FINANCIAL REPORTING AND IR

The Integrated Reporting Framework is an ambitious attempt to reshape the direction and focus of corporate reporting, and aims to provide investors with a more complete picture of business value by extending reporting beyond historical financial performance. The Framework was launched on December 9, 2013, by the International Integrated Reporting Council (IIRC), following a period of extensive consultation. The IIRC is a global coalition of regulators, investors, companies, standard setters, the accounting profession, and NGOs.

The Framework will be of particular interest to companies looking to improve the quality of their narrative reporting as a basis for better dialogue with their investors. Integrated Reporting is not necessarily intended to replace other reporting streams such as financial, corporate social responsibility, or corporate governance reporting. The IIRC’s vision is that preparers should draw together relevant information produced under other, detailed reporting frameworks – such as IFRS – to explain what they see as the key drivers of business value.

The IIRC has defined a principles-based framework that encourages businesses to tell their stories on their own terms, rather than through a checklist of disclosures. This approach requires a cultural shift by report preparers, who would need to think of their reporting suite as a platform to explain what drives the underlying value of the business and how management has acted to develop and protect this value. It requires preparers to consider what the user needs to know, rather than what they are required to tell the user.

The increased business relevance this could bring to corporate reporting is being welcomed in many quarters. However, there will be many challenges to overcome, particularly for those who still regard their annual reporting as a compliance-led regulatory activity rather than a basis for better shareholder dialogue.

The fundamentals

Integrated Reporting is built around seven key components of content: business model; organizational overview and external environment; opportunities and risks; strategy and resource allocation; performance; outlook; and governance.

By linking content across these components, an integrated report is intended to build the story of the business; starting with a basic description of the business model, addressing the external factors affecting the business, and dealing with management’s strategy. This is intended to provide a foundation to discuss the performance, prospects and governance of the business in a way that focuses on its most important aspects.

The report is expected to focus on the key drivers of business value – typically built around a thread of five or six issues that run throughout the report. These should be the same issues management focuses on in managing the business, and the same issues that should be driving investors’ decision making.

The approach recommended by the IIRC means the information relevant to each business is different. Broadly, Integrated Reporting is expected to result in the following outcomes:

• More operationally focused measures of performance, with the aim of helping users to understand progress in implementing strategy, developing business assets and creating new income streams – i.e. leading indicators of performance, rather than lagging ones.
• Greater focus on explaining key intangible business assets – e.g. customer base, intellectual property and reputation – to outline how these assets have been managed and enhanced in line with the business strategy and changes to the external operating environment.
• More emphasis on explaining factors driving future performance – including risks and opportunities – so users can form their own views on how these factors might impact future performance.

This is expected to lead to reports that are also more informative for investors’ own cash flow valuation models. In particular, it is expected to provide a clearer picture of how management’s plans and changes in the operating environment are likely to affect medium-term returns, and help investors assess the substantial element of value that is typically locked up in the ‘terminal value’ element of their models.

Embracing the opportunity

The Integrated Reporting framework offers a broader perspective on reporting shareholder value creation and should be of particular interest to companies wanting to shift the reporting dialogue beyond discussion of short-term earnings. Businesses that are embracing integrated reporting around the world are adopting an evolutionary approach. Companies will need time to develop their reports and their information systems to support the broader perspective envisaged by Integrated Reporting.

In response to the IIRC’s proposal, CPA Canada (the newly named CICA) released its comment letter indicating it agrees with the concept of integrated reporting, but said few organizations currently have sufficiently integrated systems and processes to generate a reliable integrated report. Investor relations teams should consider how the Integrated Reporting framework might support and improve their existing investor communications, and embrace it as an opportunity for more focused reporting and a more relevant dialogue with stakeholders.