Putting nature on the balance sheet

30th September 2015


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IEMA

Experts at eftec outline the benefits of the new Corporate Natural Capital Accounting framework

Corporate Natural Capital Accounting (CNCA) is a framework for organisations to account for the natural capital that they own and depend on, or for which they may be responsible. Developed for the Natural Capital Committee (NCC) by a consortium led by the environmental economics consultancy eftec, the framework collates natural capital information. It accounts for these assets in a similar way to that in which other capital assets are accounted for.

The importance of natural resources is often overlooked in decision making, typically because the full range of their benefits and value (or the costs of their decline) are not as visible as their financially recognised and accounted-for costs and benefits. Accounting for natural capital in a proper manner is a vital step towards addressing this imbalance.

Natural capital and financial accounting

The NCC defines natural capital as "the elements of nature that directly and indirectly produce value or benefits to people, including ecosystems, species, freshwater, land, minerals, the air and oceans, as well as natural processes and functions".

This definition represents the natural environment as a capital asset that has the productive capacity to generate value, in terms of goods and services and the benefits that society derives from them. Some of these, such as the value of timber from a forest, are already included in financial accounts; others, however, are not - for example, the informal recreational opportunities, amenity benefits and flood prevention functions of a woodland. CNCA recognises that inputs from other forms of capital are often needed to realise these benefits. The water filtration benefits of upland bog, for example, can be realised only if there is a substantial human made infrastructure for water collection and distribution.

Organisations assess the value of their assets through conventional financial accounting processes. This includes balance sheets summarising the assets and liabilities the company holds, and profit and loss accounts that record flows of values in an accounting period. This basic information underpins multiple decisions in an organisation, such as when funds will be required for maintenance and improvement, and how to capitalise on the increasing value of assets.

Financial accounting is not enough to make good decisions about natural capital though, as most of the benefits it generates do not appear in financial accounts. The shortcomings of financial accounting are demonstrated clearly in the way parks are treated in local authority accounts. The park is a physical asset. It gives rise to a liability due to the cost of maintaining it for public use, which is shown in the financial accounts as a cost. The park also generates recreational value but, because entry is free the financial accounts register nothing for this asset value. To the extent that an asset value is recognised at all for the park, it will be limited to some nominal value. The actual value to the users and wider society may be much higher but is not visible in the financial accounts.

What is needed is an accounting perspective that is more sympathetic to natural capital assets. It must recognise the full value that can be derived from natural capital assets, and assist in making decisions aimed at preserving that value over the long term. CNCA is designed to address this need.

What the CNCA does

CNCA gathers natural capital information and presents it in a coherent and comparable format to bring the full benefits and costs of natural assets into business decision-making. It records the benefit to both the owner and society. It does this by answering four key questions:

  • What natural capital assets does the organisation own, manage or take responsibility for?
  • What benefits do those assets produce for the organisation and wider society?
  • What is the value of those benefits?
  • What does it cost to maintain the natural assets and benefits?

The asset register is a key part of the framework. This is a catalogue of the significant assets owned by the organisation, and holds data on their extent, condition, services and benefits delivered. This information is the basis for the evaluation of natural capital values for each asset. Once evaluated, these values can be consolidated and presented in formats similar to financial reporting statements. The similarity of presentation to conventional accounting is important because it enables an understanding of natural capital that is familiar and compatible with capital concepts.

It is important to appreciate that there are some significant differences in treatment between the CNCA framework and conventional accounts, however. These arise from the key principles that guided the development of the framework. They are:

  • Type of value: The accounts must capture the full value of natural capital; therefore, the asset value includes both the private values accruing to the organisation and the external values accruing to society. These are reported separately in CNCA.
  • The relevant time period: CNCA is forward looking, so the asset value is the sum of all (forecast) future benefits from the natural capital asset, based on its existing condition. Similarly, the liabilities are the sum of future maintenance costs. In contrast to conventional accounting, CNCA is not concerned with historic benefits or costs.
  • Notes to accounts: CNCA should disclose the changes in value by cause - that is by quantity, quality or for other external reasons. The notes to the accounts should also describe the benefits that cannot be adequately expressed in monetary terms.

Testing the framework

The CNCA framework was piloted with four organisations, including National Trust (panel, p.27), the Crown Estate and United Utilities - to test and develop the approach. The organisations found the accounts useful. For example, the Crown Estate realised CNCA was a simple way of demonstrating to regulators and stakeholders the considerable value of maintaining Windsor Great Park.

CNCA adds value to existing environmental and financial information and provides powerful insights into the decisions an organisation makes on the natural capital it owns. Benefits include:

  • Highlighting opportunities to generate new revenues from natural capital - for example, new products and services, and payments for ecosystem services; and the risks to revenues, liabilities and damage to reputation of not maintaining natural capital.
  • Improving decision-making - for example, by investing in natural versus physical infrastructure, assessing the impacts of changes to natural assets, or prioritising the allocation of limited budgets.
  • Communicating the value and importance of natural assets to stakeholders, including senior managers, investors, regulators, staff and customers.
  • Monitoring the health, condition and value of natural capital, thereby improving sustainability.

CNCA is an important new tool that creates a register of natural capital and provides vital information to properly sustain and increase its value.


The National Trust - Wimpole Estate

Wimpole is a 1,200 hectare historic estate and visitor attraction in Cambridgeshire, consisting of parkland, farmland and semi-ancient woodland of special scientific interest. Due to poor soil quality, the National Trust changed from conventional arable farming to organic cropping and Higher Level Stewardship (HLS). The CNCA framework was used to measure and report the overall change in natural capital value arising from this move. The National Trust piloted CNCA to investigate a new way of recording the natural assets owned by the trust and the relative costs and benefits that flow to the business from their management. This exploration provided three benefits:

  • a new way of communicating with trustees, staff and supporters about what the National Trust is doing to conserve assets;
  • reviewing whether money is being invested in the right places; and
  • exploring whether there are sustainable ways to capitalise on the costs of some of that investment.

The range of estate benefits included farm income, visitor revenue, recreation, wildlife and carbon sequestration. Given the multiple benefits of natural capital, the challenge for CNCA was to identify value and present it in a format that provided an overall understanding of the state of natural capital for Wimpole Estate.

Comparing the current organic regime with the previous intensive arable practice showed that, despite the reduction in crop yields, overall income was about the same. This was due to a combination of lower fertiliser costs, higher HLS grant income and a slight price premium for organic produce. More importantly, there were significant benefits through increases in soil carbon sequestration, higher recreational benefits and improvements to biodiversity. Taking these additional benefits into account produced a higher overall return on investment than had been recognised in the conventional financial accounts.

The example below is a simplified version of the natural capital balance sheet produced for Wimpole Estate.

Wimpole Estate

Balance sheet - year end 2013

Renewables

Total Value

Private

External

Assets

Baseline value (2008)

£14m

£12m

£26m

Cumulative gains/(losses)

£2m

£4m

£6m

Additions/(disposals)

£2m

£2m

£4m

Gross asset value

£18m

£18m

£36m

Liabilities

Maintenance provisions

(£4m)

(£2m)

(£6m)

Total net natural capital

£30m

The purpose of the balance sheet is to disclose natural capital assets and liabilities. Assets are valued as the expected flow of future benefits based on the existing condition of the natural capital. Liabilities are evaluated as the expected flow of future costs of maintaining the condition and benefits of the natural capital in perpetuity. All values are discounted to bring the expected costs and benefits into present value terms. In this way, the overall asset values and their associated maintenance costs can be presented to highlight the net natural capital of the organisation. The format separately discloses private value (to the organisation) and external value (to all external beneficiaries). This reveals the pattern of flow of natural capital benefits to the business. This example provides further asset detail in terms of the original baseline value in 2008, plus increases in asset value due to improved natural capital condition and some additions (the acquisition of more farmland into the estate).

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