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The Role of Carbon Accounting in Corporate Carbon Management Systems: a Holistic Approach

Qingliang Tang*

Western Sydney University

Working Paper

*Contact details: Dr. Qingliang Tang, School of Business, Western Sydney University, Locked Bag 1797, Penrith, NSW 2751, Australia, E-mail: q.tang@westernsydney.edu.au, Tele: 61 2 9685 9465

I thank the participants of the workshop at the University of Sydney, Western Sydney University, Tsinghua University, Shanghai University of Finance and Economics, Honk Kong Baptist University, University of Hu Chi Ming City, Annual Conference of The Accounting Society of China in 2014, Annual Conference of The Environmental Accounting of the Accounting Society of China in 2014, Shanghai Maritime University, Nanjing University of Finance and Economics, Western and Eastern University of Finance and Economics, for their useful comments for an early version of the paper. The financial support from the School of Business, Western Sydney University for the research project is gratefully acknowledged.

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The Role of Carbon Accounting in Corporate Carbon Management Systems: a Holistic Approach

Abstract

Climate change is a complex phenomenon and a serious challenge but the role of

accounting for global warming is not made clear. The paper proposes a broad concept of

carbon accounting which refers to a system that uses accounting methods to record and

analyse climate change information, and account and report for carbon related assets,

liabilities, expenses and income for the decision-making of users. In addition, the paper

adopts a holistic approach to describe the functions of carbon accounting and shows how it

can play a role for the construction of carbon management systems and how carbon

information may be used for evaluation of energy efficiency, carbon productivity and

disclosure of carbon reduction activities. Carbon accounting is conceived of multi-

dimension subject and we need innovative and creative approaches to develop carbon

accounting framework, methodology and workable programs. Carbon accounting should be

built based on knowledge and techniques from all aspects of accounting, including financial

and management accounting and auditing. Finally, the paper concludes that carbon

accounting is in its early stage and elaborates future research opportunities.

Key words: carbon accounting, climate change, carbon management systems,

I. INTRODUCTION

There is growing unequivocal scientific evidence on the effects of human activity in general,

and of GHG emissions in particular, on global warming that would worsen the already

deteriorating ecological environment (IPCC 2013). The negative impact of climate change on

economy, social activities and people’s health has already been emerging and the trend

toward a low carbon economy has been beginning. Carbon reduction initiatives and

corporate emissions reporting have expanded rapidly across firms in response to

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institutional demands and value creation considerations. The regulatory and market-driven

changes are expected to have a major impact across a wide variety of industries (Tang and

Luo 2014). Aside from mandatory compliance, firms need to cope with rising investor

demands for transparent and credible exposure to carbon levels and associated abatement

costs (PriceWaterhouseCoopers, 2012) and have to incorporate the assets, liabilities and

risks associated with managing GHG emissions into traditional accounting, governance and

control mechanisms (Deloitte, 2009; CIMA, 2010; Ernst & Young, 2010, Hartmann, et al,

2013). Although there is some anecdotal evidence that suggests an increasing effort to

incorporate carbon accounting into traditional decision and reporting processes (Hartmann

2013), research with a carbon accounting focus is lacking. Given the paucity of current

(academic) studies the concept of carbon accounting is not clear. There is a dearth of

knowledge (Ratnatunga and Balachandran, 2009) and scant evidence of the due technical

process required and the effort that is expended by accountants in that regard (Hartmann

2013). This article attempts to review the extant literature and identify key theoretical and

empirical shortcomings and then outline some essential elements of carbon accounting. The

paper specifies the main empirical and theoretical challenges underlying this novel

accounting area which are likely to be the directions for future studies. Most specifically the

article focuses on a number of questions that emerge from accounting for implementation

of carbon management system and emission trading scheme. A case can be made that

calculation, including that of new forms of accounting, is likely to be a significant feature of

a world not only conscious of environmental issues and constraints but also committed to

achieving a more harmonious relationship between the human and natural worlds

(Hopwood 2009).

Accounting for sustainable development necessitates the broadening of these short-term

economically-oriented accounting practices to incorporate not just direct short-term

economic interactions and impacts but also to incorporate the direct interactions and

impacts between the organization, the society in which it operates and the natural

environment. Carbon accounting therefore plays a key role for this end. The purpose of the

paper is to discuss the objectives and contents of carbon accounting (CA). First, the paper

offers an operational definition of CA:

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Carbon accounting is a system that uses accounting methods and procedures to collect,

record, and analyse climate change related information, and account and report for carbon

related assets, liabilities, expenses and income for the decision-making of internal managers

and external stakeholders.

The aim of this approach is to distinguish carbon accounting more clearly from any putative

accounting for sustainable development in general and for environmental accounting in

particular. Carbon accounting is expected to address problems that are driven by a

particular confluence (interaction) of aspects in particular settings (such as ETS). Various

motifs that characterise a carbon management science approach have been outlined and

constellations of governing activities of a typical carbon management system have been

identified. The paper then elaborates the importance and objectives of CA for the carbon

management for firms that want to control its emissions, and particularly those that

participate in a carbon emission right trading market. The paper then provides detailed

methodology that can be applied for firms to improve its climate change strategy and

carbon management system to achieve carbon reduction targets.

Climate policy is an extremely broad issue, thus the need to substantially reduce GHG

emissions not only mobilises governments and private sectors, but also requires that

millions of organizations and individuals change their production procedure, consumption

patterns and life style, which implies changing an economic system to meet a threat that lies

at present and in the future (Giddens, 2009; Levy & Egan, 2003). The issue is both wider and

deeper than other national and international issues, touching all areas of human life and

fundamental human beliefs and values (Hoffman, 2011a, 2011b). To achieve this goal will

require the efforts of the entire society, and accountants and auditors are expected to

position themselves as managers of carbon control and implementation of climate change

strategy (Lovell & MacKenzie 2011). For that purpose, there are many challenges. For

example, a mix of theories about the role of calculation, measurement and expertise in

governance needs to be developed to explain the situation about accountancy and society,

epistemic communities, and governmentality.

The research for the role of accounting for climate change is still in its early stage. The main

purpose of the paper is to identify the key areas in which accounting can make contribution.

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The paper critically discussed and reviewed the theoretical frameworks in previous studies

judged to be most relevant and illuminating in relation to exploring the response of

accountants to global warming centre on issues of measurement, calculation, expertise, and

disclosure from various accounting, management and economics literatures. These diverse

literatures are especially helpful in thinking about how the application of accounting

principles and techniques can be used for carbon accounting purpose. The paper suggests

traditional accounting methods such as double entry book keeping, financial reporting in

quantitative and narrative formats, disclosure and discourse (e.g. the discursive positioning

of climate activities of carbon intensive entities) should be useful. But new approaches and

theories need to be developed.

In recent years, the role of carbon accounting for corporate carbon management systems is

becoming central. There are, at least, two implications: first, innovation in our modes of

thinking is required to address more intractable problems of measurement and disclosure of

carbon related assets and activity. Second, the academy has explored how knowledge is

created, validated and translated alongside policy and practice settings and a stream of

work (carbon management systems) has emerged which investigates how disciplines might

develop knowledge that progresses carbon control for sustainable development. The aim of

this paper is to explore what opportunities emerge for accounting in light of a carbon

management approach. To achieve this end the paper starts with an examination of the

frustrations expressed in the existing literature over the perceived lack of progress made by

environmental accounting towards addressing carbon control in particular and sustainability

in general. The paper then discusses how an accounting for carbon management can

emerge with some illustrations of how a holistic approach can be adopted to develop

carbon accounting for carbon mitigation.

As carbon control has been an exigency for business sustainability, it seems entirely

apposite to consider a need to develop an accounting system specifically for the operation

of carbon management system. From the overlap between the management accounting

(e.g., Atkinson, Waterhouse, & Wells, 1997; Henri, 2006a; Henri, 2006b) and the

environmental literature, the paper proposes the carbon accounting concept and

methodology and provides insight of how to consolidate into the roles of accounting in a

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context of ecologic sustainability and foster transparency and accountability of carbon

control activity. The focus on the various aspects of carbon accounting creates the

opportunity for a more nuanced appreciation of the association between carbon accounting

and dimensions of carbon management systems. In particular, using a holistic perspective,

the paper emphasises the interplay of many elements of accounting makes up a functioning

whole of carbon accounting.

The paper is structured as follows. The next session summarise the current literature on

holistic research approach with a focus on why carbon accounting should be studied

separately. Section III describes carbon accounting elements for carbon management

systems at firm level. This section explains how carbon accounting can strengthen corporate

carbon management systems and what are the potential challenges and difficulties facing

professional accountants. Section IV is a conclusion.

II LITERATURE REVIEW

Holistic research approach

Holism in science, or Holistic science, is an approach that emphasizes the study of complex

systems. This methodology is in contrast to a purely analytic tradition (sometimes

called reductionism). The traditional analytic methodology aims to gain understanding of

systems by dividing them into smaller composing elements and acquiring knowledge of the

system through understanding their elemental properties. Instead, the way of doing science

under holism, is sometimes called "whole to parts," which focuses on observation of the

specimen within its ecosystem first before breaking down to study any part of the specimen

(Goethe 1772).

The term holistic science has been used as a category encompassing a number of scientific

research fields (e.g. climate change science). This approach has several distinct features.

First, they are multidisciplinary. Second, they are concerned with the behaviour of complex

systems. Third, they recognize feedback within systems as a crucial element for

understanding their behaviour. The Nature Institute, a research institute in holistic science,

describes the necessity for Holism in science as follows: “Modern science has increasingly

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moved out of nature and into the laboratory, driven by a desire to find an underlying

mechanistic basis of life. Despite all its success, this approach is one-sided and urgently calls

for a counterbalancing movement toward nature. Only if we find ways of transforming our

propensity to view and control nature in terms of parts and mechanisms, will we be able to

see, value, and protect the integrity of nature and the interconnectedness of all things. This

demands a contextual way of seeing." "About the Nature Institute". Archived from the

original on November 23, 2010. Retrieved May, 2015.

The Santa Fe Institute (SFI), a centre of holistic scientific research in the United States,

expresses it in this way: “The two dominant characteristics of the SFI research style are

commitment to a multidisciplinary approach and an emphasis on the study of problems that

involve complex interactions among their constituent parts. "Santa Fe Institute's Research

Topics". Archived from the original on January 15, 2006. Retrieved May, 2015. This approach

has been adopted in a number of areas. For example, researchers in Ecology ( or ecological

science) study the ecology at levels ranging from populations, communities, and ecosystems

up to the biosphere as a whole. Also the study of climate change in the wider context

of Earth science (and Earth system science in particular) can be considered holistic science,

as the climate (and the Earth itself) constitutes a complex system to which the scientific

method cannot be applied using current technology (James Lovelock 2000).

Holism in science emphasizes two central aspects. First, the way of doing science is from

"whole to parts". Second, the researcher is not a passive observer of an external universe

and there is no 'objective truth'. Rather the individual is in a reciprocal, participatory

relationship with nature, and that the observer's contribution to the process is valuable.

Goethe developed a holistic methodology outlines (Goethe 1772) and Rudolf Steiner

presents Goethe's approach to science and lays the groundwork for a holistic epistemology

(Rudolf Steiner 1978). Alternative to reductionism approach, the holistic premise is that

there is a possible qualitative difference between an entire system and its parts, so that

modularisation may fail. Bohm pointed out: "ultimately, the entire universe (with all its

'particles,' including those constituting human beings, their laboratories, observing

instruments, etc) has to be understood as a single undivided whole, in which analysis into

separately and independently existent parts has no fundamental status." (Bohm, 2002).

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Holistic science sometimes asks different questions than a strictly analytic science. For

example, Goethe contends “we conceive of the individual animal as a small world, existing

for its own sake, by its own means. Every creature is its own reason to be. All its parts have a

direct effect on one another, a relationship to one another, thereby constantly renewing the

circle of life; thus we are justified in considering every animal physiologically perfect.

Viewed from within, no part of the animal is a useless or arbitrary product of the formative

impulse (as so often thought)” (Goethe,J. Scientific Studies, Suhrkamp ed., vol 12, p. 121;

trans. Douglas Miller).

Implication for carbon accounting study

The paper pursued holistic approach (HA) to carbon management system (CMS) that is

sensitive to and illuminates its complexity. The HA is pluralistic in that it recognises diverse

sources, flavours and types of elements. HA engages in a reasoned weighing of a brand

variety of factors, including the circumstance. The results tend to be more nuanced and

flexible. HA yields more careful, balanced and complex view of these issues. HA balanced

CMS elements and that should inform our thinking about the pressing issues as legitimacy

versus signalling.

This holistic framework contains four inter-related dimensions that collectively can be used

to gain insights into how carbon accounting framework is built from existing accounting

literature. These four dimensions are: how each element of carbon accounting constructs

their own relevant programmatic discourses; how organisations select and/or construct

mediating instruments to channel the low carbon programmatic into their local

organisational accounting processes and practices; how entities construct and embed

hybrids of accounting and auditing into their governing processes for carbon mitigation

management; and finally, how effectively these accounting- carbon management hybrids

translate the low programmatic into organisational governing processes.

Adopting our holistic framework enables the researcher to observe sequences of inter-

connected transformations. The holistic framework developed in this paper provides

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additional insights into our theoretical understanding of how to facilitate the development

of more effective assemblages of accounting-auditing-carbon management hybrids and how

to analyse their emergence in practice.

Under a holist approach an individual part of the whole system can be defined by its own

substance plus its relationship with other parts. For example, finance reporting is one of the

elements of the entire accounting system. Financial reporting is intended to communicate

with the people inside and out of the reporting entity. The reporting function is inherent

within the accounting system, but the reporting is not for the entity’s accounting system

itself. Thus, the reporting function is therefore depends on the relationship between the

entity and other stakeholders and it is the relationship that determines the nature, extent

and contents of the financial reporting. In other words, the relationship with external parts

will affect the definition of the financial reporting element of accounting system.

A holistic approach of carbon accounting system is conceived of a comprehensive and

integrated mechanism. First, all the parts of carbon accounting systems are correlated with

each other. Second, the communication, interaction, interrelatedness, interdependence,

interconnectedness and feedback between components and parts of the system are crucial.

Third, the nature of each component of the carbon accounting system and the relationship

between a particular component with other component determines the function of

component (element).

This holistic framework contains inter-related dimensions and perspectives that can be used

to gain understanding of how carbon accounting can help improve carbon management

systems individually and collectively. That means the interplay of many elements of carbon

management system and carbon accounting make up a functioning whole.

The attention paid to carbon-related issues in the carbon management literature is limited

(Epstein, 2008, Ahrens and Dent, 1998). There is, however, an increasing interest in this

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area1 concerning various aspects of carbon accounting for climate change (e.g. Milne, and

Grubnic 2011, Engels 2009). This literature may be classified into two main broad streams-

albeit with some overlapping studies and blurring between these streams. The first stream

concerns the philosophy of accounting for sustainability and the second stream considers

the operational aspects of accounting for carbon control. Regarding the first stream, Burritt

and Schaltegger (2010) show that there are two opposing perspectives regarding

sustainability accounting and reporting. The first view is the ‘critical approach’, which

maintains that sustainability accounting and reporting is a ‘fad’ that will fade over time.

Proponents of this approach (e.g. Gray 2010) contend that the very notion of being able to

account for the biosphere and its sustainability is at odds with the objectives corporations

that ‘thrive’ in a capitalist market system. The second approach suggests sustainability

accounting provides tools to measure and manage areas outside traditional financial

accounting and assist decision-making by internal and external stakeholders (Young 2011).

Proponents of this perspective attempt to demonstrate relationships between social and

environmental performance and economic performance (including stock market valuations)

suggesting elements of sustainability can be highlighted and/or addressed through existing

market mechanisms. In sharp distinction, opponents of this philosophy argue that social and

environmental unsustainability is largely a consequence of the capitalist system and thus,

sustainability cannot be achieved unless a radical or fundamental reform for capitalism

takes place. Therefore, some authors contend that accounting probably has little to do to

protect the environment. This is because accounting is under the control of companies and

profit maximising companies are held to be responsible for the damage of environment. So

any attempt to offer some alternative account would be doomed to create more harm than

good (Gray 2010). Such a pursuit is suggested in the clear recognition that so much of

accounting is under the control of those whom it purports to hold to account, accounting, as

an element of the market system is unlikely to play a role for environmental protection.

However, most of the authors appear to seek to constructively but critically engage with

businesses and other organizations to help them identify a range of social and

1 See recent special issues on carbon accounting in Critical Perspectives in Accounting Vol. 19, No. 4, 2008; the European Accounting Review , Vol. 17, No. 4, 2008; Accounting, Organizations and Society , Vol. 34, Nos 3–4, 2009, and Accounting, Auditing &Accountability Journal Vol. 24, No. 8, 2011. Note Accounting, Organizations and Society Vol. 39, 2014 is devoted to sustainability accounting which is also related to carbon accounting.

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environmental sustainability risks and opportunities and make changes to the way they

operate in a direction intended to result in less unsustainable operations. (Editorial,

Academic contributions to enhancing accounting for sustainable development. Accounting,

Organizations and Society 39 (2014) 385–394). More specifically, this argument implies

researchers should critically engage corporations to participate in carbon abatement

programs (Hopwood, 2009, Bebbington and Larrinaga, 2014). We thus argue that given the

changes in government policy, customer preference and societal expectation, we are

moving to a low carbon economy. That means firms will operate in an entirely new

environment that requires new management philosophy, policy and operating system. Then

companies do have incentives or under pressure to alter their behaviour to improve their

carbon management system and to minimise their exposure to carbon risk and liability.

This paper is largely concerned with the operation of carbon accounting at firm level. Many

studies consider the impact of global warming, carbon market and carbon regulations on

corporate accounting practices (Bebbington and Larrinage-Gonzalez, 2008, CIMA 2010,

Harmann, et al 2013, MacKenzie, 2013; IETA 2007, Cook 2009). For example, authors

address the issues such as the market effects of carbon emissions (Matsumura, et al 2014,

Chapple et al 2013), carbon assurance and auditing (Simnett et al 2009, Olson 2010,

McKinnon 2010), carbon cost accounting and carbon management accounting (Broome

1992, Ratnatunga 2007, 2008; Ratnatunga and Balachandran 2009; Ratnatunga et al 2011),

carbon disclosure, (Reid et al 2009), etc. The generally accepted view is that GHG accounting

is a huge challenge to accountants and accounting academics (Young 2010). Ratnatunga

(2007; 2008) and Ratnatunga and Balachandran (2009) describe how carbon-related

information could affect and control in various organizational areas (new product

development, supply chain management, marketing and so forth). Basically, Ratnatunga and

Balachandran (2009) point to strategic cost management and strategic management

accounting practices that may be affected by carbon accounting. Carbon costing consists of

a combination of advanced cost allocation techniques (like activity-based management and

life-cycle costing) that improve the identification and assignments of carbon-related

expenses and overheads to such objects as products, services, customers and organizational

processes (Ratnatunga and Balachandran, 2009, p. 343). In strategic management

accounting, issues are organized under general headings such as ‘business policy’, ‘human

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resource management’ and ‘marketing strategy’ (Ratnatunga and Balachandran, 2009, pp.

345–7).

In addition, the Chartered Institute for Management Accountants (CIMA) and Accounting for

Sustainability (CIMA, 2010) conducted an international survey among sustainability

professionals to investigate the role that climate change is having in shaping the

management accounting profession. The survey highlights the potential beneficial effects of

integrating carbon management in carbon accounting systems. The survey provides the

various reasons for, and obstacles against, the integration or even merging of environmental

accounting and traditional accounting. The study documents that management accountants

could have a role in areas such as carbon footprint calculation, tracking climate change

performance measures/KPIs, preparing the business case for climate change initiatives and

carbon accounting/budgeting. The CIMA (2010) study also documents that management

accounting has potential to support environmental management with its traditional

portfolio of tools (e.g., cost-benefit analysis, investment appraisal, Balanced Scorecard).

Overall, while such a research stream provides a promising area for theory testing, this type

of empirical research necessarily must rely on reliable and valid information about GHG

disclosures. From several commentaries (Bebbington and Larrinaga-Gonzalez, 2008; Ertimur

et al., 2010; Young, 2010), this seems not to be the case. Hartmann et al (2013) argue that

there is a need to establish some solid foundations, starting from a more thorough

understanding of internal mechanisms of carbon accounting and it seems appropriate to

examine how carbon accounting is deployed internally and how it relates to externally

oriented accounting systems. Currently, there is no theory, let alone empirical evidence, to

explain the extent to which environmental management goals and traditional firm goals are

both supported via one integrated management accounting system (Perego and Hartmann,

2009).

In sum, increased GHG emissions disclosure represents an emerging imperative for many

companies; however, there is a dearth of knowledge about their transition towards carbon

management and their attempt to align it with management accounting and performance

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measurement systems (Ratnatunga and Balachandran, 2009). Moreover, there is scant

evidence of the due technical process required and the effort that is expended by

accountants and financial managers in that regard. Although the aforementioned

practitioner surveys suggest a large (potential) impact of carbon accounting in accounting

practices, the magnitude and direction of the impact is less obvious and provides a relevant

and timely avenue for academic research.

Carbon accounting (CA) versus environmental accounting (EA)

While the importance of carbon accounting is gradually recognised, the distinction in the

concept and contents between carbon accounting and general environmental accounting is

not clear. We argue that carbon accounting refers to a set of accounting methods and

procedure that can be used to address climate change related issues, and account for

carbon related assets, liabilities and disclosure. The first question is: given the large body of

environmental accounting literature why carbon accounting study is necessary?

Theoretically, EA and CA are inherently correlated. This is because EA is a broad, generic and

multiple-dimension concept, whereas CA is a constitutive component. EA refers to the

principles of environment protection that guides practice. If managers are not interested in,

or do not understand the importance of, environmental protection, firms will not have

carbon reduction target. However, different companies may face different environmental

issues. Thus, for a particular firm, the EA is always intended to address specific

environmental issue (s). For example, firms with heavy emissions may consider GHG is the

most serious environmental threat and the firms will have a carbon management system

(CMS). Other firms that have water pollution problem may have a water management

system (WMS) instead of CMS. Water management system and CMS are regulated by

different laws. Thus, the incentives or pressure for water management and carbon

management should be different, at least theoretically. For example, ETS and carbon

exposure may drive the quality of CMS, but have nothing to do with water management

system. Similarly, what affects water management practice may be totally different from

that for CMS. Thus, a separate study for specific EMS, should advance our knowledge about

overall environmental protection practice.

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Despite the research in accounting journals on carbon mitigation accounting is emerging,

many issues are not adequately discussed and debated. Meanwhile, the market for carbon

accounting and assurance is burgeoning. Thus, Tang and Luo (2014) argued that GHG

emission differs from other types of pollutions and it has a unique effect on global warming

(Lash & Wellington, 2007, IPCC, 2013). In addition, corporate carbon strategy is guided by a

different set of regulations with its own requirements and criteria (Luo, et al., 2013)2. In

response to these increasingly stringent carbon regulations and standards, firms are

expected to commit financial resource , acquire specific capability and adopt a carbon

management system (Walls, Phan, & Berrone, 2011). Finally, CA can be employed by

overwhelming majority of organisations because carbon emissions are ubiquitous across all

firms, sectors and countries, as climate change and the related legislations can affect all the

businesses and organisations, directly or indirectly. As our society moves to a low carbon

economy, a dissemination of CA knowledge is complementary to the environmental

literature rather than redundant. The study on CMS can help not only managers of firms

with heavy emissions, but also other firms that are not immediately affected, but still intend

to take proactive, forward looking policy.

Therefore the question is how accounting can help? The paper argues accounting can

provide some technical support for company’s carbon policy with traditional and new

approaches and methods to reduce its operational carbon emissions. Particularly the study

is the first attempt in the literature to examine the association between the link between

elements of CMS and the function of carbon accounting.

III CARBON ACCOUNTING AND CARBON MANAGEMENT SYSTEMS

Objectives of carbon accounting

The major objectives of carbon accounting is to assist managers to formalise climate change

strategy, identify and control climate change risks and opportunities, improve carbon

management system and achieve carbon reduction targets (Tang and Luo 2014). All aspects

2 For example, ISAE3410 prescribes detailed standards on an independent GHG statement assurance. According to IAASB, ISAE 3410 provides requirements and guidance specific to engagements on GHG Statements assurance. ISAE 3410 was not effective until September 30, 2013.

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of traditional accounting knowledge and techniques can be utilised to make contribution:

financial accounting (e.g. accounting for carbon assets and liabilities, carbon disclosure etc.

Luo and Tang 2013), management accounting (e.g. carbon reduction cost control, carbon

project budget, evaluation of carbon investment, etc, Tang & Luo 2014), and auditing (e.g.

GHG statement assurance, Datt, et al, 2015, Tang 2015). However, there are inevitably

challenges to traditional accounting methodology because carbon accounting also covers

non-financial (so-called ‘narrative’) disclosure of corporate climate impact (Luo et al 2012)

and carbon benchmarking (Aldersgate Group 2007).

It is our contention that there is a consilience between the ambit of carbon management

mechanism and scope of carbon accounting. Firms must adopt certain type of carbon

management system if they have carbon mitigation target. We argue that the

implementation of the carbon management systems largely depends on the function of

carbon accounting. However, these is scant discussion of how accounting can help

implementation of carbon management systems in a systematic way. This is largely because

there is lack of study on carbon management systems and firms do not adopt standard CMS.

So our discussion is based on a theoretic model of CMS which represent the practice of the

largest companies in the world that participated in CDP (Tang and Luo 2014).

The paper considers the major objective of carbon accounting is to help improve firm level

carbon management system (CMS). But what is carbon management system? Tang and Luo

(2014) conducted the first study that identified what constitutes an efficient CMS and

empirically evaluated its effect. CMS is defined by Tang and Luo (2014) as “a way to

implement a firm’s carbon strategy or policy to enhance the efficiency of input-use, mitigate

emissions and risks and avoid compliance costs or to gain a competitive advantage”. Their

theoretical model of carbon management system contains 10 basic elements within 4

perspectives, (i.e. carbon Governance, Operation, Emission Tracking and Reporting,

Engagement and disclosure). The current paper suggests that carbon accounting can play a

key role in designing, implementing and evaluating a CMS. In the following section, the

paper elaborates the details of the methodology of carbon accounting for CMS.

1: Overall carbon governance and board function

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The first element of the CMS proposed by Tang and Luo (2014) is the establishment of a

board function for carbon governance to ensure a sound carbon policy and provide

oversight for its implementation. Board of directors has the ultimate responsibility and the

power to develop an overall climate change strategy, set mitigation targets, establish

stimulation and incentive policies, deploy resources and to prioritise actions for mitigation

purposes. Counsel such as this might suggest that plurality of truly divergent components of

carbon management system can only remain coherent in a solid corporate governance

mechanism.

However, the carbon policy is likely to be a difficult decision due to inherent uncertainty

and conflict of interest of variety of stakeholders involved in the process of the decision-

making (Lin et al 2014). For example, Reid and Toffel (2009) show private and public

political pressures can affect corporations’ carbon decision and it appears public politics

may moderates private politics in the decision-making process regarding carbon activity. It

cannot assume that organisational carbon legitimization and carbon accountability are

always consistent with organisational objectives, and there can be a constant tension

between carbon management and existing organizational culture or managerial priorities.

So when carbon management is seen as constraining to business activity or profit-making,

operational managers will bias towards their prime objective and the responsibility of

navigating this tension falls to the environmental manager. Previous studies document that

in some organization, there seems to be multiple norms at play, with top management

prioritizing profit making and operational levels concerned with the environment, or vise

versa. Some managers may have negative views or are ambivalent about carbon controls

because they are skeptical about climate change. Staff perception is often contingent upon

top management commitment and the amount of resources dedicated to carbon mitigation.

It has been well established accounting information is essential for the decision-making of

managers. It is now extended to the decision-making of board of directors for none financial

aspects such as sustainability and carbon control. Communication of climate information

and energy consumption data at all levels of the organisation is crucial for a long term and

overarching climate strategy. Carbon accountants can play a key role to provide the board

and its committee with sufficient and well-organised carbon accounting data to help an

informed debate and so an impartial opinion and final decision can be made. Carbon

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accounting can help in two ways. First, it can help to formulate a sound proactive carbon

strategy. Second, it can provide assistance for the implementation of the carbon policy. It

can be argue that carbon accounting should more actively participate in the process of

formulation of carbon policy and the provision of the quality and quantity of carbon

information by carbon accounting system can affect the decision-making of board of

directors. Thus, carbon accounting is expected to be a part of the overall carbon governance

mechanism. In addition, carbon accounting should help the board to enforce the policy via

providing feedback information in a timely manner to evaluate the effectiveness of the GHG

strategy. Participation of carbon accounting at the top level of decision-making is particularly

useful in situations with high degree of uncertainty and the interest of stakeholders are not

congruent.

2 Carbon risk assessment

Tang and Luo (2014) identify carbon risk assessment as the second element for a well-

functioning CMS. This is a formal procedure to identify and assess carbon-related risks and

opportunities and the significance of their impacts on products and financial results. CDP

indicates entities often face three categories of such risks, i.e. regulatory, physical and other

risks (CDP 2013). Changes in government climate policy are often the main source of carbon

risk but also create business opportunities. Risks/opportunities can typically be evaluated

through regular review of climate-change science and its application to existing assets and

properties. Some firm has an integrated risk-management approach that is consistent with

ISO 31000 (risk-management standards), the Enterprise Risk Management-Integrated

Framework (COSO). They measure the materiality of risk exposure in accordance with the

following consequence categories: financial; business interruption; customer impact;

reputation; regulatory/legal; environmental and health and safety. An escalation process is

followed that will determine the level and urgency of board attention based on the assessed

degree of materiality (Tang and Luo 2014).

Accountants are needed to involve in the process. The risk analysis methods frequently

advocated in financial accounting and management accounting literature should be very

relevant for the analysis of climate change related risks and its financial impact. These

methods can be applied through the development of a scenario analysis that models the

18

financial and monetary effects of government policies and public sentiment such as the

voluntary switching to renewable energy and, or to low carbon products. Although

traditional management accounting methods are ready for execution of the task, they are

often inadequate. For example, the introduction of ETS may have direct or indirect, long

term or short term impact so a new set of analytical methods may be necessary to carry out

meaningful analysis.

3 Staff involvement in carbon reduction initiatives

Firms often adopt an incentive mechanism to encourage staff engagement and

participation in carbon reduction initiatives. Having managers with a personal predisposition

towards carbon control complements firms’ efforts to achieve emission targets. Thus, this

element of CMS develops employee commitment by clearly assigning accountability and

responsibility, and providing stronger motivations. Increasing managerial awareness may

lead to improved individual performance (Etzion, 2007), intensive and broad staff

participation (Cole, 1991; Hart, 1995) and team production (Willig, 1994). Rewards for

outstanding performance steer reduction by acting as an ex ante signal about what

outcomes are desired that will unlock the potential of employees and allow optimal

behaviours to arise and continue (Brammer and Pavelin, 2006). Such a CMS may embed

climate-change considerations into remuneration and promotion package, which incentivise

responsible officers to achieve or exceed expectations.

Incentives refer to the integration of environmental criteria in the evaluation process to

direct managerial effort towards carbon reduction activities, and eco-control is used to

guard against undesirable behaviour and to encourage desirable actions (Merchant, 1982).

Carbon accounting can use management accounting methods to evaluate staff carbon

performance. Typical examples include staff performance management by expectation,

balanced score card, integration of standard energy cost with production process, analysis

of variances between actual and planed energy cost and consumption. These methods are

designed to precisely measure performance by providing rewards and feedback, permitting

19

staff to take corrective actions when the indicators show a discrepancy between actual and

desired results.

However, carbon reduction benefits are often long term and the mitigation initiatives may

not generate direct financial results (Tang and Luo 2014). Luft (2009) discusses challenges in

using combinations of accounting/financial and nonfinancial indicators, namely the accuracy

of measuring nonfinancial performance and the appropriate weighting required to ensure

balance across financial and nonfinancial measures. Carbon accounting faces the similar

challenges. In order to capture the relation between a firm’s carbon usage and its

underlying business activities and motivate continuous improvement, Hoffmann and Busch

(2008) and Busch (2010) propose four corporate carbon performance indicators that include

the physical (nonfinancial) and monetary (financial) dimension of performance, as well as

current and future performance. For example, on the financial side, they derive monetary

implications of carbon intensity from a static perspective (labelled as carbon exposure) and

a dynamic, long-term perspective (carbon risk).

Thus, the purpose of the accounting mechanism is to shift the attention of short-horizon

managers towards the long-horizon interests of the firm in alignment with climate strategies.

However, even it may be appropriate to make salaries or compensation vary with the

observed reduction of environmental risk, it may not always allow the change on

environmental performance measure to covary with the change in financial performance

measures (Baker, 2002, p. 736). Best known as the ‘Balanced Scorecard Philosophy’,

nonfinancial indicators are argued to be an effective antidote against managerial myopia,

which means managers are dysfunctionally inclined to pay attention to only the immediate

rather than the distant future effects of his decisions. Clearly, the area of environmental

performance in general and carbon accounting in particular is one area in which myopia

may be prominent. Thus, future studies can examine the cause-and-effect relationships and

the complex lead–lag relationships between carbon performance indicators and financial

performance measures (e.g. Dikolli and Sedatole, 2007). Since carbon emissions become a

tradable commodity and thus carbon market internalizes carbon performance of the firm, it

helps to understand the trade-off between non-financial and financial performance (Luft,

20

2009). But much needs to be done on how such performance indicators impact the decision-

making of managers, which is an empirical issue of prime importance in future research.

4 Emission target setting

Setting carbon targets is an essential step towards to emissions control. A firm signals its

commitment by setting reduction targets for the staff and stakeholders. These targets are

necessary for framing and motivating effective actions (Pershing and Tudela, 2003). And the

targeted emissions will directly determine the level of committed investment and personnel.

The proper design of such targets can lead to measurable progress and trigger innovation

and technology development. This is a decision that has long term and significant impact on

firm’s future operation and profitability.

However, this is not an easy job. Prior studies suggest that carbon management

commitment is affected by many external and internal factors (Luo et al 2012, and 2013).

Management must make sure the carbon target is comparable to firm’s overall objective,

taking into account all relevant factors such as availability of resource and low carbon

technology. For those organisations that are required to participate an ETS, government

climate policy will have direct effect on target setting.

Organisations can have two major types of carbon reduction targets. The first category

refers to absolute targets as opposed to intensity targets. Absolute targets are set up to

reduce the absolute amount of emission from a basement year, while intensity target

considers the relative carbon emissions to its underlying business activities. For example, a

calculation of an intensity of carbon emissions is the total quantity of scope 1 and 2 divided

by total sales, income or the number of employees. Both absolute and intensity carbon

emissions and the related targets are used widely in practice and each has its advantages

and limitations. The ultimate objective of carbon activity is to reduce the absolute carbon

emissions so as to decrease in the degree of Co2 concentration in the atmosphere. However,

the intensity target is still a useful indicator which takes into account the output with a

certain amount of energy consumption and carbon emissions. Also a target is linked to some

benchmark such as previous year emissions, or the average emissions level in the industry

or in the nation where the company operates, so comparison in energy efficiency and

21

carbon productivity can be made. Carbon reduction targets should be reasonable, because

this is the standards for staff and department evaluation of the carbon performance. The

target that is too ambitious or too low would not achieve its objective of improvement.

Carbon accounting is expected to be involved in the process of carbon reduction target

setting. Carbon accounting must provide adequate historical data regarding firm’s energy

structure, cost and efficiency, carbon footprint. What is more, carbon accounting can give

careful calculation about the required financial commitment for the implementation of the

proposed reduction targets and what is the impact of the target for future operating cost

and profitability, etc. In sum, without sufficient, relevant and adequate carbon accounting

information, it is impossible to set up reasonable carbon reduction targets.

5 Carbon reduction actions and carbon policy implementation

Carbon actions refer to various types of carbon initiatives such as energy-saving projects,

development of low-carbon products, the use of degradable materials and consumption of

renewable energy, or other green projects that could offset carbon and promote efficiency

of energy utilisation. Note that carbon activity demands implementation capability at all

stages of operation, involving all layers of employees and management and the actions

taken reflect the level of expenditure and investment for mitigation purposes. Thus, one of

the key goals of carbon management system is for management of carbon reduction actions.

The entire procedure of any emission mitigation project (action) will normally go through

several stages: feasible study, implementation, completion and evaluation of the

performance of the investment. In each of these stages, carbon accounting should be

involved by providing necessary information and calculations for project manager. For

example, in feasible study stage, carbon accountant provides data regarding project

financing and employs analytical tool for cost-benefit analysis. At the implementation stage,

carbon accountant needs to monitor the progress and control the expenditure. At the

completion stage carbon accountant will evaluate the effectiveness of the project. In sum,

variety of accounting methods particularly proposed in management accounting (e.g.

Jiambalvo, 2001, Managerial Accounting, John Wiley & Sons Inc.) should be used in order to

successfully execute and complete a carbon project. These methods include job-order

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costing system, process costing system, multiproduct analysis, activity-based costing, capital

budgeting decisions, budgetary planning and control, standard cost and variance analysis.

The selection and adoption of appropriate methods requires a combination of engineering

experience, energy expertise, as well as project management and accounting knowledge.

6 Supply-chain emission control

A comprehensive, cradle-to-grave analysis of the emissions of a commodity is important to

achieve overall mitigation (Butner et al., 2008), because the bulk of emissions often are

generated throughout manufacturing, use and disposal of products and the direct emissions

of a firm may account for only a small portion of the entire emissions. Therefore, in order to

design low-carbon or carbon-neutral products, some companies reach beyond their

boundaries to interact with others. Integrated supplier relationships enhance carbon

performance via the sharing of process and product innovations (Florida, 1996; Geffen and

Rothenberg, 2000). Thus, Dutta and Lawson (2008) describe a framework for incorporating

carbon footprint into decision-making that emphasizes the role of value chain analysis. The

Carbon Trust (2006) observed that many companies (even traditionally inward-focused)

have gradually embarked on initiatives involving upstream suppliers and downstream

customers to build influence, create knowledge, reduce emissions and generate financial

returns. These companies control emissions along a complex nexus of relationships with its

business partners and adopt techniques developed within the field of life cycle analysis to

collect energy and emissions data to ensure that all raw materials, waste, energy and

emissions are accounted for, so as to calculate the carbon footprint of a product supply

chain.

From GHG accounting perspective, the main problem refers to the allocation of carbon

emissions (and related costs) across the various supply chain stages. The GHG protocol

differentiates three ‘scopes’ : i.e. Scope 1, 2 and 33. This effectively draws three boundaries

around an entity for carbon accounting and auditing purposes. Companies are often

required to quantify and report their Scopes 1 and 2 emissions but can exercise discretion

3 Scope 1 emissions arise from activities for which the entity is directly responsible, Scope 2 are those indirect emissions associated with the purchase of electricity, heat and steam, while Scope 3 covers all other indirect emissions, such as third-party logistics, working on the company’s behalf,etc. (WBCSD/World Resources Institute, 2004).

23

over the inclusion of Scope 3 emissions. Organisations may reduce emissions by outsourcing

logistics activities if scope 3 is excluded. However, the inclusion of scope 3 emissions for all

the supply chain partners will result in double or multiple counting, artificially inflating the

total emissions allocated to a particular product (Hoffmann and Busch, 2008).

In addition, deciding upon the start and end points for carbon measurement within the

vertical supply chain is a controversial choice. Carbon emissions would be traced back to

raw material sources and the supply chain ends at the shop shelf. As an increasing

proportion of retail purchases are being made online and delivered to the home, including

carbon emissions from these post-purchase activities in the footprint calculation would be

fraught with difficulty given the variability of consumer travel behaviour, product usage and

reverse logistics options (McKinnon, 2010, Hartmann 2013).

Another problem concerns the allocation of common and joint energy costs and emissions

among different activities (transport, warehousing, consumption) along the various stages

of a supply chain (McDonough and Braungart, 2002). The allocation could be determined by

product weight, dimensions, handling characteristics or a combination of these criteria as

appropriate (Bastianoni et al., 2004; Archel et al., 2008; Young, 2010).

Carbon accounting can help resolve the boundary and allocation problems and to support

carbon management with its traditional portfolio of tools. For example, the firm can apply

cost-benefit analysis method to a carbon reduction project which must extend to an

external business partner. Also cost-volume-profit analysis can be extended to whole supply

chain of a product. Note supply chain carbon accounting is a cross cutting theme

(Spangenberg, 2011). The concept of supply chain carbon cost considers the impact of all

the aspects of activities of a group of entities on carbon emissions. However, this is at odd

with traditional accounting concept. For instance, conventional ‘accounting entity concept’

dictates that accounting should be only concerned with some costs that are borne by the

reporting entity. In contrast, external cost is one of the central themes in supply chain

carbon control and accounting and hence it is an approach that addresses the interlinkages

between supply chain ecologic sustainability, emissions control and an entity.

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Generally, we conclude that the environmental arena (and specifically GHG emissions) has

rapidly become one of the most prominent arenas in which external, institutional settings

have a potential effect on an organization’s carbon treatments. Management accounting

research on carbon accounting is extremely limited, thus, research opportunities seem

abundant. This suggests three avenues for future research in terms of constructing supply

chain carbon accounting. First, the entity should provide room for the participation of

upstream and downstream business partners in supply chain carbon accounting. This raises

challenges such as, the representativeness of participants, inclusiveness, and how to attain a

fair deliberation, etc. Second, methods need to be devised to communicate the uncertainty

about different processes in the ecological and supply chain subsystems (Funtowicz &

Ravetz, 1993, p. 743). Third, multiple approaches need to be adopted that allow the

possibility of different forms of valuation, including monetary and none monetary

evaluation. Note carbon accounting does not always assume a monetization of values as

that is perhaps at odds with the foundation of supply chain carbon accounting.

7 GHG emissions recording and accounting

Accounting for carbon is scientifically complex (for a succinct summary of this science refer

to Bebbington and Larrinaga-Gonza´lez, 2008, p. 711), particularly there are substantial

technical complications in defining and measuring GHG emissions (e.g., Milne and Grubnic,

2011). There are issues inherently associated with the underlying data capture systems and

the interpretation of the government requirements that present the professional

community and academic researchers with both challenges and opportunities in a local,

national and global context. Insofar as carbon crediting militated against fundamental social

and technological changes, each carbon credit carried long-term carbon costs, accounting

for which was recognized to be beyond the current scope of the discipline, due both to

creativity’s unpredictability (Malloy, 2000) and to its unquantifiable precursors and effects

(Larry Lohmann. 2009. Toward a different debate in environmental accounting: The cases of

carbon and cost–benefit. Accounting, Organizations and Society 34 (2009) 499–534).

On a more theoretical level, the apportionment and GHG accounting can be considered as

an issue of producer versus consumer responsibility. Bastianoni et al. (2004) have explored

25

three approaches to the problem of assigning ownership of GHG emissions between

producers and consumers including an approach that allows sharing of the responsibilities

among all the interested subjects in an effective and fairer way as consumers are taken as

responsible for most of the emissions and producers are subject to a minor but precise

imputation of responsibility (Bastianoni et al., 2004, pp. 253-57).

Thus, Tang and Luo (2014) proposed an CMS element from an emission tracking and

(internal) reporting perspective. An essential step towards carbon management is to

calculate carbon emissions and account for GHG footprint, in which carbon accounting plays

an indispensable role. A CMS must collect, summarise and measure the GHG emission data

and Co2 inventory. Such data recording and presentation should enable comparisons across

reporting periods and facilitate independent reviews for compliance and data accuracy. In

addition, sophisticated GHG accounting system can provide managers with real-time

visibility into project-, department and firm-level physical emissions flow. Thus, climate

committee can trace energy transactions and benchmark emissions levels with goals and

industry standards. At the moment, scientists and engineers still debate on technical

methods, so international recognised GHG standards are still yet to develop and different

countries use different GHG accounting protocols4. For example, Goldsmith and Basak (2001)

identify several limitations in the measurement of environmental performance indicators

that apply to the measurement of GHG. First, since pollution is a dynamic problem, products,

production processes and their associated pollutants change continuously, requiring metrics

that can adapt to these changes. Second, the cumulative effects of carbon dioxide may

persist and build up over long periods of time. In addition to the less observability of GHG

emissions, there is a problem of data aggregation. That is, energy and Co2 data are

collected over time, which tends to be aggregated into a single index or score. Finally,

pollution output may be stochastic in nature and not entirely the result of preventive

strategies applied.

4 With regard to technical GHG accounting methodology and protocol, Tang and Luo (2014) found that most local Australian firms use the method prescribed in the Australian National Greenhouse and Energy Reporting Act (NGER). Multinational companies, such as BHP, also use The Greenhouse Gas Protocol which is a widely used international accounting tool to quantify and manage GHG emissions.

26

Additionally, carbon accounting must not only consider the quantification of physical GHG

but also the emission cost or carbon price that is the financial impact of emissions. For

example, carbon allowances could be used to hedge against financial risks or even to

achieve extra gains through arbitrage. Carbon accounting and financial reporting methods

for carbon assets and liabilities created from cap-and-trade scheme (i.e. ETS) are

controversial. Unresolved questions include: what is the definition of carbon asset (liability)?

Is a free allocated emission right an asset? If yes, when the firm should recognise it in its

financial statement and how to measure the asset? What is the nature of the carbon assets?

Is this an intangible or tangible asset? These questions are important, because how to

recognise and measure them can significantly impact financial results. If carbon assets and

liabilities are completely and inherently different from traditional assets and liabilities, do

we need brand new approach and techniques to measure and report these carbon items?

In this regard, Cook (2009) outlines how the International Accounting Standards Board

tackled the issue of recognition of emission rights as carbon assets that provokes an

intractable conundrum of measurement of the assets. Cook (2009) shows and explains how

the initial attempt to promulgate a standard on GHG disclosure (IFRIC3) eventually failed

due to the potential volatility arising from recognizing changes in the value of revalued

emission rights allowances (intangible assets) in equity and income. Although there is a

growing amount of regulations and guidelines produced by government institutions that

attempt to help operationalize and solve the technical challenges (e.g. the Australian federal

government National Greenhouse Energy and Reporting Act, Australian government, 2007,

2008a, 2008b, 2009), in many cases, it will fall to the accountant to adjudicate whether the

method adopted is appropriate.

A variety of practice in carbon accounting has been observed and evidence shows carbon

accounting impact decision-making of managers. For example, the Chartered Institute for

Management Accountants (CIMA) and Accounting for Sustainability (CIMA, 2010) conducted

an international survey among sustainability professionals to investigate the role that

climate change is having in shaping the management accounting profession. Without much

theoretical explanation, the study documents that management accountants could have a

role in areas such as carbon footprint calculation, tracking climate change performance

27

measures/KPIs, preparing the business case for climate change initiatives and carbon

accounting/budgeting.

Ratnatunga and Balachandran (2009) and Ratnatunga (2007, 2008) suggest that, based on

the idea of ‘different costs for different purposes’, the carbon agenda could impact costing

principles, costing techniques and traditional costing problems and carbon-related

information could affect and control in various organizational areas (new product

development, supply chain management, marketing and so forth). Based on the opinions

collected from participants to 31 international environmental research symposia from 2003

to 2007 on the impact of the Kyoto Protocol on management accounting control,

Ratnatunga and Balachandran (2009) find that carbon accounting affected strategic cost

management and strategic management accounting practices. In strategic cost

management, carbon costing consists of a combination of advanced cost allocation

techniques (like activity-based management and life-cycle costing) that improve the

identification and assignments of carbon-related expenses and overheads to such objects as

products, services, customers and organizational processes (Ratnatunga and Balachandran,

2009, p. 343). In strategic management accounting, carbon accounting plays a role that is

recognised under general headings such as ‘business policy’, ‘human resource management’

and ‘marketing strategy’ (Ratnatunga and Balachandran, 2009, pp. 345–7).

8 Greenhouse Gas statement assurance

Independent GHG statement assurance is an important element of CMS (Tang and Luo

2014). Carbon auditing is a broad concept which includes GHG assurance, compliance audit

of carbon activities and climate change auditing which is an evaluation of climate change

policies and strategies of private and public organisations. The International Organization of

Supreme Audit Institutions (INTOSAI) emphasized the need for this type of auditing:

“Climate change involves a wide range of risks that make it particularly relevant to auditors,

for example, risks related to goal attainment, policy instruments and transparency”

(INTOSAI Working Group on Environmental Auditing 2010, page 10). Also, the complexity of

GHG emissions and their impacts on the economy, society, and the environment, as well as

28

on cross-sector organisational structures and policy instruments, make climate change

auditing vital (The Guide, page 10)5. All businesses should be conducted in a carbon-

constrained way, and an auditor may help managers identify and reduce carbon-intensive

activity, products, and services and prioritise ways to achieve mitigation targets (e.g., Tang

and Luo 2014; Ratnatunga, and Jones 2012).

GHG assurance is necessary because there is inherent uncertainty and incomplete

scientific knowledge in the measurement of GHG emissions. For instance, the rate of GHG

sequestration in biological sinks, and the “global warming potential” values used to combine

emissions of different gases and report them as carbon dioxide equivalents, are

inadequately understood. The external assurance aims to increase carbon and energy data

creditability and the level of stakeholder confidence in the use of carbon information and

assist managerial planning and encourage control of emissions (Sinclair-Desgagné and Gabel,

1997). So far GHG assurance is largely voluntary (Datta et al 2014), and the practices vary

widely in terms of level of assurance, scope, criteria and materiality. The adoption of new

assurance standards issued by the International Auditing and Assurance Standards Board

(IAASB, June 2012 ISAE 3410, Assurance Engagements on Greenhouse Gas Statements, with

assurance reports covering periods ending on or after September 30, 2013) should facilitate

this fast-growing and highly demanded service. According to ISAE 3410, the objectives of

the assurance practitioner are to obtain reasonable assurance that the GHG statement is

free from material misstatement, whether due to fraud or error, and that the GHG

statement has been prepared, in all material respects, in accordance with the applicable

criteria (ISAE 3410, IAASB). While the purpose of GHG statement assurance is similar to

traditional financial statement assurance, a review of the literature suggests some

significant differences exist.

GHG statement assurance practice

5 The International Organization of Supreme Audit Institutions (INTOSAI) is the professional organization of supreme audit institutions countries that belong to the United Nations or its specialized agencies. The Working Group on Environmental Auditing (WGEA), under INTOSAI, aims to improve the use of audit mandates and audit instruments in the field of environmental protection policies and sustainable development. WGEA published “Auditing the Government Response to Climate Change: Guidance for Supreme Audit Institutions” (INTOSAI WGEA 2010). The Guide distinguishes between audit of adaptation and audit of mitigation policies. Climate change mitigation involves taking actions to reduce GHG emissions and to enhance sinks aimed at reducing the extent of global warming while climate change adaptation focuses on actions to moderate the harm or exploit benefits caused by the actual or expected effects of global warming (The Guide, page 6).

29

GHG statement assurance is a new category of assurance that is characterised by factors

different from financial assurance, so it is important to understand the difference between

GHG assurance and traditional financial assurance. For example, GHG engagements are

ordinarily expected to be undertaken by a multidisciplinary team of experts who possess, in

addition to assurance skills; GHG competencies, such as an understanding of laws and

regulations related to emissions reporting, GHG quantification and measurement

methodologies. And chemical and engineering expertise are often required or desirable.

Moreover, investigation methods adopted may be different in GHG assurance from a

financial statement assurance perspective. For example, a large part of carbon emissions.

Thus, ISAE 3410 emphasises the importance of performing procedures on “site visits” to

identify emissions in individual geographical locations or facilities within an organisation.

Furthermore, while financial audit covers all financial statements, GHG assurance may only

cover part of carbon emissions of the entity, e.g. it may cover scope 1 and 2, but not scope 3

emissions. In addition, a firm may have less than 100% emissions to be externally verified.

Finally, risks of misstatement in a GHG statement are associated with very different factors

from those relevant to a financial statement. The accuracy of the measurement of the

carbon footprint is dependent on the development of scientific, regulatory and physical

mechanisms. It also depends on the firm’s internal control system, the degree of complexity

of its operations and the nature of the business (ISAE 3410, 23). The strength and weakness

of the systems and institutions may affect the application of the applicable criteria to the

entity’s circumstances and change the susceptibility of the entity’s GHG statement to

material misstatement. These risks can affect the GHG statement as a whole. Thus,

techniques of the assessment of the risk in GHG assurance can be different from financial

statement assurance (ISAE 3410, Para. A52–A53, A70).

9 Carbon Disclosure

Global warming and planetary degradation is an issue exigencies and this parlous situation

reinforces the need for corporate reporting of their environmental performance. Hence,

External carbon disclosure is another essential element of carbon management (Tang and

Luo 2014) and also a function of carbon accounting. Carbon disclosure is largely optional in

most parts of the world albeit the recent trend toward mandatory requirement. While many

companies keep their carbon footprints hidden, some pioneer entities voluntarily disclose

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their carbon information. In addition, some firms may just comply with minimum

institutional requirement, while others adopt more proactive strategy and attempt to

achieve more aggressive reduction target. A high degree of carbon-information

transparency reveals a firm’s climate change strategy, carbon footprint, and managerial

carbon accountability, which allows external stakeholders to monitor and seek

improvement in the entity’s operations and CMS (Sroufe, 2003, p.428; Kolk et al., 2008,

Tang and Luo 2014). Carbon disclosure can be made in a firm’s annual report, CSR report,

sustainability report, or as a stand-alone GHG statement. The channel, format and content

of carbon disclosure reflect the perceived importance of carbon emissions and activity by

managers and stakeholders.

Carbon accounting concerns what and how carbon information should be disclosed to

external users. Unresolved specific carbon accounting questions include whether GHG

emissions disclosures should be mandated rather than remaining a firm’s voluntary choice

(Cowen and Deegan 2011), whether GHG statement should be a separate, stand-alone

report or should it be combined with, or treated as a component in other social and

environmental disclosure, as well as the various accounting dilemmas around the broader

issue of reporting, assurance and valuation of nonfinancial information (Olson, 2010). As

there is no a set of internationally recognised carbon disclosure standards, the above issues

are still under debate and remain unresolved.

Regarding the content of carbon information to be disclosed, this is still a controversial issue.

A lot of research needs to be done regarding the information needs of various users and

stakeholders. For example, like financial reporting, a GHG statement is supposed to meet

the information needs of users to make decisions. Thus, who are the users? Are they just

shareholders, or there are other users and stakeholders who are interested in carbon

information? What kind of decisions they will make and what is the information the users

need for the decision-making? Should a statement disclose the trend and historical

emissions data? Most of the carbon information is none financial, should carbon report also

includes financial information such as carbon cost, energy consumption expenses etc.?

Should both quantitative and qualitative information be included? In addition, are mere

emission data sufficient for an understanding of the effect of business operation on

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environment and the impact of climate change law on business, without detailed

information about firm’s financial commitment, carbon strategy and actions?

Table 1 is a summary of the roles of carbon accounting for CMS. Firms are likely to develop a

CMS step by step. So Figure one is a summary of the major steps a firm would take to build

a CMS. Figure two then shows the role of carbon accounting in the 5 steps of development

of CMS. Figure 3 visuralizes a carbon accounting system using holistic approach.

Table 1: A summary of the roles of carbon accounting for carbon management systems

Major CMS

elements*

Purpose The role of carbon accounting

Board function To develop an overall

climate change

strategy and policy

Carbon accounting provides

adequate information for

formalisation of carbon policy to

address climate change issues.

Carbon Risk and

opportunity

assessment

To identify and assess

carbon risk and

opportunity

Carbon accounting is needed to

design the procedure to assess

climate risk and opportunity,

particularly about its financial

implications for firm operation and

profitability.

Staff

involvement and

carbon

performance

evaluation

To motivate staff and

enhance awareness

of climate change

issues

Carbon accounting method should be

used to design specific measure

required to incentivise them to

participate in carbon reduction and

energy saving projects.

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Emission target To create a mitigation

target that is

consistent with the

carbon strategy

Carbon accounting should provide

sufficient information for managers to

set up measurable and quantifiable

emission reduction target.

Carbon actions

and policy

implementation

To enforce the carbon

policy by prioritising

reduction actions and

allocating resources

to achieve targets

Carbon accounting should evaluate

low carbon projects, energy efficiency

project, clean energy initiatives.

Carbon project needs specific funding,

specific objectives so feasible study is

needed.

Supply chain

emission control

To reduce supply

chain emissions

Carbon accounting is needed to

develop specific measures to control

supply chain emissions.

GHG emissions

recording,

accounting and

internal

reporting

To keep track of

carbon inventory and

emission footprint

Carbon accounting has specific and

distinct protocol and standards and

norms to account for emission

including scope 1,2, 3. What is more,

is the need to account for emission

rights and its economic values of

carbon assets and liabilities.

Carbon accounting should prepare

this report for the decision making of

managers who is responsible to

achieve carbon target.

External carbon

assurance

To increase the

reliability of carbon

data

External and internal GHG emission

assurance and verification is also

needed to check carbon recording and

energy consumption.

33

External

disclosure

To increase the

transparency of

mitigation activities

and outcomes,

To strengthen the link

with stakeholders

Carbon accounting should specify the

contents, format and frequency of

carbon disclosure to external

stakeholders groups who care about

emissions.

Adapted from Tang and Luo (2014).

34

Figure one: The five steps of the development of Carbon management system

Feedback

Step 1: Carbon strategy

Step 2: Carbon Risk assessment

Step 3:

Reduction Target Setting

Step 4:

Program Implementation

Step 5

Carbon performance evaluation,

reporting and Assurance

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Figure 2: The role of carbon accounting for the development of CMS

The role of carbon accounting in the step 1 of the development of carbon management system

Step 1a: Carbon Strategy

Development

Analysis of impact of

government climate policy

Review of low carbon

technology and market

Assessment of internal

management and institutional

capacity

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The role of carbon accounting in the step 1b of the development of carbon management

system

Step 1b: Carbon Risk Assessment and financial

impact

Assessment of regulatory and physical risks of global warming

Assessment of product and process risk

Assessment of market risk

and consumer preference

Assessment of supply chain risk

37

The role of carbon accounting in the step 2 of the development of carbon management

system

Step 2: Carbon Risk Assessment

Assessment of regulatory and physical

risks

Assessment of product and process risk

Assessment of market risk

Assessment of supply chain

risk

38

The role of carbon accounting in the step 3 of the development of carbon management

system

Step 3: Carbon

target setting

Analysis of Historical

data of energy

consumption

Review of national target

and industry level

emissions

Financial commitment of reduction

targets

39

The role of carbon accounting in the step 4 of the development of carbon management

system

Step 4:

Carbon program implementation

Feasibility Study

Budget

Cost Control

techniques

40

The role of carbon accounting in the step 5 of the development of carbon management

system

Step 5:

Carbon performance

evaluation and reporting

Measure of carbon performance at

firm level, department and

individual staff level

Internal and External Carbon

reporting and disclosure

Carbon assurance

41

Figure 3 A comprehensive and integrated view of carbon accounting system: Holistic

approach

IV Conclusion

A review of literature suggests the role of accounting in climate change is still controversial.

Following the literature that suggests accounting should critically engage with business for

sustainability, the first conclusion of the paper is carbon accounting has the potential to

help even for profit-seeking entity reduce carbon emissions as firms cannot make profit if it

continues to manufacture carbon intensity products. The second inclusion is a holistic

Carbon accounting framework:

Basis concepts, principles and objectives

Functional module 1:

Energy data collection

Functional module 2:

Carbon emission footprint tracking

Functional module 3

Carbon operation management

Functional module 4:

Carbon performance measure and reporting

42

approach should be adopted so accounting methods can be used for improvement of

carbon management systems in an interactive way. The third conclusion is the traditional

accounting methods/approaches are inadequate, so more innovative methodology should

be considered in a carbon accounting system.

43

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