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.”
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.