Integrated reporting (IR) has been developed and promoted by the International Integrated Reporting Council (IIRC), a global coalition of regulators, investors, companies, standard setters, the accounting profession and non-governmental organisations. IR has been introduced to the syllabuses of many of the Professional level exams. This article aims to show how the idea of integrated reporting is relevant to the P5 syllabus.
RELEVANCE TO P5
IR is focused on showing the connectivity of strategic objectives, risk and performance to demonstrate how organisations create value. This means that organisations need to understand and report on all areas of performance and not just focus on short-term financial results.
You will see that IR has many elements which easily relate to P5. The definitions of IR are:
- A concise communication of an organisation’s strategy, governance and performance.
- Demonstrates the links between its financial performance and its wider social, environmental and economic context.
- Show how organisations create value over the short, medium and long term.
It is useful to imagine yourself investigating a company about which you know nothing to decide whether or not you want to invest in it. Going to the latest annual report and financial statements would probably be your starting point, but you will be left with many unanswered questions – certainly if the company shows the minimum information required by law and the accounting and financial reporting standards. You will learn relatively little about the company’s business activities (though segmental reporting helps), their competitors, their future plans or how they intend to achieve sustainable competitive advantage. IR aims to fill the gaps so that existing or prospective investors better understand the company.
Think about the evolution of modern management accounting. A few decades ago management accounting was being criticised for being too internally and operationally focused. It was recognised that there was a need for management accounting to be useful for strategic decision-making and that management accountants should act essentially as business partners in organisations. The role of management accounting now is to assist in the analysis, formulation and monitoring and evaluation of strategy. It has a significant contribution to make in the validation of strategic plans and decisions.
P5 is focused on how strategic objectives are linked to critical success factors and key performance indicators and how this is translated throughout an organisation. It encompasses the need to address risk, external influences, stakeholders, non-financial results, brand, etc. It addresses the importance of selecting the right performance management techniques, information systems, reporting functions to ensure performance is delivered at all levels and over the short and long-term.
The following IR Content Elements are particularly relevant to P5:
- Organisational overview and the external environment
- Opportunities and risks
- Strategy and resource allocation
- Business model
- Future outlook
Let's add some detail and examples to these elements:
ORGANISATIONAL OVERVIEW AND THE EXTERNAL ENVIRONMENT
What does the organisation aim to do? Who are the major stakeholders? Where is it located? How is it structured? What external events will affect if most?
Fairly obviously the organisation’s mission and objectives, stakeholder analysis, organisation chart and a PEST analysis would be relevant to this section of the IR.
OPPORTUNITIES AND RISKS
These must cover both internal and external matters. The traditional SWOT analysis usually categorises opportunities and threats (risks) as external, but it is essential to also look internally. A weakness (for example arising from gaps in new product development) is a risk to future revenues. Similarly a strong brand name creates greater opportunities for future revenue streams. Historically, the board of companies would tend to emphasise a company’s opportunities, but investors cannot make an informed decision about an investment without an appreciation of the associated risk. Some risks can be quantified (for example, by expected values and sensitivity analysis) but it is unlikely that quantified amounts would appear in an IR. A qualitative indication should be provided about both internal and external risks. The report should also mention how the risks are being managed and mitigated.
STRATEGY AND RESOURCE ALLOCATION
Does the organisation intend to develop new products, set up new factories or expand to new markets? This section of the IR can make extensive use of Porter’s models, BCG matrix and the value chain. It would be valuable to investors to be told how their company is going to respond to these changes in the market, how much it might cost to achieve the new strategies and how this change will be managed effectively.
An organisation’s business model is 'its system of transforming inputs, through its business activities, into outputs and outcomes that aims to fulfil the organisation’s strategic purposes and create value over the short, medium and long term' (IIRC). Many of the performance management models are particularly relevant here: for example, the value chain explicitly sets out inputs, processes and outputs and requires organisations to understand how value is added so that profits can be made. If a company does not understand where it adds value then the company is existing in a temporary state of good fortune. It is making profits now, but does not understand why, so chance of continued success must low.
Inputs are the major inputs such as raw material or human resources. Outputs are the key products and services. The business activities include not just the manufacturing process, but also how the company innovates, carries out its marketing, what its after-sales services are, how it delivers its goods and how it acquires, trains and retains staff.
Business process re-engineering, value-based management, activity-based management are also all methods that can influence an organisation’s business model.
This area of IR addresses how an organisation has performed against its strategy and what are its key outcomes. These outcomes can be internal or external – for example, revenue, cash flow, customer satisfaction, brand loyalty, environmental impacts, etc.
It is vital that the most appropriate performance indicators are chosen so that measurement of strategic goals is meaningful and that the value-adding activities of an organisation are identified and managed. It is also recognises the importance of reporting on non-financial, qualitative results.
An integrated report should answer the question: What challenges and uncertainties is the organisation likely to encounter in pursuing its strategy, and what are the potential implications for its business model and future performance? (IIRC)
PEST and a five forces analysis are likely to be particularly relevant here. For example, if you were a stakeholder in a conventional television company you should want to know how the company will address challenges from internet-based companies such as Netflix.
EXAMPLES FROM THE ACCA’S INTEGRATED REPORT
Here are some relevant extracts from ACCA's Integrated Report 2013–14 (see 'Related links') demonstrating some of the reporting of the elements set out above. Remember, the IIRC guidelines are principles based and organisations can change element headings and groupings.
- We are seeing new economies and sectors emerging and developing at faster rates
- In the post-recession world, there is a greater demand for and understanding of the importance of financial stability as an underpinning for economic stability
- Consumers are more sophisticated and demanding, with an increasingly tech-savvy audience expecting a personalised and tailored experience
- The competitive environment is much broader, with more and different players and with technology enabling greater international competition
- Market risks: trade protectionism, global economic stagnation, loss of UK audit recognition.
- Operational: exam process issues, worldwide legislative complexity, pricing decisions, cybercrime and data protection.
The impact of each risk is assessed and mitigation measures are explained. For example, on cybercrime and data protection:
- Impact: Potential corruption or loss of organisational data which could lead to legal liability and reputational damage as more ACCA services are provided on-line
- Mitigation: ACCA’s Information Security Officer monitors and advises on data security. Policies in place to address data security risks which are regularly reviewed, monitored and tested.
- Key resources [include]: market offices supported by global headquarters, people, partners, intellectual property and brand, suppliers, IT infrastructure, financial capital.
- Key value-adding activities: creating global networks, qualifying and regulating professional accountants to high standards, maintaining and developing a global brand that attracts students around the world, generating globally-relevant technical insight with public interest at its heats, digitally-enabled developments for an online, self-service world.
- Key outputs [include]: professional, ethical accountants, widespread recognition, best-in-class products and services.
- Key outcomes [include]: support and opportunities for members, joint initiatives, global mobility for our members, customer satisfaction.
- Societal benefit: Businesses in all sectors that are run efficiently and responsibly, that help grow economies sustainably and safeguard the interests of the public and society.
The inclusion of IR in the P5 syllabus should not cause major difficulties for students. In many ways, it is corporate reporting catching up with the aspects of analysis and reporting which management accountants have been already been performing for internal, organisational use. Management accounting has, for many years, recognised that there’s much more to appraising organisations than simply looking at their financial results.