BA606 FINANCIAL ACCOUNTING

BA606 FINANCIAL BA606 FINANCIAL ACCOUNTINGACCOUNTING

Professor Garry CarnegieProfessor Garry Carnegie

Lectures 21 & 22Lectures 21 & 22

Lectures 21 and 22 : Accounting for Lectures 21 and 22 : Accounting for corporate social responsibilitiescorporate social responsibilities

IntroductionIntroduction

Social responsibility and the maximisation Social responsibility and the maximisation of shareholders’ wealthof shareholders’ wealth

Methods of accounting for and reporting Methods of accounting for and reporting corporate social responsibilitiescorporate social responsibilities


Corporate social responsibility (CSR) is Corporate social responsibility (CSR) is increasing commanding attention in the media, increasing commanding attention in the media, the markets and in society in generalthe markets and in society in generalCSR has been broadly interpreted and is CSR has been broadly interpreted and is generally thought to relate primarily to identifying generally thought to relate primarily to identifying and assessing the impacts of a company’s and assessing the impacts of a company’s operations on the welfare of societyoperations on the welfare of societySociety may be local, state, national or Society may be local, state, national or international communitiesinternational communitiesIts meaning varies across countries and culturesIts meaning varies across countries and cultures


Socially responsible activities result from Socially responsible activities result from putting into place effective policies and putting into place effective policies and procedures to ensure an entity is an procedures to ensure an entity is an acceptable, ethical citizenacceptable, ethical citizen

These activities include attitudes towards, These activities include attitudes towards, and resultant practices associated with, and resultant practices associated with, customers, employees, government, the customers, employees, government, the environment and the wider communityenvironment and the wider community


In a global CEO survey (2002), there was In a global CEO survey (2002), there was considered to be three broad levels of considered to be three broad levels of responsibility:responsibility:- an internal focus on a healthy and safe working - an internal focus on a healthy and safe working environment and an external focus on acting environment and an external focus on acting responsibly towards all stakeholders (the main responsibly towards all stakeholders (the main tier)tier)- an orientation towards shareholder value, - an orientation towards shareholder value, environmental performance and support for environmental performance and support for community projectscommunity projects- charitable contributions and external - charitable contributions and external endorsementsendorsements


One of the key matters under CSR is to One of the key matters under CSR is to deliberate upon the extent to which entities deliberate upon the extent to which entities are responsible to society for all costs of are responsible to society for all costs of their operations, such as pollution of the their operations, such as pollution of the environmentenvironmentFrom an accounting perspective, our From an accounting perspective, our prime focus is upon methods of prime focus is upon methods of accounting for and reporting corporate accounting for and reporting corporate social responsibilitiessocial responsibilities

Social responsibility and Social responsibility and shareholder wealthshareholder wealth

Literature on the theory of the firm and on Literature on the theory of the firm and on financial management strongly supports financial management strongly supports that the objective of the firm is to maximise that the objective of the firm is to maximise shareholder wealthshareholder wealthFor a listed corporation, this translates to For a listed corporation, this translates to the maximisation of the company’s share the maximisation of the company’s share pricepriceInvestment, financing and dividend Investment, financing and dividend decisions are made to achieve this aimdecisions are made to achieve this aim


This rationalist interpretation of the role of This rationalist interpretation of the role of the firm has been repeatedly challenged in the firm has been repeatedly challenged in recent times as being too narrow and recent times as being too narrow and entities are increasing expected to act “in entities are increasing expected to act “in a more socially responsible manner”a more socially responsible manner”

Opinions vary as to what this means and Opinions vary as to what this means and how this “good feeling” is operationalised how this “good feeling” is operationalised for effectivenessfor effectiveness


Should socially responsible activities be Should socially responsible activities be undertaken if they are not regarded as undertaken if they are not regarded as consistent with the shareholders’ best consistent with the shareholders’ best interests?interests?

Best interests may be viewed as short-Best interests may be viewed as short-term or long-termterm or long-term

Socially responsible activities may involve Socially responsible activities may involve corporate reputational issuescorporate reputational issues


Management will often find it hard to justify Management will often find it hard to justify the costs of socially desirable, if not the costs of socially desirable, if not socially essential projects, purely on socially essential projects, purely on financial groundsfinancial grounds

Such costs may be justified, however, on Such costs may be justified, however, on the grounds of “enlightened self-interest”, the grounds of “enlightened self-interest”, such as under a strategy to maintain such as under a strategy to maintain organisational legitimacyorganisational legitimacy


There are three key motivations for There are three key motivations for voluntarily undertaking corporate social voluntarily undertaking corporate social responsibility activities:responsibility activities:

- Enlightened self-interest- Enlightened self-interest

- Stakeholder management- Stakeholder management

- Corporate legitimacy- Corporate legitimacy


Enlightened self-interestEnlightened self-interestThis phrase relates to those costs that are This phrase relates to those costs that are incurred by an entity which appear to be incurred by an entity which appear to be motivated by a desire to promote society’s motivated by a desire to promote society’s best interest, but which are also incurred best interest, but which are also incurred in the hope of generating benefits for the in the hope of generating benefits for the entity that exceed those costsentity that exceed those costsCorporate philanthropy often falls into this Corporate philanthropy often falls into this categorycategory


Stakeholder managementStakeholder management

Stakeholder theory suggests that an Stakeholder theory suggests that an organisation is part of the wider organisation is part of the wider environment with complex and dynamic environment with complex and dynamic relationships with its many stakeholdersrelationships with its many stakeholders

A stakeholder is anyone who is affected by A stakeholder is anyone who is affected by the continual push by entities of all types the continual push by entities of all types to achieve their objectivesto achieve their objectives


Stakeholders include groups and Stakeholders include groups and individuals such as environmentalists, individuals such as environmentalists, consumer advocates, media, government consumer advocates, media, government and global competitorsand global competitorsStakeholder theory suggests that a key Stakeholder theory suggests that a key role of management is to assess the role of management is to assess the importance of meeting stakeholder importance of meeting stakeholder demands in order to achieve the entity’s demands in order to achieve the entity’s strategic objectivesstrategic objectives


Stakeholder importance derives from the Stakeholder importance derives from the capacity to control resources that an entity capacity to control resources that an entity requires to use in order to achieve its objectivesrequires to use in order to achieve its objectives

Corporations are required to strategically Corporations are required to strategically manage relationships with important manage relationships with important stakeholders in order to continue to have access stakeholders in order to continue to have access to key resourcesto key resources

CSR reporting is seen to be undertaken as part CSR reporting is seen to be undertaken as part of a stakeholder management strategyof a stakeholder management strategy


Corporate legitimacyCorporate legitimacy

Under legitimacy theory, the relationship Under legitimacy theory, the relationship between an entity and society is subject to a between an entity and society is subject to a “social contract”“social contract”

Broadly, the implied social contract provides Broadly, the implied social contract provides that, so long as an entity is operating in ways that, so long as an entity is operating in ways which are consistent with society’s values, the which are consistent with society’s values, the entity’s legitimacy and ultimately its survival are entity’s legitimacy and ultimately its survival are assuredassured


The legitimacy of an entity is called into question The legitimacy of an entity is called into question when that entity infringes or even breaks its when that entity infringes or even breaks its social contractsocial contractIn other words, the behaviour of the entity does In other words, the behaviour of the entity does not match society’s expectations of appropriate not match society’s expectations of appropriate behaviourbehaviourThis disparity creates threats to corporate This disparity creates threats to corporate legitimacy, known as “legitimacy gaps”legitimacy, known as “legitimacy gaps”Consider the case of Arthur Andersen where the Consider the case of Arthur Andersen where the firm irreparably broke its social contractfirm irreparably broke its social contract


There are three ways to close a legitimacy gap:There are three ways to close a legitimacy gap:

- change corporate performance and activities to - change corporate performance and activities to conform with social standardsconform with social standards

- change external expectations about corporate - change external expectations about corporate performanceperformance

- direct attention away from the legitimacy gap or - direct attention away from the legitimacy gap or reinforce management’s responsiveness to reinforce management’s responsiveness to social and environmental issuessocial and environmental issues


There is support for the contention that an There is support for the contention that an unless the benefits of a socially unless the benefits of a socially responsible activity flow to an entity and responsible activity flow to an entity and exceed the costs, then legitimate reasons exceed the costs, then legitimate reasons exist, from an entity’s point of view, not to exist, from an entity’s point of view, not to act in a socially responsible manneract in a socially responsible mannerAccordingly, social costs arsing from an Accordingly, social costs arsing from an entity’s activities tend to be borne by the entity’s activities tend to be borne by the rest of the communityrest of the community


The “internalisation” of social costs makes The “internalisation” of social costs makes an entity more conscious of them and, an entity more conscious of them and, accordingly, includes them (rather than accordingly, includes them (rather than excludes them) with other costs in excludes them) with other costs in decision makingdecision making


Internalisation of certain social costs can Internalisation of certain social costs can occur in three key ways:occur in three key ways:- Imposing increased costs on entities Imposing increased costs on entities

which tend to shirk their responsibilitieswhich tend to shirk their responsibilities- Entities may jointly undertake socially Entities may jointly undertake socially

responsible activitiesresponsible activities- Governments may command entities to Governments may command entities to

act in particular socially responsible act in particular socially responsible waysways

Accounting and reporting methodsAccounting and reporting methods

Accounting for corporate social Accounting for corporate social responsibilities is unregulated in Australiaresponsibilities is unregulated in AustraliaThe other related legal requirement is The other related legal requirement is found in sec 299(1)(f) of the Corporations found in sec 299(1)(f) of the Corporations Act 2001 with respect to Directors’ ReportsAct 2001 with respect to Directors’ ReportsAccounting for such responsibilities is, Accounting for such responsibilities is, therefore, unregulated and what therefore, unregulated and what accounting and reporting takes place is accounting and reporting takes place is undertaken on a voluntary basisundertaken on a voluntary basis


Possible reasons for accounting for such Possible reasons for accounting for such responsibilities are as follows:responsibilities are as follows:

- Cost benefits analysis for internal - Cost benefits analysis for internal decision makingdecision making

- Cost disclosure for product differentiation - Cost disclosure for product differentiation purposespurposes

- Enlightened self-interest/stakeholder - Enlightened self-interest/stakeholder management/corporate legitimacymanagement/corporate legitimacy


Early corporate social responsibility Early corporate social responsibility reporting trends in Australia are reviewed reporting trends in Australia are reviewed by H, P & P, pp. 998-999by H, P & P, pp. 998-999

Impetus for change and recent reporting Impetus for change and recent reporting practice are addressed by H, P & P, pp. practice are addressed by H, P & P, pp. 999-1002999-1002


Key methods of accounting are as follows:Key methods of accounting are as follows:

- Descriptive performance reporting- Descriptive performance reporting

- Quantitative reporting- Quantitative reporting

- Full cost reporting- Full cost reporting

- Triple bottom line reporting- Triple bottom line reporting


Descriptive performance reportingDescriptive performance reporting

Such disclosures are the most commonly Such disclosures are the most commonly made by entitiesmade by entities

They appear in a stand-alone reportThey appear in a stand-alone report

Take the form of an “inventory” of CSRTake the form of an “inventory” of CSR

Typically contains “good” newsTypically contains “good” news

May be regarded as the “smiling faces” May be regarded as the “smiling faces” approach to CSRapproach to CSR


The inventory commonly includes:The inventory commonly includes:- Physical resources and environmental - Physical resources and environmental contributionscontributions- Energy- Energy- Human resources- Human resources- Product or service contribution- Product or service contribution- Community involvement- Community involvement- Other- Other


Problems with this approach:Problems with this approach:

- The list of headings and related issues is - The list of headings and related issues is virtually limitlessvirtually limitless

- Difficulty in obtaining benchmarks by - Difficulty in obtaining benchmarks by which to compare and contrast an entity’s which to compare and contrast an entity’s performanceperformance

- Captured by marketing departments and - Captured by marketing departments and reflects a “feel good” (i.e. soft) approachreflects a “feel good” (i.e. soft) approach


Quantitative reportingQuantitative reportingReporting is based on attempts to quantify Reporting is based on attempts to quantify an entity’s social and environmental an entity’s social and environmental interactionsinteractionsAn entity may, for example, attempt the An entity may, for example, attempt the quantify the environmental impacts of its quantify the environmental impacts of its products over their life cyclesproducts over their life cyclesReview Figure 30.4, H, P & H, pp. 1006-Review Figure 30.4, H, P & H, pp. 1006-10071007


Full cost reportingFull cost reportingSuch systems are intended to include in Such systems are intended to include in accounting and economic numbers all the accounting and economic numbers all the potential/actual costs and benefits potential/actual costs and benefits including environmental and social including environmental and social externalitiesexternalitiesIdeally, reported profit is adjusted to reflect Ideally, reported profit is adjusted to reflect costs and benefits which would normally costs and benefits which would normally sit outside the limits of the reporting entitysit outside the limits of the reporting entity


Various approaches used in full cost Various approaches used in full cost experiments from the 1970s include:experiments from the 1970s include:

- Early full cost experiments- Early full cost experiments

- Maintenance cost approach- Maintenance cost approach

- Asset valuation approach- Asset valuation approach

- Damage cost approach- Damage cost approach


Impediments to implementing a Impediments to implementing a dependable full cost social responsibility dependable full cost social responsibility reporting system include:reporting system include:

- Measurement of financial values- Measurement of financial values

- Data availability- Data availability

- Additivity of measurement unit- Additivity of measurement unit

- Reliability of measurement- Reliability of measurement

- Suitability of certain estimates- Suitability of certain estimates


Triple bottom line reporting (TBL reporting)Triple bottom line reporting (TBL reporting)Given concerns relating to each of the above Given concerns relating to each of the above methods, attempts have been made to methods, attempts have been made to incorporate qualitative, quantitative and financial incorporate qualitative, quantitative and financial data into a single accounting methoddata into a single accounting methodKnown as “triple bottom line” or “sustainability Known as “triple bottom line” or “sustainability reporting”, the focus is widen to embrace the reporting”, the focus is widen to embrace the economic, environmental and social economic, environmental and social performance of entitiesperformance of entitiesOtherwise known as “the three Ps”: people, Otherwise known as “the three Ps”: people, profit, planetprofit, planet


““Economic bottom line” refers to the Economic bottom line” refers to the traditional bottom line as well as to issues traditional bottom line as well as to issues relating to the long-term sustainability of relating to the long-term sustainability of an entity’s costs, of the demand for its an entity’s costs, of the demand for its product, profit margins and so onproduct, profit margins and so on


““Environmental bottom line” encompasses Environmental bottom line” encompasses the sustainability of the entity’s use of the sustainability of the entity’s use of natural, renewable or substitutable natural, renewable or substitutable resources and its restoration performanceresources and its restoration performance


““Social bottom line” is concerned broadly Social bottom line” is concerned broadly with social capital with a focus on human with social capital with a focus on human capital, such as in the form of public capital, such as in the form of public health, skills and education, and more health, skills and education, and more generally with society’s health and wealth generally with society’s health and wealth creation capabilitiescreation capabilities


TBL reporting involves disclosing a range TBL reporting involves disclosing a range of qualitative, quantitative and financial of qualitative, quantitative and financial data about an entity’s economic, data about an entity’s economic, environmental and social performance to environmental and social performance to key stakeholder groups key stakeholder groups The information reported typically includes The information reported typically includes a range of performance indicatorsa range of performance indicatorsAim is to derive a range of benchmark Aim is to derive a range of benchmark indicators across time and across entitiesindicators across time and across entities


The Global Reporting Institute (GRI) The Global Reporting Institute (GRI) guidelines for TBL reporting are:guidelines for TBL reporting are:

- Vision and strategy- Vision and strategy

- Profile- Profile

- Governance structure and management - Governance structure and management systemssystems

- GRI content index- GRI content index

- Performance indicators- Performance indicators


For a useful guide to TBL reporting, see For a useful guide to TBL reporting, see the Group of 100 web site: the Group of 100 web site: http://www.group100.com.au/publications/http://www.group100.com.au/publications/G100_guide-tbl-reporting2003.pdfG100_guide-tbl-reporting2003.pdf

For general information, also see For general information, also see Wikipedia: Wikipedia: http://en.wikipedia.org/wiki/Triple_bottom_lhttp://en.wikipedia.org/wiki/Triple_bottom_lineine


The implementation of a TBL reporting The implementation of a TBL reporting approach to CSR is an incremental approach to CSR is an incremental process, dealing with the complex and process, dealing with the complex and contestable issues involved in attempting contestable issues involved in attempting to effectively integrate economic, to effectively integrate economic, environmental and social performance environmental and social performance measurement into a single reportmeasurement into a single report

Documents

BA606 FINANCIAL ACCOUNTING