How Can Income Statements Be Expanded into Integrated P&L Accounts to Tell More Complete Performance Stories?
By Cornis Van Der Lugt, Bill Baue and Ralph Thurm
“Profit is an opinion,” Alfred Rappaport famously stated in his 1986 classic, Creating Shareholder Value, cautioning against an obsession with profit maximization as reflected on the Income Statement (or Profit & Loss Account). There have been plenty of additional opinions since then on what constitutes real value.
What’s the issue?
Over the last two to three decades, extensive work has been done on different types of impact assessments (such as environmental, social, health, and human rights impact assessments). For example, Baxter has been publishing annual environmental financial statements since the early 1990s. Considerable work has also been done to advance the application of life cycle assessments, and improve our ability to capture and quantify so-called “externalities.” Economists have made good progress in experimenting with different ways of valuing public goods and services provided by ecosystems, for example. New methodologies have been developed to assess different types of capitals, and financial analysts have started to consider new ways of applying valuation techniques. Tools have been applied at the level of products, projects, companies, and value chains.
Why it’s important?
With so much effort expended in developing new measurement tools, standards and different ways of disclosing the results, why have we not seen a radical transformation in business management during the last 20 years? The problem is twofold:
- First, the experts (including economists, analysts, accountants) who work in these respective domains don’t talk to each other. They are passionately engaged in their own silos.
- Second, the findings of these efforts are disclosed and communicated in a fragmented manner (for example through different declarations, statements and reports), non-connected, non-integrated and without a holistic helicopter view.
The result is the absence of a whole that is greater than the sum of its parts: an overall strategic narrative that is appropriately informed and speaks of enlightened executive leadership.
How can you tackle it?
How can we profit from this wealth of experimentation over the last two decades? One simple step we can take is to ask: If various estimations of material flows during a certain period are linked together, added up, aggregated and integrated with the mainstream income statement, what would the end-result look like?
The Reporting 3.0 Accounting Blueprint gives you an idea of what this may look like. It takes the conventional income statement, and builds on the financial accounting standards precedent that an additional layer can be added (as is done to reflect Other Comprehensive Income). It then adds:
- Firstly, internalities in the form of the different elements reflected in the Value Added Statements that extractive industry corporates are used to reporting annually. These reflect expenditures and income broken down by stakeholder group, for example employees (wages paid) and government (taxes paid).
- Secondly, externalities — the net benefit/loss of impacts on different capitals as determined through the application of the Natural Capital and Social Capital Protocol methodologies, for example. These are the numbers reported by pioneer corporates in Integrated P&Ls or Total Contribution Statements.
What our expanded income statement or Statement of Full Comprehensive Income (FCI) does is to tie the different pieces together in a structure that reflects the logic of the traditional (financial) income statement. It provides a core tool to assess intercapital value, a tool that is no longer simply a “financial statement” but rather an “integrated accounting statement.” It presents financial numbers, but tells you so much more about what is behind those numbers. It illustrates the value drivers behind conventional financial metrics such as EBITDA.
Some may argue that this is nothing new; it simply lumps together different experimentations that have been developed step-by-step over the years. Some have misgivings about monetization and adding up valuations of different capitals in one statement. In the interpretation of what is presented, there is for example the risk of assumed substitutability. Others would argue that this step is premature and way too radical. The financial accounting profession will never agree to this, too much complexity and uncertainty involved.
The history of financial accounting has shown that there is plenty of uncertainty and subjectivity behind determining what is eventually that “opinion” called “profit”. If you are shocked by complexity and subjectivity, welcome to the real world! This should not prevent us from systematically assessing and valuing impacts in terms of various capitals. Aligning organization-wide and strategic decision-making, this should also not prevent us from connecting the different parts and applying financial methodology in appropriate context to determine long-term consequences.
What will you have achieved?
Should we further explore ways in which decision-making on the use of diverse resources or capitals can be strategically aligned on the basis of integrated statements? If we continue to stop short of doing this, we continue with business-as-usual in which relative weighing and trading off is implied, non-transparent, and non-accountable.
As Ben Carpenter of Social Value International (SVI) stated during the online public dialogue on the draft Accounting Blueprint this past February:
“If the information is kept in separate places it is seen as different activities and the financial will continue to be seen as more important… if the accounts are integrated, the different sets of information are hardwired into core decision-making.”
What question will we discuss next time?
How can Integrated Balance Sheets bring intangible assets onto the books? Please find part 17 here.
[Context of this series: This is part 16 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]