Integrated Reporting: What the Accounting Guru Saw

Jeffrey Unerman is known as co-author of the book Accounting for Sustainability and as Professor of Accounting and Corporate Accountability and Head of the School of Management at Royal Holloway, University of London.
 
Recently in Singapore to launch a Bachelor of Science (Honours) in Management programme with Kaplan Higher Education, he spoke to CFO Innovation’s Cesar Bacani about the immediate prospects for sustainability accounting and what this means for the accounting and auditing profession. Excerpts:
 
Your book was published in 2010. What has been the progress in accounting for sustainability since then?
What we’re seeing is [still] lots of companies experimenting. The issue is that the connections between social and environmental and economic sustainability are incredibly complex. It’s very difficult to capture in one process or one guideline practices which all companies could adopt.
 
What’s been happening in the intervening period [since 2010] is that the IIRC, which stands for the International Integrated Reporting Council, has been set up and has gotten a lot of support from many companies and most of the big professional accounting bodies throughout the world and many non-government organisations.
 
The IIRC was set up specifically to try to work out and develop guidelines on how companies can provide an integrated report to integrate the social impact with economic impact with the financial impact. Next month [in April], they are going to be producing some draft guidelines.
 
The IIRC was set up by the Global Reporting Initiative and by the A4S, The Prince’s Accounting for Sustainability Project.  They’re working closely with IFAC [International Federation of Accountants], so the more traditional financial accounting bodies are recognizing that this is a very important area. And the IASB [International Accounting Standards Board] signed a memorandum of understanding with the IIRC about a month ago.  
 
Integrated reporting is the area where the accounting regulatory bodies are getting more and more interested and getting more and more active.
 
Do we have any indication about what the IIRC guidelines will look like?
It is risky to hazard a guess. The last broad announcement was done 18 months ago. What they also have is a number of organisations working on pilot projects to work out how integrated reporting can work because it is very new.
 
Has there been any company at this time that has successfully done integrated reporting?
Trying to capture these relationships in one or two figures is incredibly difficult to do. It could be that somebody very clever can work out how to do it at some point in the future. But I’m not aware at the moment that there is anybody.
 
There are various NGOs that are working on trying to do this. But I’m very cynical about it. I think the complexity involved means that you need a narrative approach.
 
There will always be things that you can measure, and things you can measure are actually a very powerful way of reporting. But there are some very important things that you can’t readily measure, but it’s still important for the shareholders and other stakeholders to be aware of the company’s approach to managing risk
 
In your book, you observe that ‘there has been little explicit connection in the reporting of financial sustainability with social and environmental sustainability, or in the materiality of the impacts arising from sustainability issues.’ Can this weakness be solved with just the narrative approach?
You can report the significance of the issues, you can forge the linkages, you can speak about the materiality issues, not necessarily [only] in numeric terms. Sometimes yes, but sometimes because it’s so complex, you would need to expect investors to work a little bit harder.
 
You can say: ‘These are the key issues, these are key connections, and these are what we see as the impacts. We can’t necessarily put everything in numbers, but we can tell you what the linkages to be.’ At some point, you have to make a qualitative judgment of these issues.
 
So you might end up having a number of footnotes in the financial statement linking the numbers with the social and environmental impacts?
What I understand as the essence of integrated reporting, which is what the IIRC is trying to do, is trying to get a very concise communication of the key sustainability issues in economic, social and environmental terms.
 
What I envision that to mean is summary statements in one or two or three pages that identify what the key sustainability issues are, economically, socially and environmentally. And then enables you to drill down through hyperlinks to the more detailed information in those areas to see how those actually work.
 
One key problem that the IIRC has very much in their focus is that the volume of information at the moment is so high. For a small investor, if you took the IFRS report of most large companies, you would not have an effective communication of what the key financial factors are for that business because it’s so complex and there’s so much detail there.
 
I think what the IIRC is trying to do is trying to say, ‘How do you distil that and point out in simplified form, be it narrative or quantitative, what the key factors are there?’
 
Is this analogous to MD&A – the Management Discussion and Analysis section in most annual reports?
The MD&A, if that’s working effectively, it should pick up what the key sustainability risks are. But I think lots of companies have not actually thought about what these key risks are.
 
Why aren’t companies doing this? Why isn’t this a widespread practice? I think one of the issues here is that companies for many years have been subject to very short term financial pressures. They have to make their quarterly profit figures.
 
If you bring into account social sustainability and environmental sustainability, the payback is much longer term, usually.    
 
There must be some companies that are doing this, though.
Certainly many big European multinationals have reported what they believe to be the key sustainability risks in the MD&A. Many of them have gone further and published separate social and environmental sustainability reports.
 
And this is not enough? Are we asking for more from these companies?
Many follow the Global Reporting Initiative guidelines. Those reports can be incredibly complex and very long. You then have same problem as you have with the financial reports. They both have become almost too complex to be meaningful.
 
The other issue is that, very often, they disclose the social impacts, they disclose the environmental impacts, they disclose the financial impacts, but they don’t show how the three are connected to each other. That’s the missing piece of the jigsaw, the integration showing the impacts of financial sustainability, social sustainability and environmental sustainability on each other.
 
How exactly are these three things connected?
On page 4 of my book, there’s a diagram that I use when I teach this concept (see diagram below).
In the middle of the diagram is a diamond that says ‘Decision or action by an organization,’ with upward and downward arrows towards ‘positive and negative economic impacts.’ I’d say that’s what financial accounting has been for many decades.
 
If we then expand that to have downward and upward arrows as well to ‘positive and negative impacts on the natural environment’ and ‘positive and negative impacts on society and social cohesion,’ obviously accounting becomes seriously more complex.
 
If you then take into account the second order effects, it becomes incredibly complex.
 
It’s so complicated that there’s probably no point in going ahead with whatever the IIRC is trying to do. Won’t you end up with a voluminous and complicated report that, as you say, is almost meaningless?
I think we can cope with complexity if we put our minds to it. Some of the impacts are potentially so large that we need to cope with it. There’s an example from three years ago, which is BP’s Gulf oil spill. If you looked at the congressional report that came out of that, it was very clear that BP was wanting to save a certain amount of money by taking a few short cuts.
 
If they had factored into that decision much more carefully, on much more systematic basis the potential ecological impact in the worst case scenario and the social impact, the safety impact, they may well not have taken the decisions they took.
 
In order to save a few million dollars, it ended up costing them billions of dollars.
 
What role, if any, will the external auditor have in integrated reporting? If BP prepared an integrated report that detailed not only the economic impact of the company’s actions but also the environmental and social impacts, would its auditor be expected to issue an adverse opinion because of the potential loss of billions in the worst-case scenario? 
I think it depends on the pressure from the shareholders, on whether there is a sufficient number of them who realise that the decision’s environmental impacts have very real financial consequences.
 

There are more and more investment funds – not necessarily ethical investor funds but purely financial investment funds – that recognise these linkages. As more investors recognise that, they may well start to put extra expectations on auditors to ensure that the auditors factor these risks into the audit processes. I think it’s more of a market pressure. 

 

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