Triple capital accounting: Reframing corporate performance on greener terms
By Laurent Le Pajolec, Board Member at Kreston Global Member Firm, EXCO A2A Polska
Christina Tsiarta, Head of Sustainability, ESG and Climate Change Advisory Services at Kreston Ioannou & Theodoulou
With scientists recently warning that the earth’s atmosphere is likely to exceed the 1.5°C global warming threshold set under the landmark 2015 Paris Agreement within the next five years, it’s clearer than ever that we all have an urgent part to play in tackling the climate emergency. That includes the world of finance and accounting.
While the International Sustainability Standards Board (ISSB) recently announced standards focus on carbon accounting, they overlook crucial considerations on what is significant for ecosystems and the climate. Building on the intent of the ISSB’s standards, triple capital accounting (TCA) is a great solution for filtering financial and strategic corporate decision making through a scientific and sustainable lens.
TCA is designed to reset the focus of accounting techniques that have traditionally only considered the financial aspects of a company’s activities and the financial assets on its balance sheet. Under the TCA philosophy, as the name suggests, there should be three strands to accounting practice: looking at financial capital, natural capital and social capital. At its heart, the concept rejects the idea that making a profit is the only way to measure the success of a business and posits instead that the organisation’s impacts on the environment and on society are important metrics too.
Natural and social capital as strategic assets
The TCA framework allows for additional lines to be added to the balance sheet to show the depreciation of natural and social capital alongside financial capital. Importantly, all three lines of capital are treated equally as strategic assets and they cannot be substituted for one another. TCA is a branch of environmental accounting that is concerned with funding the costs of maintaining natural ecosystems and social environments, by highlighting them as liabilities that must be conserved, similar to financial capital. As well as being sound practice from an environmental, social and governance (ESG) standpoint, TCA allows these assets – and other aspects of the company’s business model that might have been previously undervalued by stakeholders – to be properly valued.
Climate change may be garnering most of the headlines, and for good reason. However, it’s far from the only ecological threat we face, and therefore it’s not the only green factor companies should consider in their TCA methodologies. Biodiversity erosion, changing land use, disruption to the nitrogen and phosphorus cycle, global water use, ocean acidification, ozone depletion, atmospheric aerosols, and the introduction of new entities into the biosphere should also be included.
There are many social aspects of the business landscape to take into account too. From human rights and anti-corruption in the supply chain, to mental health and wellbeing in the workplace, and an increasing (and widening) focus on diversity and equality in company culture, the way companies carry out their corporate social responsibility (CSR) must be transparent and accountable.
The problem with traditional accounting methods is that it’s impossible to see the impacts a business is having (either positively or negatively) on the world around it. That has got to change.
What does TCA look like?
There are many different TCA methodologies available, including the Natural Capital Protocol, the Universal Accounting methodology, and the Triple Footprint Thesaurus. However, the two most common (which we focus on here) are the CARE model (Comprehensive Accounting in Respect of Ecology) and the LIFTS model (Limits of Foundations Towards Sustainability).
The CARE model proposes that there should be an obligation to preserve natural and human capital assets alongside financial assets on balance sheets, in the P&L and in other performance KPIs. Here, human and natural capital refer, not to people or ecosystems themselves, but specifically to the assets derived from services provided by humans or by nature, through which a company creates value.
As they are based on services, human and natural capital form part of what is called ‘immaterial capital’, which falls outside of a traditional contractual or market framework. This means that intangible assets like skills, for example, are measured under this model because they increase shareholder value.
Other social CARE indicators include the worker participation rate, the unemployment rate, customer service quality and training delivery. On the environmental side, issues like a company’s carbon footprint, and contribution to air quality or biodiversity are among the key indicators, alongside the financial indicators you would expect to see such as growth rate, profitability, expenditure and debt.
This model extends the idea that a company can only calculate its profits once it has repaid its debts, considering the realms of its ecological and social ‘debts’, as well as its financial ones. In this way, it helps companies better understand their true performance and their impacts across the financial, environmental and social spectrum.
The LIFTS model was designed to help companies ensure the sustainability of their activities by adopting a socio-environmental system that allows them to monitor the integrated performance of social capital and environmental capital, in a way that ensures they do not exceed the limitations of the earth’s ecosystem (known as the planetary boundaries) or degrade people’s access to basic needs (known as the social foundations).
There are three categories of impacts for which a company is responsible: operational impact, supply chain impact, and the impact of its products and services. Looking at the company’s business model, the LIFTS accounting approach determines areas of the business with a strong potential impact on the ‘boundaries’ and’ foundations’, so that transformative steps can be taken where necessary to become more sustainable in these areas – and overall.
It’s worth noting that within this model, companies can identify the planetary boundaries and social foundations that are likely to be most impacted by their activities, so that they can prioritise what’s most important when it comes to monitoring performance and effecting change. Results are presented within the balance sheet and P&L, categorised by boundary/foundation and include an associated physical unit, such as £ per ton of CO2. Each result is calculated and analysed separately and performance in one area cannot be offset against performance in another.
In this way, activities are recorded alongside audited financial accounting in order to track multi-capital performance. Once the results are put into context, they provide vital insight into the company’s integrated performance.
What’s the direction of travel?
Several frameworks and standards already exist to help organisations measure and report on sustainability. These include the IFRS’ newly published standard providing General Requirements for Disclosures of Sustainability-related Financial Information, along with the standard for Climate-Related Disclosures. A framework to allow companies to bring nature and biodiversity into their decision-making and reporting – and thereby reduce the risk that nature and biodiversity loss can pose to organisations – is being developed by the Taskforce on Nature-related Financial Disclosures (TFND).
Expectations around incorporating environmental and social considerations into corporate decision-making and financial disclosures are growing as regulations increase and as the pressure from stakeholders to demonstrate commitment to ESG issues ramps up. Organisations and policy-makers worldwide, including the UN, the World Bank and the EU are all keenly focussed on harnessing the green economy, and the voices clamouring for natural capital and social capital accounting to become widely adopted alongside financial accounting are getting louder. All of which puts TCA firmly in the spotlight.
It’s a radical new way of looking at business performance, but one that makes a huge amount of sense. Transitioning to a TCA system will require major changes in outlook and execution by businesses, which could throw up many challenges. However, it may well open up significant opportunities too, as companies gain a more rounded perspective of the impacts of their operations and use that visibility to adapt their business models to become more sustainable and resilient, adding value to their activities and to their brands in the process. TCA is the future of accounting: the future of the planet depends on it.
Why pay for news and opinions when you can get them for free?
Subscribe for free now!