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2.Conventional financial accounting practices, principles and definitions which are guided by IASB’s Conceptual Framework for Financial Reporting (CF) discourage corporations from adopting sustainable business practice. Foremost, this is due to the defined objective of general purpose financial reporting (GPFR) which limits the notion of accountability. Next, the conventions of materiality and practice of discounting liabilities do not necessitate the need to recognise future social and environmental obligations. This is also due to the limitations of the recognition requirements relating to measurability and probability. In aggregation, these financial accounting conventions, amongst others, do not encourage sustainable business practice.

The objective of GPFR, which sets precedence for financial accounting practices, principles and definitions, is not aimed at sustainable business practice. The CF specifies that the objective of GPFR is to provide financial information that is useful for decision making purposes to investors, lenders and other creditors (OB2). Further, paragraph OB10 of the CF clarifies that whilst GPFRs may be useful to other parties including regulators and members of the public, they are not primarily directed to these groups. It apparent that the CF considers shareholders and other individuals with a financial interest in the organisation as a priority, commonly referred to as a ‘shareholder primacy’ view of corporate reporting. Deegan (2014) criticises this view as it has a narrow view of accountability as focus is shifted towards shareholder returns at the expense of the broader society and environment.

Another central reason why financial accounting will not be appropriate to ‘account’ for social and environmental impacts is tied to the way we define the elements of financial reporting. Specifically, the CF definition of expenses, which interrelates with that of assets, excludes the recognition of any impacts on resources that are not controlled by the entity (such as the environment) unless fines or other cash flows result (Deegan 2014). For example, if an entity were to destroy the water quality in its local environment, consequently killing all local sea creatures and costal vegetation, no externalities would be recognised unless the entity incurs fines or other related cash flows as a result of its actions (Deegan, 2012). Accordingly, entities focused on shareholder returns are unlikely to direct efforts to minimise the occurrence of such events.

The accountant’s notion of materiality tends to preclude the reporting of social and environmental information, particularly through the practice of discounting liabilities. As highlighted in Gray, Owen and Adams (1996), an issue that arises in financial accounting is that reporting entities frequently discount liabilities, particularly those that will not be settled for many years, to their present value. This tends to make future expenditure less significant in the present period and therefore in being ‘immaterial’ it is omitted. This has particular relevance to future ‘clean-up costs’ and remediation costs. A historically related case is the The Stern Review on the Economics of Climate Change which was widely criticised for its unconventionally low discount rate in determining a significant cost of global warming on the world economy. Had a higher discount rate be used, as expected by critics, a lower present value of the cost of global warming would support greater inaction (Deegan, 2014). Therefore, materiality in the presence of discounting liability is likely to deter considerations of future environmental and social impacts.

Another impediment to recognising social and environmental costs are issues associated with ‘measurability’. Financial accounting requires the recognition of a transaction or event through the determination of both a debit and credit entry where they are both probably and measurable with reasonable accuracy. Issues of recognising social and environmental impacts are often associated with the latter as the processes requires upon various estimates. Consequently, organisations often choose to omit expenses and liabilities related to these impacts as they are deemed to be outside the scope of the CF recognition criteria (Deegan, 2014). Ji and Deegan (2011) observed this in a review of large Australian companies that were known to have some significantly contaminated land sites under their control. Ji and Deegan criticised this approach as the findings indicated the recognition criteria was used as an ‘excuse’ for omission in the presence of sufficient environmental information. In being able to ignore these impacts, organisations are able to discharge from sustainable business practices.

Taken together, the above limitation of financial accounting does tend to indicate that financial accounting conventions and principles do not provide an ‘ideal’ vehicle to encourage corporations to embrace sustainable business practices. That is because the definitions of the elements of financial reporting, materiality and the practice of discounting liabilities do not require the recognition of current externalities and future costs related in relation to social and environmental impacts. This is further supported by the recognition requirements related to measurement and probability. If financial accounting wishes to embrace sustainable business practices, modifications will need to be made to the objective of GPFRs to incorporate greater accountability.

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(b)  Statement of financial position

Statement of financial position as at 30.6.20X6   £000

Non-current assets

Land at valuation 5,400.0

(c)  Statement of changes in equity

N3 Transfer from revaluation reserve

Revaluation surplus   £972,000 Transfer 1/30 £32,400