Internalizing the Externalities

Traditionally, accounting has had 3 distinct objectives: providing data for day to day operational needs, supplying regular external financial reports, and providing management with information for decision making – all geared towards one aim – maximizing shareholder value – maximizing the economic dimension.

Sure, owners of the company who have a clear vested interest in it ought to know how their company is performing financially. It is a necessity to protect businesses and people’s investments to keep the market and economy rolling.

 However, the current accounting systems miss the bigger picture of encompassing all the 3 dimensions of the triple bottom line– people, planet and profits, thus leaving a wide gap for the companies to ignore the social and environmental dimensions. We have reached a point where most companies have highly advanced accounting systems, can probably close the books in a day, and one page look can determine the economic health, but are clueless about environmental and energy costs, as they get hidden in the general overheads and get divided between all the processes and products, directly affecting pricing.

 While large businesses have realized that the existing accounting system is flawed and it doesn’t reflect the true external environmental costs, but since these are not allocated a separate cost category, it remains hidden from the top management to take any action towards implementing effective Triple Bottom Line approach. Metrics such as energy and water usage, waste treatment etc. are all clubbed together to form overheads, where as these must be segregated into separate cost allocation of environmental costs only. Activity based costing (ABC) reaches for the solution, as it reveals where value is added and where it is destroyed – but if costs are not allocated to individual products and instead generalized as overheads, as is currently done, then the ‘clean’ products will appear to have higher costs and ‘dirty’ products will appear cheaper, when actually that is not the case.

 Over the past few years, since the idea of Triple Bottom Line has gone mainstream, businesses are also looking at providing environmental and social stewardship information to all its stakeholders – shareholders, employees, customers, suppliers, community and every one connected to the company in any way. Though still not a rule of law, it has entered a domain of ‘being seen as green’.

We think that goods and gadgets are getting cheaper all the time – well, they only appear to be cheap. Cost of deforestation, land slides, and floods that occurred during producing that product, not to mention the displaced communities and perhaps poor worker conditions – all that has not been factored in. In future, somebody has got to foot that bill. Mis-allocation of the environmental costs is one of the major challenges that need to be overcome to reach ecologically honest prices.

Rupert Howes, in one of the essays in ‘The Triple Bottom Line: Does it all add up’ sums up very nicely: ‘In effect, companies need to begin to account for the depreciation of ‘natural capital’ in the same way that accounting rules and standards require them to account for the depreciation of manufactured capital. Once these costs are internalized, everything changes – prices, costs and what is and what is not possible.’

 The current accounting system has evolved over many decades of practices and will largely be unaltered. But if we somehow manage to put monetary value to environmental externalities and internalize those costs, then the triple bottom line goals would be achieved – which are to create a win-win for both the environment and the profits.

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