Preparation of an integrated report

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  1. Describe and differentiate from current reporting practice the types of information that will need to be captured from now on in order to sufficiently meet the needs of integrated reporting. (2 Marks).

International Integrated Reporting <IR> is about integrating financial and non-financial information to enable investors and other stakeholders to understand how an organisation is really performing (ICAA). An integrated report looks beyond the traditional time frame and scope of the current financial report by addressing the wider as well as longer-term consequences of decisions and action and by making clear the link between financial and non-financial value (IIRC). It is important that an integrated report demonstrates the link between an organisation’s strategy, governance and business model.

There are several objectives of <IR> including creating a more cohesive and efficient approach to corporate reporting. Through <IR>, communicating full range of factors that materially affect the ability of an organisation over time, informs the allocation of financial capital that supports value, enhance accountability and support integrated thinking and decision-making. The International Integrated Reporting Council (‘IIRC’) needs to be very clear on who the users of an Integrated Report are. Although the Framework, paragraph 1.6 identifies the primary “Audience for <IR>” (Pitcher Partners), identifies the primary users of an Integrated Report as ‘providers of financial capital’, the underlying requirements, including the application of materiality, the concept of the capitals and value and the section on stakeholder responsiveness, would result in the content of the <IR> attempting to meet the needs of a wider group of stakeholders.

The phrase “taking account of the content of the Framework as a whole, including the fundamental concepts” is confusing (Deloitte). This becomes a concern that the caution suggests that compliance with each paragraph of the Framework is required by those preparing an Integrated Report, which is inconsistent with a principles-based approach. The main concern is that the preparation of one document designed to meet the needs of all stakeholders would result in ‘clutter’, increase the length of annual reports, and is likely to result in less relevant information for investors.

The requirement of the Framework are principles-based and do not focus on rules for measurement or disclosure of individual matters of the identification of specific key performance indicators (Drummond). It requires senior management to judge which matters are material and how they should be disclosed appropriately. The <IR> also bring concerns about the application of materiality in the Framework. If the concept of materiality is extended beyond those matters that are of relevance to investors, it might be difficult to identify all the matters requiring disclosure under paragraph 1.12.

  1. The <IR> process is intended to be applied continuously to all relevant reports and communications, in addition to the preparation of an integrated report. The integrated report may include links to other reports and communications, e.g. financial statements and sustainability reports. The IIRC aims to complement material developed by established reporting standard setters and others, and does not intend to develop duplicate content (para 1.18-1.20). Do you agree with how the paragraphs 1.18-1.20 characterise the interaction with other reports and communications? Justify your answer. (3 Marks).

The <IR> recognises that value is not created by or within the organisation alone, it is influenced by the external environment like economic conditions and technological change (Consultation Draft). The regulatory requirements and the intended purpose of a particular corporate communication may mean that the Guiding Principles of strategic focus and future orientation; stakeholder responsiveness; consistency and comparability; and, materiality may not be appropriate in all circumstances (Pitcher Partners). The appropriateness of the Content Elements to particular corporate communication will also depend on the regulatory requirements (KPMG).

<IR> is essential for the long-term decision making, which is supported by paragraphs 1.15-1.17 is supported. However, in paragraphs 1.18-1.20, different reports have conflicting objections (KPMG). For example, the financial reports prepared as outlined with IFRS reflects change for the current conditions, however market participants may or may not concur with the long-term strategic goals. The last sentence of paragraph 1.20 states: “in particular, it has combined emphasis on: conciseness, strategic focus and future orientation, the connectivity of information, the capitals, the business model, the ability to create value in the short, medium and long term and providers of financial capital as the primary audience.” (IIRC) It is idealistic to say that there is a need to reconcile various responsibilities.

From my perspective, it is important that <IR> is used as the basis for the principal reporting documents. In most cases, this will be the company’s Annual Report including the financial statements (Amato and White). I think that the <IR> Framework could provide a better explanation of who the providers of financial capital include. <IR> needs to clarify how differing objectives and motivations have been balanced to achieve strategic goals (Pitcher Partners). With regard to the interaction with other communication, while integrated thinking is an important outcome of Integrated Reporting and should run through all of a company’s communications. The idea that the principles and process of Integrated Reporting should be applied equally to all aspects of communication e.g. analyst calls.

  1. The <IR> Framework describes six categories of capital (para 2.17). An organisation is to use these categories as a benchmark when preparing an integrated report (para 2.19-2.21), and should disclose the reason if it considers any of the capitals as not material (para 4.5). Outline what such a ‘capitals framework’ means. Do you agree with this approach to the use of ‘capitals’? Provide justification and evidence in your explanation. (4 Marks).

The capital framework defines seven guiding principles of integrated reporting including factors such as strategic focus and future orientation. According to the framework, reports should provide insight into the organisations strategy and also outline how it intends to create value over time. Reports should also show the relationship between the organisation and their values, including understanding of stakeholder relationships, needs and interests. The report should be concise and material in terms of reliability, completeness, consistency and comparability (IIRC).

I agree with the concept of capitals as one possible method of identifying, organising and categorising the source and nature of resources used in a business. However, I found that this has been one of the more difficult areas of the Framework to understand. I think that the IIRC should try to simplify and condense its description of the concept of capitals in section 2B in order to improve its use in practice. The lack of clarity regarding the intended audience for the Integrated Report is also confusing. The approach to the capitals contributes, might result in a lengthy document that does not meet the needs of investors, or those of wider stakeholder groups. The IIRC should ensure that the Framework is consistently clear about its intended audience (FRC).

One of the concerns with section 2B is that the model places the non-financial capitals on an equal level to financial capital (KPMG). I recognise that to an extent that an <IR> is intended to be an investor-focused corporate communication, therefore it should be seen as supporting or contributory factors in assessing changes in and the quality of financial capital (FRC). Whilst it is important that investors are provided with information where it is necessary for a full understanding of the issues affecting future cash flows and to assess the company’s longevity (Consultation Draft), I do not believe that it should be included in investor-focussed corporate communications if it is not relevant for those purposes.

  1. Given this information differentiation, outline initiatives’ currently being undertaken at a global level (i.e. by regulators’, international bodies, accounting profession, academics etc.) to achieve this. (3 Marks).

The IIRC is a global coalition of regulators, investors, companies, standard setters, the accounting profession and NGOs (IIRC). Together, this coalition shares the view that corporate reporting needs to evolve to provide a concise communication about how an organization’s strategy, governance, performance and prospects, in the context of its external environment, lead to the creation of value over the short, medium and long term. The <IR> Framework is being developed to meet this need and provide a foundation for the future (Drummond).

Organisations that create strategies which are overly focused on optimising short term financial performance can impede the ability to create long term value. It can, for example, limit investment in research aimed at long term innovation and in the infrastructure needed to address global challenges (Magarey). For example, resource shortages as planetary limits are approached, economic instability, climate change, and changing demographics and societal expectations. I think that a Framework describing the nature and content of an Integrated Report should provide guidance or requirements to ensure the reliability of the information contained within it. It is the responsibility of the directors of a company to ensure that they have sufficient controls and procedures in place to ensure the reliability of the information in their corporate reporting.

The style of language used in the document seems to be unnecessarily complex in places. For example, the description of the theoretical model that underpins the Framework in chapter 2 stretches over more than seven pages (IIRC). If this model is to be applied in practice, I think that it needs to be described more simply and concisely. For example, phrases such as “Catalyse a more cohesive and efficient approach” (paragraph 1.5) and “value creation within planetary limits and societal expectations” (paragraph 2.39) are complex and could be more simply expressed. I think that the <IR> provides a good basis for how to prepare an integrated report. Although, I think businesses might still struggle provide integrated reports that are comparable and consistent for users because they will have difficulty evaluating the quality and completeness of information completed.

  1. Taking a positive accounting theoretical perspective outline three reasons why Integrated Reporting may not be achievable. (3 Marks).

Positive accounting is the branch of academic accounting research that seeks to explain and predict actual accounting practices. This is contrast to normative accounting that seeks to derive and prescribe ‘optimal’ accounting standards (McGraw-Hill). Positive Accounting Theory (‘PAT’) was developed by Watts and Zimmerman, based on central economics-based assumption that all individuals’ actions are driven by self-interest and that individuals will always act in an opportunistic manner to the extent that actions will increase their wealth (Watts and Zimmerman).

Positive theories can be contrasted with normative theories. Normative theories prescribe how a particular practice should be undertaken and this prescription might be a significant departure from existing practice (McGraw-Hill). <IR> states all assets should be measured at net market value, this is one reason for why <IR> may not be achievable. <IR> believes information is more useful for informed decision making than information based on historical costs, which actually could be misleading.

When decision-making authority is delegated, this can lead to some loss of efficiency and consequent costs (Deegan). For example, if the owner delegates decision-making authority to a manager, it is possible that the manager may not work as hard as the owner would have. This could be because that the manager doesn’t share directly with the results.

One of the crucial development points about PAT was the development of the Efficient Markets Hypothesis (‘EMH’) (McGraw-Hill). The EMH is based on the assumption that capital markets react in an efficient and unbiased manner to publicly available information. The perspective taken is that security prices reflect the information content publicly available information and this information is not restricted to accounting disclosures. The capital market is considered to be highly competitive and as a result newly released public information is expected to be quickly impounded into share prices. Since the share price is expected to reflect information from various sources, management cannot manipulate share prices by changing accounting methods in an opportunistic manner.

References

Amato, Neil and White, Samantha. 2013. IIRC releases International Integrated Reporting Framework. Journal of Accountancy. Volume 1.

Chand, 2012. ACCG399 Issues in Accounting Theory and Practice. 1st edition, Australia: McGraw-Hill Australia

Deegan, C. M. (2009). In Financial accounting theory. North Ryde, N.S.W: McGraw-Hill Australia.

Deloitte. 2011. Integrated Reporting: Navigating your way to a truly Integrated Report. [ONLINE] Last accessed 3 May 2014. Available at: http://www.deloitte.com/assets/Dcom-SouthAfrica/Local%20Assets/Documents/deloitte_integrated_reporting.pdf

Drummond, S. 2012. Long Way to go to Integrate Reporting. Last Accessed 4 May 2014: http://afr.com/f/free/markets/capital/cfo/long_way_to_go_to_integrate_reporting_en5uE0LSotID7GxCHwUdYJ.

FRC. Financial Reporting Council. Objectives of Framework. [ONLINE] Last accessed 5 May 2014. Available at: https://frc.org.uk/Our-Work/Publications/Accounting-and-Reporting-Policy/FRC-response-to-IIRC-s-Consultation-Draft-of-the-I.pdf

ICAA. Institute of Chartered Accountants Australia. 2013. Integrated Reporting. [ONLINE] Last accessed 3 May 2014. Available at: http://www.charteredaccountants.com.au/Industry-Topics/Sustainability/Integrated-reporting.aspx

IIRC. International Integrated Reporting Council. 2013. Consultation Draft of the International Framework: Integrated Reporting [ONLINE] Last accessed 3 May 2014. Available at: http://www.theiirc.org/wp-content/uploads/Consultation-Draft/Consultation-Draft-of-the-InternationalIRFramework.pdf

KPMG. 2012. Integrated Reporting: Performance insight through Better Business Reporting [ONLINE] Last accessed 4 May 2014. Available at: http://www.econsense.de/sites/all/files/integrated-reporting-issue-2_0.pdf

Magarey, Geraldine. 2012. Is integrated reporting achievable?Keeping Good Companies, Vol. 64, Issue No. 4. RMIT Publishing.

Pitcher Partners. 2013. Consultation Draft of the International <IR> Framework. [ONLINE] Last accessed 3 May 2014. Available at: http://www.theiirc.org/wp-content/uploads/2013/08/177_Pitcher-Partners.pdf

Watts, R. and J. Zimmerman (1978), “Towards a Positive Theory of the Determination of Accounting Standards,” The Accounting Review 53 (January), pp112–134.

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