Accounting for a zero carbon economy

Steve Priddy is the Head of Research at the London School of Business and Finance

The space of low or zero carbon has, over the last decade moved beyond regulatory driven discourse to begin to consider opportunity driven, entrepreneurial initiatives.  Significant increases in investment in clean-tech business models are no longer the preserve of the traditional, fossil fuel centred generators of power.  While it is absolutely necessary to focus on and define the ‘carbon footprint’ of the state, firms and households in society, it is equally important to foster ‘animal spirits’ in the development of innovative and entrepreneurial solutions to a low carbon future.  And while emissions trading regimes demand clear and transparent accounting to facilitate deep and liquid markets, it is important not to forget that human-made carbon sinks such as on and offshore wind farms, solar arrays in deserts, perhaps the scaling up of viable carbon capture and storage schemes, as well as the inclusion of forestation and hydroelectric power, open up new and potentially profitable ventures.

It is inevitable that onlookers to the world of accounting and finance will assume that some form of accounting standardisation is a necessary condition of existence to enable such projects of sequestration of GHG emissions to be measured and to move forward.  And perhaps in the pursuit of that assumption, to consider that International Accounting Standards (IAS) ‘fit the bill’.  After all the IAS project appears to have made remarkable progress in internationalising accounting practice in its short lifetime, with only (only!) the USA as the last significant bloc prevaricating in the adoption of such standards around the world.

Yet for IAS to be the preferred route to universal disclosure and accounting for GHG emissions several home truths need to be taken on board:

• The International Accounting Standards Board (IASB) is an organisation with scarce technical and human resources.  It follows a project centred methodology, and the creation and definition of projects is a long term and complex process.  Many examples can be produced to attest to this fact.  If climate science warns the human race that 450 parts per million of carbon dioxide in the atmosphere by 2050 is the most we can take without seriously disruptive climate change, and that reduction efforts must be in place well before that time, frankly it is debatable whether the IASB can move quickly enough
• Attempts so far at accounting for emission trading allowances via the International Financial Reporting Interpretation Committee (IFRIC) – not itself part of the IASB – have so far a) resulted in failure to gain either consensus or compliance, b) focused only on one aspect of GHG emissions, namely their trading between predominantly listed corporations
• Where the IASB has achieved ‘success’ in introducing accounting standards, this has actually been driven by leadership within the accounting profession.  Most controversially the introduction of FRS 17 and IAS 19 on post retirement benefits and the ultimate inclusion of pension assets and liabilities on the balance sheets of sponsoring employers has been largely driven by a select few accounting profession individuals who have ‘made it their mission’.  Unless there are select individuals who similarly wish to drive forward carbon financial accounting then the prognosis for an international accounting standard on the same is not good

Perhaps instead we may achieve better outcomes by considering voluntary self regulation along the lines of the ‘comply or explain’ approach of corporate governance models, whether emerging from mainland Europe (two tier boards), the Combined Code in the UK, South Africa’s ‘King 3’ principles, and the International Organisation of Securities Commissions (IOSCO) guidelines which seek to include all these initiatives under one umbrella.  The advantage of a corporate governance framing of the issue is that it may open up dialogue between institutions, whether in the private, public or Third sectors as to how best to deal with the considerable uncertainties which surround measuring, monitoring and managing GHG emissions (and sequestrations) in a robust, pragmatic way.  

Whatever the case, the need for a standard way of accounting for GHG emissions is now overriding.  Such a standard way needs to respect households and states, as well as firms.  It needs to encompass not simply the large listed corporations of the world, but also the much larger stock of so-called small and medium sized enterprises (SME’s) – many of which are as large as listed stock.  Such a standard certainly needs to comply with the conceptual accounting framework, but it should also pay attention to the management accounting of organisations, not simply what is required for filing.  And a standard must not be precious about whether accounting activity and calculation is either on or off the balance sheet.  In the oil and gas sector for example, proven oil and gas reserves are not strictly speaking on the balance sheet and are not therefore assets.  However as Royal Dutch Shell found to its cost in 2004, the misstatement of those reserves has a direct and immediate impact on shareholder value, in much the same way as the material impairment of an asset.

Lastly any standard for the accounting of GHG emissions needs to be sufficiently resilient to be used in economies and nation-states of very differing economic development.

The views expressed here are those solely of the author and in no way represent those of either CDSB or LSBF.