CFOs are wondering how backward-looking ‘profitability’ can transition to forward-looking ‘sustainability’ as the primary accounting measure of corporate performance. A joint initiative comprising RASB, ACCA, PRMIA, and the Durham University Business School believes Risk Accounting provides the answer.

An image I caught while photographing a business event in Denver.

A Call for Action

This call for action is directed to CFOs and CROs as well as subject matter experts from the accounting and risk domains; we need your active engagement to introduce accounting reform aimed at positioning Risk Accounting as the generally accepted method of transitioning to corporate sustainability reporting.

Details of how you can get involved are available here.

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What is Risk Accounting?

Risk Accounting is a standardised and integrated nonfinancial risk management and accounting framework that identifies, quantifies, aggregates, values and reports all forms of nonfinancial risk. It accounts for both the expected losses associated with accepted nonfinancial risks and the mitigating effects of environmental, social and governance (ESG) attributes.

For more information on Risk Accounting, click here.

What is Sustainability?

Sustainability is an organisation’s capacity to provide investors with reliably predictable returns on their investment in financial, environmental and social terms. Sustainability is an organisation’s financial profit or loss – the backward-looking or ‘historic’ perspective – adjusted for the expected losses associated with accepted nonfinancial risks and the mitigating effects of environmental, social and governance (ESG) attributes – the forward-looking or ‘future’ perspective.

Looking up

                    What this Call for Action Addresses

The Threat

The greatest threat to an organisation’s sustainability is the emergence of unidentified and unreported exposures to nonfinancial risk that accumulate until they pass a tipping point when they mutate into losses euphemistically termed ‘unexpected’. Organisations have become increasingly susceptible to this threat due to two primary factors:

First, recent decades have seen exponential growth in exposure to nonfinancial risks both in terms of their size and complexity. Boards and C-suite executives must now navigate their organisations through a veritable minefield of nonfinancial risks that have evolved from simple and benign to complex and treacherous. They include manufacturing, transaction processing, climate change, supply chain, cyber, conduct, fraud, geopolitical, model and legal and compliance risks.

Second, enterprise and operational risk management (ERM & ORM) tools and techniques are appallingly weak. The information reported to boards, CEOs and CFOs on the status of nonfinancial risks is typically derived from subjective, non-aggregatable, non-comparable, colour-coded (red/amber/green) risk & control self-assessments thereby disenabling the analysis, monitoring and controlling of accumulating exposures to nonfinancial risks in the aggregate.

Control of the Risk Agenda

A combination of exponential growth in exposure to nonfinancial risks, weak and ineffective ERM and ORM tools and techniques and a history of unpredicted failures of influential corporations, most significantly during the global financial crisis of 2007/8, has undermined confidence in nonfinancial risk management and financial accounting and reporting. In response, legislators and regulators have progressively taken control of the corporate risk management agenda through ever-increasing volumes of statutes, regulations and public disclosure mandates.

Perversely, the consequential migration from boardrooms to legislators and regulators of a significant portion of the accountability for the management of nonfinancial risks has stifled the capacity of organisations to innovate, inhibited their freedom to operate and, paradoxically, further increased exposures to nonfinancial risk by adding a deep layer of regulatory and compliance risk.

The Response

To halt and begin to reverse this costly, anti-business trend boards, CEOs, CFOs and CROs need risk management systems that comprehensively and reliably identify, quantify, aggregate, value, report and account for exposures to nonfinancial risk. Such solutions have not materialised to date because of a wrongheaded but universally accepted mindset that a nonfinancial risk is inherently unobservable… only outcomes are observable.

This negative, anti-progressive mindset must change. Organisations must view nonfinancial risk as a financial abstraction in the same way that profit or loss, shareholders’ equity, ROE and unit cost are viewed as financial abstractions. If accountants can transform so many diverse financial abstractions into observable accounting measures, there’s no reason why they can’t do the same for nonfinancial risks and ESG attributes.

The Solution

Risk Accounting incorporates a nonfinancial risk quantification technique first pioneered at the Chase Manhattan Bank (now JPMorgan Chase) as a production (operations) risk measurement and management tool. In the aftermath of the global financial crisis of 2007/8 the technique was extended and codified at the Durham University Business School as an integrated nonfinancial risk management and accounting solution where it was proven for application in banks through laboratory testing. Further tests were successfully conducted against publicly available bank holding company financial statement (US GAAP) datasets provided by the Federal Reserve Bank of Chicago.

Pen and Notebook

A Call for Action… How to Get Involved

If Risk Accounting is the solution that enables the successful transition from financial profitability to sustainability as the primary accounting measure of corporate performance, the task before us is formidable. The engagement of subject matter experts from the accounting and risk domains will be vital to create and validate the tables and templates that comprise the method. The engagement of CFOs and CROs from multiple industries is necessary to access live operating environments for field-testing.

If the challenges set out above excite you and you want to take up this call for action, or you just want to learn more about the initiative, we would love to hear from you. Simply email with a brief bio, your corporate title, job title and contact details and we’ll revert with all the information you require.

Pen and Notebook

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