Including natural capital in valuation methods

aksaroya —  19 September 2012 — 1 Comment

by James Bonner, independent sustainability consultant

Other posts in this series of blogs have introduced the concept of materiality, and furthermore discussed the notion that natural capital, the stock of resources and subsequent benefits we derive from the natural environment, can be considered in material economic and business issues.

However, as the TEEB (The Economics of Ecosystems and Biodiversity) study states: ‘the values of its [natural capital] myriad benefits are often overlooked or poorly understood. They are rarely taken into account through markets or in day-to-day decisions by business and citizens, nor reflected adequately in the accounts of society.’ As such, the onus on organisations to report on significant material issues, coupled with an increasing interest and pressure on businesses to disclose their impact and dependencies with regards to environmental concerns, are strong arguments to support the inclusion of natural capital issues in the corporate reporting of businesses in order to accurately reflect their corporate performance.

The following diagram depicts the interconnections between the constituent aspects of natural capital and business (as explained in more detail in a previous blogpost in this series), and infers that there are several areas where impacts and dependencies on natural capital could feasibly impact corporate value. As the highlighted area in the dashed box associates – a business entity’s consumption of raw materials (e.g. timber or pharmaceutical resources), or reliance on an operating environment which is stable and consistent (e.g. protected from flooding or benefits from natural pollination) are dependencies which stem from natural capital- and are necessary, to varying extents, for the financial revenues and on-going existence of many, if not all, businesses.  As stated in the TEEB quote above, many of these benefits are not fully understood, or reflected in accounting practices – and begs the question: if such impacts and dependencies are so fundamental to society/organisations, shouldn’t their material relevance be reflected in aspects of corporate valuation such as tangible and intangible asset values, share price, and judgments of going concern?

Furthermore, there are a number of reasoned arguments why it is actually within the interests of businesses to integrate natural capital into their valuation procedures. Companies that incorporate the externalities associated with their impacts and dependence on natural capital into their financial reporting may gain a truer and more accurate assessment of their assets and liabilities, be able to make better business decisions based on a clearer understanding of what their revenues and costs they are dependent on, and be more prepared to comply and inform external requirements (e.g. regulation, reporting requirements, taxes, etc.) in the area of natural capital (developments in this area will be discussed specifically in future blogposts).

The challenge for society, business, and the accounting sector is to utilise current, or develop new, valuation methods and techniques to reflect these natural capital issues – and to foster a clearer understanding and appreciation of the value and dependence business, the economy, and society has on the natural environment.

This blogpost intends to primarily support ACCA’s Accounting for the future session ‘Assets/Liability Valuation of Natural Capital’ on Tuesday 9 October by connecting the concept of natural capital with the corporate value of companies – an issue which will be discussed in greater detail, along with specific accounting standards which are most closely aligned with natural capital, and the implications of valuing companies from a natural capital perspective – in the session. Additionally, a number of other presentations during the conference relate to the themes covered in this blogpost:

8 October
11:30 – 12: 30 Is natural capital a material issue?

9 October
09:30 – 11:00 Assets/liability valuation of natural capital
16:00 – 17:00 Practical workshop: 6 capitals of integrated reporting – practical skills for accountants

10 October
12:30 – 13:30 Evolution of the annual report
16:00 – 17:00 Reporting developments around Rio +20

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WBCSD (World Business Council for Sustainable Development)
WBSCD is a group which brings together a range of forward thinking companies with a focus on a sustainable future for business, the economy and the environment. Its ‘Guide to Corporate Ecosystem Assessment’ tool is particularly relevant to issues around the valuation of natural capital for businesses.

One response to Including natural capital in valuation methods

  1. 

    This is a very interesting article. I look forward to the webminars. Herewith some initial comments.

    To date, three main environmental / sustainability accounting approaches for reporting purposes have been used:
    • Approach 1: Environmental Financial Accounting (EFA) constitutes an extension of conventional Financial Accounting. It aims to differentiate commercial, economic or legal events of an environmental nature which have a direct financial impact on the reporting entity. This may relate to the present (expenses, sales) or future (long-term liabilities, provisions). Accounting for natural capital from this perspective should be straightforward as it would result in the assessment / disclosure of the ecosystem services (raw materials, water, etc.) embedded in the transactions by financial accounting standards.
    • Approach 2: Extra-Financial CSR Reporting involves reporting corporate performance with non-monetary KPI. Most of the KPI of the GRI fall within that scope.
    According to ISO 14031, a standard which describes processes and methods for measuring environmental performance, three main types of environmental indicators may be used by firms to that end(indicators of business-induced environmental change (e.g. impact or pressure indicators), process-based indicators (e.g. degree of implementation of environmental management systems or action plans) and results-based indicators (e.g. eco-efficiency indicators). The indicators, which relate to natural capital, could be combined with financial accounts through integrated disclose models – http://www.integrated-sustainability-services.com/page2col.php?page=24&section=54 ; http://www.integrated-sustainability-services.com/documents/IRC-SA-WG-JHOUDET-diff.pdf
    • Approach 3: The Disclosure of Environmental Externalities (DEE) involves disclosing the negative environmental externalities of the reporting entity. These externalities do not satisfy the recognition criteria for recording liabilities: they imply sacrifices of future economic benefits to other agents the reporting entity is not required to make. The 1990 environmental report of BSO/Origin provides a good illustration of what may be done to that end (Huizing and Dekker, 1992). Quantitative environmental accounts (atmospheric emissions – CO2, NOx, SO2, solid waste, wastewater) were converted into monetary values via economic valuation tools. This allowed BSO/Origin to produce a sustainability profit & loss statement, representing the difference between conventional value-added and value-lost. Value-lost amounts to the costs of BSO / Origin externalities less its impact mitigation expenses. More recently, PUMA (sports brand) released the 2011 Sustainability P&L of its supply chains. See – http://safe.puma.com/us/en/2011/05/puma-announces-results-of-unprecedented-environmental-profit-loss/

    In other words, the key challenges for embedding natural capital into financial accounting do not relate to trying to understand whether and how changes in natural capital can affect asset / liability values (i.e. changes in natural capital will directly affect the underlying transactions anyway…) but striving to:
    – disclose the sustainability footprints of asset / liaility classes & revenues / expenses classes towards integrated disclosure models ;
    – disclose the externalities linked to the transactions given rise to financial accounting journal entries.
    See forthcoming book : Houdet, J., (In press). Le BILAN BIODIVERSITE. Natureparif – Synergiz, 155p.

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