SOCIAL AND ENVIRONMENTAL ACCOUNTING AND REPORTING
Traditionally, accounting and reporting has been as an exercise based on a set of ‘financial numbers’, composed of for example income and expenditure, asset valuations, liabilities owed and capital. However in recent decades a number of commentators have come to see that organisations, both in the private and public sectors, have an enormous impact on society. These include for example employment policies, charitable donations by organisations and their contribution to the communities, both local and national, in which they exist. A particularly important sub-set of this has been their impact on environmental issues. We are aware that these are increasingly important – a very good example in a Rwandan context would be the ban on the use of non-biodegradable plastic bags.
Organisations need to be aware of these issues for several reasons. There is first of all the moral issue, namely that they have a duty to be responsible citizens in the same way that individuals have. Indeed, it could be argued their responsibility is usually greater as they can normally have more direct impact than individuals can, both positively and negatively. There are also economic arguments too. For example, organisations that breach legislation can find themselves in serious trouble, sometimes faced with heavy fines or, in the very worst cases, faced with closure of the business. There have for example been some very significant cases of oil companies in some countries whose activities have created widespread environmental damage and have been fined multi-million US dollars as a result.
Then there is the effect of activities on customer perceptions. Consumers are becoming more aware of social and environmental issues and may be attracted towards buying the goods and services of those organisations that have a positive record in these areas and avoiding those with negative records. For example in some countries consumers will be attracted to buying imported Rwandan coffee with a ‘Fairtrade’ label over products of producers who do not have this title. However, if those same consumers were to find out that the producer was not acting in a way that deserved the ‘Fairtrade’ label then they may take their business elsewhere.
In order to address these issues adequately, organisations are increasingly adding additional information to their annual reports. These cover a number of non-financial areas and are considered in more detail below.
However, there are some underlying principles, indeed an underlying philosophy, which contrasts with ‘traditional accounting’ and these in themselves are quite challenging, namely;
- that an organisation is accountable to a broad group of stakeholders, not just for example shareholders;
- that the organisation should concern itself with more than just economic or financial events;
- that results should not only be expressed in financial terms; and
- that as a result the purpose of reporting is extended beyond financial events.
These principles are not always easy to follow as there is a possible conflict between maximising financial returns and minimising negative impacts on the environment.
It might be thought by some accountants that accounting is a ‘neutral’ subject in which there is a right or wrong answer in every situation. But this is rarely if ever true in practice. For example, when we attach a value to fixed assets we have a choice (within defined limits) about whether to use historical cost or re-value them. When we depreciate these assets we also (again within defined limits) can use a range of approaches, all of which are broadly acceptable but all of which result in different answers.
Similarly accounting is not neutral in its impacts. So, if an accountant’s work shows that it would be cheaper to close down a factory then keep it open, then the logical response would be to close the factory. But that does not take into account the societal impact of such a decision and the factory’s managers may decide not to close down the factory though they may still have no choice economically but to at least for example try to reduce its costs.
The dual purpose of social accounting and reporting
There are in fact two primary purposes for social accounting and reporting, namely accountability and management control.
As far as accountability is concerned, social accounting is designed to support the achievement of society’s objectives (though this assumes of course that they are always clearly defined, which may not be the case in practice. R H Gray, a leading exponent of this form of accounting, argues that there should be a clear flow of information in which those who control resources account to society for their use of them. This is a fundamental principle he argues of a democratic decision-making system.
Such accountability has several immediate benefits. It increases transparency and balances organisational power (which is often extremely strong, especially if the organisation is large and influential) with responsibility, something that some would argue has not always been the case in practice and even now is debatable in many instances globally. It also emphasises that for each economic benefit there is often a hidden social or environmental cost and these should also be taken into account.
However, social accounting and reporting also has a purpose regarding management control and the achievement of an organisation’s own objectives. Often reporting will be selfreporting and individual reports are frequently referred to as social audits. These help organisations to both plan and measure all aspects of their progress – social and environmental as well as financial – towards their planned objectives.
As a result, organisations get better information for decision-making and sometimes more accurate costing outcomes. They can also benefit from improved public relations and can even identify marketing opportunities as a result of social accounting (for example, some energy companies can develop products that do not rely on fossil fuels and this is an increasingly attractive and marketable proposition in many markets globally.
Social accounting is still developing and is likely to become more significant in the future. In some countries social accounting and reporting has focused on large companies who have significant social and environmental impact. However, in others (such as Australia) attempts are being made to incorporate small and medium-sized operations (SMEs) into the process. A major issue currently though is that in most cases compliance with social accounting and reporting is voluntary and therefore there may be a wide range of information and detail included as a result.
Sometimes information that is made publicly available by an organisation may be subject to an independent third-party audit, known as a social audit. This can be distinguished in some cases from traditional external auditing as not only does it involve non-financial information but can also be done without the company’s express permission, though practically speaking organisations will often cooperate to a significant extent as it would not be in their public relations’ interests were they not to do so. These independent audits are important as it is of course in an organisation’s best interests to put the most positive interpretation on their policies with regards to social and environmental accounting and reporting.
One organisation that takes a leading research role on these matters is the UK-based Centre for Social and Environmental Accounting Research (CSEAR). It’s briefing paper on social and environmental accounting and reporting makes specific criticisms of the accounting profession for what it describes as its ‘characteristic conservatism’ and suggests that this has been a barrier to further progress on the issue but that increased public interest in the matter has led to more attention being paid to these matters.
As we have already mentioned, there is no standard format for reports. However, here are some of the topics that might be included in such reports;
- An organisation’s relationship with the natural environment
- Issues concerning relationships and policies regarding employees
- Ethical issues concentrating upon consumers and products (for example, public or private sector health sector organisations might have a policy that they do not invest in companies in the tobacco industry)
- Relationships with local communities e.g. a share of organisational profits might be re-cycled into schemes to improve the local environment, improved education or health facilities etc.
- The organisational policy with regards to ensuring that there is no gender discrimination in employment policies
- The organisational policy with regard to the recruitment of individuals with disabilities.
Environmental accounting and reporting
This is really another element of social accounting and reporting. It involves the preparation and presentation of information concerning the relationship between an organisation and its natural environment. Again this is often in the form of unregulated ‘self-reporting’ though once more external organisations such as NGOs may undertake independent reviews of such information as a way of putting pressure on to improve policies in this area.
In some cases, such issues can have a direct cost that is reflected in the financial statements of an organisation. Sometimes an organisation may incur costs in a positive and voluntary way, e.g. a mining company incurs costs to restore the habitat it has affected in its operations to its original state once it has finished its extraction activities. In other cases, these costs may be negative and enforced, e.g. a large oil-spill in the Gulf of Mexico in recent years involved the company’s involved paying out substantial amounts in compensation for the damage caused.
However, environmental accounting goes beyond this. Information may still be quantitative but may also be non-financial. This may concern for example information on pollution emissions, resources used or natural habitats damaged or re-established. There is also an increasing emphasis on eco-efficiency. Measures used can include energy use, including statistics that show improvements to historical trends and waste per unit produced. Other measures can include those which show the proportion of materials recycled.
Some countries such as Australia, the Netherlands and Denmark have already introduced legislation for compulsory environmental reporting whilst some international organisations such as the United Nations are also very active in the development of it. – further information can be found in the UN Division for Sustainable Development’s publication Environmental Management Accounting Procedures and Principles which was released in 2002.
A comparatively recent development has been the concept of sustainability accounting. It attempts to measure in a quantitative way both social and economic sustainability of an organisation. Sustainability in fact has three sub-elements, namely environmental factors, social factors and economic factors and all three of them need to be in balance if an organisation is to continue to survive and hopefully thrive whilst making a positive environmental and social impact. It is important that this balance is kept; after all, being a positive contributor to the environment and society is of no benefit if economically the organisation is not sustainable and therefore goes out of business.
Whilst the process of allocating values to these elements is still in development, prospective accountants should be aware of the existence of these factors and broad approaches as it is likely to become more important in the future.
GOVERNMENT SECTOR FINANCIAL REPORTING
An International Perspective
In recent decades, accounting has become increasingly global. The trend towards globalisation began with the development of International Financial Reporting Standards (IFRSs) in the private sector. However this has in more recent times been replicated in the public sector with the development of International Public Sector Accounting Standards (IPSASs). However it would be true to say that for a variety of reasons global convergence on accounting standards is closer in the private rather than the public sectors, and even in the former there are still major challenges to be overcome if full convergence is to take place in the near future.
Traditionally, government accounting and financial reporting around the world has been based on cash accounting rather than an accruals-based approach as has been in use in most private sector organisations for decades. There are several reasons for this. One of the major ones is that governments themselves have been driven by cash. Government revenues such as from taxation, customs duties etc. are forecast for the year ahead and matched to forecast expenditure. There may often be a deficit, depending on the state of the national economy, and if this is the case then governments will seek to borrow money to make up the difference (or failing this will have to cut government expenditure and services or raise taxes).
These revenues and expenditure forecasts are factored into the detailed budget-setting process. Budgets have traditionally been for a year ahead only, though more recently the development of Medium Term Expenditure Frameworks (MTEFs) for a three-year period or longer have helped to introduce longer planning horizons into the process. However, the general economic approach which lies around the development of national budgets is driven more by cash and what is available to spend than accounting concepts such as an accrualsbased approach.
Cash is also simpler to understand. It is after all what is available in the bank, in petty cash and in other forms of cash and cash equivalents. There are no complicating factors to understand – especially for non-accountants. There is no depreciation to worry about, no revaluation of assets, no understanding of what is meant by equity capital and other forms of capital required. There is also limited judgement involved. As soon as factors such as depreciation are introduced then we are into discussions on various methods, useful economic lives etc. and rather than having one clear answer to an accounting problem we have a range of them depending on the approach used. Cash on the other hand is was it is.
Governments and politicians it would be fair to say like clear answers to questions. They and other users can more easily understand cash accounting rather than accruals accounting. However the use of cash accounting can lead to inefficient and ineffective use of funds. A common problem in many countries is that, towards the end of the year, all unspent budgets are hastily spent, sometimes in a frantic attempt to ‘use’ unspent funds rather than ‘lose’ them by returning them to central government coffers.
But what is often disguised in the process is the sometimes-large volumes of unpaid creditors, which can sometimes be so large that organisations can be virtually insolvent and it will not be obvious until it is almost too late to address the underlying problem. This can even happen at a national level; for example, in recent times the large levels of government borrowing in Greece have only become apparent when repayment of major loans is looming. We are all aware of the difficulties this has caused for the Eurozone and the wider international economy.
In order to address these conceptual weaknesses of the traditional cash accounting approach, the International Public Sector Accounting Standards Board (IPSASB) was established to create global public sector accounting standards. The long-term aim of this is to encourage all public sector bodies to embrace the accruals-based IPSASs – in June 2012, there were 32 of these in existence. However this is very much a long-term project. Few countries have embraced accruals-based accounting for their public sector.
Some have though. New Zealand was a trend-setter in this respect and the United Kingdom introduced the Resource Accounting and Budgeting (RAB) project in the late 1990s; this included amongst other things accruals-based accounting. Interestingly neither adopted IPSASs. Instead they have adapted the IFRSs for the public sector.
This might seem strange but the reasoning behind this was that IPSASs were not developed enough to adopt at the time that these countries made their accounting changes. However a major project in 2010 updated the IPSASs and made them more contemporary in their information.
The Rwandan Context
Rwanda has currently adopted a modified cash accounting approach to its public sector financial reporting. The legal basis for this approach is to be found in Article 2 (20) of Ministerial Order N. 002/07 dated 9 February 2007 which relates to Financial Regulations and states that the modified cash basis should be used “using appropriate accounting policies supported by reasonable and prudent judgements and estimates”.
More important legal background is given in the Organic Law No. 37/2006 on State Finances and Property. This requires (Article 70) the submission of annual reports from all budget agencies which include all revenues collected and received during the fiscal year and all expenditures made during the same period. It also requires a statement of all outstanding receipts and payments which are known at the end of the fiscal year.
Responsibility for maintaining the accounts and records rests with the Chief Budget Manager (stipulated by Article 21 of the aforementioned Organic Law and Article 9 and 11 of the aforementioned Ministerial Order). He/she is also responsible for preparing reports on budget execution, managing revenues and expenditures, preparing, maintaining and coordinating the use of financial plans, managing the financial resources for the budget agency effectively, efficiently and transparently, ensuring sound internal control systems in the budget agency and safeguarding public property held by it.
This very clear statement of accountability is vital. It means that the Budget Manager is clear that, although they may delegate responsibility for individual accounting tasks, they cannot delegate accountability. The result of this onerous but necessary accountability should be that they take their task very seriously indeed.
The Chief Budget Manager also signs a Statement of Management’s Responsibilities which forms part of the Financial Statements. This states that “in the opinion of the Chief Budget Manager, the financial statements give a true and fair view of the state of the financial affairs of X”. It also states publicly that they are responsible for the maintenance of accounting records that can be relied upon in the preparation of financial statements, ensuring adequate systems of internal financial control and safeguarding the assets of the budget agency. An example of the Statement is shown below:
Proforma Statement of Responsibilities
Article 70 of the Organic Law N° 37/2006 of 12/09/2006 on State Finances and Property requires budget agencies to submit annual reports which include all revenues collected or received and all expenditures made during the fiscal year, as well as a statement of all outstanding receipts and payments before the end of the fiscal year.
Article 21 of the Organic Law N° 37/2006 and Article 9 and Article 11 of Ministerial Order N°002/07 of 9 February 2007 further stipulates that the Chief Budget Manager is responsible for maintaining accounts and records of the budget agency, preparing reports on budget execution, managing revenues and expenditures, preparing, maintaining and coordinating the use of financial plans, managing the financial resources for the budget agency effectively, efficiently and transparently, ensuring sound internal control systems in the budget agency and safeguarding the public property held by the budget agency.
The Chief Budget Manager accepts responsibility for the annual financial statements, which have been prepared using the “modified cash basis” of accounting as defined by Article 2 (20) of the Ministerial Order N°002/07 of 9 February 2007 relating to Financial Regulations and using appropriate accounting policies supported by reasonable and prudent judgements and estimates.
These financial statements have been extracted from the accounting records of XXX and the information provided is accurate and complete in all material respects. The financial statements also form part of the consolidated financial statements of the Government of Rwanda.
In the opinion of the Chief Budget Manager, the financial statements give a true and fair view of the state of the financial affairs of XXX. The Chief Budget Manager further accepts responsibility for the
maintenance of accounting records that may be relied upon in the preparation of financial statements, ensuring adequate systems of internal financial control and safeguarding the assets of the budget agency.
[Chief Budget Manager]
We have already mentioned that key items should receive more detailed analysis by way of Notes to the Financial Statements. Students should note that the primary purpose of Financial Statements is disclosure which is associated with key concepts such as transparency and understandability. Notes should therefore not be seen as incidental to the Financial Statements and accordingly less important than the individual Statements we have discussed above. They are instead integral and fundamental to the Financial Statements as a whole (the IPSASs guidance is specific on this point but it is also common sense as users need more information to fully understand the financial situation).
What should be specifically included in the Notes depends on the individual entity. Proper judgement should be used – the preparers of financial statements should put themselves in the position of users who do not have the access to detailed organisational knowledge that they do. However, as we have already seen the Note on the Basis of Accounting is vital in all financial statements. Other areas which will often be presented include:
- The Presentation Currency, which will nearly always be Rwandan Francs.
- Narrative explanation of contents of revenue and numerical analysis of key contents. Transfers from Treasury will often be listed individually with the dates that the transfer was made and the amount involved.
- Narrative description of Expenditure sub-headings and appropriate additional numerical disclosure of the values involved.
- Narrative description of items in the Statement of Financial Position such as cash (which includes Cash Equivalents), Receivables and Payables.
- Details of any Foreign Exchange conversions made.
Budget Execution Report
Also included with the Financial Statements should be a Budget Execution Report. This lists out major categories in Income and Expenditure and the resultant Surplus or Deficit and gives a Budgeted amount for each category. Alongside this, presented in columnar format, Actual amounts should be entered and a resultant Variance calculated.
Dates that the Financial Statements are adopted
Finalising the Financial Statements is normally an iterative process as adjustments may emerge as a result of extra information being obtained after the Reporting Date or items requiring correction may emerge during the audit. Therefore it should be clearly stated in a prominent position when the Financial Statements are formally adopted.
The Office of the Auditor General (OAG) will be responsible for auditing the draft Financial Statements and the Auditor General will express an opinion on whether or not they give a true and fair view of the state of financial affairs of the entity.
ACCOUNTING FOR INFLATION
Inflation is a feature of most economies. Over time prices and costs generally increase (though on occasions they may exceptionally fall; this is known as deflation). Prices and costs vary partly through general economic conditions such as fluctuations in foreign exchange rates but may also vary based on specific conditions (e.g. global shortages of oil may drive up the costs if fuel).
Usually, there is no direct impact on the financial statements of entities because of rates of inflation. Many organisations still use historical costs as the basis for preparing their financial statements and in such cases, in normal circumstances, there will be no adjustments made for inflation.
There is however an exception this, even in ‘normal’ circumstances, and that is when an entity chooses, or is required to, report certain assets at fair value (usually though not always equating to market value). This would cover for example property, plant and equipment and biological assets (IAS 16 and IAS 41 respectively). In some circumstances, specific indices may be applied to assets to revalue them; this is known as current cost accounting.
There is an implicit assumption here, namely that the effect of inflation is not significant enough to require a restatement of values to take account of inflation. This may be a simplification but is usually considered not to be an especially misleading one. But it does impact on the comparability of financial statements. For example, financial statements will normally require that prior year comparative information is included and, if prices have risen in the interim, it means strictly speaking we are not comparing like with like. The assumption is that any differences will not be major and are unlikely to affect the decisions of users of the financial statements.
There is a recognition here of several factors that must be remembered when preparing financial statements. First of all, there is a balance to be struck between the costs of preparing extra information against the benefits to be obtained from reviewing it. The implicit assumption in not requiring financial values to be restated is that there is not enough significant benefit to be gained from doing so.
There is another important factor, and that is how easy it is to understand the financial statements. The more complex the accounting, the more difficult it is for non-financial experts to understand the financial statements. Therefore the lack of routine restatement for inflation is perhaps an acknowledgement that doing so would make it more difficult to understand the financial statements.
Accounting in a hyperinflationary economy
It is pleasing to note that Rwanda does not currently have a hyperinflationary economy; annual inflation stands at 5.9% as at June 2012. Hyperinflation, that is when inflation stands at very high levels, has a dramatic impact on the economy. It means that the value of savings is quickly eroded and money quickly becomes worth less.
However it is important that accountants are at least aware of the need to account different in the context of a hyperinflationary economy. The rules governing this are found in IAS 29 (issued 2001) – IPSAS 10 is the public sector equivalent. This states that hyperinflation means that financial statements are only useful if values are restated. Before considering the rules that should be applied, it is necessary to define when hyperinflation is deemed to exist according to the Standard.
Items suggesting hyperinflation
The Standard is very clear that professional judgement should always be used when deciding whether or not hyperinflation is present. However, the following may be indicators that it is;
- The general population prefers to keep its wealth in non-monetary assets rather than monetary assets.
- The general population prefers to keep its wealth in a relatively stable foreign currency e.g. US dollars, rather than the local currency. Prices will often be quoted in that foreign currency.
- Sales and purchases on credit include terms that are intended to compensate for the expected loss in purchasing power by the time the credit transaction is settled by cash or equivalent.
- Interest rates, wages and prices are linked to a price index.
- The cumulative inflation rate over the previous three years is approaching, or over, 100%.
The last indicator is especially important; some of the others may exist in isolation without necessarily meaning that hyperinflation is present.
Impact of hyperinflation on financial statements
Statement of Financial Position
The general rule is that, if items are not already restated (e.g. a non-current asset restated to fair value) then a general price index will be applied to them. The exception to this general rule is monetary items which are not restated because they are already included at the values in force at the date that the Statement of Financial Position is prepared.
Statement of Comprehensive Income
IAS 29 requires that all items in the Statement of Comprehensive Income are expressed in terms of the measuring unit current at the end of the reporting period. This is done by applying the general price index to each item of income and expenditure based on when the specific transaction took place (though in practice some approximation or averaging may be used).
Gain or loss on net monetary position
If an organisation has more monetary assets than monetary liabilities in times of high inflation, it effectively suffers a net loss in purchasing power whilst if it has more monetary liabilities than monetary gains it has a net gain. The gain or loss on the net monetary position can be derived as follows:
- Difference arising from restatement of non-monetary assets
- Difference arising from restatement of owners’ net equity
- Difference arising from restatement of Statement of Comprehensive Income
= Gain or loss in net monetary position.
This can also be estimated by applying the change in a general price index to the weighted average for the period for the difference between monetary assets and monetary liabilities.
The gain or loss on the net monetary position should be included in profit or loss. Any adjustment for assets or liabilities made as a result of the restatement should be offset against this gain or loss in net monetary position.