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Sustainability is where finances and ESG converge. Photo by Towfiqu barbhuiya on Unsplash
In today’s business environment, where the insatiable desire to grow profits overshadows environmental and social interests, it’s easy to overlook how the actions of economic actors can shape corporate—and environmental—outcomes.
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In the accounting profession, practitioners exercise skepticism and critical thinking to get their jobs done daily. But without recognizing the true power of reporting, not many have questioned the fundamentals of financial accounting or challenged accounting assumptions with the same degree of skepticism and grit.
As it stands, accounting standards relate mostly to large, publicly listed corporations rather than different economic agents. This can probably be explained by the predominance of capitalist economic structures in the United Kingdom and the United States (the origins of the “Big Four” accounting firms). Only when we recognize that power and conflict exist in society can we go about finding ways to better reflect differing interests and concerns.
Accounting reports could well be the means to achieve social balance by influencing the distribution of income, wealth, and power—if we dare challenge their current architecture.
Make room for sustainability in reporting
With growing interest in the United Nations’ Sustainable Development Goals, ESG (environment, social, and governance) investing, and impact investing, more companies are developing sustainability reports due to stakeholder pressure or to fulfill corporate social responsibilities (CSR). In practice, this typically involves including additional content on sustainability on top of conventional financial reports. But this isn’t enough.
How can we make the change toward a more sustainable world if we leave the financial information used to communicate business performance unchanged? We need to rethink reporting architecture so sustainability information can be better integrated into reports. In other words, the ways we measure and report success must change.
Essentially, integrating sustainability information into mainstream reporting is at the intersection of social, environmental, and financial accounting. CSR needs to be integrated into business, and measured and reported in a way that is financially, socially, and environmentally sustainable. We need guidelines on how to move from the old concept of CSR to doing business differently.
Not just adding, but value-adding
As the leader of the sustainability business solutions unit at PwC in Chile, Luis Perera-Aldama* pioneered the creation of a “fourth financial statement,” a concept later adopted by several large Latin American corporations. This approach wasn’t a prescriptive solution but a dynamic learning tool that fostered exploration, development, and adaptation to diverse circumstances and industries.
Following his research at INSEAD as an executive-in-residence, Perera-Aldama realized that, according to academic literature, this “fourth financial statement” was, in fact, a value-added statement (VAS) of unique characteristics. Essentially, a VAS provides a societal perspective by reinventing the commonly accepted measure of a company’s performance, typically presented as profit and loss, into wealth generated by a firm and wealth distributed to stakeholders. This realization sparked Perera-Aldama’s ambition to develop a framework to integrate sustainability and financial information, and to reshape social financial information with a sustainability frame.
The first VAS surfaced in the 1950s, but it has been—and still is—a marginal subject in accounting literature today. However, VAS initiatives abound in practice worldwide, and the Global Reporting Initiative (GRI) proposed a similar indicator and standard on direct economic impacts for sustainability reporting.
Perera-Aldama’s interest in understanding and documenting how companies implement VAS effectively led to a doctoral project on the question: How does the presentation and use of VAS contribute to the practice of integrated reporting?
Toward an integrated and integrative model
The VAS that Perera-Aldama developed while at PwC was not just a theoretical concept, but a practical tool that two large Colombian conglomerates adopted. Over a decade, these corporations integrated sustainability information into their annual reporting cycles, adapting Perera-Aldama’s VAS not only to different industry segments and geographies, but also accounting changes and organizational learning. This real-world application provided a fit-for-purpose ground for a descriptive case-based study, offering valuable insights into the process and product of incorporating the tool.
The VAS proved to be a means to bridge the financial and CSR functions in the two Colombian conglomerates, not only linking financial numbers with sustainability aspects but also the functional with the strategic parts of the business. Internal negotiations between executives, CSR leaders, and top management, alongside sponsorship and structural support from all levels, were critical for the successful integration of the VAS into reporting.
Based on these cases, Perera-Aldama proposed a normative model for integrating VAS reporting into the financial accounting architecture in his doctoral thesis. Importantly, two innovative features could significantly reshape the way financial information is reported and understood, placing a greater emphasis on the social and environmental effects of business operations.
First, the model introduces a statement of accumulated social financial value-add retained in the business. This means the VAS cannot be just an isolated annual exercise, but an ongoing and integrated representation of the cumulative social financial flows the business generates, distributes, and retains. Second, it proposes to elevate the social financial VAS to the mainstream view of corporate reporting, thereby positioning society as the ultimate beneficiary of business endeavors.
The landscape of sustainability and integrated reporting is marked by vibrant discussions about the construct of materiality. In practice, integrating sustainability into reporting cannot be done without a good grasp of the concept of materiality. The concept is widely discussed in the realm of business sustainability, and encompasses economic, social, environmental, and governance dimensions. However, there is no set standard, and it is in fact highly context-specific. The VAS architecture allows sustainability-related social financial issues (and indicators) to be contextualized, making it an appropriate starting point for materiality analysis in integrated reporting processes.
Not just accounting, but accountability
More than half a century after the notion of VAS was first raised, accountants are taking the stage. Developments such as the GRI Standards, the Sustainability Accounting Standards Board (SASB) Standards, the World Economic Forum guidelines by the Big Four, and climate-focused initiatives such as the Task Force on Climate-Related Financial Disclosures spotlight the role of the accounting profession in influencing sustainability outcomes.
Yet, none have questioned conventional financial accounting or attempted to mainstream a VAS. When sustainability is left in the periphery, it will, at best, be an afterthought. We need to update mainstream financial accounting from its 19th-century roots and 20th-century shareholder-predominant views to realign shareholders, stakeholders, and society. To do so is to redefine success, progress, and corporate performance.
The model resulting from this research aims to make sustainability an integral and central part of mainstream reporting. It’s a positive step toward a paradigm change in how we view a company’s performance and the value it creates—not only for shareholders but for society. Thus, it’s a step toward reshaping the social contract between business and society. To effect real change in sustainability outcomes, change the frame and the rules.
*Luis Perera-Aldama was INSEAD’s first executive-in-residence, attached to the INSEAD Social Innovation Centre. A career accountant and pioneer in sustainability reporting, he transitioned to academia and completed his Ph.D. at the University of Burgos.
Published June 27, 2024, by INSEAD.
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