By Cornis Van Der Lugt, Bill Baue and Ralph Thurm
The first edition of the Carrots & Sticks report by UNEP and KPMG in 2006 noted that sustainability reports — whether based on voluntary or mandatory standards, externally verified or not, issued to fulfil the letter or the spirit of a legal or corporate governance requirement — can never provide an unadulterated, “pure” version of an organisation’s performance. It will always be informed by a particular context, existing organisational positions, policies and perceptions, and will be read by readers with different agendas who will quite often arrive at conflicting interpretations of the same “factual information.”
What’s the issue?
So how can organizations produce a truly relevant and faithful representation of their health, future direction, impacts and dependencies? How do they do this in the “VUCA” world of volatility, uncertainty, complexity and ambiguity? Can they do such representation in purely quantitative and financial terms? And in as far as quantitative disclosures are complemented by qualitative or narrative disclosures, including footnotes, how do they deal with the increasing length and complexity of the resultant disclosures? How do they maintain material focus and reduce the signal-to-noise ratio?
Surveys of investors in the last decade have confirmed how, post financial crisis, investors show increasing interest in non-financial (sustainability, ESG) information in their decision-making. And while there has been frustration with the reliability and comparability of non-financial data that companies disclose, there has also been a growing realization of the critical role of strategic narrative to put performance into proper context. That includes narrative that describes the value creation process and business model of the company, as recommended by the IIRC <IR> Framework and emerging national level requirements for annual Management Discussion & Analysis (MD&A) or strategic reviews.
Why it’s important?
Professional accountancy associations such as the Association of Chartered Certified Accountants (ACCA) have stated publicly that corporate reporting has to go beyond the financial statements. The suggestion is that corporate reporting needs to provide a more holistic picture of the performance of a business, including its future outlook and prospects, strategy and intentions, as well as performance measured against non-financial operational objectives that are often more leading indicators than the lagging financial indicators.
So, if non-financial information and in particular narrative were to become so critical in providing a more balanced and holistic perspective on the performance and direction of a company, what should be the structure of such a narrative? Is it a free for all, an open “story telling” written by artistic consultants? How could some level of comparability and conciseness be assured in framing narrative reporting?
How can you tackle it?
The Reporting 3.0 Accounting Blueprintprovides an overview of key content elements and approach to be reflected in narrative reporting by organizations. This highlights progress since the 2000s when the Enhanced Business Reporting Consortium published its Enhanced Business Reporting Framework (2005) with 35 recommended disclosure categories. Today, there is a growing consensus that key items to address in narrative reporting are the business model and value creation process, strategy, governance as well as risks and opportunities.
The background to this includes important contributions made by non-financial reporting standards such as the GRI in requiring “Disclosure on Management Approach (DMA)” since the 2000s. It recognized the shortcoming of quantitative information and the need for more forward-looking narrative. In more recent years the SASB included in its standards “qualitative metrics,” underlining the fact that decision-useful and material information also includes qualitative information. Item 303 of Regulation S-K in the USA expects Management’s discussion and analysis (MD&A) to reflect a view of the company from the eyes of management and to provide indication of the context within which the company performance information should be analysed.
Which stakeholders are being addressed and the level of context (operating, industry, market, economy, society, ecology) provided remains an open question. While selecting the providers of financial capital as the primary user audience, the IIRC <IR> Framework has also recommended using a multicapital approach. This has resulted in some Integrated Reports using the six capitals as headings for structuring their narrative reporting (e.g. a Human Capital report, a Natural Capital report as chapters in the <IR>). The IIRC implementation feedback process in 2017 highlighted that such a structuring of content also has drawbacks, an important one being the ongoing risk of siloed narratives that fail to reflect the interconnectivity between capitals or different resources.
Our Accounting Blueprint suggests ways of dealing with these dilemmas of developing a relevant and faithful representation through narrative disclosures. It recommends a set of 12 Recognized Comprehensive Accounting Principles (RCAP) to serve as a foundation. One of these is being a Responsive Entity, producing entity-specific disclosure but being open, transparent and responding to all categories of stakeholders or rightsholders as we call them in Reporting 3.0.
The Blueprint also provides advice on dealing with the time frame of historical and forward-looking information being disclosed, the frequency of disclosures, comprehensiveness and conciseness, as well as aggregation of information and segmented reporting in appropriate context. The principle of Sustainability Context implies that the decision about (dis)aggregation of information is substantively important and not simply a methodological technicality.
What will you have achieved?
Prepare yourself, join our Transformation Journey and map a path for your organization towards New Accounting. In the future, Multicapital / Integrated Accounting systems and procedures will enable (i) new ways of packaging and disclosing timely information, (ii) more useful, strategic narrative for decision-makers, and (iii) more comparable, structured narrative combined with quantitative information in hybrid statements such as a Statement of Long-term Risks that includes reference to scenarios and financial estimations.
Building on digital technology innovations in for example artificial intelligence (AI) and distributed ledger technology (DLT, also known as “blockchain”), accounting systems in the future will enable information packages tailored for different rightsholder groups. Online and mobile disclosures and exchanges will be the norm. Furthermore, boilerplate legalistic text on risks will be replaced by more meaningful narrative on risks and opportunities, providing for more productive exchange through various media and personal interactions. The processes behind this will include narrative shaped by interdisciplinary teams from reporting organizations, including involvement of top and senior level management. Finally, the Statement of Long-term Risks and Estimated Value of Non-Current Assets & Liabilities 20 years onwards — as proposed by our Accounting Blueprint– will make for a more comparable and structured combination of narrative and quantitative information in a concise format.
Integrated Accounting, as advocated by the Accounting Blueprint, ultimately pulls together all quantitative information from the multilayered / multicapital income statements, balance sheets, and long-term statements and synthesizes them with narrative reporting to create a truly integral account of organizational impact and system value creation.
What will we discuss next time?
What does Advocation and Leadership look like for a Green, Inclusive and Open Economy. Please find part 20 here.
[Context of this series: This is part 19 of the Reporting 3.0 series that forms the basis of an Implementation Guide that summarizes the total value of Reporting 3.0 in implementing a future-ready sustainability strategy and disclosure approach, in line with the idea of a Green, Inclusive and Open Economy. By posting these articles here Reporting 3.0 seeks feedback in the writing process of the final document, to be released as Blueprint 5 at the 5th International Reporting 3.0 Conference in Amsterdam, The Netherlands, on June 12/13, hosted by KPMG, see www.2018.reporting.org]