ESG Implementation & Assurance
The Era of ESG
ESG, which stands for Environmental, Social, and Governance, is gaining increasing attention as businesses face greater pressure to disclose their ESG performance and strategies. The philosophy of ESG began to evolve when the industry analysts and stakeholders went beyond the profit-making benchmark of prosperous corporates to delve into their impact on the environment and social system. Investors began to think about sustainable investing and that led to the prominence of ESG or sustainable reporting in the recent era.
Examples of some ESG matters considered by stakeholders and interested parties are:
E- Environment: Raw material Sourcing, production process, sustainable products and packaging, waste management, greenhouse gas emissions, pollution, loss of biodiversity, and many such operational hazards are together seen as ESG matters.
S- Social: Employee health and safety, labor management, human capital development, inclusion, and equity, product quality, supply chain standards, etc form the basis of the social impact of an organization.
G- Governance: Ownership structure, business ethics, anti-corruption, anti-bribery, lobbying and proximity to political parties, tax transparency, and other management-related matters form a part of governance.
ESG analysis evaluates risks and opportunities beyond the scope of traditional financial analysis. In an ever-evolving ESG reporting environment, the accounting profession has faced challenges with respect to the extent of information to be reported to stakeholders, including regulatory authorities and investors. Moreover, there is also a question for the accounting fraternity regarding the assurance of the accuracy of the ESG parameters.
ESG Accounting:
Traditional accounting has a limited scope in the measurement of a company’s transactions. When it comes to ESG accounting, accountants need to broaden their vision and think about ways to describe, assess and measure the impact of a company’s business on the neighborhood, its employees, their health, their social needs, the effects of its operations on the environment and so on and so forth. Though seemingly very subjective, the measurement of these factors is imperative for the evaluation of a company’s financial statements.
ESG matters and their direct or indirect impact on a company’s financial statements were taken up in a paper published by the Financial Accounting Standards Board (FASB) on the Intersection of Environmental, Social, and Governance Matters With Financial Accounting Standards. As outlined in the paper, ESG matters could impact a company’s financial statements in a direct manner, for example, in the recognition and measurement of compensation expenses. ESG matters may indirectly affect the financial statements of an entity that may suffer reputational damage from environmental contamination that reduces sales. Certain ESG matters may be taken as input to an accounting analysis, for example, a material decline in demand during the reporting period may be considered while estimating future cash flows.
Hence, risks and opportunities related to ESG matters may have an unfavorable, favorable, or neutral effect on financial statements.
Besides the above, there could be tax implications as well. For example, tax incentives to real estate builders for providing affordable housing or similar tax incentives for companies setting up green businesses, for example- tax holidays for companies setting up solar energy businesses.
As the need intensifies for sustainable investing, stakeholders and investors are now focusing on ESG information to ascertain a company’s value proposition and manage investment risks. The role of ESG in accounting continues to grow creating more and more challenges in the accounting and reporting arena.
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