Is Integrated Reporting in the Future?

Considering the Costs, Benefits, and Role of CPAs

Concerns about the impact of business activities on society have led many companies to start issuing reports that provide information about their environmental and social performance. These reports have various names, including a corporate citizenship report, an environmental report, and a sustainability report. Although aspects of environmental and social activity may also be included in a company's annual report to stockholders, the two reports usually remain separate. Recently, however, organizations and authors have advocated the need to combine all aspects of sustainability reporting and financial reporting into a single, integrated report. (For additional details, see "Towards Integrated Reporting: Communicating Value in the 21st Century," International Integrated Reporting Council [ERC], 2011, and Robert G. Eccles and Michael P. Krzus, "Integrated Reporting for a Sustainable Strategy," Financial Executive, March 2010, pp. 28-32.)

The following discussion explores the concepts underlying integrated reporting, provides examples of how integrated data can be reported, and analyzes the costs and benefits of integrated reporting. With this knowledge, CPAs can become involved in the integrated reporting process-for example, they can help ensure that the report's environmental, social, and governance data are consistent with the company's financial data.

Sustainability Concepts

Sustainability is an abstract concept that means different things to different people. Often, it is based on a definition of sustainable development that was provided in a 1987 United Nations report-that is, development that meets the needs of the present without compromising the ability of future generations to meet their own needs (Our Common Future, World Commission on Environment and Development). In practice, sustainable development means that an entity's activities need to be evaluated (and reported upon) in terms of their impact on future generations, as well as on current stakeholders.

One approach to sustainability reporting is to think of a triple bottom line: environmental, social, and economic impact. In 'Triple Bottom Line Reporting for CPAs," Steven M. Mintz noted that triple bottom line reporting "is emerging as an important and necessary part of an organization's disclosure" (The CPA Journal, December 2011, pp. 26-33). This approach expands an organization's reporting practices. Traditionally, annual reports have focused primarily on financial measures of performance; with a triple bottom line, however, companies also report nonfinancial measures of the impact their activities have on the environment and society.

Suggestions to expand reporting requirements to include nonfinancial measures are not new to the accounting profession. In the 1970s, major U.S. accounting organizations published monographs discussing why accountants should expand their reporting practices to include social and environmental issues. Although these did not use the term "sustainability," they discussed the reporting of environmental and social measures. The National Association of Accountants (now the Institute of Management Accountants) published The Measurement of Corporate Environmental Activity by Loren A. Nikolai, John D. Bazley, and R. Lee Brummet in 1976; the American Accounting Association (AAA) published Phantasmagoric Accounting: Research and Analysis of Economic, Social, and Environmental Impact of Corporate Business by Robert Jensen in 1976; and the AICPA published The Measurement of Corporate Social Performance, written by its Committee on Social Measurement, in 1977.

Whereas earlier suggestions for reporting on social and environmental issues advocated separate financial and social reports, the focus has turned to an integrated approach that includes all financial and nonfinancial measures together in one report (i.e., an integrated report).

An Integrated Report

This type of report provides information about all aspects of a company's performance, including financial, environmental, social, and any other dimension management wants to include. Eccles and Rrzus define an integrated report as one that "combines the financial and narrative information found in a company's annual report with the nonfinancial (such as on environmental, social, and governance issues) and narrative information found in a company's 'Corporate Social Responsibility' or 'Sustainability' report" (One Report, John Wiley & Sons Inc., 2010, p. 10). Other definitions of an integrated report are much broader. In its white paper, the IIRC described its vision for integrated reporting as follows:

Integrated Reporting brings together the material information about an organization's strategy, governance, performance and prospects in a way that reflects the commercial, social and environmental context within which it operates. It provides a clear and concise representation of how it creates value, now and in the future. Integrated Reporting combines the most material elements of information currently reported in separate reporting strands (financial, management commentary, governance and remuneration, and sustainability) in a coherent whole, and importantly:

* shows the connectivity between them, and

* explains how they affect the ability of an organization to create and sustain value in the short, medium, and long term. (IIRC 2011, p. 6)

To support this vision, the IIRC recently issued a consultation draft of a proposed framework for integrated reporting ("Consultation Draft of the International (IR) Framework," April 2013, http://www.theiirc.org/consultationdraft2013). The framework advocates reporting a company's resources and relationships from six different perspectives (described as "capital" in the framework). Although the framework does not require companies to use these specific capitals, the IIRC believes they should be used as a benchmark to ensure that an integrated report includes all of a company's important resources.

As shown in Exhibit 1, the financial, social and relationship, and natural capitals are consistent with the triple bottom line reporting of financial, social, and environmental activities. In addition to these perspectives, the IIRC draft proposes that an integrated report should provide information about manufactured capital, intellectual capital, and human capital. Manufactured capital includes buildings, equipment, and infrastructure. Organizational knowledge involving procedures, systems, and reputation is intellectual capital. The competencies and capabilities of people are human capital.

In the IIRC's vision of an integrated report, an organization would report the inflows and outflows, risks, and opportunities for each type of capital and explain how they affect other capitals. For example, an organization's employment practices affect many capitals. The cost of employees is an outflow (expense) to an employer, but the payments provide inflows to employees and the community. Employees impact the environment and contribute to the community in many ways. Investments in training increase the organization's human capital and may result in an increase in social and relationship capital if the training leads to shared norms and values.

But there are also risks associated with employees. If customers are displeased with the quality of a product or service provided by employees, then there will be a decrease in social, financial, and intellectual (reputation) capital. Employees also provide opportunities for increasing capital in each of these areas. In an integrated report, the inflows, outflows, risks, and opportunities would be shown for each capital and the interrelationships among the capitals would be noted.

Transnet SOC Ltd. provides an example of how companies might report data using the IIRC framework. (Its 2013 integrated report is available at http:// examples.theiirc.org/organisation/83.) The company is wholly owned by the government of the Republic of South Africa and exists to manage the country's freight railways, ports, and pipelines. Its objective is to improve the competitiveness, growth, and development of the South African economy by providing reliable freight transportation and handling services. On page 8 of its integrated report, Transnet identified the inputs it uses in each of the six capitals to create value. The company uses its capitals to perform activities such as maintaining and operating the railways, ports, and pipelines. Value is created by providing services to customers, returns to shareholders, taxes to the government, income to employees and suppliers, and support to communities.

In addition to showing the details of the capitals, an integrated report should identify the risks and opportunities that affect a company's ability to create value. Transnet identifies such risks on page 15 of its integrated report. Many of these risks affect different capitals, whereas others are focused on a single capital. For example, regulatory risk is identified with financial, manufactured, and natural capitals, but human resource risk is associated primarily with human capital. For each of the risks shown in its report, Transnet provides details about its relationships with stakeholders, opportunities, and actions that might reduce the risks. Exhibit 2 lists these details for regulatory risk.

Although not shown in Exhibit 2, similar details about stakeholders, opportunities, and mitigation measures are provided for each of the risks noted in the company's integrated report. For example, employees and organized labor are identified as the principal stakeholders for human resource capital. Opportunities include building trust with organized labor, skills development, and staff wellness. Enhancing the human resources system is noted as the major mitigating action.

Transnet identified outcomes for 2013, as well as target outcomes for 2014-2020, in its integrated report (pp. 8-9). For human capital, the company hired 3,804 new employees and invested R846 million (currency in South African rands) in skills development in 2013. By 2020, the company expects to have 66,750 employees and invest 4% of payroll in skills development.

Because reporting is derived from strategic objectives, each company's report will be different, but it should identify objectives, risks, and opportunities for the various capitals, as seen in the example of Transnet. It is important to remember that each company will receive different benefits and incur different costs in integrated reporting.

Weighing Benefits and Costs

Benefits. The main benefit of integrated reporting to an organization might be that it leads to integrated thinking, which is valuable in evaluating a company's longterm sustainability. Integrating environmental, social, and governance data with financial data forces companies to consider the long-term impact of decisions on the various capitals, rather than focusing on short-term results.

In a 2011 paper, "Integrated Reporting: A Better View?," Deloitte noted that separate reporting of financial, environmental, social, and governance (ESG) issues may lead to isolated thinking by managers and other stakeholders. The report concluded:

Some parties may contend that separate financial and ESG reports provide sufficient information for stakeholders to determine if a company is "sustainable." However, such reports are usually produced in isolation and thus lack a "big picture" view. Correlations can be better understood when financial results are directly connected to ESG performance and ESG performance is directly tied to overall strategy and business models. (p. 10)

Adam M. Kanzer advocates integrated thinking in "Toward a Model for Sustainable Capital Allocation" (The Landscape of Integrated Reporting: Reflections and Next Steps, ed. by Robert G. Eccles, Beding Cheng, and Daniela Saltzman, Harvard Business School, 2010, pp. 45-57). He reaches the following conclusions:

* Although many analysts ignore separate corporate sustainability reports, an integrated report puts this information in front of analysts and highlights its relevance to financial factors.

* Integrated reporting can ensure that corporate sustainability performance is not just an isolated consideration in a company's corporate social responsibility (CSR) department, but also the concern of senior management and the board. An integrated report should make this aspect of the company's performance more relevant to senior management because the relationship between the company's sustainability performance and the long-term value of the company is more clearly expressed and measured.

* If done properly, integrated reporting should improve both financial and sustainability performance, as well as ensure that the two are aligned.

A summary of the benefits cited for integrated reporting is shown in Exhibit 3. Generally, these benefits fall into three categories: 1) communication benefits, 2) risk management benefits, and 3) cost benefits. The communication benefits shown in Exhibit 3 are based on the premise that integrated data will be perceived as more reliable if it is included in a report that also includes audited financial data. Currently, sustainability and citizenship reports might be viewed as public relations gimmicks, even though the intent is to present useful information to various stakeholders. If the information is integrated into a report with financial data, consumers and investors might believe it is more reliable frían data presented in separate reports.

Integrated reporting might also signal to managers and employees that environmental, social, and governance issues are being given the same weight as financial considerations in making decisions. It might also make the company more attractive to future employees-for example, through a decision to pay a living wage to all workers.

An integrated report might also have risk management implications. Although improving communications is one aspect of managing risk, reporting the specific risks faced by the organization can help an organization improve its reputation. In One Report, Eccles and Krzus cited a survey of executives, which found that reputational risk ranked first as the most important and difficult risk to manage (p. 153). They noted that reasons for the difficulty managing reputational risk included poor communications with external stakeholders and a lack of coordination between the board, the risk management function, and the corporate communications function. The process of preparing an integrated report forces management to identify risk areas, after which they can focus on managing these areas.

Lowering risk should also help companies to lower costs and become more profitable. Understanding and managing risks should lower a company's cost of capital because the risk premium should be reduced if reputational risk is lower. The company might also be able to lower reporting costs by including all activity reports in a single report; however, other costs might increase with integrated reporting.

Costs. The implementation of integrated reporting can be difficult and costly. Companies need to identify information that is relevant and significant for each strategic objective. Employees need education and training about integrated reporting. The data for integrated reporting can come from many sources, including human resources, operations, risk management, and accounting; personnel in these departments need to understand the reporting process.

Companies that are not currently preparing sustainability or citizenship reports will incur even greater education and training costs. In addition, they will need an information system that collects and summarizes tiie data, which could create a need for new systems. Once these initial costs are incurred, tiie incremental costs for later years should be lower, and the benefits of integrated reporting should start to accrue. But the initial cost will probably be significant unless standardized information systems can be developed to support integrated reporting.

Many companies currently collect environmental and social data, but they do not integrate it with financial data in one report. For example, one survey by the IIRC found that only 1.4% of Fortune 500 companies combined sustainability and financial data in one report ("Integrated Financial and Sustainability Reporting in the United States," April 2013, p. 4). Of the 500 companies, however, 499 made some sustainability disclosures in their financial reports. Thus, large companies may be able to prepare an integrated report without collecting significantly more data; however, this might not be the case for small and medium-sized businesses. Although their costs might be higher, they should also benefit from the process of collecting the data required for an integrated report.

Small and medium-sized businesses. Although small and medium-sized businesses might be more affected by cost issues than larger businesses, the long-term risks and opportunities might be more critical to these businesses than they are to Fortune 500 companies. Thus, small and medium-sized businesses should benefit from understanding what integrated reporting entails and how it provides benefits in making decisions.

As noted earlier, the main benefit of integrated reporting for all businesses is the integrated thinking required to develop the report. The process of identifying strategic objectives, considering risks and opportunities of operations, and understanding how these risks interact with the various capitals is important for long-term success. Small businesses might be subject to greater risks than major companies in many areas, such as reputation, and they need to recognize the potential impact of these risks. Likewise, small businesses will probably have more and different opportunities that need to be identified if they are going to be successful in the long run,

Many types of decisions made by businesses of all sizes will benefit from integrated thinking; these range from capital investment decisions to product introduction decisions. With integrated thinking, managers are more likely to consider the impact of risks and opportunities from all perspectives when evaluating alternatives and making decisions.

The Role of CPAs

As businesses move toward integrated reporting, the accounting profession must consider how it can contribute. Having CPAs involved in the integrated reporting process will help ensure that the environmental, social, and governance data are consistent with the financial data. Because the data will be presented in an integrated manner, there should be a lower risk of inconsistencies.

But CPAs will also encounter challenges when it comes to integrated reporting. In his CPA Journal article, Mintz identified opportunities and challenges for management accountants and CPAs in triple bottom line reporting. He noted that accountants will need to leam new skills and work with experts in other fields. CPAs will also need to deal with other challenges related to collecting and reporting information.

Exhibit 4 identifies some measurement and reporting issues that will provide challenges for accountants in integrated reporting. As shown, measurement challenges will occur with outflows, inflows, risks, and opportunities. Questions that the accounting profession needs to consider for each of these areas are also presented in Exhibit 4. CPAs are already accustomed to dealing with measurement issues, with respect to inflows and outflows for financial capital, so the questions in these areas will be familiar. The main issue will be identifying inflows and outflows for riie other capitals.

CPAs will also need to determine which risks should be measured and whether probabilities should be presented. If probabilities are shown, should expected values be calculated? Just as there are risks related to business activities, they also present opportunities. The main issue for CPAs will be to identify these opportunities and assess their potential values for each of the capitals.

For an integrated report to be successful, reporting principles will need to be established in order to determine what should be reported. At the current time, voluntary reporting principles are available from several organizations, including the Global Reporting Initiative (www.globalreporting.org/reporting/g4/Pa ges/default.aspx; a list of most of the wellknown guidelines is available at www.enviroreporting.com/detail_page.pht ml?page=resource2). Before integrated reporting becomes widely accepted, accountants will need to decide whether one set of principles is appropriate for all organizations or whether different industries should have different frameworks. They will also need to decide how much assurance work should be done on the integrated data. Finally, the format of the report must be considered-will all companies be required to use a similar format, or are alternative formats acceptable? As CPAs gain experience in the area, other issues will undoubtedly arise and require answers.

Looking to the Future

The demand for more information about riie environmental and social impact of business activities is likely to increase in the future. A recent recommendation by a United Nations task force proposed that "at least by 2030-all large businesses should be reporting on their environmental and social impact-or explain why if they are not doing so" (A New Global Partnership: Eradicate Poverty and Transform Economies Through Sustainable Development, 2013, p. 24, http://www.post2015.org). If reporting additional information is going to be expected in the future, there might be benefits from developing and issuing one integrated report. To prepare for this possibility, the accounting profession must consider the issues associated with integrated reporting. ?

EXHIBIT 2

Stakeholders, Opportunities, and Mitigation Measures for Regulatory Risk

Key Risk Issue

Regulatory uncertainty

Stakeholders

Government, regulators, suppliers, customers

Opportunities

Identify common ground to create regulatory certainly for investment

Mitigating Actions

Engaging with policymakers and regulators to align policy and strategy

Drafting compliance control plans and performing audits on priority legislation

Source: Transnet Integrated Report, 2013, pp. 16-17

EXHIBIT 3

Benefits of Integrated Reporting

Communication Benefits

* Better alignment of reported information with investor needs

* More accurate nonfinancial information available for data vendors

* Greater engagement with investors and other stakeholders

* Development of a common language

* Greater collaboration across different functions within the organization

* Greater clarity about relationships and commitments among various functions

* More consistency and efficiency in internal and external reporting

Risk Management Benefits

* Higher levels of trust with key shareholders

* Improved ability to identify and manage risks

* Lower reputational risk

Cost Benefits

* Better resource allocation decisions

* Better identification of opportunities for operational efficiencies, brand differentiation, and innovation

* Lower cost of capital because of improved disclosure

Sources: Adapted from the International Integrated Reporting Council, Towards Integrated Reporting: Communicating Value in the 21st Century, 2011, p. 21 ; Robert G. Eccles and Michael P. Krzus, One Report, 2010, pp. 146-161; and Deloitte, "Integrated Reporting: A Better View?," 2011, p. 7

Harold P. Roth, PhD, CPA, CMA, is a professor of accounting in the department of accounting and information management at the University of Tennessee in Knoxville.