Beyond ESG reporting

‘This marks a seismic shift in how businesses define and manage value, and challenges conventional notions of accountability and strategy,’ says Mark Lumsdon-Taylor, a partner specialising in sustainable accounting and finance at MHA, an independent member of Baker Tilly International.

Multiple capitals

To understand long-term value creation, organisations need to be aware of the risks and opportunities, or impacts and dependencies, linked to more than just their financial and produced capital.

These include natural capital – the state of ecosystems, biodiversity and the resources the business depends on; social capital – the quality of relationships, community wellbeing and social cohesion; and human capital – the skills, health and engagement of employees and partners.

Impact accounting constitutes an advancement beyond ESG reporting, which primarily examines how sustainability issues influence a company; in contrast, impact accounting evaluates how a company’s activities affect the broader world.

ESG often focuses on a company’s external disclosure, whereas impact accounting ‘starts internally with the information an organisation needs to understand value creation, including its future opportunities and how performance is developing,’ says Martin Lok, executive director at the Capitals Coalition.

‘In many ways it is the next phase of ESG because of that,’ Lok adds.

Where ESG might note that a company has a biodiversity policy, impact accounting will measure the actual ecological gains or losses resulting from land use, supply chain choices or restoration projects, and potentially translate them into measurable financial implications.

‘The shift is essentially from managing reputation to managing reality,’ Lumsdon-Taylor says.

Think differently

Impact accounting allows organisations to think differently. For instance, Alan McGill, sustainability reporting and assurance partner at PwC, says some organisations are now looking to be restorative towards the damage they have done, and can see the value in strengthening resilience in their supply chains and looking at how the business model can be improved.

‘The more progressive companies are realising that there is even more value in what their position is and have moved from net zero to being planet positive,’ McGill says.

At the heart of impact accounting lies the challenge of measurement and monetisation – translating an organisation’s environmental and social impacts into information that can inform decisions and be compared alongside financial results.

However, businesses are often dealing with multiple issues that are measured in multiple different ways and with a different unit of measurement. This might be metres cubed of water, tonnes of CO2 or hectares of land.

But simply knowing the measurement doesn’t demonstrate how important it is for an organisation. If a business can convert that into an impact through monetisation, they can ascribe a value to what has a bigger impact from an ESG perspective.

‘That monetisation allows you to convert lots of different thematic issues and measurement basis into a common unit of measurement which may allow you to use that information within the business,’ McGill says.

Monetary limits

But not all impacts can or should be reduced to monetary terms. While monetary valuation helps translate complex impacts into a common language for decision-makers, it has clear limits. Not every aspect of human or natural wellbeing can be meaningfully captured in financial terms.

Carol Adams, professor of accounting at Durham University Business School, says measuring impacts in financial terms ‘does not help manage impacts and can steer attention away from significant impacts where the financial consequences are not known’.

For instance, Adams says she does not see value in putting a financial figure on an organisation’s impact on people, the environment or the economy ‘where such measures are subjective’.

Impact accounting therefore combines quantitative measures with qualitative assessment. ‘The priority should be to measure each significant impact of an organisation in appropriate terms,’ she says.

Information barrier

The key thing for an organisation when starting to measure impact is having the information to understand the true resilience of their business model, and the key risks and opportunities based on the dependencies on which it relies.

McGill says he has worked with an FMCG company that has operations in the Asia-Pacific region that is trying to do deforestation-free supply chains over key raw materials and ingredients.

But that approach requires organisations to have a better understanding of where they are buying things from to be able to understand where those impacts are and what they can influence, McGill says.

‘That requires the organisation to look far outside the boundaries of its own floors of the factory it owns and operates,’ he says.

And despite the growing prevalence of impact accounting, a lack of awareness and scepticism remain a barrier. ‘What the farmer doesn’t know he doesn’t eat,’ Lok says. ‘Sometimes people are just unaware; they do not know you can value impacts and dependencies beyond the regular financial capital. And if they do know, they are often not always convinced that it is meaningful to business.’

Role of accountants

This is where accountants can make a real difference by ensuring that the information that companies use to underpin their decisions is relevant and consistent. Indeed, in the perception of many organisations there is not enough rigour and consistency in sustainability data, so it cannot stand the comparison of financial data, according to Lok.

‘The process that accountants go through for financial data has evolved over time, so bringing sustainability data the same level of confidence is one of the key things,’ he says.

Accountants are ‘uniquely positioned’ to lead the advancement of impact accounting, says Marco van Ackooij, managing partner at Kreston Van Herwijnen, a Kreston Global member firm.

‘They bring a deep understanding of measurement, materiality and assurance – core principles that are now being extended to include environmental, social and human capital,’ he says.