There is a tendency to narrow the scope of discussion of environmental reporting from the items listed above to matters, which can more easily be disclosed in the corporate report – an ascertainable cost as opposed to intentions and statistics. A number of working parties in Canada, USA, Europe and IFAC are developing ideas, and it may be that the development of auditing guidelines and even legislation will increase the pressure for environmental information in corporate reports.
The first logical step is to decide what is meant by the term ‘environmental cost’, which itself can be divided between ‘environmental measures’ and ‘environmental losses’. ‘Environmental measures’ include the costs of prevention, reduction, or repair of damage to the environmental, and the conservation of resources. Cost incurred to conserve energy, and closure costs for environmental reasons are at the periphery of this cost classification. Capital expenditure on improved technology will bring production efficiencies as well as environmental benefits, and the allocation of expenditure to these two classifications s a matter of judgment.
A commentary is needed to explain these matters to users of the financial report. ‘Environmental Losses’ cover costs that bring no benefits to the business such as legal damages, fines, penalties paid, and asset which prove irrecoverable for reasons of conversation. Suggestions for treating these costs are: 1) Most environmental costs should be charged to the profit and loss account when they are incurred, being regarded as maintenance or repair costs, with material separate items disclosed as exception under FRS 3. Expenditure concerning discontinued activities will be treated accordingly.
2) Expenditure leading to future economic benefits, to alleviate future environmental damage or conserve resources, can be capitalized as part of the cost of an asset created. Some authorities suggest that even the costs of staff training could be capitalised in this way. 3) Fines and penalties relating to past activities do not conform to the definition of prior period adjustment in FRS 3 (arising from changes in accounting policy or the correction of fundamental errors), so they will be charged to the profit and loss account on the current year basis.
Under this rule, past estimates now adjusted are treated as current period costs, which are significant for estimates of environmental liabilities, which are fraught with uncertainty. For instance, The Shell Report disclosed that: This year we report fines for not meeting laws, regulations and permits (amounting to just over $1. 4 million) which we believe is the best measure of our compliance. At the end of 2001, total liabilities for environmental clean-up, decommissioning and site restoration were $3069 million.
4) There are some debates as to the capitalisation of environmental expenditure, to improve safety or reduce emissions from existing capital assets. Capitalization can be supported if it results in economic benefit in future periods in terms of cash flows or output, but the decision is less clear-cut if the expenditure is to conform with new laws and regulations. It is difficult to support the capitalisation of cost, which would result in a carrying value for the asset in excess of its recoverable amount.
Measuring expected benefits in these circumstances is subject to great uncertainty. 5) The recognition of future environmental expenditure may support a provision out of profit to cover that cost, but provisions should only be made if a liability exists to transfer economic benefits. Thus the business must have an obligation to incur environmental cost before a provision can be made. The ASB statement of Principles suggests that a board decision is not enough to generate a liability, but that a legal or irrevocable commitment is needed before a provision can be justified.
Until the liability crystallizes, the item is contingent and should be dealt with as such a change in the law to raise standards may cause expenditure to bring existing plant up to standard. Such costs should be charged to profit and loss in the year of expenditure, but provisions suggested in years before the legislation is passed on grounds of prudence breach the principle that no obligation exists before the law is changed. The future effect of expected legislation can be disclosed as a note to the account.
There is still much to be decided before firm rules emerge for the treatment and disclosure of environmental expenditure in the corporate report. Provisions to set aside amounts out of profit to meet future environmental costs are now covered by FRED 14 Provision and Contingencies. The section of environmental liabilities suggests the following rules: 1) A provision should only be made when the business is obliged legally or ‘constructively’ to undertake rectification in the future. Of an obligation is created to spend more than the legal minimum, the full amount should be provided.
2) Expenditure provided should only be capitalised is an asset is created, i. e. giving access to future economic benefits. Costs incurred to prevent future contamination or to comply with new laws on smoke emission can be capitalised, but the cost of cleaning up this year’s spillages is a revenue item. 3) Is a business is granted a license to operate a factory, conditional upon spending money on decommissioning – i. e. cleaning up the site when the factory is abandoned – this is a liability which can be the of a provision.
The amount of the provision can be discounted to its present value, with periodic reviews of the estimates made in the face of uncertainty. The cash flows are adjusted for risks and discounted at a risk free rate. Moreover, a full or summary of environment audit report should be disclosed in the most simplified way of reporting. Environmental auditing is exactly what is says: auditing a business to assess its impact on the environment, or as the CBI expressed it ‘the systematic examination of the interaction between any business operation and its surrounding’.
The audit will cover a range of areas and will involve the performance of different types of testing. The scope of the audit must be determined and this will depend in each individual organisation. There are, however, some aspects of the approach to environmental auditing are worth mentioning: 1) Environmental Impact Assessments (EIAs) are required, under EC directive, for all major projects, which require planning permission and have a material effect on the environment. The EIA process can be incorporated into any environmental auditing strategy.
2) Environment Surveys are a good way of starting the audit process, by looking at the organisation as a whole in environment terms. This helps to identify areas for further development, problems, potential hazards and so forth. 3) Environmental SWOT Analysis. A ‘strengths, weaknesses, opportunities, threats’ analysis is useful as the environmental audit strategy is being developed. This can only be done later in the process, when the organisation has been examined in much more detail.
4) Environment Quality Management (EQM). This is seen as part of TQM (Total Quality Management) and it should be built in to an environmental management system. Such a strategy has been adopted by companies such as IBM, Dow Chemicals and by the Rhone-Poulenc Environmental Index, which has indices for levels of water, air and other waste products. 5) Eco-audit. The European commission has adopted a proposal for a regulation for a voluntary community environmental auditing scheme, known as the eco-audit scheme.
The scheme aims to promote improvements in company environmental performance and to provide the public with information about these improvements. Once registered, a company will have to comply with certain on-going obligations involving disclosure and audit. 6) Eco-labelling. Developed in Germany, this voluntary scheme will indicate those EC products, which meet the highest environmental standards, probably as a result of an EQM system.
It is suggested that eco-audit must come before an eco-label can be given. 7) BS 7750 Environmental Management System. BS 7750 also ties in with eco-audits and eco-labelling and with the quality BSI standard BS 5750. Achieving BS7750 is likely to be a first step in the eco-audit process. 8) Supplier audits, to ensure that goods and services bought in by an organisation meet the standards applied by that organisation. As a conclusion, environmental reporting is continuing to expand and evolve.
Whilst current best practice is relatively easy to identify – and an increasing minority of companies can be seen to be operating at this level – some important issues remain. Probably the most important of these are ensuring the widespread practice of environmental reporting – a virtual impossibility in the absence of regulation; developing standards for the completeness of environmental disclosures; establishing best practice in attestation of the reports; and looking forward to the more demanding challenges of reporting about sustainability.
One thing seems certain, however, environmental reporting is no passing trend. It is here to stay. Therefore, such proposals could be introduced almost immediately, would force experiment, encourage research and, most importantly, begin the process of moving the external accounting and reporting process into a more environmentally caring role. The only questions are what form it will eventually take and how its adoption by all organisations will be achieved?
