ACF3100 Advanced Financial Accounting

Lecture Three Sustainability & Corporate Governance

Learning Objectives
Explain the meaning of sustainability.
Contrast financial reporting with sustainability reporting.
Apply theories to explain firm incentives in sustainable development and sustainability reporting.
Identify the commonly used guidelines (e.g., GRI) for sustainability reporting.
Understand the mandatory requirements relating to sustainability reporting in Australia.
Understand the objectives and concept of integrated reporting.
Understand the increasing importance of ethical investment.
Outline various emission reduction schemes (e.g., emissions trading scheme, carbon tax, emission
reduction fund).
Explain what corporate governance is and why good corporate governance systems are needed.
Discuss the relationship between positive accounting theory and corporate governance.
Illustrate the role of accounting and financial reporting in corporate governance.
Understand the ASX Corporate Governance Principles and Recommendations.
Discuss the key areas involved in corporate governance (eg risk management, executive remuneration,
ethics)

Where Does This Fit into Unit Learning Goals?

Examine contemporary financial accounting issues
Apply a range of theories of accounting to explain accounting practices and appreciate the judgments,
estimations and assumptions influencing accounting numbers
Critically assess and appreciate changing influences in standard setting and regulatory requirements
Apply judgment, communication and problem solving skills to deal with advanced financial accounting
issues

Part A Sustainability and Integrated Reporting

Sustainable development is development that meets the needs of the present without compromising
ability of future generations to meet their own needs
Sustainability report presents economic, social and environmental information to stakeholders
Other terms
o Corporate Social Responsibility (CSR)
o Corporate Social Responsibility Reporting
o Triple Bottom Line Reporting
o Environmental Reporting
o Social Audit
o Environmental, Social and Governance (ESG) Reports
o Stakeholder Reports

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Financial Reporting vs. Sustainability Reporting

Benefits of Sustainability Reporting for Companies

Embedding sound corporate governance and ethics systems throughout all levels of an organisation
Improved management of risk through enhanced management systems and performance monitoring
Formalising and enhancing communication with key stakeholders such as the finance sector, suppliers,
community and customers
Attracting and retaining competent staff by demonstrating an organisation is focused on values and its
long-term existence
Ability to benchmark performance both within industries and across industries

Benefits for Sustainable Development: BHP as an Example

Reduced business risk and enhanced business opportunities
Gaining and maintaining our license to operate and grow
Improved operational performance and efficiency
Improved attraction and retention of workforce
Maintained security of operations
Enhanced brand recognition and reputation
Enhanced ability to strategically plan for the longer term

Beyond the Business Case

Improved stakeholder trust
Improved standard of living and economic contributions
Self-sustaining communities
Enhanced resource conservation and biodiversity
Improved work/life balance

Theories Explaining Sustainability Practice/Reporting

Legitimacy theory
Stakeholder theory
Positive theory
Institutional theory
Prescribed article

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Stakeholder Interests in Corporate Sustainability

Guidelines for Sustainability Reporting

A range of guidelines have emerged to provide direction on appropriate sustainability reporting
The United Nations (UN) has produced a number of reporting initiatives
o Principles for Responsible Investment (institutional investors)
o United Nations Conference on Trade and Development
Other groups that have provided guidelines include:
o The Organisation for Economic Cooperation and Development (OECD): Disclosure in
Guidelines for Multinational Enterprises
o The International Organisation for Standardisation (ISO): ISO14000 Environmental
Management, ISO26000 Social Responsibility

Global Reporting Initiative

Launched in 1997 as an initiative to develop a globally accepted reporting framework to enhance the
quality of sustainability reporting
A joint initiative of the Coalition of Environmentally Responsible Economies (CERES) and the United
Nations Environment Program (UNEP)
The sustainability reports based on the GRI Framework can be use to demonstrate organisational
commitment to sustainable development, to compare organisational performance over time, and to
measure organisational performance over time, and to measure organisational performance with
respect to laws, norms, standards and voluntary initiatives
Principles under 4th Generation Sustainability Reporting Guidelines (G4):
o Report content: stakeholder inclusiveness, sustainability context, materiality, completeness
o Report quality: balance, comparability, accuracy, timeliness, clarity, reliability
o Category: economic, environmental, social (labour practices and decent work, human rights,
society and product responsibility)
o In accordance levels: core or comprehensive
o More disclosures on supply chain, governance and director remuneration

Mandatory Sustainability Reporting Requirements in Australia

The Corporations Act 2001 requires directors to outline the companys performance in relation to
environmental regulations.
o S299(1)(f) requires companies to include details of breaches of environmental laws and
licences in their annual reports and

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o ss1013(A) to (F) require providers of financial products with an investment component to

disclose the extent to which labour standards or environmental, social or ethical
considerations are taken into account in investment decision-making.
The National Greenhouse and Energy Reporting Act 2007 (NGER Act) introduced a national framework
for reporting and dissemination of information about greenhouse gas (GHG) emissions and energy use
by certain corporations.
ASX Corporate Governance Principles and Recommendations (3rd edn) issued 24 March 2014 --
Principle 7: Recognise and manage risk
o Recommendation 7.4: A listed entity should disclose whether it has any material exposure to
economic, environmental and social sustainability risks and, if it does, how it manages or
intends to manage those risks.

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Objectives of Integrated Reporting

Improve the quality of information available to providers of financial capital for resource allocation
decision making
Cohesive and efficient communication of factors that materially affect the ability of an organisation to
create value over time
Enhance accountability and stewardship for six broad capitals (see next slide) and promote
understanding of their interdependencies
Facilitate integrated thinking, decision-making and actions that focus on the creation of value over the
short, medium and long term

Six Capitals
Financial funds for use in the production of goods and services eg: debt or equity capital
Manufactured manufactured physical objects for use in the production of goods or services eg:
equipment, building
Intellectual organisational knowledge-based intangibles eg: patents, reputation
Human peoples competencies, capabilities and experiences
Social and relationship institutions and relationships within and between communities eg: common
values, social licence to operate
Natural environmental resources eg: water, land, ecosystems

Ethical Investment
Ethical investment and ethical investment funds are increasingly taking an interest in corporate
sustainability performance and reporting
More broadly many institutional investors are concerned about the economic, financial and regulatory
risks of global warming
Carbon Disclosure Project (CDP)
o Set up by large institutional investors
o Surveys companies about their policies concerning GHG emissions and climate change
o Powerful stakeholder group
Dow Jones Sustainability Indexes
Climate Change and Accounting
The Kyoto Protocol is an agreement that commits signatories to achieve GHG or carbon emissions
reduction

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Under the Kyoto Protocol countries were allocated allowed emissions in the form of assigned units that
corresponded to their agreed emission targets

Emissions Reduction Schemes

Many countries have (are) developing emissions reduction schemes to mitigate or reduce climate
change
Two common approaches
o Emissions trading scheme (ETS): to control emissions by allowing participants to trade excess
emissions permits
o Carbon taxes: a levy is paid based o the amount of emissions or GHGs
Significant costs:
o Reporting requirements such as compliance and monitoring costs
o Investments to mitigate and manage emissions
o Re-evaluation of corporate strategies, operational and control systems

Emissions Trading Scheme (ETS)

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Part B Corporate Governance

What is Corporate Governance?
The procedures and processes according to which an organisation is directed and controlled
The corporate governance structure:
o Specifies the distribution of rights and responsibilities among the different participants in the
organisation (eg: the board, managers, shareholders and other stakeholders)
o Lays down the rules and procedures for decision-making
By doing this, it:
o Provides the structure through which the company objectives are set, and
o The means of attaining those objectives and monitoring performance

The Growing Interest in Corporate Governance

Interest in corporate governance appears to be driven by:
Highly publicised corporate misconduct
o Corporate failures eg: ABC Learning, Enron
o Environmental catastrophes eg: BHP oil spill in Mexico
Agency problems separation of ownership and manager
o Managers may not act in the best interest of capital providers (owners):
Anti-social corporate behaviour
Hiding or falsifying information fraud
Perceived gap between performance and remuneration excess perquisites
Therefore, their behaviour should be monitored
Realisation of other benefits (advantages of good governance)
o Reduce the cost of capital
o Increase shareholder base
o Manage increased scrutiny
o Increase customer confidence
o Facilitate economic growth

Corporate Governance For Whom?

Whose interest are to be protected and what are appropriate objectives of the corporation?
Traditional or Anglo-Saxon Model
o The key role for corporate governance is enabling the efficient use of resources by helping
financial markets to work properly and gives priority to shareholder value
European Models
o Alternatives to the traditional view suggests that corporate governance must go beyond the
narrow interests of shareholders and should be extended to a wider group of stakeholders

Positive Accounting Theory and its Relationship with Corporate Governance

Refer Week 2 for discussion of PAT
Positive accounting theory explains that for efficiency reasons companies are formed and can be
viewed as a network of contracts or agreements that determine the relationships with and among the
various parties involved
One important agency relationship that arises from this nexus is that between the managers and the
capital contributors who authorise the managers to make the key business decisions

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Overview of the Shareholder-Manager Relationship in Agency Theory

Role of Accounting and Financial Reporting in Corporate Governance

Accounting clearly has a central role in directing and controlling a corporation
o Management accounting provides a significant part of the information on which company
operations will be decided
o Financial accounting provides the means for outsiders to monitor the corporation and to
assess how well those responsible for managing corporation have performed
There are two key ways in which accounting is used to direct and control the managers of a
corporation
o Encourage appropriate decisions: linking managers' performance to rewards
o Transparency and disclosure: requiring specific disclosure about areas relevant to corporate
governance eg: AASB 124 Related Party Disclosures and AASB 2 Share-based Payment

Corporate Governance Guidelines and Practices

It is generally acknowledged that there is no one system of corporate governance
The practices and procedures required or desired will be affected by:
o The nature of the particular corporation and its activities
o The environment in which the corporation operates

Summary of ASX 8 Principles of Corporate Governance

1. Lay solid foundations for management and oversight
2. Structure the board to add value
3. Promote ethical and responsible decision making
4. Safeguard integrity in financial reporting
5. Make timely and balanced disclosure
6. Respect the rights of shareholders
7. Recognise and manage risk
8. Remunerate fairly and responsibly

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Developments and Issues in Corporate Governance

The GFC has provided an impetus for regulators, corporations themselves and other organisations to reconsider
aspects of corporate governance:

Increased Focus on Risk Management

Risk management deficiencies during the GFC noted include:
o Risk was not managed or monitored at the entity level, but rather at individual activity level
o Information about risks were not reaching the board
o Organisational culture encouraged risk taking
o Disconnect between the corporations overall risk strategy and related procedures

Executive Remuneration
During the GFC, concerns have been raised about:
Size of executive remuneration
Disconnect between performance and pay
Use of public (bail-out) money to pay bonuses
Rewarding short-term focus

There have been a variety of legislative responses.

In he US, the Dodd-Frank legislation includes Claw-Back provisions if it is found that compensation
paid was based on inaccurate financial statements
o In Australia, recent legislation includes:
Increased disclosure
A two-strikes rule where if more than 25% of shareholders vote against the
remuneration report for two consecutive years, the board itself can be put up for re-
election

The Role of Ethics

At the core of good governance is doing the right thing by acting with honesty, impartiality, integrity,
trustworthiness, respect for the law and due process. A commitment to ethical values is fundamental.

Good corporate governance cannot exist without ethics.

The Sarbanes-Oxley Act in the US requires disclosure of whether or not there is a code of ethics for
senior financial officers
CPA Australia argues that implementation of a corporate governance structure is not sufficient and will
only work if the culture of the corporation supports good governance
The Hong Kong Institute of Certified Public Accountants guidelines for public bodies places emphasis
on the personal qualities of individuals as the foundation for good corporate governance