Archives For natural capital

wind turbines

By Martin Kelly FCCA, associate professor, accounting at Waikato Management School, New Zealand

Corporations sometimes pollute rivers, destroy forests and generate dangerous gases without reporting any of the costs that such errant behaviour may ultimately incur. The UN has explained why business managers should consider the effects of their decisions not only on finance, but also on social systems and natural capital.

Business decision models must recognise how those decisions will affect natural capital, despite the effects not being material on reported profits. ACCA’s recent report, Is natural capital a material issue? is welcome because it highlights concerns about current business decision making practices.

However, attempting to make companies put value on natural capital in their financial reports may not be the best way forward.

Society is structured so that any organisations cannot exist unless they make profits. Managers are aware of this, but most managers might agree that it is wrong to:

  • Pollute streams and the sea;
  • Pollute arable land so that little will grow on it
  • Pollute the air and in so doing affect people’s health
  • Add to the world’s carbon emissions
  • Add to global warming
  • Add to ozone depletion
  • Destroy forests
  • Destroy fish and other natural food stocks
  • Drive species of plants and animals to extinction
  • Pass onto the next generation a degraded natural environment.

Depleting or destroying natural capital in these ways usually results from business activities undertaken to increase profits. While the ACCA report suggests that in accounting terms ‘a material issue is largely defined as one that has a significant financial impact on corporate activities’, the natural capital destruction listed above typically never appears in financial reports; it is invisible to people who are trained to view the world financially.

It is interesting to examine the efficacy of financial reports in discharging their more traditional role. The 2011 working paper of the International Integrated Reporting Committee, referring to financial reports observed: ‘The small percentage of market value now explained….down to 19 per cent in 2009 (for the S&P 500) from 83 per cent in 1975. The remainder represents intangible factors…’

Do we wish to introduce further estimates and complications to financial reports? It would be difficult to provide comparable natural capital figures for all financial reports that all interested parties would agree were fair. The ACCA report itself declares: ‘Studies undertaken….showed that corporate reporting on biodiversity is largely qualitative in nature…’

The argument that what cannot be quantified cannot have influence is an absurd one. A fishing company could decide not to fish within the habitat of an endangered species. Would it be worth estimating how much the company’s total fish catch declines in value as a result, or what the value of public relations benefits are? Would everyone agree?

Most managers are aware of such disastrous outcomes as those listed above. Surely they will avoid such outcomes, even without valuations, because it is the right thing to do. Or should managers do the right thing only when it can be justified financially? If we cannot trust senior managers to behave responsible, we must re-educate them away from the hegemony of the current market model or suffer the consequences.

ACCA’s report is welcome because it challenges its readers to address an issue that everyone, for the time being, can choose to ignore. The longer the issue is ignored, the more difficult it will become to sustain natural capital. It is undeniable that natural capital is a material issue in our world. It must be recognised as such, and the related problems are quantified and appear in financial reports.

This post first appeared in Accounting and business, February 2013

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.

By James Bonner, independent sustainability consultant

In order to understand and translate the aims and objectives of sustainability into economic development terms, and to engage with groups such as business and governments who have economic growth interests, an approach based on multiple ‘capitals’ has evolved in sustainable development theory. Such a ‘capitals’ model aims to encapsulate and categorise the interrelated and interdependent resources, or stocks, which human development and wellbeing fundamentally relies upon and to communicate their value including in economic terms.

As stated in recent work they have undertaken on the capitals approach, the UK Government’s environmental department DEFRA emphasises that:

• social wellbeing and growth depend on services that flow from various types of capital, including natural capital; and
• broad categories of stocks of capital (produced, human, social, natural) are maintained so that the potential for wellbeing is non-declining over time.

While the capital model, and the broad categories which it includes, will be explored in greater detail in a forthcoming post in this blog series- this post aims to introduce the specific category of natural capital. As stated by the prominent international initiative TEEB (The Economics of Ecosystems and Biodiversity) natural capital ‘underpins economies, societies and individual well-being’ and ‘in addition to traditional natural resources such as timber, water, and energy and mineral reserves, also includes biodiversity, endangered species and the ecosystems which perform ecological services.’

With such studies and perspectives drawing attention to the vital role and integral function natural capital plays in our local and global social and economic development, ACCA, in partnership with KPMG and international conservation group FFI, are currently undertaking an extensive study to look at the concept of materiality in accounting practice, and the extent which it reflects the increasing realisation and acceptance of natural capital as a significant business issue.

By means of introduction to the topic, the following is an amended version of a diagram which will be included in the report – linking together the various environmental terms, and business concepts, of natural capital, biodiversity (the variability amongst living organisms- a key requirement for a functioning and healthy environment), ecosystem services (the benefits humanity obtains from biodiversity and the environment) and corporate value. It aims to introduce and depict some of the key, and overarching, relationships of these concepts and to demonstrate the potential tangible impacts and dependencies that society, the economy, and business have on, and with, natural capital.

This blog post intends to primarily support ACCA’s Accounting for the future session ‘Is Natural Capital a Material Issue?’ on Monday 8 October by introducing the concept of natural capital, and its potential materiality for organisations- issues which will be discussed in greater detail in the session. Additionally, a number of other presentations during the conference relate to the themes covered in this blog post:

Monday 8 October
11:30 – 12:30 Is Natural Capital a Material Issue?
14:00 – 15:30 Measuring risk: Material or significant – what it means to me

Tuesday 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

Wednesday 10 October
12:30 – 13:30 Evolution of the Annual Report

Friday 12 October  
18:00 – 19:00 Practical Workshop: The Economy in 2050