Geoff Wells

In the practical world of business, environmental accounting has been, until
recently, a relatively minor matter of internal costs. It has related to a straightforward
management and management accounting issue: how to identify and capture
environmental costs, with a view to minimising them. In the course of the last
decade, however, the theory and practice of environmental accounting has taken it
well beyond the boundaries of this exercise. Environmental accounting is now seen
not only as a core business issue, but as raising fundamental questions of accounting
theory, and even of challenging the foundations of accounting and of the theory of
business itself. This paper attempts to trace the outlines of this trajectory, and
suggests some possible research strategies directed to exploring these issues further.
At a first level of analysis, it is clear that environmental impact and management is
increasingly seen as relevant to all the major divisions of modern corporate practice,
including marketing, operations, and finance. It now figures as a major component of
corporate strategy. The emphasis is moving away from the impact of environmental
factors on the cost burden, to the strategic opportunities becoming available as the
result of a sea-change in the marketplace. This change has been lead by a
transformation of consumer sentiment, particularly in Europe: environmental
legislation and regulation; media reporting of environmental damage; consumer
concerns over environmental safety and health; consumer preferences for
environmentally friendly products and services; an upsurge in community awareness
and understanding of environmental issues and implications, from a wide educational
base; all are well established trends, particularly in Northern Europe, but, to different
degrees, in most major developed and developing markets.1
It is a trend that is discernible even in countries that historically have largely
ignored the environmental dimension of government policy, such as China: faced with
catastrophic degradation of soil and water, on a vast scale, the Chines government is
beginning to incorporate environmental dimensions in major policy initiatives,
including those that regulate corporate practice, in the new environment of WTO
accession. Interestingly, this is a trend that is less well developed in North America,
where the underlying cultural belief in the intrinsic beneficence of science and
technology, and of the corporations who use them, is apparently highly resistant to
evidence to the contrary. Even in the US, however, the natural foods sector has been
© 2004 Dr. Geoff Wells

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accountants are not. Monsanto presents perhaps the most spectacular example of the consequences of American hubris. Monsanto still seems unable to understand or accept. Geoff Wells Page 2 . remediation and clean-up. in its attempt to export genetically-modified seed stocks to Europe. Typically. savings. such as pollution controls. it generally becomes clear that environmental costs are a far greater percentage of total costs than had been realised. through cost reductions from the prior year to the report year. after a fruitless expenditure of millions of public relations dollars. or lifecycle cost reductions are typically not captured.Draft growing. To put it bluntly. through identification of lower polluting materials or reprocessing. are not even identified for what they are. Environmental costs are scattered across overhead accounts. this underestimation is a consequence of lazy accounting practice.” This financial statement identifies costs associated with the company’s environmental programmes. a US company producing. An example of a systematic attempt to capture internal costs and benefits arising from its environmental programme comes from Baxter International. as a rule. Accounting theory and practice now has to reflect that new reality. raw material initiatives. they cannot be effectively managed. or difficult to classify (in my experience. Thus the financial returns potentially available from waste reduction. energy conservation. developing and distributing medical products and technologies. As a result. even manufacturing processes. because they are not consolidated and appropriately classified. and a line item called ‘cost avoidance’ relating to additional costs other than the report © 2004 Dr. comfortable in having habitual practice challenged. and. at more than 30% per year over the past decade. ignore consumer preferences for environmentally safe and friendly products and services. and therefore whose national governments. with impunity. or captured only partially. and American corporations are coming to terms with the fact that they cannot. whose consumers. and its takeover and corporate relegation by Pharmacia. waste disposal. Overhead accounts become general dumping grounds for costs that are out of the ordinary. still central to the way in which companies think about the environment. with annual revenues in excess of US$5 million. There is nothing unreasonable in such a focus. the purpose of which was to report on “the total of financial costs and benefits that could be attributed not only to the environmental programme itself but to the environmentally beneficial activities across the corporation. a modern company ignores the environmental dimensions of its business at its peril. Once systematic analysis of business operations and processes is undertaken. In 1995 Baxter developed an Environmental Financial Statement. nevertheless. admittedly on a small base. Cost efficiencies are. and in having to think things through from first principles). have been fiercely resistant to such products—a miscalculation (or culpable myopia) which even now.

flooding up to 2000 square kilometres (the size of greater Sydney). which cost more than US$ 3. BP Amoco is a notable example to the contrary: for the past several years it has been adopting in its global operations strategies to maximise cost efficiencies and capture competitive advantage in this new environment. and monitoring and subsequently more than US$5 billion in punitive damages claims by commercial fishers and native Alaskans. actual cost savings can be made. ruining the subsistence plots and destroying the wildlife of the region. the riverbed has filled up with sediment. and regulatory infractions. Relatively few companies have begun to think about the potential upheaval in their cost profiles and cost reduction strategies in the carbon emissions caps and trading environment that is rapidly approaching. are not common practice because conventional financial analysis doesn’t support them. that the focus of the analysis is entirely internal— the entity assumption is maintained. is Exxon Corporation’s Alaskan oilspill. fines. and no external environmental impacts of the business is considered—but it does demonstrate that by explicitly considering environmental dimensions of a business. as society’s expectations of company performance become greater and less prepared to countenance environmental damage. legal defence (against class actions. product recalls.2 It should be noted that intangible cost reductions are even less likely to be identified and secured. and flushed 70 million tonnes of waste a year down the river system to sea. and penalties. There is no question that the legislative and regulatory component of the societal framework within which contemporary business functions is targeting fundamental aspects of business operations—processes which may have funded a company’s profitability for decades —and is being administered more strictly. however. Penalties for infractions are being raised across the world. and waste can generate significant contingent liabilities for rectification. for example). the BHP Ok Tedi copper mine has turned a mountain into a basin. In the process. a healthy surplus. Present outlays to avoid future expenses. Note.5 billion in clean-up. Geoff Wells Page 3 . wiping out its rainforest canopy. and by capturing its impact in the accounting structure. The environmental bottom line is then calculated as the sum of savings and cost avoidance less costs—in Baxter’s case. Risk management and liability reduction is an associated arena of environmentallydirected business strategy. environmental mitigation. It remains to be seen whether the $80 million settlement of the class action launched on behalf of the Ok Tedi villagers will be the end of the © 2004 Dr. Resource depletion. of course.Draft year’s savings that were not incurred. pollution. The most notable example of this liability. Closer to home. The land and watercourses of the lower Ok Tedi river have become a heavymetal toxic waste dump. fines. but would have been incurred in the report year if the waste reduction activity had not taken place. product liabilities. customer boycotts. clean-up. such as landfill.

3 Clearly. one would have to be sceptical. environmental strategies offer not just cost reductions but competitive advantages in the market.4 Again. and they cannot achieve environmental excellence by evaluating and rewarding performance based strictly on short-term financial indicators. not total costs produced to both entity and society. this is the result of a sustained and deeply-based upsurge of consumer © 2004 Dr. a company must consider total costs. Geoff Wells Page 4 . an observation to which we will return. In recent years. we might look to this statement. more than most. As noted. the entity assumption that is fundamental to accounting theory has become comprehensively breached.Draft matter. has been faced with the realities of environmental challenges: Oil and gas companies cannot continue to achieve financial success without also achieving environmental excellence. That is the result of an almost total lack of comprehension of the enormous costs of miscalculating the environmental risks.000 villagers affected in both livelihood and health. rather than on its social context. when one attempts to manage and report on risks of this magnitude. current performance appraisal process only incorporates a fraction of all environmental costs. and the economic consequences of changes in corporate image linked to environmental performance. As an example of what might be called the progressive corporate view of environmental performance. hidden. and international environmental taxes will help oil and gas companies integrate environmental performance into their management evaluation and rewarding systems. particularly when dealing with such vast environmental and social impacts as those of Exxon Valdez and BHP Ok Tedi. however. We may have an uneasy feeling that. When evaluating management performance. the tools of risk management and financial modelling are manifestly inadequate. taken from the oil and gas industry—an industry which. To do otherwise can lead to poor environmental decisions which eventually will adversely affect the company's long-term profitability. with their associated physical and social consequences. “Total costs” here means total costs to the entity. future regulatory compliance. The less tangible. and increasingly in contemporary business. note that the emphasis of such a comment is on the entity. are largely ignored. as the company jettisons its holding in the operation into a Singapore trust for the benefit of the 30. environmental multiplier. indirect costs such as potential legal liability. For many oil and gas companies. Environmental performance. including all internal and external environmental costs.

That it is deeply-based is now well confirmed: recent market research undertaken in Europe on consumer attitudes to genetically-modified food. to be allocated as overheads. about the nature of science. even about the nature of life itself—which are simply not amenable to manipulation through standard advertising and promotional techniques. and processes. and then the advantage for environmentally friendly products will be simply access to market. external social impacts (Ok Tedi demonstrates how interdependent these are). they are managed as a central business focus by margin analysis. to business centres and products. The focus of the analysis has still not moved outside the entity—the only environmental costs considered are those incurred by the entity—but the entity’s enterprise has been penetrated by the environment. finance. either now or in the © 2004 Dr. of which now. In textiles. In this context. and green labelling and marketing are part of a company’s differentiation strategies. Geoff Wells Page 5 . Experience suggests. even standards of shrinkproofing in the yarn and fabric. limitations on the residues of pesticides and chemicals in greasy wool (unprocessed wool). In this consumer environment. At present. it is necessary to take account.Draft sentiment in favour of environmentally friendly products. for that matter. the newly introduced European Ecolabel. Let us now come back to the question of external environmental impacts. These are no longer unavoidable costs of doing business. has demonstrated that consumer resistance to these products has its roots in fundamental beliefs and attitudes—about family health. and marketing. along with accountants and executives. Without it a company will not even be able to enter the competitive arena. such environmental marketing strategies command a premium in the retail market. but a central part of the business itself. or. the costs associated with meeting environmental standards are seen in an entirely different light. As such. They are product linked—direct costs—a central component of the cost of goods sold. required standards for dissolved solids in scouring effluent (cleaning the wool). for example. feeding directly into the calculation of gross profit. extending even to the processes by which they are produced—animal welfare or sustainable agriculture production. One has only to walk into a UK supermarket to verify this trend: products are labelled with an array of environmental classifications. they become not part of the business environment. for example. places strict requirements on the entire lifecycle of the product: in woollen fabric and garments. It is clear from the foregoing account that there may well be costs incurred by the impacts of the operations of the business that are not met. that these products will become commoditised. services. in the pursuit of competitive advantage. driven by government regulation. to conserve garment use and minimise disposal volumes. demand has emerged for the production and delivery of green products and services. however. across the range of products and markets. Environmental considerations thus move from the margins of the business into its core segments of operations.

In fact. distinguishing between the costs of renewable and non-renewable resources. (2) The basic principle of materiality has tended to preclude the reporting of environmental information. (5) Conventional accounting does not account for the full cost of production because it assigns no monetary costs to the consumption of natural resources such as air. Most attempts to assign value to external environmental impacts move quickly into estimates. in the current environment. reported profits would not be directly impacted. it may result in a lower net profit and lower earnings per share. with the resulting decimation of associated flora and fauna. with their associated controversies concerning methodology. This is because the notion of expenses is linked to the notion of reduction of assets. (6) Accounting rules may penalise environmentally responsible behaviour. Unless this behaviour is reflected in a higher price for its products. (4) In financial accounting expenses are defined to exclude the recognition of any impacts on resources that are not controlled by the entity. Geoff Wells Page 6 . given the relative difficulty of identifying and quantifying some categories of environmental costs and benefits. In large part. That is. (3) Measurability is an associated limitation. Social costs and related benefits are ignored. The recognition criteria of financial accounting require an item to have a cost or other value that can be measured financially and reliably. they are costs picked up by the society at large. water and land fertility. unless fines or other cash flows result. we evaluate the performance of companies and their management—mean that if an entity were to progressively degrade the quality of water in its vicinity. and assets are defined in terms of future economic benefits controlled by the entity. The net result of these deficiencies of conventional accounting—the structure by which.Draft future. which in turn have their foundation in financial accounting theory. or providing accounting incentives for protection of the environment. the public at large. monitoring the use of green assets. the performance of such an entity could well © 2004 Dr. then to the extent that no fines or other related cash flows were incurred. (7) Conventional accounting does not have a mechanism for recording green assets. This limits access to information by people who are impacted outside the financial parameters of the entity. Some of these limitations are as follows5: (1) Financial accounting focuses on the information needs of those parties involved in making resource allocation decisions about the entity— predominantly stakeholders with a financial interest in the entity. this is due to limitations in conventional accounting and costing rules. or their consumption. that is. with its underpinnings in political economy theory. by the company itself.

there is something profoundly wrong about this system of measurement. Here are two examples.Draft be portrayed as very successful. but intra© 2004 Dr. using studies of sustainable shadow pricing. However. BSO/Origin deducted the total of these costs (which it called “extracted value”) from operating income to give what was then defined as “sustainable operating income”. with simply reporting these costs. courageous attempts—to develop new accounting approaches that might begin to internalise the external environmental impacts of an entity. issued by the World Commission of Environment and Development in 1987. As has been well. . however. that can signal success in the midst of desecration and destruction. a North American electricity distributor (now Hydro One). Physical impacts were then assigned monetary value through economic valuation techniques. There sustainable development was that defined as “.” This lead to a concern with not only inter-generational equity. all such approaches represent themselves as “full-cost accounting”. A more radical approach has been offered by BSO/Origin. The damage function was calculated by techniques using market prices to estimate monetary values from those impacts. or in parallel with. which placed a monetary value on the external environmental costs of the company’s operations. In one way or another. pioneered a “damage function” approach. while impacts external to the entity were recognised and valued.development that meets the needs of the present world without compromising the ability of future generations to meet their own needs. a Dutch computer consultancy organisation. as an approximation to the real costs. The most-quoted definition of sustainability is that of The Brundtland Report. For some years the company provided environmental accounts. in the current corporate environment. or difficult to come by. they were not fully internalised into the company’s accounts. and using “willingness to pay for”.6 There have been some attempts—one would have to say. if emotionally. . Carried through to the bottom line. . Its methodology used two methods: actual damage costs. . These estimates were combined with environmental modelling techniques to consider potential damage to the environment. or “willingness to accept”. in parallel with the company’s accounts. prevention costs. Not content. This is hardly hypothetical: business practice worldwide abounds with such examples. the world-wide rise of the notion of sustainability. such as crop losses. where these are not available. a system that makes things visible and which guides corporate and national decisions. but presented in parallel. that are traded in the market. the new result becomes “sustainable net income. changes in environmental quality. and. for impacts that are not explicitly traded in the market. said: .” It is interesting to note that the demand for full-cost accounting arose as a consequence of.7 Ontario Hydro. Geoff Wells Page 7 .

is that the biosphere (itself difficult to define) is a dynamic system. but used sensibly in discourse. in the same way that principles like ‘democracy’ are widely defined and implemented. one may feel. like “freedom”. which is explicitly linked to sustainability. however. One recent commentator noted. but nobody is sure of what it means (at least it sounds better than ‘unsustainable development’). Accounting concepts need to be sufficiently defined to allow. which commentators think they intuitively understand. . approach to full cost accounting. It has been noted that the decade that followed the Brundtland Report has done little to clarify the concept of sustainability: it has been estimated that there are more than 5000 definitions now circulating in the literature. it doesn’t work for accounting.9 The problem with this definition. The Brundtland initiative was followed in 1992 by a European Earth Summit. Such a figure would be a notional one. and measure. it has been argued that although there is a conspicuous lack of consensus on the exact definition of sustainability. this document made the crucial connection between sustainability and environmental accounting which has governed radical critiques since that time. . in the contemporary business environment. however admirable in spirit. which released a document called Towards Sustainability.Draft generational equity. “Sustainable development is a term that everyone likes. called for. through the following definition: . in other words. “a redefinition of accounting concepts.sustainable cost can be defined as the amount an organisation must spend to put the biosphere at the end of the accounting period back into the state (or its equivalent) it was in at the beginning of the accounting period. The kind of difficulty one can encounter is illustrated by the NZ-based Landcare Ltd. I will not attempt to deal here. which follows a development trajectory. conventions and methodology so as to ensure that the consumption and use of environmental resources are accounted for as part of the full costs of production and reflected in market prices”—a tall order. to anyone educated in the elements of biology.” In response. Geoff Wells Page 8 . However. among other things. This document. and disclosed as a charge to a company’s profit and loss account. “Sustainability” is one of those concepts. One would have to reframe the definition to include: © 2004 Dr.8 While granting the validity of this argument for some purposes. uniform practice. Whether this has been a helpful link is open to question. rules. has widely different interpretations. but which. on closer examination. a concern with globally conceived social justice —an important component of subsequent environmental accounting theory with which. it carries a core meaning which is substantive and important.

used on the dirtier parts of the wool. if approaches to full cost accounting of external environmental impacts are to be logically consistent.Draft . Both are directed to getting large contaminants. but it is. It sounds a promising approach conceptually. A major Australian woolprocessing company (which shall remain nameless. the second. is allowed down the drain. such as skirtings. bellies. the modelling of the complex global land. . would one want to measure the social benefit of employment. some of this effluent is first diverted to a large © 2004 Dr. employs acid. when it reaches the regulatory level of TDS. Essentially it involves taking wool in its raw state—termed ‘greasy wool’—and washing it with various detergents and chemicals. Geoff Wells Page 9 . and atmosphere systems associated with global warming). Effluent from scouring (which is common to both processes) and from carbonising is treated. useless in practice. This in turn would require sophisticated modelling and measurement at a level which is only now taking its first. and similar financial treatment of these benefits in the company’s accounts? For example. as I’ve laid them out here. tentative steps (for example. out of the wool: the first process is. by physically combing the wool. such as burrs. which carbonises these solids to make them easier to eliminate. it does seem to me that this is a question that may have to be answered. Without having analysed it very fully. and then. Let me turn now to a case study which nicely illustrates the main issues associated with environmental accounting. for commercial-in-confidence reasons) has been looking at the way it is handling in its accounts environmental aspects of its operation. I will return to this notion in a moment. which would be far greater in a large company than in a small one? Or the multiplier effect in the economy of a company’s transactions with suppliers? And so on. It seems to me one could argue as follows: if it is to be required that company’s should internalise the costs of their operations on society at large (as in environmental and social impacts). There are two primary processes: combing and carbonising. as the name implies. And the answer may lead to a re-configuration of the very idea of a business. locks. One other observation on the theoretical challenges to financial accounting theory as it attempts to meet the demands of environmental externalities. At the site of this particular processor. Wool processing is a dirty business. and so on. then treating it in various ways for specific fibre performance. and that financial statements reflecting these costs are a truer representation of the company’s value: why should one therefore not require similar treatment of benefits to the society at large of the external impacts of the company’s operations. .the amount an organisation must spend to put the biosphere at the end of the accounting period back into the state it would have been in without the operations of the company during the accounting period. water. to all intents and purposes.

The impact of running types that generate high TDS loads is thus increased water flow and increased energy usage. these measurements are captured in KPI reports. These are determined by looking at the previous ten or so runs of that type. Most of the environmental measurement currently occurring is at the plant level.Draft composting project. which is currently under development and testing. Different product types require different inputs of: water. Geoff Wells Page 10 . that has been the focus of some initial work in environmental accounting. that the kind of compost produced here did not itself generate environmental negatives when applied to agricultural or horticultural enterprises. it is legitimate to question whether. Secondly. the definition of waste becomes important. with the expectation that different wool types will dilute it. However. just because a product has commercial value. and the outcomes of these runs. if one wants to link ‘waste’ and ‘environmental impact’. that under this view. and must therefore be disposed of with maximum cost and environmental efficiency. Moreover. data on the relationship between product batches and water usage is collected but has not been analysed or costed. This is measured as Total Dissolved Solids (TDS) before it is released to the drain. it is released to the drain. carbonising. the flow from the plant is recycled back through the plant. There has been no attempt to drive measurement through to the product level (‘types’). If the TDS measure is too high. One would want to be sure. detergent. but are not currently costed. it has been calculated that this plant (one of the largest wool processing plants in the world) would generate sufficient material to compost the entire Barossa Valley vineyards every year. the following environmentallyrelated accounting observations have been made: Clearly anything one wants to do to advance environmental accounting requires underpinning in the measurement of materials. From one point of view. hydrogen peroxide. electricity is only measured for the plant as a whole. At the same time. In looking closely at the carbonising process. However. now it is a product in its own right. however. for example. ‘waste’ may change as commercial conditions change. Note. ‘waste’ would be any output from the plant that has no commercial value. only approximately 50% of key materials flows in the carbonising process are currently measured. It is the second of these processes. Thus woolgrease was of no commercial value a decade ago and had to be burnt. sodium carbonate. In addition. The same may shortly apply to compost: if the compost process reaches the required specifications. it is free of environmental impacts. Here therefore are some key questions that arise from this analysis: © 2004 Dr. Flow down the drain therefore varies in composition from product to product. When the TDS measure is at the level allowed. earning significant revenue.

conceive of a commercial environment where the main product resulting from wool processing was not wool. Geoff Wells Page 11 .) c) If one looks at by-product sales. the introduction of the Ecolabel may require a reexamination and reconfiguration of the manufacturing process.Draft a) What elements of the manufacturing process contribute most to the cost handling the TDS load? Have the costs of all elements been captured? What does this imply for materials measurement. where the environmental accounting begins to impact marketing and selling decisions. appropriately classifying. for costing. All this is simply to demonstrate that the kinds of issues that are arising in environmental accounting. but wool grease—with the clean wool fibre becoming a waste product of no commercial value that must be disposed of? What would be the trajectory of the accounts. including the environmental accounts. in tracking this kind of fundamental change in the identification of manufactured products?) d) How can one best account for the potential impact of external costs—for example. where the question of externalities looms uncomfortably large—is becoming. But it is intriguing. or in possible risks associated with the byproducts. The Ecolabel criteria set levels of certain components of the effluent from scouring.) Finally. and raises some challenging questions. and a change in the marketing and selling strategies by product and market. Here a better understanding of costs by product may lead to a revision of gross margins. what is the best way of understanding the costs of producing them (at present. for example. Irrespective of the actual environmental impacts of its manufacturing processes. as noted above. the company will now have to meet these environmental standards in order to maintain access to its European market. and about which the academic accounting establishment is © 2004 Dr. Could one. wool grease and compost? (This is an example of Level 3 analysis. the Ecolabel criteria prohibit the use of some manufacturing processes. such as the use of chlorine in shrinkproofing.) b) What product types contribute most to the cost of handling the TDS load? (This is an example of Level 2 analysis. woolgrease is assumed to have no cost of production)? Will this change as the commercial value of outputs changes over time? (This too is an example of Level 2 analysis. a ‘stay-in-business’ issue—yet is not in any way being captured in the current accounting or projections. in the drain discharge. and for bringing these costs to book? (This is an example of what we may call Level 1 analysis. and these criteria incorporate other standards relating to chemical residues in the greasy wool. In addition. and therefore reducing manufacturing costs. for instance. in fact. in which the focus of the environmental accounts is exclusively on capturing. while still setting standards for the shrinkproof qualities of the processed fibre.

This approach holds that the real economic value of a firm’s business. there is an added benefit to society. The first concerns what has been termed “value based management”.Draft busying itself—very real challenges to contemporary business practice.is the specific function and contribution of business enterprise. . or not. specifically. these are issues that have penetrated all the main segments of the business— here. especially publicly owned companies. Conventional GAAP principles. and the entire economy benefits.11 There is.12 The implementation of this dictum in modern best practice is widely agreed to be value based management (VBM). as we will see. In consequence. whether it is completely reflected in the firm’s stock price or not. they don’t reflect the opportunity cost of equity nor consider the time value of money. in my experience) profitable in the conventional accounts. This is the view that “all companies. . reason to challenge the view that shareholder value and value to society are inherently linked. which in turn is held to generate the maximum economic benefit for the society of which the company is a part: Managers create shareholder value by identifying and undertaking investments that earn returns greater than the firm’s cost of raising money. let us for the moment work within the framework which accepts that economic results are the primary outcome by which a company is to be evaluated. and finance—and have become part of the strategic landscape within which the company operates. and the reason for its existence. Various discounted cash flow (DCF) methods have been developed for analysing the expected future cash flows of a business: these include free cash flow (promoted by © 2004 Dr. and cannot therefore be used effectively in managing for increased value: accounting earnings do not equal cash flow nor do they reflect risk. When they do this. it is argued. finally. is equal to the discounted value of expected future cash flows accruing to the shareholders. Ultimately they may even play the major part in determining whether the company stays in this business. operations. It is work to obtain economic performance and results. are not designed to reflect value creation. yet at the same time be destroying economic value. a view expressed with characteristic pungency by Drucker.”10 This equates to managing for maximum shareholder value. marketing. Let us turn. a business can appear to be (may well be. Geoff Wells Page 12 . As noted above. should be managed to create as much wealth as possible. nearly four decades ago: Economic performance. Competition among firms for funds to finance their investments attracts capital to the best projects. to two research directions which seem to me to arise from this analysis. However.

and done well. and cash flow return on investment (developed by the Boston Consulting Group). and so on. But without it being done. and public disclosure of environmental issues in the annual accounts and reports of companies in the European Union. to environmental impacts that will occur in the immediate or short-term future. That will apply as much to environmental matters as it does to any part of the business. A further challenge arises from the discounting component of DCF methods. The EC guidelines allow the present value measurement of environmental liabilities. Moreover. and therefore resources.development that meets the needs of the present world without compromising the ability of future generations to meet their own needs. and. which. discounted cash flows and the use of net present value calculations are becoming commonplace in the external reports of companies. Geoff Wells Page 13 . and on the significant management challenges associated with driving VBM through an organisation. in its most widely accepted form looks for “. economic value added (developed by Stern Stewart). even if these liabilities will not be settled in the near future. this is very challenging. Nevertheless. it will include predictions of the likely trajectories of regulation and legislation. The structure of the numbers directs management attention. I repeat.Draft McKinsey). With respect to environmental issues. Accounting standards in Australia enable the disclosure of discounted cash flow information. The first is that the numbers to which the DCF methods are applied are not historical: they are projected numbers. environmental technology. they represent the ground on which modern management is conducted. These methods are far from uncontroversial: there is continuing debate on the correlation of DCF valuations with stock price. These guidelines focus on monetary information and accept discounted cash flow and net present value as appropriate measurement methodologies for environmental issues. DCF valuation techniques don’t have much validity. as any executive worth his or her salt will tell you. There is a systematic method for developing a view of the shape of the future business: this is termed “scenario analysis”13. and they arise from a comprehensive and detailed view of what the business will look like over the next five or ten years. measurement. projections are hard to do well. It thus appears to contradict the basic notion of sustainability. it has been pointed out that discounting the value of future liabilities in effect discriminates against future generations. as we have seen. the evolution of physical systems. There are at least two important challenges to such an approach. . The valuation is only as good as the projections. consumer sentiment and the form of demand.” The question that presents itself is therefore © 2004 Dr. and most companies won’t take it on. . A first research question might therefore be: can discounted cash flow methods capture the various dimensions of environmental business issues outlined above? In June (2001) the European Commission produced guidelines on the recognition. However.

I have © 2004 Dr. having some thirty years ago concluded that Marxist theory has fundamental.provides corporations with their legal standing and attributes and the authority to own and use natural resources and to hire employees. . lurks—a second research question that has the potential to overturn the fundamental assumptions about business within which one is here functioning: I refer to the entity assumption. or whether DCF tools can be developed to meet this challenge successfully. the criteria which a business has to meet in order to be seen as legitimate: Society. and waste products.Draft whether there is something in the particular character of environmental issues associated with business which precludes the use of DCF methods in managing these issues. environmental issues in accounting and finance practice and theory logically force an analysis of the nature of business itself. The organisation has no inherent rights to these benefits. are urgently seeking such methods in order to manage their businesses. which is now found used with increasing frequency—and. and its treatment in the literature is less than convincing. The main accounting theory which attempts to deal with this relationship is Legitimacy Theory. it is reasonable at least to begin with the assumption that they can be met. Geoff Wells Page 14 . particularly in the resources sector. it should be noted that major companies. do tend to raise disquieting questions that seem to demand resolution. I have some sympathy for these forays. as we have observed. flaws. and in order to allow their existence. society would expect the benefits to exceed the costs to society. more effectively. there is held to be a social contract between a company and the society in which it operates. of course. Under this theory. and its relationship to the society in which it functions is. and their stakeholder relations. The nature of the business. are very great. critical to the way in which the environmental impacts of business are handled. Simply put. Both challenges are important and require systematic resolution. a central entry point for critical accounting theorists. The social contract expresses the expectations of the society. and of the society in which it operates. with widely differing results in business practice—in company reports. Organisations draw on community resources and output both goods and services. this is a research and consulting direction I intend to pursue. it must be said. entity. to the general environment. one might observe. It is. I am not myself a Marxist. and irretrievable. but such critiques. Given the promising record of DCF approaches in management. Behind this sits—or perhaps. Moreover. The implications of this position. .14 This position is encapsulated in the phrase “license to operate”. Working with members of this department. it seems to me. or accounting.

as too difficult. Such a theory would start from the axioms associated with a commercial transaction. © 2004 Dr. intellectually provocative—that. or perhaps too threatening—can be moved towards some kind of resolution. at least.Draft been exploring the idea that an important component of what is needed to further the analysis may be a theory of business. This is to be distinguished from the economic theory of the firm. for the current disciplines of accounting and of management. may well be. is the hope. and attempt to construct logically the structure of contemporary business. It may be that with such a conceptual structure in place these deeper questions—which we recognise but tend to push to one side. I would warn. the consequences of such a logical resolution. However. Geoff Wells Page 15 . or the financial accounting theory of the business entity.

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