It is essential that organisations get out of a compliance mindset and start to communicate their financial story in the most effective and transparent way. This, argues Geraldine Magarey FCA, Manager, Sustainability and Regional Australia, Institute of Chartered Accountants in Australia, is what integrated reporting sets out to do.
T he annual report has a key role to play as a means of furthering accountability, while also being an important channel for communication between typically larger organisations and their many stakeholders. Increasingly, the value and relevance of the information provided in an annual report are being questioned.
Around the globe, there have been calls to find a solution to the mountains of information (both financial and narrative) that need to be provided according to compliance rules. This is where the concept of integrated reporting is proving to be increasingly welcomed by preparers and users of annual reports.
In 2010, the Prince of Wales’s Accounting for Sustainability Project (A4S) and the Global Reporting Initiative (GRI) announced the formation of the International Integrated Reporting Council (IIRC). The IIRC’s stated mission is to create a globally accepted integrated reporting framework. In September 2011, the IIRC released its discussion paper Towards integrated reporting: communicating value in the 21st century. The paper sets out the rationale for integrated reporting.
There is no single agreed definition of integrated reporting. The IIRC defines integrated reporting as ’a new approach to corporate reporting that demonstrates the linkages between an organisation’s strategy, governance and financial performance and the social, environmental and economic context within which it operates’. Integrated reporting has been adopted by several forward-thinking companies around the world. South African companies listed on the Johannesburg Stock Exchange (JSE) have been mandated to prepare integrated reports. Many listed companies are now in their second year as the initial start was for financial years starting on and after 1 March 2010.
The concept of integrated reporting is not new. In 2008, the Institute of Chartered Accountants in Australia (ICAA) launched its paper Broad based business reporting: the complete reporting tool. There were two important aspects of broad based business reporting. First is its value proposition that businesses can benefit from clearly reporting on their strategy, their performance in implementing it, and insights about their performance prospects. Second, it is the requirement for businesses to manage limited resources effectively in delivering on strategy, and then clearly monitoring and reporting sustainable progress in achieving stated objectives.
Linking strategy to finance and sustainability
Integrated reporting brings together material information about the strategy, governance and performance of an organisation. How does that differ from the current annual report? The annual report is focused predominantly on financial and commercial aspects and often does not reflect social and environmental information that is material to the organisation.
An integrated report provides insight into an organisation’s strategic focus. It explains how the organisation can create and sustain value over the short, medium and long term. An integrated report does not replace the need for financial statements. Financial statements contain important information about an organisation. It is vital that this information is reported and available to all stakeholders, however, it should not be the primary report on an organisation’s performance.
Currently, many organisations tend to produce a suite of reports which serve different purposes and meet the needs of different stakeholders. This reporting is often fragmented, voluminous, complex and ultimately without regard for how the information is actually used. An integrated report would eliminate this overwhelming load of information while at the same time aligning an organisation’s reports with the information needs of its various stakeholders.
The IIRC discussion paper sets out five guiding principles that underpin the preparation of an integrated report in terms of both content and presentation.
- Strategic focus – an integrated report should provide insight into the organisation’s strategic objectives, and how those objectives relate to its ability to create and sustain value.
- Connectivity of information – an integrated report shows the connections between the business model, external factors and the resources and relationships on which the organisation depends.
- Future orientation – it should include management’s expectations about the future so that users can understand and assess the organisation’s prospects.
- Responsiveness and stakeholder inclusiveness – an insight should be provided into an organisation’s relationships with key stakeholders and how it understands, takes into account and responds to the needs of these stakeholders.
- Conciseness, reliability and materiality – if integrated reporting is to be seen as a credible and primary report for stakeholders, it needs to provide concise, reliable information that is material to the organisation.
These guiding principles are crucial to the success of integrated reporting. However, getting it right is a challenge. Entities that are preparing to report on an integrated basis often explain that connectivity of information is the biggest challenge they face.
Because of the advent of the King Report on Governance for South Africa 2009 (King III), many South African companies are well advanced with regard to integrated reporting. Vodacom is an example of one South African company which has found that integrated reporting is a journey beginning at board level.
What is included in an integrated report?
The IIRC discussion paper also provides an outline of the content it believes should be included in an integrated report.
- Organisational overview and business model – this should explain what the organisation does and how it creates and sustains value over time.
- Operating context, including risks and opportunities – the report should explain the circumstances in which the organisation operates, including details of the key resources and relationships the organisation depends on. It should also explain the key risks and opportunities the organisation faces.
- Strategic objectives and strategies to achieve those objectives – this section should explain the strategic direction of the organisation and its plan for achieving these objectives.
- Governance and remuneration – an integrated report should explain an organisation’s governance structure as well as how this structure assists the organisation to achieve its strategic objectives. The link between executive and board remuneration and performance in the short, medium and long term should be explained.
- Performance – the organisation needs to explain how it has performed against its strategic objectives and related strategies.
- Future outlook – the organisation should outline the opportunities, challenges and uncertainties it is likely to encounter in achieving its strategic objectives as well as the implications for achieving these objectives.
Although most reporters agree with the suggested content, further guidance is required to assist report preparers understand what is required. Two areas which will be discussed further as we look at the issues associated with integrated reporting are around business models and future outlook.
The business case for integrated reporting
Many organisations are already benefiting from reporting on an integrated basis. Research on the experience of these organisations has identified a number of benefits.
- Improving the quality of information reported so that it better aligns with the needs of investors – this can result in a lower cost of, and better access to, capital.
- Alignment of reporting cycles – some organisations report on different areas of the organisation over different time frames. Aligning the reporting cycles of its various reports such as financial and sustainability reports can result in cost savings.
- Better risk management including reduced reputational risk – conversely, it also allows for better identification of opportunities.
- Improved engagement with key stakeholders – these include including employees and investors.
Although the benefits of integrated reporting are explained in the IIRC’s discussion paper, more work is required to further explore and explain these benefits.
Why should a board of directors embrace integrated reporting? Consider the following.
Communicating versus complying
It is now a universal complaint of boards and finance professionals that financial reporting is not achieving what it sets out to do. The complaint is that it is too complex with a focus on compliance whereas it should be really about communication. The recent leadership paper jointly developed by the ICAA, the Financial Reporting Council (FRC), and the Institute of Chartered Accountants of Scotland (ICAS) explores the merits of increased communication emanating from the audit committee at a board level (see Walk the line: discussions and insights with leading audit committee members, available from www.charteredaccountants. com.au/walktheline). It is essential that organisations get out of a compliance mindset and start to communicate their financial story in the most effective and transparent way. This is exactly what integrated reporting sets out to do.
According to the IIRC discussion paper, 83% of market value in 1975 was explained by physical and financial assets whereas by 2009 the figure was down to 19%. Directors, investors and other stakeholders are realising that the value drivers of an organisation are increasingly intangible and include items such as intellectual and human capital as well as environmental, social and governance issues. The change in how value is driven has not been matched by changes in financial reporting. This goes to the heart of integrated reporting.
Breaking down silos
Integrated reporting shifts the focus away from traditional financial reporting and looks at an organisation on multiple levels. This helps to break down silos and encourages information sharing.
So where does integrated reporting lead us? Communicating better and more useful information will lead to increased transparency. Bob Laux, Senior Director, Financial Accounting and Reporting at Microsoft, believes increased transparency ‘gives CFOs a chance to take a leadership role in telling the company story in a more effective way, making an even bigger impact on their organisations’.
Concerns with the proposed integrated reporting framework
While the IIRC’s discussion paper identifies a number of benefits of integrated reporting, many reporters believe there are a number of concerns with both the paper and with the concept of integrated reporting. In fact one of the issues with the discussion paper is that it examines the benefits more than the challenges. Although many of these concerns have not been fully explored in the discussion paper, they will receive further scrutiny and discussion as a result of the IIRC receiving over 200 responses to the paper.
The concept of value creation is a key plank of integrated reporting. However, issues have been identified with this concept. The main issue is the definition of value. Who is the value created for? Is it investors, stakeholders or society at large?
Materiality is very important to the success of truly reporting on an integrated basis. The definition of materiality will also involve a number of challenges for reporters and for stakeholders. Materiality is a long-accepted notion in accounting; however, it is applied in a different sense in other forms of reporting such as sustainability reports.
The suggested content of an integrated report includes a section on future outlook. Many are concerned with potential liability issues for both the organisation and those charged with governance related to making forwardlooking statements.
For any report to be useful there must be a degree of comparability and consistency. This applies both internally and externally. The information provided in an integrated report must be comparable from one period to the next for report users to understand how the organisation has performed over time. It is also crucial for organisations to report in ways that allow information between entities to be compared. Although there are some differences in how accounting standards are sometimes applied and which standards are used, the current financial reporting regime enables a degree of comparability between organisations.
A crucial plank of any organisation’s governance structure should be its external audit function. Integrated reporting and the need to report on non-financial information may provide a challenge in having the information audited. Some have questioned whether it is possible to audit this information. Many organisations that already report on an integrated basis obtain some form of audit or assurance over their information as they understand the benefit of audit in ensuring the credibility of their reports and the role audit provides in their governance structure. Chartered Accountants provide assurance over non-financial information such as carbon emissions and sustainability reports. They have proven methodologies and standards to guide this work which can be utilised in an integrated reporting framework. For its 2011 annual report, the ICAA was one of the first member bodies in Australia to engage external auditors to conduct a limited assurance review on the nonfinancial information contained in its annual report.
Concerns have been raised over an organisation needing additional resources and the potential costs associated with these resources to produce an integrated report. However, many who already report on an integrated basis have experienced a more efficient use of existing resources as the many existing reports they had were streamlined into fewer reports and reporting cycles were synchronised.
Another area of concern for reporters is around the requirement to discuss business models.
First, there is a lack of an agreed definition of what is meant by a business model. To achieve comparability and for integrated reporting to be credible, there needs to be a commonly accepted definition of a business model.
The second area of concern relates to confidentiality. Although there was substantial support for discussing business models and an organisation’s ability to create and sustain value, some have raised concerns about alerting competitors to information that is potentially commercially sensitive.
For those forward-looking organisations that are contemplating integrating their reporting, the best lessons we can learn about the pitfalls come from the experiences of listed South African organisations where integrated reporting is mandated.
Materiality is very important to achieving an integrated report. Materiality can mean different things to different people. What may be material in one part of an organisation may not be material to the organisation as a whole. Materiality is commonly used in relation to financial information. The challenges come when assessing materiality in relation to nonfinancial information. The Integrated Reporting Committee of South Africa has provided guidance on materiality for non-financial data in its discussion paper released in January 2011, Framework for integrated reporting and the integrated report.
The most common observation of the integrated reports produced in South Africa in 2011 was that most were simply a combining of the annual report and the sustainability report. This is not integrated reporting. It resulted in lengthier reports which did not enhance or provide any further insight into the organisation.
Nearly all organisations have reported that getting the linkages right between financial and non-financial information provided the toughest challenge for them. The connectivity of information is one of the guiding principles so the importance of getting the linkages right is paramount.
The IIRC is running a pilot programme which currently features over 60 organisations from around the world. Among global giants such as Microsoft, Coca Cola Company and Marks and Spencers are three Australian organisations: bankmecu Ltd, National Australia Bank Ltd and Stockland. The pilot programme will underpin the formation of the integrated reporting framework and test the principles and practicalities of integrated reporting. It is hoped this testing will support the creation of a global standard in integrated reporting.
The IIRC has identified a number of next steps it will take following the release of its 2011 discussion paper and the launch of the pilot programme. These include:
- developing an international integrated reporting framework exposure draft – this will draw on the responses received to the discussion paper and the lessons learned from the pilot programme
- working with others to support the development of emerging measurement and reporting practices relevant to integrated reporting
- raising awareness among investors and other stakeholders and encouraging organisations to adopt and contribute to the evolution of integrated reporting
- exploring opportunities for harmonising reporting requirements within and across jurisdictions, and
- developing institutional arrangements for the ongoing governance of integrated reporting.
The results from the pilot programme will play an important role in shaping these next steps.
Many forward-looking organisations are already starting to report on an integrated basis or making plans to change the way they report. They understand the benefits to their organisations and are making changes to the way they report in advance of the draft framework. The IIRC has provided some good theoretical principles. However, there is definitely a need for practical guidance to assist in making integrated reporting a reality.
It will be interesting whether more countries follow South Africa’s lead and mandate the need for integrated reporting. For forward-looking organisations seeking to distinguish themselves from the pack and to demonstrate stewardship and how they create and sustain value, the early adoption of integrated reporting may bring rewards.
Geraldine Magarey FCA, Manager, Sustainability and Regional Australia,
Institute of Chartered Accountants in Australia
Geraldine Magarey can be contacted on (02) 9290 1344 or by email at: Geraldine.Magarey@ charteredaccountants.com.au.
This article was first published in the May 2012 issue of ‘Keeping Good Companies’, the journal of Chartered Secretaries Australia. Reprinted with kind permission of the publisher.