AICPA&CIMA: Sustainability and business

Accounting for carbon

Dr. Martin Farrar, Associate Technical Director Research and Development, Management Accounting, AICPA&CIMA discusses the importance to corporates of carbon accounting to bring consistency, reliability, and coherence to reporting on an emerging field of the profession in a bid towards reaching net zero targets

Nine out of 10 executives polled by Deloitte last year agreed the earth is in a global climate emergency. Top management worldwide is increasingly concerned about climate change because most companies have been negatively affected by it, according to the Deloitte survey that involved more than 2,000 senior executives in 21 countries. (Source: Deloitte CxO Sustainability report)

Scientists have unequivocally identified the rise in greenhouse gas emissions over the past 250 years as the reason the earth has warmed to the point that the climate is now changing rapidly. Ever more frequent and severe floods, wildfires, storms, heat waves, and droughts are already threatening the livelihoods of 45% of the world’s population. Unless we get a handle on greenhouse gases, particularly carbon dioxide emissions, the impact of more severe weather and rising sea levels could cost us 4% of global annual economic output by 2050, an analysis by ratings firm S&P Global suggests. (Source: FM May 2022)

Business leaders can address the global climate emergency by implementing climate agreements that governments have signed. Finance professionals play an important role in that implementation.

Carbon accounting is a step toward reducing a business’s carbon footprint or climate change impact. Bolstered by thought leadership from global organisations such as the United Nations and the World Economic Forum, regulators and standard setters worldwide are increasingly aiming for businesses to reduce their carbon footprint to net-zero. A business that is carbon net-zero or carbon-neutral manages to either eliminate all carbon emissions or removes as much carbon from the atmosphere as it emits.

Finance professionals are at the forefront of initiating a business’s carbon accounting journey. With a little upskilling or some help from a consultant, management accountants can bring consistency, reliability, and coherence to an emerging field of the profession.

Dr. Martin Farrar
Associate Technical Director Research and Development, Management Accounting

Six steps to integrate carbon accounting into business management processes

As an emerging field, carbon accounting is made up of many methodologies without a single agreed-upon process. A lack of comparable data and metrics, consistent language, and coherent reporting standards are other big challenges businesses face as they aim to address climate change in a way that satisfies regulators, investors, shareholders, consumers, employees and local communities.

Legislation on net-zero targets and mandatory carbon reporting exists in several countries, including China, Canada, Japan, the European Union and the UK, and extensive disclosure requirements have been proposed in the US, but these regulatory requirements currently lack coordination and coherence. Efforts by the newly established International Sustainability Standards Board (ISSB) could change that. The ISSB has the ambition to develop a global climate standard that will provide comparable and consistent sustainability data across companies for global capital markets.

To start thinking about accounting for carbon emissions and transition the business to a lower-carbon model, finance professionals can follow six high-level steps.

In step one, the finance function in collaboration with the board of directors, senior management, and internal and external stakeholders devises a vision for change. This may require upskilling employees and bringing in resources where gaps exist. The vision and the language to describe the effort, the engagement of all stakeholders, and the required knowledge-sharing build the foundation for a business’s carbon accounting journey.

Understanding a business’s historic and current carbon footprint is step two in the transition. The finance function will need buy-in and support from cross-functional teams to collect accurate and verifiable trend data needed to set a baseline. The baseline measures the greenhouse gases each business activity or process emits and how much the emissions contribute to global warming – a measurement called carbon dioxide equivalent, or CO2e. Base years need to be representative and cannot date earlier than 2015.

Defining the baseline allows a business to take step three, which is to determine the emissions gap that must be bridged to reach net-zero targets.

Step four in a business’s carbon accounting journey is to set verifiable and quantifiable key performance indicators – metrics, milestones, and timelines that guide as to how and when the business will reach short- and long-term targets. That includes specifics on direct emissions from sources such as furnaces, boilers, and vehicles owned by the business; and indirect emissions, which include CO2es emitted to generate the power the business consumes and the CO2es in the business’ s supply chain.

Carbon offsetting or carbon sequestration, which uses technologies to capture and store carbon, can be part of a carbon transition plan. These mitigation strategies help a business reach targets by making up for CO2es it emits.

It is the responsibility of the board and senior executives to integrate the carbon transition plan into the overall business strategy, revisit and update the plan regularly and make sure targets are reached.

Stakeholders are given the chance to hold the board and senior executives accountable, because step five calls for annual progress reports. These reports are either published as part of the business’s annual financial reports or as sustainability reports. They should disclose climate-related issues material to the business’s ability to create value and be publicly available online.

The final step in the transition is to loop stakeholder feedback back into the business. That allows the board, senior management, and the finance function to update or revise the transition plan and adapt to changing circumstances and the evolving science underpinning climate change.

Role of the finance professional

It behooves finance professionals to become more familiar with and better understand the risks and opportunities climate change poses as stakeholders demand more transparency from businesses.

The struggle for the finance function is to find the expertise to set the foundation for the business to transition toward net-zero carbon in a consistent, timely, and balanced manner. Rather than collate data, finance professionals must learn to tell the story of a business’s nonfinancial impact, facilitate debate and change, and build stakeholder trust.

By following the six steps, the finance function can get a business started on the road to embedding carbon controls into strategic planning, budgeting, and performance measures and reviews, thereby making them a core component of business decisions.