This article was first published in the May 2013 International edition of Accounting and Business magazine.
How many times have you woken up to the sound of the day’s business news being reported on the television or radio? In the vast majority of cases, the journalist will focus exclusively on the numbers coming out of the business – the previous quarter’s turnover, profits and earnings per share figures will be dissected in minute detail, before the inevitable prediction is made about how the company’s share price will perform when the markets open.
Yet how many times have you checked later in the day to see whether these predictions have come true? Unless you work in the financial markets, or for the particular company concerned, probably not that often.
Take my word for it: more often than not, the markets will respond very differently from the confident predictions made only hours earlier on the breakfast news. It isn’t that markets have a mind of their own, but that they take into account a broader range of factors than just the financials when determining the value of a particular stock.
The way businesses report has failed to keep up with this reality. Integrated reporting paves the way towards more meaningful, concise and material disclosures, bringing corporate reporting up to date.
Let me be clear. Numbers are an absolutely essential part of today’s corporate reporting landscape. They provide a measurable benchmark from one reporting period to another, they are trusted by investors, and assurance can be provided around the process of preparing the financial statements, which helps to underpin confidence. And, thanks to the work of financial reporting standard setters around the world, the International Accounting Standards Board (IASB) and Financial Accounting Standards Board (FASB) especially, the quality of financial reporting today is very high. I am proud that both the IASB and FASB are represented around our table at the International Integrated Reporting Council (IIRC) and that earlier this year we cemented our relationship with the IASB through a memorandum of understanding.
But think of a business today – for example, one of the major businesses involved in the IIRC’s pilot programme such as Coca-Cola, Hyundai, Microsoft or Unilever – and what you see is a melting pot of creativity, talent, ideas, financial resources, global brands and reputation, all of which contribute to the value placed on them as businesses. The numbers in the financial statements tell only a fraction of the story and the predictive quality of these statements in terms of the long-term resilience of the business is waning.
It is also the case that population growth, the shortage of natural resources and climate change are presenting businesses with very real challenges, both in terms of managing risks and in demonstrating to investors the viability of business models over the short, medium and long term.
Today’s reporting model was created at a time when financial and manufactured resources represented over 80% of the value of a business, yet in the early 21st century it is estimated that these physical resources typically represent only around a fifth of a business’s market value. It is surely time to put in place a different vision that supports the rebuilding of trust and confidence in reporting, enables more efficient and productive capital allocation decisions by investors, and creates efficiencies by breaking down silos in the business.
That is the IIRC’s ambition and we are not alone. The IIRC is an international coalition of businesses, investors, accounting bodies, regulators, standard setters and other market participants working together on creating a new reporting framework. Together with more than 90 internationally renowned businesses, and over 50 institutional investors, the IIRC is consulting over the next three months on the consultation draft of its international integrated reporting framework.
I encourage you to take part in this consultation, which runs until 15 July 2013. In the first place, you can read the consultation draft by accessing the link (see left). Please respond to the questions: if you have strong views on only one aspect of the draft, then you can just address that issue. We will be grateful for all contributions, and it is important that all voices are heard as we move forward towards the release of the initial international integrated reporting framework this December. You can also participate in events all over the world during the consultation period – you can find the details of workshops and other events on the IIRC’s website.
Reporting matters to business and to the success of the economy. It matters to investors, who must use the information to make capital allocation decisions. It matters to businesses themselves, which need to communicate how the business model and strategy are creating value over time. And it matters to society, because a properly functioning corporate reporting framework can underpin business resilience, financial stability and sustainable development.
Businesses spend a lot of time, money and energy on collecting management information and the corporate reporting cycle each year. Many readers will feel the burden of reporting has increased to an unsustainable level over the past 20 years and may question the wisdom of embarking on a new initiative. But integrated reporting is designed by business for business. It is a market-led evolution in reporting that seeks to address today’s challenges.
I do not pretend that we have all the answers, but we are confident enough to invite you to shape the future of corporate reporting by taking part in our consultation, which will do so much to improve the business, investment and economic landscape for the future.
The current and future application of capitals in integrated reporting have been set out in a recent background paper published by ACCA with the Netherlands Institute of Chartered Accountants.
It explores the multiple capitals recognised by the International Integrated Reporting Council (IIRC) as fundamental to integrated reporting: financial capital, manufactured capital, intellectual capital, human capital, social and relationship capital, and natural capital. All organisations depend on various forms of capital for their success, including ones they do not own, and the different capitals should be part of the business model and strategy.
The report provides a sound basis for the role of capitals in the integrated reporting framework. It suggests new proposals for improving the categorisation and descriptions of capitals adopted by the IIRC and provides more background to what may be unfamiliar concepts to help in their practical application.
Rachel Jackson, head of sustainability at ACCA and a member of this paper’s steering group, says: ‘Although companies depend on the six capitals to different extents, collectively these capitals affect the long-term survival of any company and influence its value creation. Reporting on them is therefore a crucial element in future corporate reporting and will be necessary to meet stakeholders’ expectations.’
We provide key extracts from the consultation draft of the integrated reporting framework, picking out the essential threads that will weave a more effective reporting structure
The framework lays the foundations for a new reporting model that will enable businesses to communicate concisely how they create value over time. An organisation’s business model is the vehicle by which it creates value. That value is embodied in the capitals that the organisation uses and affects. The assessment of an organisation’s ability to create value in the short, medium and long term depends on understanding the connectivity between the business model and a wide range of internal and external factors.
An integrated report prepared in accordance with the framework will disclose those factors:
Integrated reporting recognises that value is not created by or within an organisation alone, but is:
- influenced by the external environment (including economic conditions, technological change, societal issues and environmental challenges), which creates the context within which the organisation operates;
- created through relationships with others, including employees, customers, suppliers, business partners, and local communities;
- dependent on the availability, affordability, quality and management of various resources.
Integrated reporting therefore aims to provide insight about the following factors:
- the external environment that affects the organisation;
- the resources and relationships used and affected by the organisation, referred to in the framework as the ‘capitals’;
- how the organisation interacts with the external environment and the capitals to create value over the short, medium and long term.
- An integrated report results in a broader explanation of performance than traditional reporting by describing, and measuring where practicable, the material elements of value creation and the relationships between them. In particular, it makes visible all the capitals on which value creation (past, present and future) depends, how the organisation uses them and its effects on them.
- The mission and vision encompassing the entire organisation set out its purpose and intention in clear, concise terms.
- Those charged with governance are responsible for creating an appropriate oversight structure, within which the various elements are in dynamic flux.
- Continuous monitoring and analysis of the external environment in the context of the organisation’s mission and vision identifies relevant opportunities and risks.
- The organisation’s strategy identifies how it intends to maximise opportunities and mitigate or manage risks. It sets out strategic objectives and strategies to achieve them, implemented through resource allocation plans.
- At the core of the organisation is its business model, which draws on various capitals in one form or another as inputs and, through its business activities, converts them to outputs (products, services, by-products and waste). The organisation’s activities and outputs affect the capitals. Some capitals belong to the organisation while others belong to stakeholders or to society more broadly. The organisation and society therefore share the cost of input capitals and the value created by the organisation.
- The organisation needs information about its performance, which involves setting up measurement and monitoring systems to provide information for decision-making.
- The system is not static; regular review of each element and its interactions with other elements, and a focus on the organisation’s future outlook, leads to revision
The six capitals
Social and relationship
The essence of integrated reporting is that an organisation creates (or destroys) value over time by using, and affecting, the six capitals (or resources and relationships) listed here in the context of its external environment (those aspects of the legal, commercial, social, environmental and political context that affect it).
The value that is created, or destroyed, is stored in the capitals that flow through the organisation. Changes in the capitals over time are, therefore, the measure of value created or destroyed by the organisation.
What goes on inside the organisation determines how it interacts with the external environment, what capitals it uses and how it affects them. This is the organisation’s unique value creation story, which integrated reporting, and in particular the integrated report, seeks to demonstrate.
The consultation deadline is 15 July.