Ideas for Leaders #571

Stakeholder-Focused Accounting: Value Creation and Risks

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Key Concept

Current accounting methods inadequately represent and reward stakeholder value creation. Value-creation stakeholder accounting (VCSA) — which combines the disciplines of accounting, value creation and stakeholder theory — is the theoretical foundation for new stakeholding-focused accounting. The best mechanism for implementing the theory is through value-creation stakeholder partnerships (VCSPs), derived from partnership accounting (as opposed to traditional entity convention accounting). 

Idea Summary

Stakeholder Theory is a view of capitalism that stresses the interconnected relationships between a business, its customers, suppliers, employees, investors, communities and others who have a stake in the organization.

Traditional accounting fails to adequately represent the risk and returns of stakeholder activities — i.e. the net value created by ‘stakeholders’. Stakeholders include customers, employees, shareholders, suppliers, and the communities in which they operate.

Attempts have been made to rectify these inadequacies, write the authors of a new Journal of Management Studies article entitled, ‘Stakeholder Inclusion and Accounting for Stakeholders’. However, non-financial accounting methods such as the ‘balanced scorecard’ or the ‘triple bottom line’ do not account for the full range of risks borne by stakeholders.

The article introduces a new transdisciplinary framework for stakeholder accounting, known as value creation stakeholder accounting (VCSA), that more comprehensively addresses stakeholder risk by building on three disciplines:

Accounting. The purpose of accounting — through its processes of counting, recording, summarizing and reporting — is to develop and communicate knowledge. Knowledge is an accumulative process of usability that starts with facts, which are organized into data, which combined with meaning become information, which applied to the situation become knowledge. These four knowledge stages correspond with the four usability steps of accounting: facts are counted, data are recorded, information is composed of summarized data, knowledge is reported information.

Value creation. In business, value is created through activities for and with stakeholders. Creating value through these activities requires that the activities be aligned so that value can be created through the interaction of stakeholders. Finally optimal value is created if there is reciprocity: value creation for one stakeholder group translates into value creation for many stakeholder groups. These four value creation premises correlate with the four accounting usability functions: activities are counted, alignments (e.g. matching) allow recording, processes of interaction guide summarization (e.g. net-based computations); and processes of reciprocity guide the reporting process.

Stakeholder theory. Stakeholder theory argues that shared risk is central to accounting for stakeholder value. Specifically, accounting should cover both types of risk: the risk involved in actions (what the authors call Sinking the Boat Risk for the Firm or SBRF; and the risk involved in not taking action (what the authors call Missing the Boat Risk for Firms or MBRF).

Connecting stakeholder theory to the four usability functions of accounting and to the four premises of value creation, the authors develop a four-level high-risk-to-low-risk hierarchy:

  • Riskiest. Making decisions based on counting activities is the riskiest, in terms of both SBRF and MBRF. There simply is not enough information available.
  • Second to Riskiest. Alignment of stakeholders might reduce SBRF but missing the boat is still a high risk.
  • Second to Safest. The next-to-lowest risk level in the hierarchy is when decisions are based on actionable information (built from summarized data tied to stakeholder interactions). The sinking-the-boat (SBRF) and missing-the-boat (MBRF) risks are equal at this level.
  • Safest. The lowest risk is attained at the optimal level of value creation, when reciprocity rules. For example, involving the greatest number of stakeholders possible allows better reporting (enabling decision makers to take action at moderate sink-the-boat or SBRF risks), while decreasing the likelihood of missing an opportunity (i.e. MBRF is low).

Business Application

Value-creation stakeholder accounting (VCSA) as described above is a theoretical framework for identifying and representing the full range of stakeholder risk. Implementing VCSA requires using a value-creating strategic partnerships (VCSP) mechanism, which would involve the following four steps:

  • Identify the units to be counted. Traditional accounting counts observables, such as assets. Implementing VCSA calls for counting activities among primary stakeholders — including activities beyond the boundary of the corporate entity.
  • Base the recording process on matching reward to risk (using the units of accounting). The recording process does not differ radically: in addition to the traditional units, the recording process must add activities accounts. Value creation to customers, for example, could be represented by Net Buyer Benefit (value of goods or services above the price).
  • Summarize based on accounting classifications linked to SBRF and MBRF risk-bearing. Specifically, this requires a two-step closing process. The first step is to close the books based on the conventional process: close all revenue-expense nominal accounts (including the new VCSA accounts) to determine net income or loss. The second step is to allocate this net income or loss to the stakeholder partners based on the proportions agreed in the VCSP.
  • Use partnership accounting for reporting. In other words, there would be a new financial report — a Value Creation and Value Distribution Statement — that shows the results of the two processes described above: the net income or loss (value creation), and the allocation based on the risk-bearing activities of the stakeholders (value distribution). 
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