Can accounting save the world and your company?

As we recorded this podcast, the World Economic Forum convened in Davos. The Forum published its Global Risks Report, which finds that environmental risks make up half the Top 10 risks over the next ten years. Climate change remains one of the most urgent challenges confronting boards in their oversight capacity.

How can boards improve their oversight of climate-related risks? And what does accounting have to do with it?

In this podcast, Dr Sabine Dembkowski, Founder and Managing Director of Better Boards, discusses how boards can improve their oversight of climate-related risks with Mike Mahoney. Mike is the CEO of the E-liability Institute, a global non-profit organization advancing accounting upgrades to drive green innovation and reduce carbon emissions. In November 2021, Professor Bob Kaplan of Harvard Business School and Professor Karthik Ramanna from the University of Oxford published a prize-winning paper, Accounting for Climate Change, which debuted the E-liability concept. The Institute helps entities pilot this approach and shares their results widely to improve carbon accounting.

Before joining the Institute, Mike was a partner at Tapestry Networks, working with hundreds of non-executive directors of the largest North American and European companies for over a decade.

Some of the key takeaways of the conversation include:

“Let’s focus on the fact that investors say climate change poses one of the largest sources of financial risk to companies and their asset owners”

Climate change has been discussed for years in the context of ESG and sustainability, but Mike says it remains a top risk for boards. Of course, risk is often the flip side of opportunity. Mike feels companies can develop and sustain advantages in how they effectively mitigate these risks or in how they help customers mitigate these risks. These are important strategic issues for management and boards alike.

To Mike, many companies announce aspirational targets to reduce carbon emissions without a clear plan around how they will do it. There’s no effective management oversight of the process or true accountability. So, while the narrative is a step in the right direction, companies would do better to treat climate risks like financial risks and measure and analyse them according to the same strict standards.

“As emissions continue to grow around the world, the current system simply isn’t working”

Mike feels most companies use approaches to carbon accounting based on carbon disclosure requirements that aren’t fit for purpose. To appropriately analyse and mitigate climate risk, companies need to precisely understand the carbon intensity of their operations and that of their suppliers. Instead, firms are leaning on estimates and industry averages, which can be highly inaccurate and introduce so much distortion as to render carbon disclosures useless. It’s also impossible to provide a fair and true audit of these kinds of estimated disclosures.

“There are six questions to answer about how the company and management are thinking about measurement and accounting of climate-related and emissions data”

Mike suggests management and boards seek to answer six key questions:

• How does management measure and account for emissions from its operations and suppliers? What’s the methodology?
• How is management moving to improve the quality and accuracy of emissions data by using more primary direct data and reducing reliance on industry average data, making it more vendor and product-specific?
• How is management using this data to identify opportunities to reduce emissions in the company’s operations?
• How are emissions embodied in the products and services the company buys considered in procurement decisions and in the context of other procurement elements like cost, quality, performance, etc.?
• What’s the role of the finance organisation and internal audit team with respect to emissions measurement and accounting? How are the people, processes, and IT systems already in place for robust financial accounting evolving to support robust carbon accounting?
• What kind of external assurance is being done on this emissions data? If it’s only limited assurance, what’s the pathway to a fair and true attestation of these emissions disclosures?

Mike realises these questions aren’t necessarily easy to answer and recommends that to find sound and true answers for environmental disclosures. Firms turn away from estimates and averages to lean on an alternative approach, e-liability accounting.

“With e-liability, instead of accounting for costs, we’re accounting for carbon”

E-liability is an accounting algorithm that allows organisations to produce real-time accurate and auditable data on their total direct and supplier emissions and those of any of its products and services. It is a simple, open-source, free-to-use set of principles that can create an accurate and auditable total “cradle to grave” carbon footprint number. It is based on established financial and cost accounting principles and empowers consumers, investors, management, and boards to understand true carbon impact.

Currently, Mike’s E-Liability Institute is working with dozens of companies worldwide to pilot adoption and lean on major software firms to support enterprise-wide scaling. Rather than needing to push hard on this, he gets good support from the big accounting and software firms because this approach looks so much like established financial accounting that it feels like a familiar and natural next step.

“If I were on an audit committee now, I would focus on assurance and attestation”

For Mike, audit committees need to look at how management is moving the reporting and use of emissions data from a limited assurance approach to a fair and true audit. Accuracy around emissions is required for disclosure and what regulators will use to hold firms accountable in the future. So, boards and management should be confident there won’t be any concerns about the quality of their data and actively move from less accurate to more accurate systems of measurement.

The three top takeaways from our conversation are:

• Climate risk is financial risk, and companies and their boards should manage it as such. Climate risk can be quantified, measured, and mitigated. It can represent a strategic opportunity for competitive differentiation as long as the company’s claims for differentiation can be audited and are meaningful to its customers.
• It matters how a company does its carbon accounting. Management and the board need rigorous emissions accounting to understand and mitigate risks and seize opportunities.
• Everyone should learn more about how companies can improve their carbon accounting by visiting the E-Liability Institute. The site has a wealth of information, including the original papers published Bob Kaplan and Karthik Ramana, and a chance to connect with the company to learn more and explore pilot adoption of this approach.

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