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Murphy's new approach to climate-based accounting

28th Jun 2019
Sustainable cost accounting - provide for decarbonisation
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Sustainable cost accounting - provide for decarbonisation

Accountancy and tax justice campaigner Richard Murphy this week proposed replacing international financial reporting standards (IFRS) with an alternative methodology based on calculating the costs of making business sustainable.

In a paper delivered at a Debating Nature’s Value network meeting in London on Thursday, the City of London political economy professor argued, “IFRS accounting is inappropriate in the era when we are tackling the climate crisis and has to be replaced.”

The rollout of IFRS in 2005 was a revolution in accounting, he told the meeting. Instead of looking to maintain the productive capital of the enterprise by linking value back to historic costs, the mark-to-market approach in IFRS focused more on reporting the changes in value of capital over time.

According to Murphy, the IFRS capital model is only interested in whether the value of the entity increased: “Any concept of stewardship went out the window. Stewardship is incidental, it’s all about buy-sell-invest.”

This financial capital maintenance concept fuelled the climate crisis because of its inherent assumption that the “free gifts” of nature are ours to exploit at will, when it is now very apparent that this is not true, he said.

Under this system, scarcity increases value. “If we still command resources, our value goes up. So the world can heat up, but we’re OK,” said Murphy. “I gave up trying to reconcile this concept with the need to restrain the use of resources. What we would do instead is abandon the maintenance of financial capital as an accounting basis and replace it with a new capital maintenance concept.”

Sustainable cost accounting explained

The logic underlying Murphy’s sustainable cost accounting is that the natural capital of the planet must be maintained. The sustainability of the entity is directly linked to the sustainability of the environment in which it works.

“It does this by requiring that each entity appraise its environmental viability and this environmental viability then determines whether the entity is a going concern or not,” said Murphy. The process would involve undertaking a review of business processes and related investments to determine whether they can be made compliant with limiting global temperature changes to 1.5C.

In an appeal to accounting traditions, Murphy said his approach revived the “idea of prudence that was abandoned when adopting international financial reporting standards”.

His new precautionary principle of sustainability requires a business’s processes to become carbon neutral within an agreed timescale (not later than 2030) and that the costs of achieving this transition are assessed.

“The entity has to then state the value of the assets engaged in these processes in their accounts at the lower of their cost or net realisable value (both estimated using the principles of historical cost accounting) or at that cost or net realisable value less the provision required to make the processes in which the asset is used carbon neutral,” he said.

“When we introduce sustainable cost accounting, any business would need to make full provision to be consistent with the objective to maintain life at the time of adoption. Oil companies are currently writing off assets over 80 years. We can’t burn oil for that long and survive. We must make full provision now. If you can’t use the full asset, you provide for it.”

Carbon insolvency

Businesses that could not meet their commitments to sustainability would become “carbon insolvent” according to Murphy, whose regime would put them into a period of administration to give them time to work their way towards a sustainable business model.   

As well as estimating the costs of becoming sustainable, accountants would also be responsible for auditing this work. Ultimately for Murphy, his proposal is designed to put businesses right at the heart of the transition to sustainability. “At the moment they think they are on the periphery of transition. This brings climate change and biodiversity right bang into the middle of business and says, ‘It’s your problem. You’ve created products that are destroying the planet, now you have to do something about it,’” he said.

“If you are making products which are never going to be carbon neutal, this would all have to be published, provisioned and reported.”

Murphy acknowledged his sustainable cost accounting model was likely to encounter powerful opposition, but remained defiant. “It’s a radical step that makes allowance for the size of the crisis,” he said. “There will be significant write-offs of capital and we will wipe out shareholders’ reserves. This has a knock-on effect – large numbers of pension funds will find holes in their portfolios.”

Businesses and vested interests would probably stack up all their power against his proposals, he said, but the same people raised similar objections when he first proposed country-by-country reporting in 2003 and sharing tax information six years later; both are now part of the global compliance landscape.

“We are in an environmental crisis, so business has to respond to this challenge. It’s a question of change or die. In the court of public opinion this is really important, and it is changing,” he said.

Replies (6)

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Hallerud at Easter
By DJKL
01st Jul 2019 10:24

And there I was thinking accounting using profits and losses was subjective.

I can sort of see it happening in a world where the profit motive has become irrelevant, but suspect we are still a very long way from that- however maybe the whole concept of the pursuit of wealth will be devalued, though I do somehow doubt it, "Greed is Good" has been a maxim for thousands of years- just think of Midas- and there are few signs in mankind that this will change.

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By Huw Williams
03rd Jul 2019 11:49

I think the starting point (which may not have been agreed by everyone) is that we need to become carbon neutral.

For many businesses, this will involve a cost.

If there is a cost, it needs to be accounted for (at the moment a provision as it is a future cost for lots of businesses).

Talking about international mark-to-market accounting policies is possibly a separate issue.

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By Russell51
01st Jul 2019 15:58

Fascinating idea, and a really important topic.

My only cynicism comes from the fact that large companies have spent years dancing around the issues of any corporate social responsibility (they might proudly state they do a bit of charity work, but don't look too deeply into their supply chains). I can't imagine them being too keen on this coming in.

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By listerramjet
03rd Jul 2019 10:35

No thank you!

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By listerramjet
03rd Jul 2019 10:41

Whether we have a “climate crisis” or not is more in the nature of a religious question. Stern gave us the economic answer to the narrow question of carbon emissions; carbon tax; and that has been implemented. There might be a valid debate about how to account for it, but otherwise this would seem to be Murphy angling for grant funding. Personally I don’t get why you give him the oxygen of publicity.

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Teignmouth
By Paul Scholes
19th Jul 2019 12:43

Sustainable, Social, Environmental, call it what you will, accounting has been bumbling along for 30-40 years (anyone remember Prince Charles's A4S?) and will continue to do so until all those spreadsheets and numbers melt or flood.

Accounting is irrelevant in this respect, you don't need to review and assess the accounts of a tobacco manufacturer to discover how many deaths their products cause. It's a bit like relying on police reporting to tell us how many murders and assaults took place last year, without expecting them to do anything about it.

Accountants however do have influence, they are involved with huge numbers of businesses and individual consumers. All they need to do is get onboard with David Attenborough, Greta Thunberg et al.

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