This article was first published in the September 2013 International edition of Accounting and Business magazine.
What would be the financial impact on a multinational drug company if one of its blockbuster drugs was counterfeited? How big an economic loss would be suffered by a commercial bank that found itself unable to attract the top-tier talent it needed to meet its growth targets? How will insurance company profits be affected if super storms become the norm?
If you answered ‘I have no idea’, you’re not alone. Current accounting guidance and practice don’t even attempt to quantify the material social, environmental and governance issues that most companies must deal with today. ‘The relevance of accounting information in financial statements is decreasing at an alarming rate,’ according to Baruch Lev, a finance and accounting professor at New York University’s Stern School of Business.
Existing accounting standards were developed at a time when a company’s growth and value depended almost exclusively upon its access to financial capital. Today the long-term performance and prospects of corporations also depend on social and environmental capital, and market values increasingly reflect these factors. As a result, triple bottom line (TBL) reporting is becoming a fact of life: such reporting increased from 20% to 53% by S&P 500 companies between 2011 and 2012, according to the Governance and Accountability Institute. But it is critical to move from reporting to valuation and to account for material sustainability-related issues, so that they can be included in a company’s financial disclosures.
The Sustainability Accounting Standards Board (SASB) was created two years ago based on the idea that financial reporting must reflect the reality of the TBL. SASB is developing accounting standards for disclosure of material environmental, social and governance issues that are not addressed or disclosed by companies under the existing rules and guidance in the US Securities and Exchange Commission’s (SEC) Forms 10-K and 20-F.
Although SASB is not affiliated with the US Financial Accounting Standards Board, it hopes to attain a similar position in regard to non-financial issues to the one FASB has achieved for financial issues, requiring companies to provide a more complete picture to investors and other stakeholders.
Like F Scott Fitzgerald’s Great Gatsby, the great SASB is nothing if not bold and full of hope. By 2015, SASB intends to create accounting standards for about 80 industries grouped into 10 sectors. SASB supporters believe that the time is right for this ambitious effort. The American National Standards Institute (ANSI) has accredited SASB to develop these standards, thereby ensuring that the SASB process will be ‘balanced, accessible and responsive’ and that all stakeholders will be heard ‘without dominance by any party and in a manner that is open to public scrutiny’.
Like Gatsby, the great SASB has opened its doors to the world, and huge throngs have come to the party. It remains to be seen whether these celebrants are merely the young and careless or serious players that can make meaningful change happen. The evidence tends to suggest both. Although hundreds of business leaders have participated in the working groups, very few of them are senior and none of them are official representatives of their organisations. So it’s impossible to predict whether their companies will ultimately support SASB’s efforts. That said, the draft standards that have been developed thus far are thoughtful, rigorous, well researched and practical. They also address some of the biggest problems and opportunities facing the world.
To illustrate, the standards for the biotech and pharmaceutical industries, released 31 July, set forth a number of potentially material issues, including:
- pharmaceutical water contamination – an environmental risk;
- access to medicines – a social opportunity; and
- corruption and bribery – governance risks.
The guidelines explain each issue, provide evidence for its potential material impacts on companies and investors, and estimate the timing of the impacts. On counterfeit drugs, for example, the guidance states that 10% to 15% of the world’s drug supply is counterfeit, causing 100,000 deaths annually. One illustrative case is counterfeit Avastin. Avastin is a cancer medication produced by Roche’s Genentech division that typically sells for $2,400 per 400mg vial and generated $5.8bn in revenues in 2012. The impact of fake Avastin on Genentech includes reduced sales, potential liability and the loss of consumer confidence in the short and long term.
Other standards affecting companies in the finance, technology, communications, non-renewable resources and transportation sectors are already well advanced through SASB’s pipeline. In 2014, SASB will convene working groups in services, resource transformation, consumption, and renewable resources and alternative energy. SASB is scheduled to wrap up with infrastructure in 2015.
Why is SASB important?
SASB standards will be a significant element of integrated reporting, through which all material information on a company will be disclosed in one place. If SASB succeeds, its standards will eventually be incorporated into SEC regulated disclosures.
Companies that are now reporting on the triple bottom line using the Global Reporting Initiative (GRI) or other sustainability reporting frameworks will need to measure, discuss and report on material TBL issues in their financial disclosures. Information that is not material to shareholders, but is of importance to other stakeholders, may be included elsewhere in the annual report, in a separate TBL reort, or on the company’s website.
Although the SEC has asked to be briefed on SASB’s progress on a quarterly basis, no commitment by the agency is expected before the completion of the standards in 2015. The green light is, if anything, further away than the one at Daisy’s dock. SASB leadership is also meeting with the Public Company Accounting Oversight Board (PCAOB), established to ensure quality audits of public companies in an accounting industry that was previously self-regulated, because its main goal is the same as SASB’s – investor protection.
What should you do now?
The great SASB may not achieve all its aspirations, but it should succeed in catalysing some important changes in accounting and disclosure rules, especially if environmental and social problems continue to dominate headlines and impede economic growth. Accountants and auditors will play an important role in the development, adoption and implementation of the sustainability accounting standards. Hopefully, the standards that emerge will be relevant and useful and will come with the technical guidance required to do the job. Accountants and auditors can:
- Learn more by participating in SASB’s webinar series.
- Consider the kinds of material disclosures your company or clients will need to make under emerging SASB standards. Participate in an Industry Working Group, review the industry-specific standards as SASB issues them, provide feedback as appropriate or join SASB’s pilot program commencing in 2014.
- Review SEC’s Regulation S-K, Item 303 – Management’s discussion and analysis (MD&A) of financial condition and results of operations, which requires disclosure of any known trend, demands, commitments, events or uncertainties that are reasonably likely to have a material effect on a company’s operating results or financial condition. This may become the selected ‘home’ for reporting on sustainability accounting metrics and is a logical place to see any such disclosures today if corporations choose to make them.
- Review the American Institute for Certified Public Accountants (AICPA) AT Section 101 – Attest Engagements, which governs how an attest engagement should be performed, in the context of preparing for or conducting an audit of sustainability accounting metrics. Obtain specialised training, when it becomes available, in order to better prepare for or conduct audits of compliance with SASB standards.
Will the great SASB reach its ambitious goals? If F Scott Fitzgerald knows, he’s not saying.
Holly Clack is a CPA and a senior director with Alvarez & Marsal and Andy Savitz is an expert on sustainability and founder of Sustainable Business Strategies