12 November 2009
By Roger Latham
If governments prove incapable of agreement on limiting climate change at Copenhagen, individuals will need to slow it through their own actions. An accounting approach to sustainability can help them, says Roger Latham
As the leaders of the nations prepare to meet in Copenhagen next month at the United Nations’ climate change summit, it is plain that it is not the earth’s future that is at stake. The earth’s continued existence is assured – it is our future as a species that is at risk.
The UN’s Intergovernmental Panel on Climate Change 2007 assessment report conservatively evaluated what some of the changes might be by the end of this century.
We can look forward to an increase in temperature of between 1.1°C and 6.4°C; sea levels rising by between 18 and 59 centimetres; rainfall and flooding affecting millions of people; drought in Africa leading to a 50% reduction in some crop yields; and the movement of pests and diseases towards new areas.
This year, the UK Met Office asserted that if greenhouse emissions went unchecked, global warming would probably exceed 4°C by the end of the century, with much greater changes in temperature in particular regions.
The economic consequences of this can only begin to be imagined. In the UK, the 2006 Stern Review on the Economics of Climate Change tried to assess the impact of the expected changes in climate as a result of past activity. Lord Stern estimated it at a permanent reduction of around 5% of global gross domestic product – about the level of the current recession. But if the international panel’s predictions are correct, the permanent reduction could be as much as 20%.
Renewable energy sources and more energy-efficient economic activity will mitigate some of the effects. But with sustained growth in economies and population, it is unlikely that they can offset the effects of climate change. We will simply have to recognise that in economic terms we are collectively consuming too much of our planet.
If we don’t address these issues, we can expect predation, pestilence and famine. In human terms, predation implies more conflicts and wars over resources. The effect of desertification and drought on the resources of Sudan and, particularly, the impact on the ecology of the Darfur region offer a graphic indication of the kinds of conflict that might arise. Pestilence and disease follow from population growth and our predilection for travel. Finally, on the third impact – famine – we need say little because the evidence is all too clear for us on our TV screens.
So, if we don’t get to grips with the problem, the problem will get to grips with us. This has not yet got through to the general public. There are the deniers – a small band of academics, journalists and commentators busily claiming that the best scientific advice of 2,000 organisations is wrong. There is also a wider group who are prepared to accept that climate change is taking place but believe that it has nothing whatsoever to do with the human race.
The most common response, however, is cognitive polyphasia – the ability to hold two contradictory views at the same time, asserting the truth of both, while not being prepared to do anything about either of them. A 2007 poll found that 80% of people in the UK believed that climate change was occurring, but only 41% accepted that human beings had anything to do with it. Seventy per cent felt that it was the government’s responsibility to do something about it, but fewer than 20% were prepared to behave differently.
With these responses, it is unlikely that governments will have the electoral mandate to undertake major change. So political activity is painfully slow. In Rio de Janeiro in 1992 there was recognition that this issue needed to be addressed. By 1997’s Kyoto Accord, many nations, but not all and most notably not the US, were prepared to accept ten-year targets to slow the growth of climate-changing activity. The Bali Conference in 2007 recognised that more needed to be done, and at Copenhagen we might begin to move towards accepting a target of setting policies aimed at producing no more than a 2°C rise in global temperatures. The problem is that time is not on our side.
If politicians won’t rise to the challenge, then it falls to individuals. It needs the response of millions of us on a daily basis to address the issues and reduce the impact of climate change.
This is where the accountants come in. It’s the way that we recognise, measure and report on economic activity that provides the information on which individual day-to-day decisions in a market-based economy are taken, and is essential for providing a framework within which the response of each of us is manifested.
There are three accounting concepts that need looking at: going concern; the definition of entity; and the proper accounting treatment of time and longer-term factors.
We set our accounting standards to reflect the fact that an economic activity can continue indefinitely if it creates a viable surplus. We have standards that prevent an organisation from over-distributing that surplus. Accounting standards do not guarantee that an organisation will continue forever or that its business strategy is viable. If a strategy is ill-advised, an organisation will fail, even if its accounting is impeccable. Some big financial institutions have discovered the truth of this recently. But, assuming that the strategy is feasible and sound, proper application of accounting standards should ensure business survival.
So what does ‘going concern’ mean at a community level? The definition in the UN’s 1987 Brundtland Report– that ‘sustainable development is a development that meets the needs of the present without compromising the ability of future generations to meet their own needs’ – is as good as it gets. But it requires further development. We are talking about needs and not wants – so much of the modern consumerist society has to be regarded as non-essential.
‘Going concern’ to many in the developed world will not be a matter of economic growth but of ‘contract and converge’. The West will have to make do with less, while developing countries grow, so that in time we all converge at a sustainable level of consumption.
If businesses fail to follow the accounting standards, then the chances are that they will go bust. Not so with governments. The continued existence of governments – and their ability to put off issues that they cannot address at present – means that the sharp edge of going concern is blunted.
The challenge of long-term fiscal sustainability in the public sector is therefore to assess the degree to which future generations are expected to contribute. It would be okay for them to contribute towards the development and maintenance of public assets and services that they as well as the present generation will benefit from. It is not okay to burden them with liabilities imposed by the present generation’s profligacy and consumption.
At present, there are no proper accounting standards to assess the longer-term future commitments resulting from current government activities and the degree to which one generation is mortgaging the future of another. The debate around this issue is a live one because several countries, including the UK, have intervened to support their financial sectors at the cost of raising a significant amount of future debt.
One of the main problems that governments will experience at the Copenhagen summit is encapsulated in the protests of such countries as China that the climate change consequences of their economic activity are not a result of their decisions. They pin the blame on the collective decisions of Western consumers for whom the Chinese are acting as a manufacturer. It is only by moderating these demands that the Chinese government can be expected to contribute its part towards the international effort on climate change.
To an economist, the issue presented by the ‘China question’ is a problem of externality – the unmeasured impact of economic activity outside the organisation that controls that activity. This is where the concept of entity comes in. The accountants’ questions – For what do we keep an account? What do we recognise as an accounting event? When do we recognise it? How do we measure it? – are essential in tackling the problem of externality. Both accounting and economics have to deal with externality.
We can’t treat it like an off-balance-sheet item. Our thinking about entity needs to be expanded to recognise the existence of externality. The first step must be to recognise and measure that externality and to record it in the accounts of the reporting entity. Simply giving the information can sometimes have suitable behavioural effects.
But unless externalities are effectively internalised within an entity and therefore form part of the accounting for the surplus created by the organisation, there is unlikely to be a big enough impact on the market to create sufficiently powerful individual responses. At present, many of the world’s resources are seen as ‘free’. Organisations that possess those resources do not feel a need to account for their replacement or renewal. The cost of replacing natural resources such as oil is not factored into accounts. If sustainability is to be taken seriously, the replacement or renewal cost needs to be recorded.
Another tricky issue is the accounting treatment of time. We already have a good range of discounting techniques, but the outstanding issue is how to deal with risk. Much of the current best practice risk analysis in respect of economic activity takes place after the strategy has been decided and not during the strategic process. It is often based on an expectations approach, which is relevant only when risks are small scale, repeatable and independent.
Not many significant events for an organisation fall into that category. So catastrophic risk and interdependent risks are not given proper weight, as the current economic crisis has made clear. A proper accounting treatment of time and longer-term factors requires recognition of the different categories of risk and the different kinds of mitigation measures upfront, as strategy is developed.
It implies that the actual accounting outcomes from year to year could have a more probabilistic nature. It would mean, for example, that an entity that has suffered significant current difficulties would find the probability that it could ‘trade out’ of those difficulties to be significantly diminished, and the risk of it failing to be a going concern would be greater.
In such circumstances, a shortened period for liquidation of assets and the crystallisation of liabilities might form part of the accounting treatment. Such an organisation would then be encouraged to retain more of its surplus in-house rather than to distribute it.
So, where does this leave us? It is unlikely that we are going to get an internationally agreed political solution that can deal with climate change. Instead, it will be the ‘invisible hand’ of the market, working through millions of individual decisions, that is going to make an impact. If this happens, then accounting is vital to the way that those market outcomes are recognised, measured and reported.
Technical solutions are not going to provide a magic formula. For the West, ‘contract and converge’ will be the order of the day.
We cannot combat climate change without solving the problem of international and national income distribution. But making such changes is not going to be easy. The cycle of grief experiences will be played out nationally and internationally – denial, anger, bargaining, depression – before we finally get to acceptance.
They will also not be accomplished as a single great step. The Buddhist tradition places great emphasis on ‘the middle way’. When asked what the middle way actually is, an enlightened person might point to the position that you are currently at and where you want to get to. Go halfway towards that, and you will be at the middle way. However, when you are at the middle way, both your goal and your initial position will have changed, and so will the middle way. Taking that kind of step-by-step approach seems to be to be more likely to achieve our goal.
But we have little time. If we were to stop everything now – which is simply not practical – the impact of previous economic activity would still be with us. However, this is not a reason to do nothing; it is a reason to start now.
Roger Latham is CIPFA president and visiting fellow at Nottingham Business School
By Roger Latham
If governments prove incapable of agreement on limiting climate change at Copenhagen, individuals will need to slow it through their own actions. An accounting approach to sustainability can help them, says Roger Latham
As the leaders of the nations prepare to meet in Copenhagen next month at the United Nations’ climate change summit, it is plain that it is not the earth’s future that is at stake. The earth’s continued existence is assured – it is our future as a species that is at risk.
The UN’s Intergovernmental Panel on Climate Change 2007 assessment report conservatively evaluated what some of the changes might be by the end of this century.
We can look forward to an increase in temperature of between 1.1°C and 6.4°C; sea levels rising by between 18 and 59 centimetres; rainfall and flooding affecting millions of people; drought in Africa leading to a 50% reduction in some crop yields; and the movement of pests and diseases towards new areas.
This year, the UK Met Office asserted that if greenhouse emissions went unchecked, global warming would probably exceed 4°C by the end of the century, with much greater changes in temperature in particular regions.
The economic consequences of this can only begin to be imagined. In the UK, the 2006 Stern Review on the Economics of Climate Change tried to assess the impact of the expected changes in climate as a result of past activity. Lord Stern estimated it at a permanent reduction of around 5% of global gross domestic product – about the level of the current recession. But if the international panel’s predictions are correct, the permanent reduction could be as much as 20%.
Renewable energy sources and more energy-efficient economic activity will mitigate some of the effects. But with sustained growth in economies and population, it is unlikely that they can offset the effects of climate change. We will simply have to recognise that in economic terms we are collectively consuming too much of our planet.
If we don’t address these issues, we can expect predation, pestilence and famine. In human terms, predation implies more conflicts and wars over resources. The effect of desertification and drought on the resources of Sudan and, particularly, the impact on the ecology of the Darfur region offer a graphic indication of the kinds of conflict that might arise. Pestilence and disease follow from population growth and our predilection for travel. Finally, on the third impact – famine – we need say little because the evidence is all too clear for us on our TV screens.
So, if we don’t get to grips with the problem, the problem will get to grips with us. This has not yet got through to the general public. There are the deniers – a small band of academics, journalists and commentators busily claiming that the best scientific advice of 2,000 organisations is wrong. There is also a wider group who are prepared to accept that climate change is taking place but believe that it has nothing whatsoever to do with the human race.
The most common response, however, is cognitive polyphasia – the ability to hold two contradictory views at the same time, asserting the truth of both, while not being prepared to do anything about either of them. A 2007 poll found that 80% of people in the UK believed that climate change was occurring, but only 41% accepted that human beings had anything to do with it. Seventy per cent felt that it was the government’s responsibility to do something about it, but fewer than 20% were prepared to behave differently.
With these responses, it is unlikely that governments will have the electoral mandate to undertake major change. So political activity is painfully slow. In Rio de Janeiro in 1992 there was recognition that this issue needed to be addressed. By 1997’s Kyoto Accord, many nations, but not all and most notably not the US, were prepared to accept ten-year targets to slow the growth of climate-changing activity. The Bali Conference in 2007 recognised that more needed to be done, and at Copenhagen we might begin to move towards accepting a target of setting policies aimed at producing no more than a 2°C rise in global temperatures. The problem is that time is not on our side.
If politicians won’t rise to the challenge, then it falls to individuals. It needs the response of millions of us on a daily basis to address the issues and reduce the impact of climate change.
This is where the accountants come in. It’s the way that we recognise, measure and report on economic activity that provides the information on which individual day-to-day decisions in a market-based economy are taken, and is essential for providing a framework within which the response of each of us is manifested.
There are three accounting concepts that need looking at: going concern; the definition of entity; and the proper accounting treatment of time and longer-term factors.
We set our accounting standards to reflect the fact that an economic activity can continue indefinitely if it creates a viable surplus. We have standards that prevent an organisation from over-distributing that surplus. Accounting standards do not guarantee that an organisation will continue forever or that its business strategy is viable. If a strategy is ill-advised, an organisation will fail, even if its accounting is impeccable. Some big financial institutions have discovered the truth of this recently. But, assuming that the strategy is feasible and sound, proper application of accounting standards should ensure business survival.
So what does ‘going concern’ mean at a community level? The definition in the UN’s 1987 Brundtland Report– that ‘sustainable development is a development that meets the needs of the present without compromising the ability of future generations to meet their own needs’ – is as good as it gets. But it requires further development. We are talking about needs and not wants – so much of the modern consumerist society has to be regarded as non-essential.
‘Going concern’ to many in the developed world will not be a matter of economic growth but of ‘contract and converge’. The West will have to make do with less, while developing countries grow, so that in time we all converge at a sustainable level of consumption.
If businesses fail to follow the accounting standards, then the chances are that they will go bust. Not so with governments. The continued existence of governments – and their ability to put off issues that they cannot address at present – means that the sharp edge of going concern is blunted.
The challenge of long-term fiscal sustainability in the public sector is therefore to assess the degree to which future generations are expected to contribute. It would be okay for them to contribute towards the development and maintenance of public assets and services that they as well as the present generation will benefit from. It is not okay to burden them with liabilities imposed by the present generation’s profligacy and consumption.
At present, there are no proper accounting standards to assess the longer-term future commitments resulting from current government activities and the degree to which one generation is mortgaging the future of another. The debate around this issue is a live one because several countries, including the UK, have intervened to support their financial sectors at the cost of raising a significant amount of future debt.
One of the main problems that governments will experience at the Copenhagen summit is encapsulated in the protests of such countries as China that the climate change consequences of their economic activity are not a result of their decisions. They pin the blame on the collective decisions of Western consumers for whom the Chinese are acting as a manufacturer. It is only by moderating these demands that the Chinese government can be expected to contribute its part towards the international effort on climate change.
To an economist, the issue presented by the ‘China question’ is a problem of externality – the unmeasured impact of economic activity outside the organisation that controls that activity. This is where the concept of entity comes in. The accountants’ questions – For what do we keep an account? What do we recognise as an accounting event? When do we recognise it? How do we measure it? – are essential in tackling the problem of externality. Both accounting and economics have to deal with externality.
We can’t treat it like an off-balance-sheet item. Our thinking about entity needs to be expanded to recognise the existence of externality. The first step must be to recognise and measure that externality and to record it in the accounts of the reporting entity. Simply giving the information can sometimes have suitable behavioural effects.
But unless externalities are effectively internalised within an entity and therefore form part of the accounting for the surplus created by the organisation, there is unlikely to be a big enough impact on the market to create sufficiently powerful individual responses. At present, many of the world’s resources are seen as ‘free’. Organisations that possess those resources do not feel a need to account for their replacement or renewal. The cost of replacing natural resources such as oil is not factored into accounts. If sustainability is to be taken seriously, the replacement or renewal cost needs to be recorded.
Another tricky issue is the accounting treatment of time. We already have a good range of discounting techniques, but the outstanding issue is how to deal with risk. Much of the current best practice risk analysis in respect of economic activity takes place after the strategy has been decided and not during the strategic process. It is often based on an expectations approach, which is relevant only when risks are small scale, repeatable and independent.
Not many significant events for an organisation fall into that category. So catastrophic risk and interdependent risks are not given proper weight, as the current economic crisis has made clear. A proper accounting treatment of time and longer-term factors requires recognition of the different categories of risk and the different kinds of mitigation measures upfront, as strategy is developed.
It implies that the actual accounting outcomes from year to year could have a more probabilistic nature. It would mean, for example, that an entity that has suffered significant current difficulties would find the probability that it could ‘trade out’ of those difficulties to be significantly diminished, and the risk of it failing to be a going concern would be greater.
In such circumstances, a shortened period for liquidation of assets and the crystallisation of liabilities might form part of the accounting treatment. Such an organisation would then be encouraged to retain more of its surplus in-house rather than to distribute it.
So, where does this leave us? It is unlikely that we are going to get an internationally agreed political solution that can deal with climate change. Instead, it will be the ‘invisible hand’ of the market, working through millions of individual decisions, that is going to make an impact. If this happens, then accounting is vital to the way that those market outcomes are recognised, measured and reported.
Technical solutions are not going to provide a magic formula. For the West, ‘contract and converge’ will be the order of the day.
We cannot combat climate change without solving the problem of international and national income distribution. But making such changes is not going to be easy. The cycle of grief experiences will be played out nationally and internationally – denial, anger, bargaining, depression – before we finally get to acceptance.
They will also not be accomplished as a single great step. The Buddhist tradition places great emphasis on ‘the middle way’. When asked what the middle way actually is, an enlightened person might point to the position that you are currently at and where you want to get to. Go halfway towards that, and you will be at the middle way. However, when you are at the middle way, both your goal and your initial position will have changed, and so will the middle way. Taking that kind of step-by-step approach seems to be to be more likely to achieve our goal.
But we have little time. If we were to stop everything now – which is simply not practical – the impact of previous economic activity would still be with us. However, this is not a reason to do nothing; it is a reason to start now.
Roger Latham is CIPFA president and visiting fellow at Nottingham Business School
