Integrated reporting and performance management
A previous technical article – 'Integrated reporting' (see 'Related links') – discussed the relevance of Integrated Reporting to organisations’ performance management, and therefore how integrated reporting (IR) could be relevant to the APM syllabus.
However, as well as recognising the overall significance of IR for organisations, in the APM exam you could also be expected to assess the practical implications of this for a management accountant – for example, how organisations can assess their performance in relation to the different capitals identified in IR.
This article begins by recapping the key features of IR, before then considering the role of the management accountant in collecting, collating, reporting the required data, and potential issues the management accountant may face in doing this.
Integrated reporting
An important development in performance reporting over the last few decades has been the recognition of the importance of measuring and monitoring non-financial aspects of performance, not just financial ones. This applies to corporate reporting (eg narrative commentary in companies’ annual reports), and to management accounting (eg multi-dimensional performance measurement systems such as Kaplan & Norton’s balanced scorecard, or Lynch & Cross’ performance pyramid.)
IR builds on these developments by looking to provide a more holistic way to report the value created by an organisation, by considering the use of non-financial resources as well as financial resources, and also by giving a longer-term view of the organisation.
IR provides an insight into an organisation’s business model, and how it draws on a range of different capitals as inputs and transforms them – through the organisation’s operating activities – into outputs (products, services, waste/pollution). The business model also leads to wider outcomes (eg staff development; investment in environmental regeneration, or in local infrastructure).
Six capitals
The International Integrated Reporting Council (IIRC) identifies six categories of capital which help an organisation create value: financial, manufactured, intellectual, human, social and relationship, and natural.
Capital |
Definition |
Financial |
The pool of funds that is:
- Available to an organisation for use in the production of goods or the provision of services
- Obtained through financing, such as debt, equity, or grants, or generated through operations or investments
|
Manufactured |
Manufactured physical objects that are available to an organisation for use in the production of goods or the provision of services, including:
- Buildings
- Machinery and equipment
- Infrastructure (eg roads, ports)
Manufactured capital is often created by one or more other organisations (not the reporting organisation) but can also include assets manufactured by the reporting organisation where these are retained for its own use
|
Intellectual |
Organisational, knowledge-based intangibles, including:
- Intellectual property, such as patents, copyrights, and licences
- ‘Organisational capital’ such as tacit knowledge, systems, procedures, and protocols
- Intangibles associated with the brand and reputation that an organisation has developed
|
Human |
People’s competencies, capabilities and experience, and their motivations to innovate, including their:
- Alignment with, and support for, an organisation’s governance framework and risk management approach, and ethical values, such as recognition of human rights
- Ability to understand, develop and implement an organisation’s strategy
- Loyalties and motivations for improving processes, goods and services, including their ability to lead, manage and collaborate
|
Social and relationship |
The institutions and relationships established within and between each community, group of stakeholders and other networks (and an ability to share information) to enhance individual and collective well-being.
Social and relationship capital includes:
- Shared norms, and common values and behaviours
- Key relationships, and the trust and willingness to engage, that an organisation has developed, and strives to build and protect, with customers, suppliers, business partners, and other external stakeholders
- An organisation’s social licence to operate (eg approval from regulators, appropriate risk management and governance practices)
|
Natural |
All renewable and non-renewable environmental stocks that provide goods and services that support the current and future prosperity of an organisation. Natural capital includes:
- Air, water, land, forests, and minerals
- Biodiversity and ecosystem health
|
Source: International Integrated Reporting Council (2013)
Although intellectual, human, and social and relationship capitals are classified separately, the IIRC acknowledges that these are related and interdependent. However, it has argued there are sufficient differences between the that they should be viewed as three separate capitals, rather than combining them into a single group, and the IIRC suggests that one helpful way to differentiate between the three could be to view them in terms of the ‘carrier’ of each:
- For human capital, the carrier is the individual person
- For social and relationship capital, the carrier is networks within or between organisations
- For intellectual capital, the carrier is the organisation.
Interrelationships between the six capitals
Together, the six capitals are the basis of an organisation’s value creation. However, they are not independent of each other. To take a simple example, if an organisation buys a new piece of equipment for its production process, the immediate effect of this will be to decrease the organisation’s financial capital (by the cost of the equipment) but to increase its stock of manufactured capital. Over time, the organisation should then expect the increased efficiency or productiveness of the new machine (ie increased outputs from its manufactured capital) to offset the initial decrease in financial capital, thereby adding value to the organisation overall.
Nonetheless, the extent to which organisations are building up or running down the various capitals can have an important effect on the availability, quality, and affordability of those capitals. This is of particular concern with respect to capitals that are in limited supply, such as skilled staff, and those that are non-renewable, such as fossil fuels. A reduction in those capitals could affect the long-term viability of an organisation’s business model and, therefore, its ability to create value over time.
As such, the IIRC highlights that IR also needs to encourage integrated thinking within an organisation; that is, management’s understanding of the interconnections between functions, operations, resources and relationships which have an effect on the organisation’s ability to create value over time.
Measuring and reporting on the capitals
It is all very well being aware of the different capitals, and their potential impact on an organisation’s ability to create value, but for IR to be useful to management for decision-making and control, they will need to be able to measure performance in key areas.
Quantitative indicators, such as key performance indicators (KPIs), could be very important in explaining an organisation’s use of, or impact on, various capitals. However, it is important to recognise that it would not be practical to expect organisations to quantify every aspect of all the capitals. Therefore, the objective of IR is not to measure all the capitals, or movements in them. Importantly, as the IIRC (2013; pg 4) notes: 'Many uses and effects on the capitals are best (and in some cases can only be) reported on in the form of narrative rather than through metrics.'
This could be important for a management accountant when deciding how to report on performance. It may be more appropriate to provide narrative commentary on performance in relation to certain capitals, whilst then using quantitative indicators to report performance in relation to other capitals.
Selecting performance measures
One of the key issues involved in using quantitative indicators will be deciding which indicators to include in a report. The International Integrated Reporting Council (IIRC)’s aim is that IR reporting should pull together relevant information to explain the key drivers of an organisation’s value. Information should only be included where it is material to stakeholders’ assessment of the business.
However, while the range of reporting (ie over the six capitals) may be wider than in traditional reporting, the underlying approach being advocated here should still be familiar to management accountants from traditional approaches to strategic planning and control: ie identifying the key factors of an organisation’s success (critical success factors (CSFs)) and then selecting the relatively small number of key performance indicators (KPIs) which enable an organisation’s performance against its CSFs to be measured.