broader process for setting organizational strategy, implementing action plans and assessing outcomes.'
2.3.2 THE LOCAL SCENARIO
In a recent study by Voghel and Thompson (2012) it was discovered that Small and Medium Sized Enterprises (SMEs) are slowly shifting towards a Sustainability strategy due to its ties to business performance. Yet, despite the growing awareness about Sustainability, literature on what Maltese companies actually do in practice is very much lacking. Studies outline the general perception that such practices should be restricted to large and listed companies and small business should be exempt. This is perhaps why Maltese companies do not give Sustainability much importance. In a public consultation on non-financial information disclosure between the European Commission and organizations from member states in 2011, respondents generally stated that reporting requirements should be restricted only to large companies since they 'have a bigger effect on the economy' and despite their collective large impact, SMEs should not be subject to mandatory disclosures. However, this contrasts with the view of Voghel and Thompson in their article on The Accountant (MIA Malta) (2012), in which they state that SMEs can be guided by Small and Medium Sized Practices (SMPs) in developing an EMS. The IFAC (International Federation of Accountants) assists SMEs in applying Sustainability principles by providing them with a guide to practice management. Thus they should not be exempt from applying Sustainability practices.
According to Rizzo (2012), Sustainability reporting does not feature highly on most firms' agenda and companies are still adopting a 'let it be' attitude. He stated that without top-down initiatives from government and a legal framework, Maltese firms are often tempted give Sustainability a back seat. As a result Malta is still far off from conducting Sustainability practices without a 'policy of voluntarism' but for the time being may need to emphasize their importance through regulation.
2.3.3 SUSTAINABILITY ASSURANCE
The growth in Sustainability reporting in recent years has given rise to voluntary Sustainability assurance. In a study carried out by Cheng, Green and Ko (2012) it was discovered that assurance of Sustainability reports tends to increase investor's willingness to invest since companies would be sending a positive signal about their risks. Moreover, they discovered that the willingness to invest is likely to be higher for companies whose Sustainability report is audited by an accounting firm rather than a consultancy firm.
Both locally and overseas, the Big Four accounting firms started combining their knowledge and expertise in order to 'capture a significant share of the growing market in assurance on sustainability reports' (O'Dwyer, 2011). However, most companies still seem to question the quality of such assurance since there is lack of overall experience. In a public consultation with the EU Commission on disclosing non-financial information, respondents stated that although auditing a Sustainability report would enhance accuracy and confidence among stakeholders, it poses a cost that is difficult to quantify (EU Commission, 2012). Despite this, Sustainability assurance continues to have growing importance since it allows companies to obtain long-term shareholder value and increase credibility through the published Sustainability report (PwC, online). Appendix 2 provides an example of a Sustainability Assurance report for Vodafone Malta Limited audited by the company auditors PricewaterhouseCoopers (PwC).
After discussing various aspects of Sustainability measurement and accounting, Sustainability reporting and assurance, the following sections will explore any current local practices. Given that in Malta literature on such aspects is lacking, these sections will attempt to address the gap in local knowledge.