1 Unit
CPD technical article
Graham Holt outlines the purpose of, and what's involved with, adopting the IIRC's new integrated reporting framework
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The International Integrated Reporting Council (IIRC) has recently released a framework for integrated reporting. This follows a three-month global consultation and trials in 25 countries. The framework establishes principles and concepts that govern the overall content of an integrated report.
An integrated report sets out how the organisation's strategy, governance, performance and prospects lead to the creation of value. There is no benchmarking for the above matters and the report is aimed primarily at the private sector, but it could be adapted for public sector and not-for-profit organisations.
The primary purpose of an integrated report is to explain to providers of financial capital how an organisation creates value over time. An integrated report benefits all stakeholders interested in a company's ability to create value, including employees, customers, suppliers, business partners, local communities, legislators, regulators and policymakers, although it is not directly aimed at all stakeholders. Providers of financial capital can have a significant effect on the capital allocation and attempting to aim the report at all stakeholders would be an impossible task and would reduce the focus and increase the length of the report. This would be contrary to the objectives of the report, which is value creation.
Historical financial statements are essential in corporate reporting, particularly for compliance purposes, but do not provide meaningful information regarding business value. Users need a more forward-looking focus without the necessity of companies providing their own forecasts.
Companies have recognised the benefits of showing a fuller picture of company value and a more holistic view of the organisation. The International Integrated Reporting Framework will encourage the preparation of a report that shows their performance against strategy, explains the various capitals used and affected, and gives a longer-term view of the organisation. The integrated report is creating the next generation of the annual report as it enables stakeholders to make a more informed assessment of the organisation and its prospects.
Culture change
The IIRC has set out a principle-based framework rather than specifying a detailed disclosure and measurement standard. This enables each company to set out its own report rather than adopt a checklist approach. The culture change should enable companies to communicate their value creation better than the often boilerplate disclosures under International Financial Reporting Standards (IFRS).
The report acts as a platform to explain what creates the underlying value in a business and how management protects this value. This gives the report more business relevance than the compliance-led approach currently used. Integrated reporting will not replace other forms of reporting, but the vision is that preparers will pull together relevant information already produced to explain the key drivers of their business's value.
Information will only be included in the report where it is material to the stakeholder's assessment of the business. There were concerns that the term 'materiality' had a certain legal connotation, with the result that some entities may feel they should include regulatory information in the integrated report. However, the IIRC concluded that the term should continue to be used in this context as it is well understood.
The integrated report aims to provide an insight into the company's resources and relationships which are known as the capitals and how the company interacts with the external environment and the capitals to create value. These capitals can be financial, manufactured, intellectual, human, social and relationship, and natural capital, but companies need not adopt these classifications. The purpose of this framework is to establish principles and content that governs the report, and to explain the fundamental concepts that underpin them. The report should be concise, reliable and complete, including all material matters, both positive and negative, and presented in a balanced way without material error.
Key components
Integrated reporting is built around the following key components:
- Organisational overview and the external environment under which it operates.
- Governance structure and how this supports its ability to create value.
- Business model.
- Risks and opportunities and how they are dealing with them and how they affect the company's ability to create value.
- Strategy and resource allocation.
- Performance and achievement of strategic objectives for the period and outcomes.
- Outlook and challenges facing the company and their implications.
- The basis of presentation needs to be determined, including what matters are to be included in the integrated report and how the elements are quantified or evaluated.
The framework does not require discrete sections to be compiled in the report, but there should be a high-level review to ensure that all relevant aspects are included. The linkage across the above content can create a key storyline and can determine the major elements of the report, such that the information relevant to each company would be different.
An integrated report should provide insight into the nature and quality of the organisation's relationships with its key stakeholders, including how and to what extent the organisation understands, takes into account and responds to their needs and interests. Furthermore, the report should be consistent over time to enable comparison with other entities.
An integrated report may be prepared in response to existing compliance requirements; for example, a management commentary. Where that report is also prepared according to the framework or even beyond the framework, it can be considered an integrated report. An integrated report may be either a standalone report or be included as a distinguishable part of another report or communication. For example, it can be included in the company's financial statements.
Nature of value
The IIRC considered the nature of value and value creation. These terms can include the total of all the capitals, the benefit captured by the company, the market value or cashflows of the organisation, and the successful achievement of the company's objectives. However, the conclusion reached was that the framework should not define value from any one particular perspective, because value depends upon the individual company's own perspective. It can be shown through movement of capital and can be defined as value created for the company or for others. An integrated report should not attempt to quantify value, as assessments of value are left to those using the report.
Many respondents felt that there should be a requirement for a statement from those 'charged with governance' acknowledging their responsibility for the integrated report in order to ensure the reliability and credibility of the integrated report. Additionally it would increase the accountability for the content of the report.
The IIRC feels that the inclusion of such a statement may result in additional liability concerns, such as inconsistency with regulatory requirements in certain jurisdictions and could lead to a higher level of legal liability. The IIRC also felt that the above issues might result in a slower take-up of the report and decided that those 'charged with governance' should, in time, be required to acknowledge their responsibility for the integrated report, while at the same time recognising that reports in which they were not involved would lack credibility.
There has been discussion about whether the framework constitutes suitable criteria for report preparation and for assurance. The questions asked concerned measurement standards to be used for the information reported and how a preparer can ascertain the completeness of the report.
Future disclosures
There were concerns over the ability to assess future disclosures, and recommendations were made that specific criteria should be used for measurement, the range of outcomes and the need for any confidence intervals to be disclosed. The preparation of an integrated report requires judgment, but there is a requirement for the report to describe its basis of preparation and presentation, including the significant frameworks and methods used to quantify or evaluate material matters. Also included is the disclosure of a summary of how the company determined the materiality limits and a description of the reporting boundaries.
The IIRC has stated that the prescription of specific key KPIs (key performance indicators) and measurement methods is beyond the scope of a principles-based framework. The framework contains information on the principle-based approach and indicates that there is a need to include quantitative indicators whenever practicable and possible. Additionally, consistency of measurement methods across different reports is of paramount importance. There is outline guidance on the selection of suitable quantitative indicators.
A company should consider how to describe the disclosures without causing a significant loss of competitive advantage. The entity will consider what advantage a competitor could actually gain from information in the integrated report, and will balance this against the need for disclosure.
Companies struggle to communicate value through traditional reporting. The framework can prove an effective tool for businesses looking to shift their reporting focus from annual financial performance to long-term shareholder value creation. The framework will be attractive to companies who wish to develop their narrative reporting around the business model to explain how the business has been developed.
Graham Holt is director of professional studies at the accounting, finance and economics department at Manchester Metropolitan University Business School
1 Unit