Sustainability accounting: Stricter requirements will put pressure on businesses

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Once upon a time, the only goal was to avoid books in the red at year end. Since then, a splash of green is now the new normal. A new EU directive, however, may cause accounting departments to wring their hands.

The Corporate Sustainability Reporting Directive (CSRD) will expand requirements for listed companies, forcing them to report on not only their own sustainability, but also that of companies in their value chain.

“In practice this means that companies must contact all their subcontractors, including small, independent companies, and ask them about, for example their greenhouse gas emissions,” points out Thomas Riise Johansen.

A professor of accounting at CBS, Johansen previously worked in the accounting profession. Even though he views the expanded requirements for sustainability accounting positively, he is somewhat cautious about the directive.

Challenges collaboration

“Most industries have numerous tiers in the value chain but also multiple companies at every tier. For example, the entire value chain in a large technology firm has 170 direct contractors and 7,000 subcontractors in the value chain on average,” stresses Johansen, adding:

It becomes a colossal task to get each and every tier to provide quality numbers on their sustainability efforts.
 

“Not only that, the value chain also includes customers and consumers. It becomes a colossal task to get each and every tier to provide quality numbers on their sustainability efforts. Especially for smaller firms that are part of the value chain and that probably do not possess sufficiently detailed knowledge about accounting or the green transition to deliver reliable data.”

He also predicts that the new rules may present a challenge for collaboration in the value chain. If, for instance, a company has contractors that only use diesel forklifts or tools with high energy consumption, then it may request that they replace equipment before the collaboration can continue.

Or food manufacturers may consider asking farmers to use a different feed to reduce their climate impact.

In both cases the requests emerge due to the negative effect the contractors’ environmental impact has on the company’s green accounting.

Good intentions

According to Johansen, the ideas behind the forthcoming directive are solid. Until now, comparing the green profile of companies has been difficult since they have been able to select which green initiatives they felt were important to report. Moreover, companies have been able to market themselves as green without any systematic documentation.

The specific new requirements, which are expected to affect about 50,000 European companies, will put accounting departments to the test as they will be required to transparently report on sustainability in a standard way. The aim is to allow investors, customers and the rest of the world to better assess a company’s actual sustainability performance.

I believe the companies have yet to fully recognise how many accounting challenges the forthcoming directive potentially poses for them.

In addition, even though the directive generally only applies to listed companies and other large firms, small and medium-sized enterprises (SMEs) will also be compelled to work with sustainability measurement. This is because SMEs are often subcontractors for big companies required to report on their entire value chain.

“Many of the intentions behind the directive are really good. I’m just afraid that they are so ambitious that they will not work as anticipated because the companies cannot or will not allocate the necessary resources to establish complete and reliable reporting,” explains Johansen.

“There is also the issue of whether users are interested in the new reporting. In other words, whether non-governmental organisations, customers, investors and others will look critically at the quality of the reporting. We must remember that reporting alone does not create a green transition. It’s the decision-making based on the reporting that must drive development,” emphasises the CBS researcher.


Risk of play-acting

According to Johansen there is now the risk that the upcoming initiatives will lead to what he calls play-acting, i.e. that actors may receive sustainability numbers of a poor quality from, for example, subcontractors or companies they have invested in, and then skip a critically review of the numbers.

“If someone in the value chain states that they have reduced their CO2 levels by 50 percent then others in the chain are also likely be happy because that will affect their green performance positively and then they may not ask the right questions and scrutinize the information they receive,” Johansen underlines, continuing:

“If the new requirements are taken seriously and complied with, they are much more comprehensive than many people realise. Especially many smaller companies risk facing challenges. They suddenly need competences to assess their climate footprint. What’s more, they will have to publish a plan for how to pursue a green transition, including, for example, whether or not parts of their production must be restructured or abandoned entirely.”

“The directive will fundamentally change company reporting –– also for the many SMEs that are suppliers for large companies,” says Johansen.

Green accounting must lead to action

According to Johansen sustainable accounting serves several purposes. For example, it should allow the outside world to hold the company accountable. Investors within sustainable investing also need a basis to assess sustainability performance and make decisions on whether to invest or not.

“But sustainability accounting is also a management tool for individual companies. The idea is to get management to act and link action to climate goals to ensure that the company is fully aware of what it takes to remove carbon and other goals. Also in terms of understanding the consequences, especially what it will cost,” explains Johansen, who goes on to state:
“Ten years ago there weren’t many in management that was truly concerned with sustainable accounting. Today they are keen on the green transition, but I believe they have yet to fully recognise how many accounting challenges the forthcoming directive potentially poses for them.”

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Facts about the new EU directive

•    Name: Corporate Sustainability Reporting Directive (CSRD)
•    Will take effect 1 January 2024
•    Will ensure that businesses in the EU report reliably on sustainability in a standard way
•    Sets completely new specific requirements for companies reporting on environmental, social and governance (ESG) factors
•    Read the press release

Meet the researcher

Photo: CBS

Thomas Riise Johansen er professor ved Institut for Regnskab på CBS.
Har en ph.d. i regnskab.
Arbejdede før sin ansættelse ved CBS i ti år for Ernst & Young.
Forsker primært i revision, bæredygtighedsrapportering og den relaterede regulering.
Er projektleder på et stort forskningsprojekt, ”Time Mirror”, der undersøger virksomheders brug af grønne regnskaber.
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