This article was first published in the October International 2013 edition of Accounting and Business magazine.
The shortcomings of traditional corporate reporting have long been of concern to users of financial statements and other stakeholders. The gist of the issue is that corporate reporting has a considerable way to go to explain the value creation capabilities of the company.
Steven Wallman, an expert on intangible valuation and former commissioner of the US Securities and Exchange Commission (SEC), says: ‘The inability to recognise as assets on the balance sheet some of the new and most significant building blocks of business has resulted in balance sheets that bear little resemblance to the true financial position of firms they are supposed to describe. We are assigning the balance sheet to the status of an antique and ignoring the needs of a broad array of financial statement users, including users such as creditors who are increasingly lending on soft assets.’
In April, the International Integrated Reporting Council (IIRC), a coalition of regulators, investors, companies and standard-setters, released for comment its latest draft of the integrated reporting framework. By most accounts, the framework is an ambitious and holistic approach to capturing and reporting the activities of companies. Integrated reporting, according to the IIRC, attempts to:
- catalyse a more cohesive and efficient approach to corporate reporting that communicates the full range of factors that materially affect the ability of an organisation to create value over time;
- inform the allocation of financial capital that supports value creation over the short, medium and long term;
- enhance accountability and stewardship for the broad base of capitals (financial, manufactured, intellectual, human, social and relationship, and natural) and promote understanding of their interdependencies;
- support integrated thinking, decision-making and actions that focus on the creation of value.
The April framework was the culmination of a multi-phased public consultation process beginning with the 2011 discussion paper Towards integrated reporting – communicating value in the 21st century, and followed by a prototype framework in November 2012, successive drafts, and a final review and endorsement by the IIRC’s working group and council. Meanwhile, over 100 companies around the world are currently testing the principles of integrated reporting in their corporate reporting cycles.
Once again, the public was asked to comment on the integrated reporting framework; not unexpectedly, the 359 responses provided mixed reviews. On the one hand, the IIRC was lauded for its efforts to give stakeholders a fuller understanding of how companies produce value; on the other, achieving consensus on a final version of integrated reporting is clearly a work in progress.
The work of the IIRC is widely valued by the broader accounting community. The Federation of European Accountants ‘commends the IIRC for the significant achievement of issuing the draft framework… and supports the IIRC’s objective of gaining as much practical experience with the draft framework as possible.’
Similarly, international companies such as Microsoft welcome a fresh look at corporate reporting that gives greater transparency and communication with shareholders. As Microsoft’s treasury controller Bob Laux explains: ‘Many of us involved in financial reporting have lamented, admittedly in very generalised terms, that financial reporting seems to be moving more towards a compliance exercise rather than a communication exercise. Microsoft believes that integrated reporting provides the mechanism to improve financial reporting by providing information in a concise manner on how a company creates and sustains value.’
ACCA also believes the IIRC is on the right lines with its framework and the way ahead is to flesh out the gaps. Richard Martin, ACCA’s head of corporate reporting, says: ‘The plans for integrated reporting are right in principle and there is a significant opportunity for the quality of corporate reporting to be improved by giving to investors and others a more complete view of the entity and its prospects over a longer time frame than is usually covered in traditional corporate reporting. However, the framework still needs to be fully field-tested, and it would help prospective preparers greatly if the IIRC were able to provide case studies of best practice across a range of different organisations. These would also help promote adoption and aid compliance in an area where there is much enthusiasm but little awareness.’
However, challenges remain. One major question is whether an integrated report is to be the overarching reporting framework with links to sub-reports that are traditionally required, or whether elements of integrated reporting should be incorporated into other established reports. The American Institute of CPAs (AICPA) suggests the filer should decide, and that US companies may prefer to incorporate the content elements of integrated reporting into their existing voluntary reporting structures, as opposed to developing a separate standalone report.
Observers have also commented that the current framework is too conceptual and that integrated reporting will be neither comprehensive nor comparable between companies unless there is authoritative guidance. CGA Canada says that without specific guidance or standards the model loses its appeal, and has called on the IIRC to adopt a more proactive approach and develop authoritative and principles-based comprehensive standards, including specific indicators and measurement methods. ‘In the absence of such authoritative and principles-based comprehensive standards,’ it warns, ‘diversity in practice will emerge and the comparability of integrated reporting will diminish.’
Others question the wisdom of adding yet more disclosure and reporting to the plate of the CFO and, without the force of law, whether there’s any real hope of adoption. Business Europe, an organisation representing business and labour associations across Europe, says: ‘Instead of bringing the existing reporting together and reducing the overall excessive amount of information, the consultation draft is suggesting introducing yet another separate report.’ It goes on to warn that another standalone report will not only increase the administrative burdens for business, but ‘will add to the existing information overload that prevents stakeholders from seeing the wood for the trees’.
Although the IIRC recognises the ability to obtain reliable data will affect how far integrated reporting can be applied, critics recommend a reality check. The Canadian Investors Relations Institute says the IIRC ‘does not adequately acknowledge the fundamental shift in corporate culture and the significant investment in systems and processes required to enable integrated management that must take place before an integrated report can be produced. We recognise that the IIRC’s mandate is reporting, but success will be elusive without more effort to provide some guidance on implementing integrated thinking and many of its inherent processes.’
Some companies also suspect the IIRC is simply asking too much. HSBC Bank says: ‘With the current burden of reporting borne by financial institutions, we do not think it is reasonable to expect companies to produce separate integrated reports. Given the detailed statutory and regulatory framework which is applied to banks, and the volume of required disclosures, it will be difficult to integrate reporting in full.’
Finding a way to measure or even describe the ‘six capitals’ and their inter-relationships also remains a concern. HSBC says the IIRC does not go far enough in explaining how value should be measured: ‘The framework is surprisingly vague on how companies should compute value and on how users of an integrated report should assess it, given that value creation is at the heart of integrated reporting. Value created in the form of financial returns to providers of financial capital is a familiar concept, but qualifying it in the form of positive or negative effects on other capitals and other stakeholders introduces a degree of subjectivity which is virtually impossible to quantify.’
Others question the value of reporting on any of the six capitals unless they can somehow be tied to the bottom line.
The way ahead
So where does this leave the IIRC in its efforts to spawn new ‘integrated thinking’ around how a company creates value? Many want practical case studies from existing pilot projects, and for a slow and iterative approach to future drafts.
ACCA recommends that the IIRC makes sure that any further iterations of the integrated reporting framework are developed in close consideration of existing frameworks. One of the IIRC’s short-term priorities, it says, should be to liaise with other regulators and standard-setters to address potential barriers to the adoption of integrated reporting. ‘In particular, steps need to be taken to ensure that integrated reporting can be made consistent with, and avoid duplication with, existing requirements and guidance relating to corporate reporting – for example, the UK’s new strategic report. Best practice examples are needed on how cohesion can be achieved with current requirements for annual reports, MD&A, sustainability reports and the like.’
PwC, which has been supportive in its response to the latest framework consultation draft, sees it not so much as the final destination as a step in the right direction: ‘We believe integrated reporting has the potential to enhance the depth, breadth and quality of corporate reporting and a principles-based framework is a major step in its development. The complexity of the issues being addressed and the extent to which experimentation will expose further challenges will almost certainly result in the need for the framework to continue to evolve. The existing framework should not therefore be regarded as the final destination but a big step in the direction of bringing the reporting model firmly into the 21st century.’
The IIRC plans to issue the initial version of the framework in December 2013 and to update it periodically as integrated reporting evolves.
Ramona Dzinkowski is an economist and business journalist