Social and environmental audit: why?

The social and environmental accounting ‘movement’ began in the mid-1980s, when it was first coherently argued that there was a moral case for businesses, in addition to reporting on their use of shareholders’ funds, to account for their impact on social and natural environments. While accounting instruments already existed for reporting financial performance, there weren’t any for accounting for non-costable impacts, and it was this that gave rise to modern social and environmental accounting.

If, for example, a meat processor buys in beef and processes it for onward sale (eg as burgers), then the cost of the beef includes all of the identifiable costs incurred by the supply chain up to that point (plus profit margins, of course). So, for beef, those costs will include elements of farming, land costs, logistical costs, abattoir costs, and so on. However, the farmer who produced the beef may have reared the cattle on land bought as a result of forest clearance. He may have paid a market price for the land upon which to graze his cattle, but the initial deforestation has implications that could not have been factored into the price he paid for the land. How, for example, could you attribute a cost to the loss of species habitat or the loss of greenhouse gas processing capacity? It is because of the difficulties in allocating the costs of these externalities that, environmental activists say, the price of that beef does not reflect the true – or full – cost, which should include the cost to the environment. The same would apply to almost any product of course, not just beef. In the case of oil and gas, for example, the environmental footprint includes the extraction of a non-renewable energy source and the release of greenhouse gases (carbon and sulphur-based gases) into the environment.

What has all this got to do with audit? It is important because, increasingly, many investors and other stakeholders want to know about an organisation’s environmental footprint in addition to its economic performance. Typically, there are three sources of pressure for this:

• There is a growing belief that environmental issues represent a source of risk in terms of unforeseen (or foreseen) liabilities, reputational damage, or similar.

• The ethical performance of a business, such as its social and environmental behaviour, is a factor in some people’s decision to engage with the business in its resource and product markets. This means, for example, that some consumers will not buy from companies with unfavourable ethical reputations (ie in product markets) and, in resource markets, potential employees may use ethical performance as a criterion in their choice of potential employer.

• An increasing number of investors are using social and environmental performance as a key criterion for their investment decisions. While this has been a factor in ethical funds since they first appeared in the early 1980s, ethical concern has become more ‘mainstream’ in recent years.

Environmental audit: what?

An environmental audit, and the production of an environmental report, enables an organisation to demonstrate its responsiveness to all the sources of concern outlined above. Except in some highly regulated situations (such as water), the production of an environmental audit is voluntary. The production of such a report, however, ensures that an organisation has systems in place for the collection of data that can also be used in its environmental reporting.

An environmental audit typically contains three elements: agreed metrics (what should be measured and how), performance measured against those metrics, and reporting on the levels of compliance or variance. The problem, however, and the subject of most debate, is what to measure and how to measure it. As an environmental audit isn’t compulsory, there are no mandatory audit standards and no compulsory auditable activities. So, an organisation can engage with a social and environmental audit at any level it chooses (excepting those in regulated industries for which it is mandatory). Frameworks do exist, such as the data-gathering tools for the Global Reporting Initiative (GRI), AA1000, and the ISO 14000 collection of standards, but essentially there is no underpinning compulsion to any of it.

This does not mean that it is entirely voluntary, however, as stakeholder pressure demands it in some situations. Most large organisations in developed countries collect a great deal of environmental data, many have environmental audit systems in place, and almost all produce an annual environmental report. Some organisations audit internally and others employ external auditors, partly to increase the credibility of the audit and partly because of a lack of internal competence.

In practice, the metrics used in an environmental audit tend to be context specific and somewhat contested. Typical measures, however, include measures of emissions (eg pollution, waste and greenhouse gases) and consumption (eg of energy, water, non-renewable feedstocks). Together, these comprise the organisation’s environmental footprint. Some organisations have a very large footprint, producing substantial emissions and consuming high levels of energy and feedstocks, while others have a lower footprint. One of the assumptions of environmental management is that the reduction of footprint is desirable, or possibly of ‘unit footprint’: the footprint attributable to each unit of output. If a target is set for each of these then clearly a variance can be calculated against the target. Some organisations report this data – others do not. It is this ability to pick and choose that makes voluntary adoption so controversial in some circles.

A recent trend, however, is to adopt a more quantitative approach to the social and environmental audit. The data gathered from the audit enables metrics to be reported against target or trend (or both). It is generally agreed that this level of detail in the report helps readers better understand the environmental performance of organisations.

Summary

Audit and assurance is a concept that extends beyond statutory financial audit. In addition to the widespread use of internal audit, social and environmental auditing is widely adopted and is increasingly being employed by organisations to increase investor confidence and respond to other stakeholder demands. In some cases, this is an integral part of internal control, but in other situations, it is a standalone activity. In the case of social and environmental auditing, in addition to providing management information, the data might also be used to provide content for external environmental reporting.

Unlike financial audit and assurance, a lack of mandatory standards means that the value of these audits is disputed, but it is generally agreed that more knowledge and information on any aspect of governance is better than less.

Adapted and updated for SBL from an article originally written by a member of the P1 examining team