Environmental, social and governance (ESG) reporting has grown in popularity in recent years. About 90% of all companies in the US S&P 500 now issue some form of ESG report. However, these reports are often not worth the paper that they are written on, because there are few requirements or clear standards, and companies are free to choose what they include.
As a starting point to creating change, an article published in Harvard Business Review in November/December last year suggested an alternative approach to accounting for greenhouse gas emission, which we summarise below.
The main criticism of the current measurements of emissions is double-counting
The current protocol requires businesses to report three types of greenhouse gas emissions: those they produce themselves, those that are produced by their electricity supplier, and those produced by their other suppliers and customers. The emissions up and down a value chain may therefore be counted multiple times, making accounting harder.
The new approach uses a ‘reverse value added’ method to allocate emissions
The approach set out in the article suggests a similar approach to the financial ‘value added’ method used in accounting. At each stage of manufacture, a product generates emissions, and therefore incurs an ‘e-liability’. This is passed on through suppliers, and added to each new customer’s own liabilities, to generate a final figure for the product.
Each company’s liabilities are therefore a combination of original and inherited emissions
This means that each company knows exactly what emissions it has inherited, and can add to these the emission costs of its own activities (for example, manufacturing processes, or transport costs). At the same time, customers can also clearly see what the actual environmental cost is of every product—and which stages incur the biggest emissions liabilities.
This approach is also amenable to offsetting
This approach also allows companies at each stage to offset emissions, for example, by planting trees, or using carbon capture technology. This offsetting can be applied—in accounting terms—to both their own activities, and their ‘inherited’ liability. This means that companies further down the value chain can take positive action to reduce the effects of their suppliers’ activity, and reduce the liability handed on.
There are two steps required for this new accounting system
The first step is to measure the net e-liabilities incurred by the company in each period. These must be added to the inherited liabilities passed on from previous stages in the supply chain. This is usually done by estimating the volume of greenhouse gas emissions from each of the company’s activities. The second step is to allocate the liabilities to each end-product, which uses a system similar to activity-based costing.
Liabilities can also be ‘banked’ and transferred later
Just as physical assets and liabilities can be ‘banked’ against future accounting periods, e-liabilities can also be transferred later. For example, the emissions related to constructing a facility can be transferred to customers of that facility (depreciated, in accounting terms) over a period of several years.
This approach means that emission accounting matches financial accounting
This method puts accounting for emissions on a very similar basis to financial accounting. The ‘balance sheet’ will show liabilities in and out, and any liabilities generated and/or offset through the company’s own activities. The effect of each stage of value chain is clear.
There are criticisms of this approach, including the ability to avoid scrutiny
Companies that transfer all products and liabilities downstream will end up with a net liability of zero—no matter how emission-intensive their own activities. Critics suggest that this may allow these companies to avoid scrutiny. However, the balance sheet approach should make clear the volume of liabilities created and transferred at each stage.
The new approach eliminates considerable opportunity for ‘gaming’
Companies can currently eliminate their own primary emissions, for example, by outsourcing production of raw materials. However, under the new approach, the liabilities are transferred along with the products. The new system is also easier to record and audit. Technologies like blockchain could be used for transfer of liabilities to reduce any opportunity for fraud.
This new system could be applied to all organisations
This approach could be mandated for all organisations, from private sector companies, through to governments and third sector organisations. The advantage of this would be that the entire emissions value chain would be visible, and therefore there would be little or no scope to hide anything.