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News

Yale Professor: Interest in ESG Rises Among Accounting Students

By:
Karen Sibayan
Published Date:
Sep 16, 2024

Aneesh Raghunandan, an assistant professor of accounting at Yale School of Management, has an encouraging message about accounting education and its relationship with environmental, social, and governance (ESG).

Writing for Bloomberg Tax, Raghunandan said that despite the general dip in accounting enrollments seen throughout U.S. business schools, there’s one silver lining: the rising demand for ESG-related courses.

Students in these courses focus on measuring a company’s carbon emissions footprint. Their curiousness about potential new regulations, such as the Securities and Exchange Commission’s recent adoption of its climate disclosure rules, and their desire to understand firms’ climate risks more generally are also boosting this interest.

Raghunandan says that comparability is a crucial role of accounting information. In this case, comparability means that accounting information allows the setting side by side of firms’ performance, with the same concept applying to nonfinancial settings.

He explained that at Yale, students are taught that strategic reporting choices used for short-term incentives can twist comparability and that students must understand the rules behind firms exercising their discretion. He clarified that these ideas are not exclusive to financial accounting, but talking about them this way helps students understand the relationship between financial and ESG accounting.

Since the adoption of the Kyoto Protocol—an international agreement through which industrialized countries and economies committed to transition to limit and reduce greenhouse gases—Raghunandan said that, at least conceptually, reporting firms can designate their emissions profile into three scopes. Scope 1 are an organization's direct emissions, Scope 2 are its indirect emissions, from purchased electricity, steam, heat, and cooling. Scope 3 are all other emissions associated with an organization's activities. Although giving students a high-level view of each scope’s emissions and what they capture is not hard, explaining the intricacies of measuring within this framework is trickier.

One important question is: Is it necessary to know what assumptions a firm makes in calculating the scope?  Another is: Must caution be exercised when comparing numbers that seem like-for-like, such as two competing firms' Scope 1 emissions?

The inherent problems are related, Raghunandan wrote, to companies' discretion regarding emissions measurement. For example, these organizations can use either a market- or location-based approach when measuring Scope 2 emissions.

Companies might also elect one or the other for strategic reasons, including whether they pay their suppliers for “green” energy. The differences might make comparing the two firms’ Scope 2 emissions problematic, Raghunandan writes.

Using financial accounting analogies can help make these kinds of issues more comprehensible to students who have a traditional accounting background. Raghunandan said that, at Yale, students are taught from the beginning of their financial accounting courses that accounting rules are flexible enough to allow companies to name specific items in a way they consider the most fitting for their underlying operations.

Raghunandan said that a potential disadvantage is that such flexibility can help companies practice strategic reporting. For instance, for a company selling a product or service included in a multiyear contract, how much revenue will it allot to this year compared to how much it will reserve for the next years? How much is that aligned with a strategic desire to hit a certain earnings target in the current year?

The analogy to emissions measurement here is simple. Although the market-based approach cannot always be used, companies have the flexibility to offer a more accurate picture of the carbon emissions associated with the energy they consume.

Raghunandan said that the strategic reporting element is relevant here as well. Why would a firm be more likely to report its use of the market-based approach to measuring Scope 2 emissions if it had spent money on “green” energy? How should this be considered in comparing the reported figures for two firms using the two different approaches?

He elaborated that companies that have spent money on using green energy sources have more incentive to use the market-based approach. Not appropriately accounting for these strategic reporting incentives can result in understating the difference between two firms’ Scope 2 emissions. 

For Scope 1 emissions, Raghunandan said that it is commonly not practical to have carbon sensors at each output source. A typical firm uses activity-level emissions estimates published by the Environmental Protection Agency and other national regulators to create a weighted average emissions figure based on its activities.

How can these estimates potentially work against companies that invest more proactively in green technology while permitting a relatively "brown firm" within a sector to conceal its activity? The dependence on activity-level averages instead of a precise measurement can make it hard for companies to call attention to their investments that generate lower-than-average emissions for an activity.

Finally, Raghunandan emphasized that companies have to disclose data on several different items, both financial and nonfinancial, to be used by a broad stakeholder base. The overarching point is that discretion exists in how many of these items are calculated, although the reasons that underlie reporting choices are generally alike.