Contributing to the Global Economy

Financial Accounting Must Enable the Circular Economy

Aglaia Fischer, Lucas Geusebroek, Marvin Nusseck | March 3, 2022

Businesses must measure more than just financial impact to survive in the 21st century, and accountants need to establish new circular accounting approaches to capture the value of circular business models and help circular businesses take root and be successful. 

Accounting and financing are catalysts for circular businesses to thrive and crucial to driving sustainable development. According to a new report by the Coalition Circular Accounting (CCA)*, a collaboration between Circle Economy and the Royal Netherlands Institute of Chartered Accountants (NBA), Financial accounting in the circular economy: Redefining value, impact and risk to accelerate the circular transition, scaling circular business models is the route to accelerating the circular transition, unlocking the profitability of businesses in a rapidly changing world and reaching key climate goals, such as net-zero. However, the current challenges associated with financing and accounting for circular business are major obstacles that prevent their wide-spread and successful adoption. This report provides guidance to overcome these challenges and capture the value of circular business. 

“Disclosure is a great way to demonstrate progress towards a circular economy. It provides assurance to a range of stakeholders. Also, perhaps more importantly, it creates an internal momentum and focus on circularity, by forcing everyone in the organisation to consider circularity in design, processes and operations.”
(Financial accounting in the circular economy, 2022, p. 22)

The official launch of the report took place during a webinar on 25 January 2022, at which a panel discussed the key findings of the report. The new chair of Royal NBA, Kris Douma, highlighted “We are confident that this coalition will raise awareness about the need for more circular businesses. Not only among our members, but also amid their clients, their colleagues and on top of that in many companies where accountants are working in financial management positions. This report explains why financial accounting is in a powerful position to not just support the shift to a circular world, but to become a main driver.”

On behalf of the Dutch public impact investor Invest-NL Guy de Sévaux added: “The saying goes: money makes the world go round. But is this actually the case? Currently, it seems that money makes the world go linear—and it sustains our make-use-waste-economy.  The insights of the Coalition will help us to rework the system. We expected accounting to be an area where change was needed to facilitate the transition. But it became clear that accountancy can be a real driver to ensure that money truly makes the world go round.”

Usha Ganga, Director, Sustainability at Royal NBA highlighted that the project involved discussions on residual value, the effects on depreciation, revenue recognition in the case of delivering product as a service earnings model, and the implications on financial ratios and financeability. Our work at the CCA has taught NBA that many accounting principles are still valid within the circular economy. They only require a different application or a new way of interpretation so that they can reflect when a company is performing well and sustainably. The circular economy needs to be enabled by the accountancy and finance profession rather than hindered by them.

The report helps to address critical questions including: How do we value and account for how companies create long-term value for all stakeholders in the long run? How do we measure the ability of a company to thrive in a circular economy? And how do we as accounting and finance professionals recognize and report on the true impact of a company?

Ten years to double global circularity

A circular economy is essential to preventing the worst impacts of climate breakdown—and if carried out on a global level, it provides the answer to limiting global warming to 1.5-degrees in line with the goal of the international Paris Climate Agreement of 2015. Excessive pollution and waste, rampant resource extraction, biodiversity loss and fluctuating global temperatures are the markers of our time; but circular strategies and business models, which eliminate waste, keep products and materials in use and regenerate nature, offer solutions. Businesses have a key role to play in mitigating climate change by moving to circular models. They also stand much to gain: in the long term, circular businesses can be more profitable and are resilient to sustainability risks. But how can we ensure that finance and accountancy enable the transition?

It's hard to go circular in a world dominated by linear practices and mindsets: circular businesses often struggle to entice investors, who may be used to working with linear business models—yet financiers are increasingly searching for financially-safe, sustainable investments. Accountants are also grappling with new requirements in corporate disclosure on sustainability impact. Without a shift in financing and accounting practices that incentivize pioneering companies, circular progress may grind to a halt.

This has been the driver of the CCA’s two-year-long research journey to devise solutions. This latest report brings together the learnings from a series of four research papers and case studies and explores accounting and reporting challenges and solutions for circularity through the lens of real-life business case studies.

Redefining value for circular business involves new sources of value, such as extending the lifespan-and capturing the value- of products and materials. Viewing waste and pollution as design flaws rather than inevitable by-products of the things we make can push us towards structuring our production processes differently.

Redefine value, impact and risk to push the circular transition forward and unlock business opportunities

The key to truly reaping the benefits of a circular economy for business is measuring companies' social and environmental impacts—not just their financials. Doing so will capture the true positive impact of circular businesses. But it will require an overhaul of how we define value, impact and risk: rethinking existing approaches, shifting mindsets and transforming vocabulary to support circularity.

  • Value. We must learn to appreciate and quantify the value generated with circular business models beyond monetary terms. This includes reassessing what we call 'waste' and introducing concepts such as residual value. We should also move away from the existing approach whereby value is considered primarily in the short-term—products being purchased and then disposed of—to one where materials are kept in use for as long as possible.
  • Impact. Impact must be understood (and measured) to capture the long-term social, environmental and economic impacts organizations have on their stakeholders. Non-financial impacts should be listed on companies’ income statements and balance sheets alongside financial factors.
  • Risk. A new approach to risk is needed to steer capital away from non-circular (and often riskier) businesses, and towards ones that promise long-term, stable value creation and positive impact. We need holistic risk assessments which take into account a company’s total long-term impact and relationship with the human and natural environment—not only financial returns.

“Circular reporting involves collecting and releasing data on circularity performance and will create increased accountability and pressure to act on circularity.”  
(Financial accounting in the circular economy, 2022, p. 8)

Changing the way we do business, for the better

Everyone has a role to play in making large-scale systemic change a reality: from accountants and auditors to financiers, businesses and regulators, all actors must embrace a shift in mindset to truly change the way we do business. And the time is now: in the wake of COP26, investments to mobilize climate action are more crucial than ever in limiting the impending crisis. 

 

*The Coalition Circular Accounting was founded by the Royal Netherlands Institute of Chartered Accountants (NBA) and Circle Economy in 2019 to identify accounting related challenges in the circular economy. The coalition includes experts and scientists in the field of finance, accounting and law, who together create solutions to overcome barriers to circularity. 

Also see article, Rethinking the Value of Used Parts – The Accounting and Financial Management Implications.

 

Aglaia Fischer

Finance Initiative Lead, Circle Economy

Lucas Geusebroek

Policy Advisor Sustainability, Royal NBA

Marvin Nusseck

Finance and Metrics Strategist & Project Manager, Circle Economy

 
 

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