10.
The concept of capitals

10.1 Introduction

Capital is a fundamental concept in accounting and economics, representing the resources an organisation uses to create value. As accounting students, it is crucial to understand the concept of capitals and the various forms of capital. However, the definitions and measurement of the different forms of capital are not straightforward, as they depend on various political, social, cultural and environmental factors. Traditional accounting practices tend to focus on financial and manufactured capitals. This treatment ignores or undervalues other forms of capital, such as natural, human, intellectual and social capital – particularly capitals that are used but not necessarily owned by organisations. These forms of capital are essential for the long-term sustainability and performance of an organisation, as well as that organisation’s impact on society and the environment. In this unit, we will demonstrate that a more comprehensive and integrated approach to capital, based on Integrated Reporting’s six categories of capital, can provide a more holistic way to report the value created by an organisation and promote sustainable value creation. We will also consider various frameworks used to measure and report on the different forms of capital and discuss some challenges and limitations of these approaches.

10.2 What is capital?

Scholars have also defined capital as power and about maintaining power. Rambaud (2024, p. 73) suggests that “Capital is the symbolic representation of Power, but not just any power; it represents the Modern Power of the Subject […] Subjects are, by definition, those who have the Capital and Capital defines who is a Subject in Capitalism. Maintaining Capital, therefore, does not mean maintaining biophysical things, for instance, but only maintaining Power, that is, the expansion of the Goals of Subjects in the future.”

Capital can be broadly described as a resource or an asset that provides future value or benefit. As Coulson et al. suggest: “Accountants traditionally use the word ‘capital’ as an economic metaphor for financial assets and manufactured means of production, subject to financial valuation and representation.”¹ Capital underpins our society, and all of the world’s economic output is dependent on capitals of one form or another. In this unit, we will broaden our understanding of capital beyond traditional financial metrics to better appreciate the importance of managing and accounting for various forms of capital and the true costs of doing business.

In pure accounting terms, capital represents the value of the investment in the business by the owner(s). It is often described as the equity, which is part of the accounting equation. Accounting further divides capital into various categories, such as working capital, which is determined by subtracting current liabilities from current assets. Working capital reflects the liquidity that is available for day-to-day operations. The word capital is also associated with capital costs, which are costs which can be included as non-current assets.

Whereas early forms of accounting considered capitals to be mainly tangible assets such as land, farms, livestock and equipment, the concept of capital has evolved over time and has become the basis for understanding the importance of the social and ecological impact of an organisation’s operations. For example, the Capitals Coalition describes capital as follows:

Capital has traditionally been thought of only as money, but capital describes any resource or asset that stores or provides value to people. Natural capital, social capital and human capital work in much the same way as traditional capital – if we invest in them, they create value, and if we degrade them, we limit their value.

Concepts such as ‘natural capital’ have started attracting attention, particularly in accounting research.^2 3 Beyond academia, this recognition has also led to international programmes, such as the Capitals Coalition which was formed in 2020 following a merger between the Natural Capital Coalition and the Social & Human Capital Coalition.

These initiatives reflect the recognition that sustainable economic growth and value creation depend on a variety of resources beyond just physical and financial assets. They also highlight the need for organisations and economies to manage and account for these different forms of capital in a holistic and integrated manner that creates value for nature, people and society alongside businesses and the economy. How these different forms of capital are managed and maintained becomes the central issue for sustainability. The next section will focus on various limitations of the traditional accounting practices in measuring and reporting on these forms of capital.

10.3 The need to move beyond financial capital

This emphasis on financial capital (money or investments) and manufactured capital (physical or tangible assets, such as machines or products) ignores and undervalues other forms of capital, such as natural capital or social capital – particularly capitals that organisations use (from society and the environment) but do not necessarily own. Recognising and reporting on these capitals is essential in understanding the full scope of an organisation’s resources and its impact on the environment and society.

Natural capital refers to the valuable stocks of natural resources and ecosystems that provide benefits to society. As defined in HM Treasury’s Green Book: Appraisal and Evaluation in Central Government, it “includes certain stocks of the elements of nature that have value to society, such as forests, fisheries, rivers, biodiversity, land and minerals,”⁴ encompassing both living and non-living aspects of ecosystems. Similarly, Barker and Mayer describe natural capital as “the stock of natural ecosystems on Earth including air, land, soil, biodiversity and geological resources… (which) underpins our economy and society by producing value for people, both directly and indirectly”.⁵

The environment is a natural capital because it provides fresh air, water, soil and life itself. However, as a society we do not put a price on these valuable resources. A company that produces palm oil may destroy thousands of trees for which they pay no price, but in doing so they make palm oil that is then priced in the market and sold for profit. One reason why natural capital of this type hasn’t been accounted for in the past is that it cannot easily be monetised. How do you calculate the loss of value to the environment of felling trees to produce palm oil?

Recent advancements have led to the development of methodologies and frameworks that allow for the valuation and reporting of natural capital, such as the Global Reporting Initiative (GRI), the Taskforce on Nature-Related Financial Disclosures (TNFD), Enabling a Natural Capital Approach (ENCA), Accounting for Sustainability (A4S), and the six capitals of Integrated Reporting (<IR>). We will look at these in later sections.

In the next section, we will consider the concept of double materiality and the broader consideration of an organisation’s impacts on society and the environment.

10.4 The concept of double materiality

The concept of double materiality acknowledges that organisations are not only materially vulnerable to environment-related events and risks (outside in), but also materially impact the environment through their own activities (inside out). By contrast, a single-materiality perspective includes only the impact of environment-related events and risks on the organisation (outside in).

The concept of double materiality initially appeared in the European Commission (EC)’s 2019 Guidelines on non-financial reporting: Supplement on reporting climate-related information.⁶ Following its introduction in these guidelines, the term ‘double materiality’ has been further explored in recent academic studies, such as that by Adams et al. (2021)⁷ and incorporated into proposals for regulations and guidelines such as the International Financial Reporting Standards (IFRS) Foundation’s Consultation paper on sustainability reporting.⁸ The concept of double materiality is also used by organisations such as the GRI and the European Financial Reporting Advisory Group (EFRAG).⁹

Figure 10.1 depicts the EU’s Non-Financial Reporting Directive (NFRD) guidelines on reporting climate-related information from a double-materiality perspective. The left-hand side of the diagram indicates how climate affects the value of the company (financial materiality), while the right-hand side indicates the company’s external impact on the environment and society (environmental and social materiality).

10.5 Valuing and reporting on non-financial capitals

There have been many attempts to value and report on different types of capital, making the different proposed reporting approaches a topic of significant interest to both accounting researchers and industry practitioners. Many organisations provide additional social and environmental reporting voluntarily, thereby responding to demands by interested parties for more information on how organisations create value.

TCFD is distinct from the Taskforce for Nature Related Financial Disclosures (TNFD) framework, which focuses on nature.

Approaches to measuring non-financial capitals such as natural and social capital have developed over time. Many organisations now report on their broader impacts using guidance in frameworks promoted by the GRI, the Task Force on Climate-Related Financial Disclosures (TCFD), Enabling a Natural Capital Approach (ENCA) and the UN Sustainable Development Goals, and bodies such as A4S seek to influence the finance community to adopt a more sustainable approach to decision making.

The GRI is regarded as the global leader for impact reporting, providing the world’s most widely used sustainability reporting standards. The GRI’s standards cover a broad range of environmental and social topics such as biodiversity, emissions and equality, and provide guidance for companies to use for their voluntary reporting.

The TCFD was formed in 2015 to improve the reporting of climate-related financial information so that financial markets could price climate-related risks more accurately. The TCFD recommended four key themes: metrics and targets, risk management, strategy and governance. The work of the TCFD has now been incorporated into the work of the International Sustainability Standards Board (ISSB).

While bodies and frameworks like these have raised the profile of reporting on the non-financial impacts of organisations, one disadvantage of such reporting is that it is often presented separately to financial reporting information. This has led to multiple different reports targeted at different audiences, and a lack of connectivity between financial information and other types of information.

In the next section, we will consider a comprehensive and integrated approach to financial and non-financial capitals, based on Integrated Reporting’s six categories of capital, which promotes a more holistic way of reporting on how organisations can create and promote sustainable value.

10.6 Integrated Reporting’s six capitals

Read this 2018 article by John Elkington about rethinking the phrase ‘triple bottom line’.

Over time, the existence of multiple different types of reporting and accounting for different capitals have led to calls for a single report, one that captures both the traditional financial activities of organisations and their broader impact. One of the most influential attempts at a combined form of reporting was Elkington’s proposal of ‘triple bottom line’ accounting in the 1990s,¹⁰ which recognised the importance of three factors – profit, people and planet – in terms of organisational accountability.

More recently, Integrated Reporting has emerged as a way for organisations to report on and be accountable for six different capitals. These six capitals are shown in Figure 10.3, and comprise: financial capital, manufactured capital, human capital, intellectual capital, social and relationship capital, and natural capital. Integrated Reporting is a holistic, principles-based way of reporting that recognises that firms use a broad set of resources to generate value. You can see in Figure 10.3 that financial and manufactured capitals sit at the centre, showing the relatively narrow remit of traditional financial reports, and that Integrated Reporting then extends out to consider other, broader types of capital.

The International Integrated Reporting Framework (<IR> Framework), shown in Figure 10.4, describes an integrated report as “a concise communication about how an organisation’s strategy, governance, performance and prospects, in the context of its external environment, lead to the creation, preservation or erosion of value over the short, medium and long term”.¹¹ The core principle of the <IR> Framework is that companies should extend their reporting to cover all resources used as inputs in their business activities. In Figure 10.4, you can see how the resources on the left of the diagram are used by organisations as inputs and, through the businesses’ activities, contribute to outputs, shown on the right of the diagram.

The six capitals are explained below:

1. Financial capital refers to the array of monetary resources that an organisation can access and use for the production of goods or the provision of services. This type of capital is critical because it represents the economic fuel that powers business operations, enabling companies to invest in new projects, maintain operations, and expand their reach.

Financial capital can originate from various sources, including:

• Equity financing: This involves raising money by selling shares of the company to investors. Equity investors provide capital in exchange for ownership stakes in the company, typically with the expectation of receiving dividends or realising gains from increased stock value over time.
• Debt financing: Organisations can also generate financial capital through borrowing. This can include loans from financial institutions, the issuance of bonds, or other forms of credit. Debt financing must be repaid over time – usually with interest, which represents the cost of borrowing.
• Grants: Some organisations may receive grants from government bodies, non-profit organisations or other entities. Grants are typically allocated to fund specific projects or initiatives and do not require repayment, making them a highly valuable form of financial capital for those eligible.
• Internal operations: Beyond external financing, organisations also generate financial capital through their operational activities. This includes profits from the sales of goods and services, which can be reinvested into the business to fuel growth and development.
• Investments: Companies may also obtain financial capital through various investments, such as in real estate, stock market holdings or other financial instruments that can provide returns or increase in value over time.

The effective management of financial capital is crucial for an organisation’s sustainability and growth. It requires careful planning and strategic decision making to balance the sources of capital, manage risks and ensure that sufficient funds are available to meet both immediate needs and long-term objectives. By optimising their financial capital, organisations can support day-to-day operations and also invest in innovation and expansion, thereby enhancing their competitive position and ensuring long-term profitability.

2. Manufactured capital encompasses all physical assets produced by human effort that are used by organisations to produce goods or provide services. This category of capital is fundamental to the operational infrastructure of any business, as it directly influences production capacity, operational efficiency and service delivery quality. Manufactured capital includes a wide range of tangible assets, such as buildings and facilities, machinery and equipment, infrastructure, technology systems, and vehicles and transportation equipment.

Investment in manufactured capital is not only about acquiring physical assets, but also about continuous improvement and upgrading. This involves adopting newer technologies, maintaining and repairing existing assets and strategically decommissioning outdated or inefficient equipment. Effective management of manufactured capital ensures that assets remain functional and efficient over their lifespan, reducing operational costs and minimising environmental impacts through better energy efficiency and reduced waste.

Moreover, the strategic deployment of manufactured capital plays a crucial role in scaling operations, entering new markets and meeting regulatory compliance standards. It enables organisations to optimise their production processes and supply chain logistics, leading to sustained growth and competitive advantage.

3. Intellectual capital is a critical component of an organisation’s overall value and encompasses the non-physical, knowledge-based assets that drive innovation, competitive advantage and market leadership. This form of capital is primarily concerned with the intangibles that contribute to an organisation’s long-term sustainability and profitability.

Investing in and managing intellectual capital effectively is crucial for fostering innovation, improving efficiency and achieving strategic goals. Organisations that prioritise intellectual capital development tend to adapt more rapidly to market changes and technological advancements, and hence secure a sustainable competitive advantage in their industries.

4. Human capital represents the skills, knowledge, experience and abilities of the employees within an organisation. Human capital is developed through education, training and experience, and is critical for problem solving, innovation and providing competitive services or products. It also includes the creativity and leadership capabilities that influence corporate culture and strategic direction.

5. Social and relationship capital refers to the value that an organisation derives from its relationships and networks with external interested parties. This form of capital is crucial as it influences reputation, relationships and the ability to access resources and opportunities through external partnerships. It encompasses a broad spectrum of relationships that extend from local communities to global networks, including interactions with customers, suppliers, partners, government entities and the wider public.

The components of social and relationship capital include:

• Customer relationships: Building strong, enduring relationships with customers is fundamental to business success. These relationships are built on trust, reliability and consistent customer satisfaction. Organisations that excel in customer engagement often enjoy higher loyalty rates, repeat business and enhanced brand reputation – all of which contribute significantly to long-term profitability.
• Supplier and partner networks: Collaborations with suppliers and business partners can lead to improved innovation, cost reductions and access to new markets. Strong partnerships are based on mutual benefits, trust and shared goals. Effective management of these relationships ensures a more resilient supply chain and a broader base from which to source ideas and solutions.
• Community engagement: The relationship an organisation maintains with its local communities can significantly affect its operational freedom. Community support is often essential for access to resources and continuity of business operations. Organisations that invest in community relations often benefit from enhanced corporate image, reduced regulatory pressures and community-driven growth initiatives.
• Employee relations: Although often considered under human capital, the relational aspect of employee interactions contributes to social and relationship capital. Organisations with strong internal relationships enjoy better teamwork, lower turnover rates and higher employee engagement, all of which enhance overall productivity and innovation.
• Regulatory bodies and government relations: Maintaining constructive dialogue and compliance with regulatory bodies and governments can facilitate smoother operations and help pre-empt regulatory challenges. Positive relationships in these areas can also lead to favourable policy influences and quicker approvals for business initiatives.
• Communication: Open and transparent communication with all interested and affected parties, including investors and the media, builds trust and supports an organisation’s reputation. Regularly sharing information about business operations, successes, challenges and strategies helps align all parties with the company’s goals and mitigates potential conflicts or misunderstandings.

Building social and relationship capital is a strategic and ongoing process. It encompasses not only proactive engagement strategies but also a deep commitment to corporate social responsibility and ethical business conduct. Organisations that successfully manage their social and relationship capital are seen as trustworthy and socially responsible, which attracts more customers, partners and investors, and often gives those organisations a competitive edge in their markets.

6. Natural capital incorporates the Earth’s extensive natural resources, including air, land, water and the diverse array of flora and fauna that form ecosystems. These elements are vital for organisations, as they rely on these ecosystems and resources for obtaining raw materials, generating energy and processing waste, among other vital ecosystem services.

This type of capital includes renewable resources such as forests, fish stocks and agricultural lands, which can naturally regenerate over time, as well as non-renewable resources such as minerals, oil and natural gas, which are finite and irreplaceable once exhausted. The prudent management and preservation of natural capital are essential for achieving sustainability and resilience, supporting not only the immediate operational needs of organisations but also securing these resources for future generations.

The significance of natural capital is increasingly acknowledged for its fundamental role in both sustaining the environment and underpinning economic activities that foster prosperity. Organisations that invest in maintaining and restoring natural capital help promote a sustainable economic framework that considers ecosystem health, biodiversity and the environment’s ability to deliver critical services such as clean air and water, crop pollination and climate regulation. This approach ensures the long-term viability of businesses and enhances overall social welfare.

Examples of Integrated Reporting

Sanford Ltd is a listed New Zealand-based fishing company that has won awards for the quality of its integrated reports. Open Sanford’s most recent integrated report and see how they have described their six capitals and how they use them to create value.

Another example of Integrated Reporting can be found in the annual reports of SGS, a Swiss multinational company headquartered in Geneva, which provides inspection, verification, testing and certification services. Open its most recent integrated report and contrast it with the Sanford example.

10.7 The future of accounting for capitals

The six capitals of Integrated Reporting, as introduced in Section 10.6, facilitate organisational value creation in the short, medium and long term, and expand their impact and contributions to the economy and society beyond the scope of conventional financial reports. In addition, Integrated Reporting is intended to catalyse Integrated Thinking within organisations. Integrated Thinking is a form of management that encourages managers to make decisions that consider all capitals, not just financial capital.

The main promoter of Integrated Reporting has been the International Integrated Reporting Council (IIRC), formed in 2010. The IIRC brought together a global coalition of regulators, investors, companies, standard-setters, accounting professionals, academics and non-governmental organisations. The coalition collectively held the view that discussing the creation, preservation or erosion of value (Figure 10.4) represented the next stage in the evolution of corporate reporting.¹² More recently, the work of the IIRC has been taken under the umbrella of the ISSB, the body formed by the IFRS Foundation with a focus on producing a set of globally recognised standards for sustainability reporting. It is important to note, as we discussed earlier, that the ISSB now also encompasses the work of the TCFD and has agreed to work closely with the GRI. It also complements the UN SDGs, making it likely to exert significant influence over the way that companies report on their activities in the future.

10.8 Summary

• Capital can be broadly described as a resource or an asset that will deliver a future value or benefit.
• Traditional accounting practices focus on catering for the needs of financial capital providers (investors).
• The concept of double materiality refers to financial materiality affecting the value of the company as well as the broader impact of the company’s activities on the environment and society.
• There are various ways of measuring non-financial capitals, such as natural and social capital. Many organisations now report on their broader impacts using frameworks such as the GRI, TCFD and the UN SDGs.
• Integrated Reporting is a relatively recent development in organisational reporting that encourages organisations to report on six capitals and how they use these capitals to create, maintain and destroy value. The six capitals are: financial capital, manufactured capital, human capital, intellectual capital, social and relationship capital, and natural capital.