At a dialogue session in Singapore earlier this month, executives of the Chartered Institute of Management Accountants, International Integrated Reporting Council, Singapore Accountancy Commission, Institute of Singapore Chartered Accountants and CFOs of the city state’s most venerable firms were of the view that a new way of financial reporting is needed if corporates are to stay relevant to their stakeholders in the future.
They also agreed that a firm’s management accountant will become increasingly important in spearheading that change.
Intangible assets such as human, intellectual and environmental capital are not adequately valued on the company’s books, even though such assets now account for 84% of the value of S&P 500 companies
“We are now living in very fast-moving and complex world, one in which the value of many businesses is moving from being predominantly on [the balance sheet] to off the balance sheet,” Charles Tilley, CEO of the Chartered Institute of Management Accountants (CIMA), told CFO Innovation. “The value of companies like Apple and Microsoft for example, is in their intellectual property and talent and not in the physical capital that typically sits on the balance sheet.”
In that light, today’s CFOs must look beyond their firms’ tangible assets and begin accounting for the intangibles on their books. “This will help them make better decisions, respond appropriately to current challenges and protect the value generated by such assets in the business,” says Tilley.
The value that's unaccounted for
Under the existing corporate reporting system, however, much of that value remains unaccounted for. According to Ocean Tomo, an intellectual property merchant bank, intangible assets such as human, intellectual and environmental capital are not adequately valued on the company’s books, even though such assets now account for 84% of the value of S&P 500 companies. In comparison, intangibles represented just 20% of the companies’ assets in 1975.
Consequently, investors are not receiving the information required to fully understand the value of a company’s business and gauge its potential for growth. “So, moving forward, CFOs need to think about accounting for the entire business rather than just its physical capital, such as property and machinery. The profession must develop a new way of accounting effectively for the intangible value generated by a company,” Tilley says.
Demand for a more comprehensive method of accounting is rising. According to a CIMA survey of around 400 global business leaders, some 94% agreed that such a method is important to be able to effectively explain how their business creates value through corporate reporting.
Meanwhile, 92% believe that combining financial and non-financial information will help to explain the value-creation process, drive improvements in decision- making, as well as identify and manage risks within the firm.
Enter integrated reporting, which aims to give a company’s stakeholders a better understanding of the factors that materially affect its ability to create value. “Integrated reporting is essentially telling a story about how your business creates value over a period of time and the risks at hand,” says Tilley.
In other words, an integrated report effectively communicates how an organization's strategy, governance, performance and prospects lead to the creation of value in the short, medium and long term.
Underpinning all that is integrated thinking, which refers to financial decision-making based on information that encompasses both the tangible and intangible assets of a business and that is more interconnected and forward-looking than traditional financial analysis.
“Integrated reporting forces a CFO to really understand the entire organization. It makes you consider how you run your business, tests your understanding of the external environment and makes you think about what your competitors are doing in order to create value,” says Tilley.
“More importantly, it forces everybody in the organization to work together. Is production cooperating with marketing, is marketing communicating with sales, and does finance support it all, for example?”
In Singapore, the stock exchange has made Environmental, Social and Governance reporting compulsory by 2017
“The move to integrated reporting is a significant shift away from the cash and accrual accounting methods we have become accustomed to over the years, but we are already seeing accountants and regulators demanding a new reporting method which better accounts for the intangible value generated within an organization,” adds Tilley.
So far, it is now a requirement for all listed companies in the UK and South Africa to produce an integrated report. Meanwhile, some180 businesses are currently practicing integrated reporting in Japan, according to the International Integrated Reporting Council website.
In Singapore, the stock exchange has made Environmental, Social and Governance (ESG) reporting compulsory by 2017, but some firms are already adopting integrated reporting, which goes beyond the requirements of ESG. These include the Singapore Maritime Port Authority as well as blue-chip property developer City Developments.
In Malaysia, government-owned conglomerate Sime Darby has also opted to produce integrated reports.
How to do it
So, how can companies start shifting to integrated reporting? The way Tilley sees it, that initiative depends on the management accountant of a firm.
“Typically there are different roles accountants play in an organization. There are the auditors who report on the accounts, financial accountants who are focused on the financial position of the business, and then there are the management accountants who support high quality decisions which drive the organization forward,” he says.
According to Chartered Global Management Accountant (CGMA) principles, management accounting is having the right data and analysis to support the CEO in making strategic, top level decisions. The management accountant must also make sure that decisions are communicated effectively to the right people so that the organization can work together to create and preserve value.
“In that light, management accounting supports integrated thinking and enhances a firm’s ability to tell its story through good integrated reporting,” says Tilley.
CGMA is a professional management accounting designation which was first issued by a joint venture owned by CIMA and the American Institute of Certified Public Accountants in January 2012. Its aim is to promote the science of management accounting on the global stage. Currently, CGMA represents about 600,000 accountants worldwide. Since its launch, it has certified over 50,000 new management accountants.
Still, Tilley admits that the drive towards adopting integrated reporting has not been easy. For instance, resistance towards what many accountants perceive to be a larger volume of paperwork under integrated reporting is mounting. Indeed, several accountants who attended the dialogue voiced frustrations at having to prepare reports amounting to hundreds of pages, which they doubt are ever read by investors and lenders.
“So far, people are seeing integrated reporting as yet another layer of work when they have so much to deal with under existing regulations already,” says Tilley. “We have heard many examples of accountants saying their job isn't adding value because they are already bogged down by compliance work.”
Essential and inevitable
The way Tilley sees it, though, the shift towards integrated reporting is essential and inevitable for corporations to survive and thrive in today’s environment.
“Integrated reporting is really about the board communicating with the external world regarding how a business is run and how it generates long term value. This should make your business a more trusted and sustainable brand, and that, in turn, will help your share price rise, which benefits everyone,” he says.
In other words, like it or not, integrating reporting will be part of what finance will be doing in the near future. Whether it is painful or less so, implemented relatively smoothly or not so much, depends in large part on how the CFO and the finance team is preparing the ground today.
About the Author
Kristin Kang is a CFO Innovation Contributing Editor based in Singapore.
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