Accounting Theory report

Accounting theory

ENVIRONMENTAL ACCOUNTING: CASE STUDY OF DEEEPWATER HORIZON OIL SPILL

Overview

Environmental accounting is a very important complement to informed decision making by corporate managers and the advocates of environmental conservation. Failure by the accounting professionals of an entity to seriously analyze, evaluate and incorporate environmental accounting information in its financial reports can cause adverse impacts to the firm’s financial performance and the ecosystems of the environment in which it operates. An example of an environmental disaster is the Deepwater Horizon oil spill of April 20, 2010. This report analyzes the financial implications of BP’s response to the Deepwater Horizon oil spill and also emphasizes on the need for more reliable environmental accounting and reporting by the corporate entities.

Introduction

The essence of environmental accounting has been emphasized by corporate managers and advocates of environmental conservation as an important element of improved environment-friendly decision making in the corporate world (Uno &Bartelmus, 2013). Sound environmental accounting helps firms to prevent pollution of the environment and attain corporate sustainability. As a result, firms become innovative in identification and implementation of financial practices that are environmentally desirable. Environmental accounting practices enable a firm to report its true financial performance and avoid false disclosures to the shareholders and the general public (Daniel, 2010).The need for the development of consistent and decisive environmental accounting principles has been well illustrated by the occurrence of calamities that have had adverse effects on the environment. An example of such a calamity is the Deepwater Horizon oil spill on the Gulf of Mexico.

Discussion

The Deepwater Horizon oil spill that occurred in the southeast of Mississippi River delta on April 20, 20110 is regarded as the largest oil spill. It is believed to have been caused by an explosion of an oil platform on the Deepwater Horizon offshore. The flow of oil from the spill into the Gulf of Mexico continued for 86 days until July 15, 2010 when BP reported to have capped the well. According to (Crone & Tolstoy, 2010), approximately, the Macondo well released 5 million barrels, 4.2 million of which poured into the waters of the Gulf of Mexico. BP was the developer of the oil filed where the spill occurred, and it had contracted Deepwater Horizon (owned by Transocean) to drill the exploratory well. Before the accident happened, Halliburton had finalized cementing of casings in the Macondo well. The US Government pointed out BP as the company responsible for the spill and would thereby be held accountable for the cleanup costs associated with the spill(Water, 2011). BP has since accepted the responsibility but it also suggests that both Transocean and Halliburton should bear accountability for the accident.

According to the group income statement released by BP on 1st February 2011 for the fourth quarter of 2010, BP reflected a charge of US $40.9 billion attributed to the Deepwater Horizon oil spill. This charge included US $17.7 billion for the costs incurred effectively in 2010 from the oil spill. All the charges resulting from the oil spill were treated as non-operating items, and were deducted from the taxable income of the company(Water, 2011). Within the stated amount was also a US $20 billion escrow account created by BP for the sale of US assets to cater for any legitimate claims and litigation settlements for the damages caused by the oil spill on the natural resources(Boyd, 2010). In addition, BP committed about US $500 million for a research program that would last for 10 years in studying the impact of the Gulf of Mexico oil spill and BP’s response on the marine and its ecosystems.

The amount reflected by BP on its income statement as the charge related to the Deepwater Horizon oil spill was inadequate to account for the loss caused on the ecosystem by the accident(Crone & Tolstoy, 2010). The charge did not reflect any amount related to fines and penalties that might arise from the accident for gross negligence except for those arising from proven strict liability. BP argued that it was impossible for the company to reliably estimate both the amount and timing of the amount.According to the company reports, there was significant uncertainty pertaining to the exact amount that the company would ultimately pay. The amount would be dependent on several factors such the date on which the flow of oil was permanently halted, the total amount of oil that spilt from the well, the period taken to clean up the site and the claims that would ultimately result from the accident (Farrell, 2011).

According to (Crone & Tolstoy, 2010), the uncertainty surrounding the amount to be charged by BP signals the lack of proper environmental accounting framework that would adequately match the potential rewards versus risks carrying out a particular project before an unforeseen tragedy strikes. Research shows that BP agreed to establish the US $20 billion escrow fund under pressure from the US Government to cater for cleanup costs and compensation for the destruction of the ecosystems(Boyd, 2010). The accounting practice by BP reveals the shortcomings of the traditional accounting system that recognizes the monetary transactions of firm in the books of accounts but largely ignores the aspects of the environment.

As a result, the users of financial reports of the company can read very many pages of corporate annual reports and other related financial documents and derive all information such as financial ratios, but they not get any information about the environment. This causes ignorance by the stakeholders on the financial risks associated with activities and projects such as deforestation and deep-well drilling. Environmental accounting is a component of the Generally Accepted Accounting Principles and it entails the provision of additional and valuable information about a financial activity and the associated environmental risks.

According to (Uno &Bartelmus, 2013), environmental accounting involves similar principles as those of financial accounting such the definition of the scope of the activity (entity principle), considering the worst scenario case (conservatism) and matching the revenues versus expenses (the matching principle). The Gulf of Mexico disaster clearly illustrates the fallout of the financial accounting. Following the explosion of BP’s Deepwater Horizon rig, BP investors were adversely affected as the share value for BP’s shares on the London Stock Exchange plunged immediately(Crone & Tolstoy, 2010). Also, the aggregate value of BP stock shed about $1000 within two months after the oil spill, which is about half the value of the firm’s stock (Water, 2011). From an accounting perspective, the dramatic fall in share value also represented mismatch of costs and revenues by BP and thus fostering an improper image of the firm to the shareholders and the public.

Incorporation of environmental accounting by BP would have required additional disclosure to provide cover for environmental contingencies and thus create a better understanding of the company’s financial performance(Water, 2011). The management, the board of directors and the shareholders of the company would also get an insight of the consequences resulting from an ecological calamity. Such disclosure would also have made it possible for the interested parties to take preventive measures before such a catastrophic.

The financial and ecological impacts of the Deepwater Horizon oil spill would be very difficult to quantify in terms of money and space(Boyd, 2010). The effects of the accident have obviously been calamitous as marine wildlife could be seen floating in a blob of oil off Louisiana’s coast. This is an indication of a decrease in the carrying capacity of the nature and it shows why environmental accounting ought to be a matter of great concern. The spill has affected about twenty ecosystem services related the Gulf of Mexico, such the ultimate shut down of Louisiana commercial fishery that generated US $2.5 billion per year (Farrell, 2011). Other affected services include recreational, cultural, and aesthetic values. These services in Mississippi River Delta are estimated to range between US $12-47 billion per year and this is a great loss that would be difficult to recover fully(Water, 2011).

Given the ambiguity surrounding scientific and economic knowledge, the penalties for the accident are most likely to be determined through political bargaining rather than technical calculation(Joël& Charles, 2011). This is downfall in the part of regulatory authorities for failing to put in place reliable methods for measuring and calculating financial implications of ecological calamities. Courts, trustees and plaintiffs currently lack powerful tools for effectively assessing the marine liability damages(Farrell, 2011). Therefore, it can be pointed out that this is the reason why BP was unable to disclose the exact details related to the damages on the ecosystems and social services, as well as the methods that the firm used to arrive at the pre-tax charge of US $40.9 billion, according to (Joël& Charles, 2011. There should be sufficient information that is critical in guiding the parties in the assessment of amounts charged globally to account for any negative externalities that might result in the derailment of ecosystems.

In addition, the guidelines should provide an understanding of how restoration efforts for the destroyed ecosystems and values would be undertaken. BP’s disclosure does not reveal to the stakeholders the real picture of environmental, social and financial implications of the Deepwater Horizon oil spill. Environmental accounting would help BP in minimizing huge swings in revenues and expenses(Farrell, 2011). The potential costs of a disastrous failure of a deep water oil rig could be estimated, and this supplementary information would be included in the interim and annual financial reports of the company.

The Gulf of Mexico oil spill has consequentially resulted in the need for more reliable environmental accounting and reporting and this requires more stringent regulation of oil and gas industries in the US and across the globe(Boyd, 2010). This will lead to environmental protection, health and safety promotion as well as controls and oversight of oil drilling operations and the access to the drilling areas. BP acknowledged that the uncertainties surrounding timing and evaluation of the costs related to the oil spill and the regulatory changes were likely to result from the incident would expose the group to greater risks over a significant period. Consequently, the company’s competitive position, prospects, cash flows and shareholder returns would be adversely affected(Joël& Charles, 2011).

For firms to become serious and focused to their corporate environmental performance, financial and environmental regulatory authorities must emphasize on the need for more reliable environmental accounting(Daniel, 2010). To ensure reliability of information disclosure by the private-sector companies, an integrated reporting framework should be emphasized. This can be achieved by putting side-by-side financial, environmental and social information in a meaningful design that would help stakeholders in decision-making (Uno &Bartelmus, 2013). The updated trends of the ecosystems within which a company operates should be timely availed to the stakeholders to ensure that they have information of any potential calamity and its impacts on the firm and the general environment (Boyd, 2010). This would increase collaboration of the stakeholders with research organizations NGO’s and public institutions for collection and analysis of ecosystem information.

Regulators such as the Australian Accounting Standards Board (AASB) should raise the bar for information disclosure and safety standards in the places where firms undertake their activities. Investors would therefore gain more confidence in the firms and the chances of them being blindsided by the financial implications of a possible disaster are minimal. Environmental accountants in collaboration with other experts should calculate the yearly costs for companies that depend on natural ecosystems for their operations, just as they account for their fixed assets based on the traditional accounting and disclosure practices(Daniel, 2010). For instance, suppose environmental economists valued the Gulf of Mexico’s ecosystems at US $800. BP should therefore have set US$800 billion as asset and offset the same to an equity account. They then calculate an annual cost for the use of the ecosystems, say US$ 75 just as they account for annual rental payments.

Conclusion

In conclusion, neglect of the concept of environmental accounting by corporate firms can have detrimental impacts on the firm’s financial performance when a calamity occurs, as with BP oil spill. Failure to integrate environmental accounting in the interim and annual financial reports of an accounting entity might present a false image about the firm’s true financial performance and thus mislead the stakeholders who rely on such information for decision making. Regulatory bodies should provide strict guidelines on environmental accounting information disclosure and the safety standards in places where corporate firms rely on natural ecosystems for their investment activities. This would reduce uncertainties about the valuation of calamities that might occur and at the same shield investors from losses if such disasters occur.

References

Boyd, J., 2010. Lost ecosystem goods and services as a measure of marine oil pollution damages. Resources forthe Future DP 10-31, 25p.

BP p.l.c., 2010. Group results Second quarter and half year 2010

Crone, T.J. and Tolstoy, M., 2010. Magnitude of the 2010 Gulf of Mexico oil leak. Science, 330(6004), pp.634-634.

Daniel B., 2010. Why we need environmental accounting. The Bottom Line.

Farrell, C., 2011. Gulf of Mexico Oil Spill. ABDO Publishing Company.

Joël, H and Charles G., 2011.The Financial impacts of BP’s response to the

Deepwater Horizon oil spill. Synergiz Case Study 2011-01.

Uno, K. and Bartelmus, P. eds., 2013. Environmental accounting in theory and practice (Vol. 11). Springer Science & Business Media.

Water, D., 2011. The gulf oil disaster and the future of offshore drilling. Report to the President [of the USA].

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