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Sunday, August 22, 2010

'Traditional' vs. 'Triple Bottom Line' Accounting.










The American Institute of Certified Public Accountants (AICPA) defines accounting as "the art of recording, classifying, and summarizing in a significant manner and in terms of money, transactions and events which are, in part at least, of financial character, and interpreting the results thereof."[1] This, and similar, definition have been crucial over time as governments and individuals have sought to understand and quantify growth and wellbeing of a company. While many entities around the world produce financial and accounting records there is a growing call for a new and more representative means of assessing growth and the overall health of a company. The way accounting procedures are set up today, the end result is the bottom line, and the path that ultimately leads to that bottom line has often been unimportant. In short, companies all around the world have been practicing a, ‘the end justifies the means’, mentality. As the world has grown and becomes ever more globalized, so too should our understanding of growth. Is there a way to serve the means and the end result?

While still in need of fine tuning as well as wide spread adoption, other systems of assessing the health and ‘profit’ of a given entity exist. A popular alternative to traditional accounting is triple bottom line accounting (TBL), sometimes called people, planet and profit. This, so called, full-cost accounting method attempts to expand the traditional spectrum of values and criteria for measuring organizational success by examining growth from a ecological, social as well as economic perspective. This and other methods are inherently harder to quantify thus making adoption and acceptance difficult. Despite these obstacles, changing mindsets of both executives and the individuals is crucial for continued success for both this and subsequent generations.
To change mindsets and spark innovation in this field, one must first, understand the problem. How did our current system of accounting lose its way? According to Mike Niedenthal, writing for the Kansas City Business Journal, “Years of labor efficiency and machine utilization reporting conditioned everyone to a system in which the apparent objective was to keep everyone and all machines busy all of the time.”[2] At the time, traditional cost-accounting practices were considered accurate because direct labor was variable, there was minimal overhead to deal with and most companies manufactured a similar range of products. In the past, “the costs of direct labor and materials could be traced or easily allocated to individual products. However, in today's environment, labor now is largely fixed and overhead has become a large part of total cost.”[3] This system has persisted in various forms for generations. As the accounting became more complex so too did the systems set up to watch over misconduct.

To help watch over traditional accounting systems we have entrusted public regulatory agencies like the Securities and Exchange Commission, Environmental Protection Agency, and Food and Drug Administration with the task of overseeing and scrutinizing entities fiduciary responsibility.[4] Because of their privileged status it is imperative that they act in the best interests of the public. Because of this consideration, looking simply at the bottom line is insufficient at best and negligent at worst. Acting in the best interests of the public “requires consideration of natural, social, and economic systems. Natural systems provide the context and sustenance for social systems and, therefore, must be respected, nurtured, and sustained.”[5] Additionally, “social systems provide the context and purpose of economic systems” and cannot be overlooked.[6] While on a personal or micro level this may seem self evident. Natural systems, social systems and economic systems like those administrated by governments and multinational corporations need to set the example. A global market place that focuses exclusively on the bottom line, is not only naive to its own impacts, but also squeezing itself out of “an excellent change of being more successful tomorrow than it is today, and remaining successful, not just for months or even years, but for decades or generations.”[7] A greater focus on sustainability, which is the hallmark and guiding principle of triple bottom line accounting, is what regulatory agencies like the SEC need to promote growth and limit misconduct.
In recent years there have been a number of major financial setbacks. While there are many factors at work for all these financial setbacks, the SEC’s narrow range of considerations, with a focus solely on the ‘bottom line’ certainly does not help. Even before the global recession many industry executives were aware of problems within the system. In July of 2003 the International Federation of Accountants (IFAC) released a report entitled ‘Rebuilding Public Confidence in Financial Reporting’. The IFAC identified the structural weaknesses of the market system that regulatory bodies like the SEC need to find ways to access more proactively. They are bulleted below.
  • management incentives tied to share prices can produce unacceptable self-satisfying behavior;
  • internal discipline and controls neglected due to entities concentrating solely on the ‘bottom line’.
  • the failure by boards to engender a strong governance culture;
  • auditor independence is continually called into question, particularly in relation to the provision of non-audit services.
  • differences in accounting standards among countries can cause confusion and impedes international comparability.
  • convergence with international standards is the intent of most countries but few have in place an adequate implementation plan;
  • regulation of both companies and professions may vary in effectiveness, particularly where independent monitoring is weak; and
  • an alarming trend has emerged where some participants in the financial reporting process have failed to act ethically.[8]

While triple bottom line accounting does not solve greed, corruption, poor management or any other policy or ethical concern surrounding the current financial markets, it does have the power to change the mindsets of those working in such industries. Perhaps the better approach is not finding the perfectly worded law that promotes financial markets and ultimately growth while preventing misconduct. Perhaps it is our whole approach to the problem. Viewing corporate performance only as an economic outcome not only excludes things like risk management, effects and repercussions to reputation etc., it also ignores the needs of stakeholders who might be socially or environmentally inclined. It ignores investors willing to invest in companies that do not, for example, “employ child labor, buy from companies that operate ‘‘sweat shops’’ for labor, or operate in countries that have questionable political systems or poor human rights records.”[9] Add to that growing concerns about global warming, the trendiness of the ‘green’ generation, the potential for ecological disaster like the recent BP oil spill in the Gulf as well as hysteria surrounding swine flu, mad cow disease, etc. and we begin to see the need for a system like TBL accounting.[10]

Because the triple bottom line method of accounting is intended to “capture and present a comprehensive view of corporate economic interactions with all stakeholders” it is able to be more representative as well as more adaptive.[11] This allows prolonged growth with an emphasis on the long-term. This is accomplished in TBL accounting because “the scope of the economic interactions with the impacts of the corporation on the stakeholders go beyond those of the traditional financial reports in that issues such as intangible assets gain more weight in TBL reporting.”[12]
CMA Management Magazine published an article entitled ‘Adapting your Accounting Practices to Triple Bottom Line Reporting’. This article along with being a practical guide for accounting professionals to transition also discussed areas that may be adjusted in order to accommodate triple bottom line accounting. With regard to assurance and auditing processes, certified management accountant David Crawford said, “In the future, accountants will need to be capable of verifying environmental and social criteria, or have the ability to work with other experts such as environmental auditors and community-based organizations to verify non-financial performance.”[13] Ultimately, accountants in the future will be “required to report and verify non-financial information to the same standards that financial information must meet.”[14] As part of needing to verify and quantify environmental and social criteria reporting in the future will need to be assessed. As such TBL reporting processed are standardized, “accountants and their member bodies will be involved in integrating these processes into existing structures or will be assigned responsibility to create new processes.”[15] Similarly, in the future many managerial accountants will need to develop and access environmental and social key performance indicators (KPI). Common environmental KPIs include “emissions to air, land and water and natural resource use. Environmental KPIs are often calculated per unit of production so that stakeholders can easily understand an organization’s direct environmental impacts.”[16] Common social KPIs include “worker injury and illness rates. In the future, accountants will have to know what indicators are appropriate to measure TBL performance.”[17] Additional areas that will need to be adapted toward triple bottom line reporting is taxes and subsidies. Accountants will be directly involved in financial calculations that “demonstrate how organizations can reduce their taxes or take advantage of new market conditions as a result of changes in government policies. Examples include tax exemptions for the production of sustainable energy and job creation incentives for disadvantaged social groups.”[18] All in all there are a great many ways in which a traditional corporate governance business systems can be adapted to fit a triple bottom line method. While standardization is still key, the greatest impediment seems to be acceptance and the overall need that such systems provide.

Accounting as a system, is more than 7,000 years old.[19] Clearly much in the accounting field has changed to keep pace with the times. Each time a cross roads, and each time a stronger more successful way forward was found. We are at those cross roads again and I am certain that, as time will tell, we find our way. Not only is there a stewardship factor that cannot be overlooked, but so too are untapped sources of wealth. For example, “DuPont has introduced the use of renewable energy, which generates annual savings of between $10 to $15 million U.S. dollars.”[20] Accountants and business professionals need to look at a changing business world as an opportunity. Triple bottom line accounting is the future. Still undecided is the specific nature of such a system but any way forward will have to consider the values of TBL accounting and a shared understanding of the needs of people, planet and profit.


[5] Ibid, page 2.
[6] Ibid, page 2.
[10] Berthelot, S., D. Cormier and M. Magnan, ‘‘Environmental Disclosure Research: Review
and Synthesis,’’ Journal of Accounting Literature 22 (2003), pp. 1–44.
[12] Ibid, page 125.
[15] Ibid.
[16] Ibid.
[17] Ibid.
[18] Ibid.
[19] Friedlob, G. Thomas & Plewa, Franklin James, Understanding balance sheets, John Wiley & Sons, NYC, 1996, ISBN 0471130753, p.1
[20] http://www.greenbiz.com/business/research/report/2005/02/08/adapting-your-accounting-practices-triple-bottom-line-reporting/
Photo's from http://www.cwcdvan.com/triple_bottom_line.html,
http://www.eatwelldogood.com/peopleplanet.html
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