Q: Why does IFAC see Integrated Reporting as important?
A: We are at a crossroads in public trust. According to the Edelman Trust Barometer, trust has been in severe decline in various institutions in recent years, and is eroding particularly in business. Behavior and decisions by corporations are often perceived to compromise society and the environment for the short term benefit of organizations and their shareholders.
Capital allocation and corporate behavior that supports financial stability and sustainable development builds trust in business and the accounting profession – outcomes that are in both the public and private interest and aligned to IFAC's vision that the global accountancy profession be recognized as a valued leader in the development of strong and sustainable organizations, financial markets and economies.
Integrated reporting is an initiative that IFAC helped establish in 2009 to facilitate more meaningful corporate reporting as well as integrated thinking, both of which are a foundation of 21st century integrated corporate governance. The corporate governance arrangements in various countries are extending boards of directors’ duty of care to investors and other stakeholders beyond financial performance and short term returns to the long term success of an organization. This means they need to understand value creation more fully to guide strategic and operational decisions about resource allocation and value creation over time. Investors and others assessing performance of organizations are also increasingly taking a broader multi-capital perspective based on value creation.
The evolving demands of the 21st century organization require accountants to contribute to the management and reporting of value creation in a way that drive both corporate responsibility and growth.
IFAC strongly supports and encourages the involvement of professional accountants in capturing broader aspects of value creation. The technical and business skills and expertise of professional accountants are well suited to advance integrated thinking and reporting in terms of measurement, valuation and organizational management.
The future accountant needs to provide information and analysis that supports decisions about all aspects of an organization. A professional accountant in business or the public sector needs to be able to answer the question, “What is driving value creation and preservation in the present and future, and how is my organization responding to opportunities and risks?” Auditors in turn are increasingly expected to provide confidence in wider information reported about an organization and its performance and prospects.
Q: How does Integrated Reporting differ from and relate to other reporting frameworks?
A: Unlike other reporting frameworks and disclosure requirements, integrated reporting is holistic covering all parts of an organization relevant to value creation. The “multi-capitals” model of managing critical resources relates to all aspects of an organization and its business model(s).
Importantly, integrated reporting provides a basis for integrated thinking, as well as providing a meaningful story on how value is created for others outside the organization (as described in paragraph 2.6 of the International Integrated Reporting Framework). A report should not be seen as the main outcome of integrated reporting.
The integrated thinking process should allow a better understanding of the various sources and drivers of value in the short-term covering business as usual, and the medium and long term covering plans as well as potential game changers. Ultimately, integrated reporting should improve board and management information and decision making. An integrated report should inform capital providers of key drivers of enterprise value and provide confidence to them and other stakeholders that the organization has a strategy for long term value creation taking into account its own aspirations and plans and how it is responding to changes and uncertainties in the business environment, legitimate stakeholder expectations, and opportunity and risk.
Creating Value with Integrated Thinking, The Role of the Professional Accountant explores what professional accountants working in the public and private sectors can do in practical terms to facilitate integrated thinking in their organization.
Integrated reporting encourages a more external focus in:
- Identifying and analyzing the impact of macro trends on the business environment
- Understanding the impact of products and services on society and markets
- Understanding and assimilating the perspectives and expectations of providers of financial capital and other stakeholders
- Incorporating all of the above into the organization’s management and planning processes.
Consequently, an integrated report should be:
- Strategic and externally focused
- Both current and forward looking
- Well-structured by providing connectivity between information
- Concise and accessible.
Most organizations adopting integrated reporting have reported the internal benefits from their experiences including:
- Greater clarity and understanding of business issues and performance
- Improved understanding and relationship between board and management
- Improved management information and information flow, leading to improved decision making
- Enhanced relationships with key stakeholders.
Research highlighting the benefits of integrated reporting:
Q: What is value in the context of Integrated Reporting?
A: Integrated reporting requires an understanding of value beyond the bottom line. Creating returns to investors and funders is an outcome of delivering value creation to other stakeholders, and recognizing a broader range of capitals or resources upon which value creation ultimately depends.
Value is not created by or within an organization alone. Organizations interact with their external environment and various capitals to create value over the short, medium and long term. That value has two interrelated aspects – value created for:
- The organization itself, which enables financial returns to the providers of financial capital
- Other stakeholders. An organization can think about value creation in terms of value to shareholders and funders, customers, employees, suppliers, partners, regulators and society.
Both aspects of value creation are critical to the survival of any organization – it cannot survive for very long delivering one without the other. Unless an organization creates value for itself it will risk going out of business; and unless it creates value for others it could either become irrelevant or lose its social licence to operate.
Value is also created over different time horizons and for different stakeholders through different capitals, resources and competencies. Therefore, it is unlikely value can be created through the maximization of one capital while disregarding the others. For example, the maximization of financial capital (e.g., profit) at the expense of human capital (e.g., through inappropriate human resource and supply chain practices) is unlikely to maximize value for the organization in the longer term and lead to a resilient business model.
The value an organization creates for others and the organization’s ability to create value for itself are closely related and achieved through a wide range of activities, interactions and relationships, many of which are non-financial in nature.
Integrated reporting should lead to greater connectivity between intangible drivers of value and financial outcomes including the value of a business. Value metrics and the story around these are highly sought by many providers of financial capital. For example, key drivers of shareholder of value will depend on second and third order value drivers related to relevant strategic and operational activities such as serving customers, innovating, ensuring quality and inventory, employee satisfaction and performance. Institutional investors and asset managers look to corporate communications, reporting and disclosure to help them understand enterprise value.
Q: How does integrated reporting fit within the corporate reporting landscape?
A: The current reporting system is often viewed as fragmented with many reporting frameworks and disclosure requirements covering information related to different capitals. This situation has arisen primarily because of the increasing interest and demand in information relating to non-financial capitals over the past 10 to 15 years.
Reporting standards and frameworks enable higher quality reporting of both financial and non-financial information covering areas such as economic, social and governance, or sustainability impacts.
The International Integrated Reporting Framework does not provide suggested metrics or indicators but rather a principles-based multicapitals approach to reporting on all the relevant and material activities of an organization that relate to value creation. Other reporting standards and frameworks can support the evaluation of content for integrated reports.
An integrated report can be an organization’s primary report providing greater interconnectedness between different underlying reports.
It is unlikely, particularly for larger organizations with more complex or diverse operational business models, that one report format will meet the needs of all stakeholders. For example, Generali’s “Core and More” reporting suite has its integrated annual report as its strategic hub (the core), such that the integrated report can be used as an “umbrella” report for an organization’s broad suite of reports and communications. The analogy of an octopus places the integrated report as the head of the octopus serving as a clear reference point for other communications. Integrated reporting supplements and builds upon other developments in reporting and disclosure, and can be applied continuously to all relevant reports.
For smaller organizations, an integrated report might suffice as their main form of strategic communication.
To ensure integrated reports remain concise and focused on material matters, organizations can adopt a layered approach, whereby the integrated report draws on existing report strands to tell the value creation story. Cross-referencing to regulatory filings, voluntary reports and website content provides easy access to more detailed information.
Alternatively, some organizations may choose to satisfy regulatory requirements and manage disclosure burden through a single integrated report and therefore improve the efficiency as well as effectiveness of their business reporting. It is also necessary for an organization to consider how its regulatory disclosures relate to the integrated report. For example, matters identified as material in integrated reporting may be subject to disclosure under company and securities law.
Integrated reporting’s relationship to financial reporting, management commentary, sustainability reporting and climate change related reporting is outlined below.
- High quality financial reporting using international and national standards is critical to fostering confidence in capital markets. This provides the basis for capturing financial performance. But financial statements and reporting are insufficient in capturing all those factors that will affect an organization’s ability to create value making it difficult to assess capital employed, and assets and liabilities that may affect financial performance in the short, medium and long term. Hans Hoogervorst, Chair of the International Accounting Standards Board, captured the limits of financial statements in his presentation at the IIRC Council meeting in 2017.
- Financial reporting standards for private and public sector organizations provide the basis for compiling financial statements, which help investors (and other providers of financial capital) evaluate the financial performance of an organization. General purpose financial reports are not designed to show the value of an organization but rather its financial position. This largely historical information provides insight into the effects of transactions and other events on an organization’s economic resources and the claims against it.
- Financial statements do not include information showing directly how value is created by financial and non-financial capitals, resources or intangible assets. For example, human resources and intellectual assets that drive value creation are hidden from financial reports because they cannot be practically measured in monetary terms. This information gap has led to a misalignment between reported profitability in the financial statements and share valuations. Consequently, financial statements do not adequately explain enterprise market value. This is true of the market values of relatively young companies with disruptive business models, which can be many more times their current profitability, as well as established companies whose enterprise value typically exceeds book value represented by the balance sheet. The more organizations invest internally in developing intangible assets, the less reported earnings are useful to investors in forecasting future profitability.
Management commentary (narrative) reporting takes various forms in different countries and has many commonalities with an integrated report, such as Management Discussion and Analysis (MD&A), Operating and Financial Review and Strategic Report. In some jurisdictions, there might be potential to apply integrated reporting to existing regulatory arrangements for management commentary reporting. This can be achieved by ensuring that the key integrated reporting concepts and principles are incorporated into the requirements of management commentary.
The mindset required in integrated reporting can be broader than what is typically required for management commentary in terms of:
- Time horizons – the International Integrated Reporting Framework encourages a medium to longer-term perspective to reporting going beyond much of today’s reporting around strategy and performance which is focused on the current or immediate future
- Broader multicapitals perspective – encourages organization’s to think about their dependency on capitals, critical resources and relationships beyond its immediate operations, and across its value chain, and the potential outcomes arising from how these capitals are managed
- Value creation – broader than providing context to the financials
- Connectivity and integrated thinking leading to a better understanding of how value is created in the context of the trends in the external environment, various capitals, the business model and linking drivers of value to financial outcomes.
The IASB will be revising and updating its Practice Statement on Management Commentary to reflect new developments in corporate reporting. IFAC strongly supports such a project as a means of clarifying the relationship between integrated reporting, narrative reporting, and financial statements. The development of fundamental concepts and principles of integrated reporting that should feature in management commentary reporting could also be useful to national regulators and others seeking greater alignment. It will present an opportunity to professional accountants to further extend their expertise in financial reporting to integrated reporting.
Various forms of sustainability reporting have emerged:
- The Global Reporting Initiative’s Standards for sustainability reporting are widely used and have been in existence for around twenty years. GRI standards cover a range of economic, social and environmental impacts related to sustainable development. GRI related disclosures and impact indicators may or may not be relevant to an organization’s ability to create value over time but will help inform decisions around materiality in integrated reporting.
- SASB’s sustainability accounting standards are sector specific environmental, social, and governance (ESG) indicators aimed at meeting the needs of investors. SASB’s US perspective focuses on improving the effectiveness and comparability of corporate disclosure in corporate SEC filings such as Forms 8-K, 10-K, 20- F, and 40-F. SASB standards include the sustainability topics that are reasonably likely to be material and to have material impacts on the financial condition or operating performance of companies in an industry based on the definition of “materiality” under U.S. securities laws.
Climate Change Reporting Frameworks and Initiatives
Integrated reporting also helps to place into context the increasing number of disclosure requirements around the world emerging at national and regional levels such as the EU Non-Financial Reporting Directive. Such disclosure requirements covering primarily policies and performance related to environmental, social and governance challenges. Integrated reporting helps place such disclosures into a strategic context linked to value creation.
Through the Corporate Reporting Dialogue (CRD) various corporate reporting standard and framework setters including the Global Reporting Initiative, the Carbon Disclosure Project (CDP), the Financial Accounting Standards Board, International Accounting Standards Board, and Sustainability Accounting Standards Board published a landscape mapping document that provides a snapshot of a comparison of their frameworks, standards and related requirements through the lens of integrated reporting. The CRD also developed Common Principles of Materiality.