There’s a proposed global system of carbon accounting

This innovative method would help measure Scope 3 emissions, which may become mandatory reporting next year.

The new ISSB standards that kick in next year will include mandatory reporting for Scope 3 emissions. The government is currently consulting on whether or not to adopt these standards in the UK. That means that Scope 3 emissions may soon be something accountants will have to understand and measure.

Two leading accounting academics have developed an accurate and useful method for accounting for Scope 3 emissions, which we will go into below. They aren’t regulators or standard-setters, but their method may help with regulatory and compliance-related demands regarding Scope 3 and decarbonising supply chains.

The context

Just ahead of the United Nations’ major climate change conference – COP28 in Dubai, which began this week – accounting professionals convened for the annual Accounting for Sustainability summit.

Founded by King Charles in 2004 when he was Prince of Wales, Accounting for Sustainability – or A4S – is a charity that aims to connect and inspire finance leaders to make a shift towards more sustainable business models.

“The financial and accounting systems that underpin our economy focus on short-term financial outcomes and do not adequately reflect the dependency of our economic success on the health and stability of our communities and the natural environment,” A4S says.

It advocates for a change in focus to long-term, sustainable performance that better understands the interdependence between financial, social and environmental factors. Sustainability needs to become embedded in organisations’ strategy, operations and reporting, it argues.

Finance is of course key to success. If we are to achieve net zero, we will need significant investment in green industries, technologies and adaptations. But the accounting and financial reporting process can also help companies and other organisations better understand their climate impact, informing management decisions that will support the move to a decarbonised economy.

Emission scopes

One emerging area of innovative thought and practice is adapting accounting principles to support the measurement and reduction of Scope 3 emissions.

Carbon emissions are divided into three categories or scopes. Scope 1 is the emissions a business generates directly through the boilers and vehicles it runs. Scope 2 is those that are incurred indirectly through, say, the gas and electricity it buys.

Scope 3 is the trickiest to get a handle on as these are the emissions that are generated throughout the value chain, for example from suppliers or from its products once they are being used by customers. It’s where the bulk of an organisation’s carbon footprint – estimated at around 70% – is found, but is challenging for organisations to understand and control.

Measuring your supply chain’s footprint

This is where accounting innovations come in. Two leading accounting academics, Professor Robert Kaplan of Harvard Business School and Professor Karthik Ramanna of the Blavatnik School of Government at the University of Oxford, have developed a methodology to help businesses track their Scope 3 emissions. Dubbed the E- (or environmental) liability approach, the professors set out their thinking in a paper published two years ago and have since founded a not-for-profit institute – the E-liability Institute – to advance the idea further.

“We’re trying to put a specific value on any product or service produced in the economy,” Prof Ramanna told the A4S summit. Any entity that uses financial accounting knows the embedded cost in its products or services and the same principles can be applied to emissions, he explained

“It’s not just an exercise of accounting for accounting’s sake, because as you start calculating these embedded emissions, cradle to gate, what you’re able to do is identify actions that might contribute to decarbonisation.”

Once the emissions value of individual products and services are understood these can be aggregated to give an overall picture of an organisation’s emissions.

“So just like you construct the financial balance sheet of a company by adding up what happens at [the level of] individual transactions, events or conditions, you can compute an environmental ledger for any organisation by adding up the embedded emissions of its products or services,” Prof Ramanna said.

How it works

In order to make this system work. each part of the supply chain passes on details of its Scope 1 emissions to the next customer in the chain, starting right at the beginning with the production of raw materials, Prof Kaplan added.

“And [emissions value] just goes naturally up the chain the same way the cost of goods sold flows up even the most complex and diverse supply chains,” he told the A4S summit.

“The beauty of this is that the companies need only get information from their immediate suppliers who they all know. So in addition to understanding the prices that they’re paying, they will also understand the carbon content in every single one of the products or services they’re purchasing.”

Scaling up this approach globally will be “a journey” and will take some time, Prof Kaplan said. But he estimated that in three to five years we could have a global system of carbon accounting that will be relatively easy and inexpensive for companies to adopt.

Maintaining accuracy

Scope 1 emissions need only be measured once, avoiding double counting, and at the place where they occur, he added. It is also important that they are audited, again at the place where they occur.

“We need assurance that the data coming downstream is valid,” Prof Kaplan said. “We can get to a solution here where the accuracy and the reliability of the carbon data is as strong as financial accounting and reporting data are today.”

The approach is currently being piloted by a range of organisations in the public and private sectors in the UK, US and further afield, Prof Ramanna said. “The idea is that we can start with a small network of lead steer organisations that are really interested in seeking answers in their own decarbonisation journeys.”

The e-liability system helps companies understand how clean or otherwise their supply chains are and make decisions about where they source materials from accordingly. For instance, copper from a clean mine in northern Sweden will be very different from copper from a mine in South America that has to be transported over thousands of kilometres before it can be processed, Prof Kaplan explained.

“It’s so important not to use averages, but to look at the specifics of each company’s supply chain.”
He urged accountants in the A4S audience to follow Nike’s advice and “just do it”, approaching the E-liability Institute for any support and advice they may need.

“Dip your toe in the water and start the journey.”

Vivienne Russell is a freelance writer and editor with a particular interest in public finance and public services. Until June 2023 she was Head of Communications, Content and Events at CIPFA, the only professional accountancy body in the world with a focus on the public sector. Before that she was editor of the award-winning Public Finance magazine and has written extensively about public financial management in the UK and internationally.