‘Clarity’ of financial information has long been the goal for some in the accounting profession, but it is rarely achieved because of a continual growth in complex literature. This results in reporting that is inaccessible to most people without an understanding of contemporary accounting practice.
Audit reports misunderstood
In these circumstances a ‘clean’ audit or review report is often used as a proxy by the stakeholder in lieu of actually reading the financial statements. The audit report is perceived by some people as a ‘things are okay’ statement in good times. This is far from the truth. In the context of historical financial statements auditors operate within the confines of auditing standards and are required to report on the representation of the financial state of the entity by the directors and senior management in the financial statements within the context of auditing standards and applicable financial reporting framework.
An ‘expectation gap’ or ‘expectation gaps’ – as some would have it – exist on what professionals believe should be clear to users in terms of the scope of both financial reporting and what the average user with some shares in a business might understand as the function of audit. This discussion arises whenever a corporate collapse occurs or there is a global financial catastrophe of sorts. It is a discussion that is not a feature of general debate during times when there is a boom, but its gains a greater prominence when stakeholders and others seek to attribute responsibility for action or inaction in a particular situation.
In other words, interest in the debate is usually in proportion to the financial interest that individuals have in an entity or entities experiencing financial distress rather than being a debate engaged in for the sake of improving the principles underlying audit and reporting practice. How then are users and others expected to reflect on the emerging integrated reporting framework?
Why integrated reporting?
Integrated reporting is the latest term to emerge over a period that describes a reporting style dealing with issues that sit outside the scope of those covered by financial statements. It is defined by the International Integrated Reporting Committee (IIRC) as a reporting framework that “demonstrates the linkages between an organisation’s strategy, governance and financial performance and the social, environmental and economic context within which it operates”.
“By reinforcing these connections,” the IIRC web site states, “Integrated Reporting can help business to take more sustainable decisions and enable investors and other stakeholders to understand how an organisation is really performing”.
Integrated reporting is therefore seen as a reporting construct that seeks to do more than financial reporting. That part of the exercise – to be frank – is easy. Financial reporting deals explicitly with the figures of an organisation. That’s what financial reporting is intended to do. It is and always will be a numbers game. Narrative in the financial reporting space has tended to be used to supplement the numbers appearing on the face of the financial statements.
Financial reporting does not contemplate reporting on a range of environmental and social issues except in the context of the financial costs of restoration. Debate can be had over measurement of restoration obligations, for example, but that is as far as financial reporting will go. The rest of the issues are quite rightly the domain of integrated reporting or sustainability reporting or reporting under some kind of principles of corporate social responsibility.
Still a necessity
Financial reporting can never be replaced by integrated reporting. Those advocating for the adoption of integrated reporting need to be clear on this point. Financial reporting and integrated reporting can happily co-exist, but one should never be confused for the other nor should one seek to replace the other. The framework, standards and interpretations sitting within the body of guidance that is issued by the International Accounting Standards Board (IASB) stands alone.
Financial reporting concerns itself with one aspect, one attribute, of an entity’s performance. The literature that underscores all of this has been developed over many decades in a range of jurisdictions. This development of accounting thought is gradually being meshed together at an international level, given the work across the globe to have a single set of accounting requirements.
Seeing the whole picture
Integrated reporting concerns itself with a range of attributes. Think of it as a house that has large glass panes on each side. Looking through each pane gives you a picture of a particular room or enclosure. Put together the accounts of what is seen at any one time through each pane and it is a comprehensive report.
Financial reporting will give you an idea of what goes on in the ‘engine room’ in financial terms. Entities have physical, intellectual and environmental resources that can be reflected in a meaningful fashion in a report but that may be reflected in the accounts only in a number buried somewhere in a note. This is the heart of the argument for integrated reporting. It is an unarguable proposition that the accounting profession along with other professionals involved in corporate reporting need to get better at telling stories. The question is how best to do so.
Comprehensible reports
Some commentators have sought to use the GFC as a rallying point for the cause of developing integrated reporting. It is true that people do not always understand the financial risks an entity enters into when trading in exotic instruments. Plain English explanations of what entities are doing entering into financial arrangements with the monies invested by ordinary folk are desirable.
A crusade for plain English comprehensive reports that is being fought partly on the back of the GFC, however, trivialises what is in its own right a significant issue. The GFC was a global catastrophe in which more than an absence of clear reporting was to blame for the confusion. Enabling a greater understanding of the operations of entities ought to be worthwhile as an objective in its own right and not just because of the GFC and the tsunami-like impact it has had on financial markets. The GFC is only one of the many global catastrophes that has occurred – and will occur – both within our lifetimes and beyond. Holding the GFC up as an argument in support of the development of a global narrative disclosure framework arguably cheapens the discussion of the principle. The points made in the case of the GFC would have been equally valid in the context of World.Com, Enron and similar financial collapses.
One of the questions researchers will need to ask as integrated reporting starts to take hold and accounting standards continue to evolve steadily over time is whether stakeholders will actually notice improvement. The question is not merely rhetorical. One of the first things that happens when there is a corporate collapse is that various risk management and governance mechanisms come under criticism.
How do we as a profession nurture the community’s interest in the role played by financial reporting and audit – and integrated reporting – over a period of time, given the aspect of self-interest outlined earlier? First, the profession needs to come to terms with the fact that this task of educating the community is incremental. It is not a finite project that can be given to a senior manager in an accounting firm or a professional accounting body to deliver and then be forgotten, or it will be a part of somebody’s key performance indicators and then disappear.
Ongoing education needed
Finite projects in the area of building community understanding will fail. Anything that is finite is usually aimed at assisting the passage of legislation that might otherwise lead to an anomalous outcome to the profession and the community as a whole. Education in that context is merely fire fighting rather than fire prevention.
The best way of dealing with this is through a rolling campaign designed to enhance community awareness during good times and bad. This requires a financial investment and a commitment of people to the task. The goal needs to be awareness-raising irrespective of the point of the economic cycle we are in. It is also important to remember that building knowledge in the community needs to happen over a long period of time. Those of us who are debating these issues today will eventually leave this mortal coil. That knowledge dies with us.
We need to establish a financial literacy program to build an understanding of financial reporting, audit and – eventually – integrated reporting. It is only then that the job of educating the community in the public interest can be said to have begun. While it will not get to everybody that needs to know at first at the very least the profession will be able to say action is being taken to improve understanding.
Once we create an environment that nurtures understanding we can claim to have taken steps to improve clarity.
