Taking account of moral issues

By Jeremy Nicholls and Kate Ruff

29 May 2014

Jeremy Nicholls and Kate Ruff discuss the need for financial reporting to take account of ethical issues.

"Most investors are good people. We would not want our investments to support child labour, slavery and environmental degradation any more than we personally would employ a child as a domestic worker or routinely dump household rubbish in the local park. We are at heart "moral investors" who want to live in a moral world.

We assume that a combination of the law and a business's financial accounts ensures that, by and large, none of these things happen. It is becoming increasingly apparent that this is not the case, whether it's the effects of business in general on climate change or examples of poor labour conditions in retail supply chains, conflict minerals in our mobile phones or sugar and fats in our food, we cannot rely on legal systems to deal with or even always recognise legitimate claims and we cannot rely on financial accounts to have included costs that may be being incurred by people as a result of a business's operations.

The general response has been for calls for either more legislation or more company reporting of both. What has escaped our notice is the potential role of accountancy in providing a solution that can give us much more comfort as the moral investors we are.

Accounting is the process of deciding what should be included in a set of accounts and then, once included, valuing it. This decision is informed accounting standard developed to comply with the Companies Act and the requirement that accounts should give a "true and fair view".

But true and fair has to be informed by something and this has come to be the needs of a "wealth-maximising investor". The assumption of a wealth-maximising investor underpins financial accounts because the judgement of what is included is based on judgements about the information needs of this assumed wealth maximizing investor.

Once we recognise that this is an assumption behind public policy as set out in the Companies Act, we are able to start a public debate about how we may want to define the morality of this investor in order to reflect our individual and societal needs.

If we were to specify the investor to be a moral investor, the decision on what should be included or excluded would be based on different assumptions.

The work of the GRI (the Global Reporting Initiative), TEEB (The Economics of Ecosystems and Biodiversity), and the SROI Network shows that it is possible to identify and value the broader effects of a business's activities on its stakeholders. Likewise, "Impact Investing" – a growing segment of the securities industry which caters to investors who seek a social as well as a financial return – shows that there is a demand from investors and that it is possible to consider social returns alongside financial returns.

In these initiatives the level of accuracy required for the decision to include issues and for their valuation is not as high as that required for the financial accounts. These approaches make the decision on whether to include issues in the accounts on the needs of all stakeholders who are materially affected. This is a problem for financial accounting that is designed for the needs for one stakeholder, the investor. Redefining the morality of the investor as someone who is interested in the material effects on all stakeholders resolves this problem.

The moral investor only wants a reasonable level of assurance that there are issues and that the business had a role in creating them.

A good example of what this might look like at the moment is Puma's environmental profit and loss account. The environmental cost of Puma's activities is estimated to be $145m. Puma's environmental costs are not material to a wealth-maximising investor, and this is not a cost that it is likely Puma will have to pay. It is, though, material to a moral investor who is interested in comparing the relative environmental cost per unit of expected financial return.

The assumed motivations of the investor are a matter for public policy as reflected in company law. If this is changed there would be implications for accountancy practice, but the accountancy profession would prepare accounts on that basis. It is time for a debate about the morality of the idealised investor that underpins our accounting practice and a discussion on the implications for financial accounts."

This abridged article also appeared in the June issue of The CA Magazine.

About the authors

Jeremy Nicholls is Chief Executive of the Social Return on Investment network.

Kate Ruff is a PhD Student in Accounting at York University,Canada researching materiality judgements in the context of social performance data. She serves on the Advisory Board of the Social Impact Analysts Association (SIAA) in Canada.


  • Corporate and financial reporting

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