Integrated Reporting (IR) represents a possible way forward in the field of regulation that is more holistic and inclusive than current reporting regimes. The International Integrated Reporting Council (IIRC), a global coalition of regulators, investors, companies, standard setters, accounting and finance professionals and NGOs is the acknowledged leader in the field of IR. The IIRC is of the view that communication about value creation should be the next step in the evolution of corporate reporting. The International Integrated Reporting (IR) Framework has been developed by the IIRC to meet this need and provide a foundation for the future.
Integrated Reporting should already be on the radar for every quoted company, as it should be for any company considering an IPO. At first sight IR may appear to have little relevance to SME’s and other unquoted companies/organisations, but this is not the case. If you use the principles espoused by the IIRC, that underpin IR, as a management model and IR and the integrated report (discussed below) as a management tool that can be adapted/tiered to meet the needs of any organisation, it becomes relevant to all stakeholders and organisations. IR is therefore unlike many current reporting regimes which provide minimal value except to lenders, credit rating agencies, major customers and suppliers, and a small number of major shareholders. With the exception of those (senior) employees benefiting from the likes of bonus based upon earnings per share, traditional corporate reports are of little or no interest to the vast majority of employees and other stakeholders.
ABOUT INTEGRATED REPORTING
The IIRC’s long term vision is that of a world in which integrated thinking is embedded within mainstream business practice in the public, private and not-for-profit sectors; a vision that will be facilitated by adopting Integrated Reporting (IR) as the corporate reporting norm. The IIRC’s aspiration is therefore far more holistic and inclusive than existing reporting regimes. The cycle of integrated thinking and reporting, resulting in efficient and productive capital allocation, will act as a force for financial stability and sustainability and aid good corporate governance.
IR is intended to:
• Improve the quality of information available to providers of financial capital to enable a more efficient and productive allocation of capital;
• Promote a more cohesive and efficient approach to corporate reporting that draws on different reporting strands and communicates the full range of factors that materially affect the ability of an organisation to create value over time;
• Enhance accountability and stewardship for the broad base of capitals/resources (financial, manufactured, intellectual, human, social and relationship, and natural) and promote understanding of their interdependencies. This element links very directly to the issue of good governance; and,
• Support integrated thinking, decision-making and actions that focus on the creation of value over the short, medium and long term.
The IIRC’s Integrated Reporting Framework (The Framework), which provides principles-based guidance for companies and other organisations wishing to prepare an integrated report, is designed to:
• Provide impetus to greater innovation in corporate reporting globally to unlock the benefits of IR, including the increased efficiency of the reporting process itself; and,
• Over time, establish IR as the corporate reporting norm. No longer will an organisation produce numerous, disconnected and static communications. This will be delivered by the process of integrated thinking, and the application of principles such as connectivity of information.
An integrated report differs from other reports and communications in a number of ways. In particular, it focuses on the ability of an organisation to create value in the short, medium and long term, and in so doing it:
• Has a combined emphasis on conciseness, strategic focus and future orientation, the connectivity of information and the capitals and their interdependencies;
• Emphasises the importance of integrated thinking within the organisation. Integrated thinking is the active consideration by an organisation of the relationships between its various operating and functional units and the capitals that the organisation uses, or affects it is therefore holistic in nature. Integrated thinking leads to integrated decision-making and actions that consider the creation of value (sustainability) over the short, medium and long term. Integrated thinking takes into account the connectivity and interdependencies between the range of factors that affect an organisation’s ability to create value over time, including:
o The resources that the organisation uses, or affects, and the critical interdependencies, including tradeoffs, between them;
o The capacity of the organisation to respond to key stakeholders’ legitimate needs and interests;
o How the organisation tailors its business model and strategy to respond to its external environment and the risks and opportunities it faces; and,
o The organisation’s activities, performance (financial and other) and outcomes in terms of the assets/resources – past, present and future.
The more that integrated thinking is embedded into an organisation’s activities, the more natural will be the connectivity of information flow into and from management reporting, analysis and decision-making. It also has the potential to lead to better integration of the information systems that support internal and external reporting and communication, including preparation of the integrated report.
IR is intended to promote a more cohesive and efficient approach to corporate reporting and aims to improve the quality of information available to both the providers of financial capital to enable a more efficient and productive allocation of capital, but also to stakeholders more generally. An integrated report benefits all stakeholders interested in an organisation’s ability to create value over time (its long-term sustainability), including: employees; customers; suppliers; business partners; local communities; legislators; regulators; and, policy-makers. An integrated report will therefore provide a comprehensive ‘helicopter’ view of an organisation and generate greater transparency.
The Framework, as previously mentioned, takes a principles-based approach. The intention being to strike an appropriate balance between flexibility and prescription that recognises the wide variations in the individual circumstances of different organisations while enabling a sufficient degree of comparability across organisations to meet relevant information needs. It there acknowledges that one-size does not fit all. In which respect, it is consistent with the approach adopted by the King Committee in King III. This is perhaps unsurprising given that Judge Mervyn E King, Chair of the King Committee, also chairs the IIRC council. The Framework does not prescribe specific key performance indicators, measurement methods, or the disclosure of individual matters, but does include a modest number of requirements that should be applied before an integrated report can be said to be in accordance with the Framework. An integrated report may be prepared in response to existing compliance requirements, and may be either a standalone report, or be included as a distinguishable, prominent and accessible part of another report or communication. It should include, transitionally at least on a ‘comply or explain’ basis, a statement by those charged with corporate governance, typically the board of directors, trustees, or governors, accepting responsibility for the report.
An integrated report should provide insight about the resources and relationships used and affected by an organisation. It should also seek to explain how the organisation interacts with the external environment and the resources to create value over the short, medium and long-term. The resources/capitals are stocks of value that are increased, decreased or transformed through the activities and outputs of the organisation. They are categorized in the Framework as: financial; manufactured; intellectual; human; social and relationship; and, natural resources. Organisations preparing an integrated report are not required to adopt this categorisation or to structure their report along the lines of the resources. However adherence to the fundamental principles of IR does suggest that there is no avoiding what might be termed the ‘intangible’ assets/resources such as: intellectual; human; and, social.
The ability of an organisation to create value for itself enables financial returns to the providers of financial capital, which is interrelated with the value the organisation creates for stakeholders and society at large through a wide range of activities, interactions and relationships. When these are material to the organisation’s ability to create value for itself, they should be included in the integrated report. An important characteristic of both IR and the Framework is the focus on the short, medium and long-term future, which does represent a significant shift in terms of the traditional models for corporate reporting. We consider this shift from the traditional (retrospective) position to adopting a more future-focussed perspective is to be welcomed – constantly looking backwards can be counter-productive when an organisation is seeking to go forward i.e. ensure a sustainable future.
THE IIRC FRAMEWORK
The stated purpose of the Framework is to establish Guiding Principles and Content Elements that govern the overall content of an integrated report, and to explain the fundamental concepts that underpin them. The Framework:
• Identifies information to be included in an integrated report for use in assessing the organisation’s ability to create value;
• It does not set benchmarks for such things as the quality of an organisation’s strategy or the level of its performance;
• Is written primarily in the context of private sector companies, of any size, but it can also be applied, adapted where necessary, by public sector and not-for-profit organisations.
The Framework proposes that an integrated report include eight ‘Content Elements’ that are fundamentally linked to each other and are not mutually exclusive:
• Organisational overview and external environment: What does the organisation do and what are the circumstances under which it operates;
• Governance: How does the organisation’s governance structure support its ability to create value/sustainability in the short, medium and long term;
• Business model: What is the organisation’s business model;
• Risks and opportunities: What are the specific risks and opportunities that affect the organisation’s ability to create value over the short, medium and long term and how is the organisation dealing with them;
• Strategy and resource allocation: Where does the organisation want to go and how does it intend to get there;
• Performance: To what extent has the organisation achieved its strategic objectives for the period and what are its outcomes in terms of effects on the assets/resources (capitals);
• Outlook: What challenges and uncertainties is the organisation likely to encounter in pursuing its strategy, and what are the potential implications for its business model and future performance; and,
• Basis of presentation: How does the organisation determine what matters to include in the integrated report and how such matters are quantified, or evaluated.
The Guiding Principles contained in the Framework underpin the preparation of an integrated report, informing the content of the report and how information is presented:
• Strategic focus and future orientation – An integrated report should provide insight into the organisation’s strategy, and how it relates to the organisation’s ability to create value in the short, medium and long term, and to its use of and effects on the resources;
• Connectivity of information – An integrated report should show an holistic picture of the combination, interrelatedness and dependencies between the factors that affect the organisation’s ability to create value over time;
• Stakeholder relationships – An integrated report should provide insight into the nature and quality of the organisation’s relationships with its key stakeholders, including how and to what extent the organisation understands, takes into account and responds to their legitimate needs and interests;
• Relevance – An integrated report should disclose information about matters that substantively affect the organisation’s ability to create value over the short, medium and long term;
• Conciseness – An integrated report should be concise, which suggests that it should be easily read and understood;
• Reliability and completeness – An integrated report should be comprehensive and include all material matters, both positive and negative, in a balanced way and without material error; and,
• Consistency and comparability – The information in an integrated report should be presented on a basis that is consistent over time and in a way that enables comparison with other organisations to the extent it is material to the organisation’s own ability to create value over time.
An integrated report explains how an organisation creates/delivers value over time. That value is not created solely within an organisation, it is also:
• Influenced by the external environment;
• Created through relationships with stakeholders; and,
• Dependent on various resources.
An integrated report is therefore intended to provide an insight into: the external environment that affects an organisation; the resources and the relationships used and affected by the organisation, which are referred to collectively in the IIRC Framework as the capitals; how the organisation interacts with the external environment and the resources to create value over the short, medium and long term. Value created by an organisation over time manifests itself in increases, decreases or indeed transformations of the assets/resources caused by the organisation’s (business) activities and outputs. That value has two interrelated aspects – value created for:
• The organisation itself, which enables financial returns to the providers of financial capital; and,
• Others (i.e., stakeholders and society at large), which constitutes a major factor for public sector and not-for-profit organisations.
Providers of financial capital, which may include governments and inter alia tax payers, are interested in the value an organisation creates for itself. They are also, particularly in Public Sector and Not-for-Profit organisations, interested in the value an organisation creates for others when it affects the ability of the organisation to create value for itself, or relates to a stated objective of the organisation (e.g., an explicit social purpose such as the provision of healthcare) that affects their assessments.
The ability of an organisation to create value for itself is linked to the value it creates for others. This happens through a wide range of activities, interactions and relationships in addition to those, such as sales/services to customers, that are directly associated with changes in financial capital. These include, for example: the effects of the organisation’s (business) activities and outputs on customer satisfaction, suppliers’ willingness to trade with the organisation and the terms and conditions upon which they do so, the initiatives that business partners agree to undertake with the organisation, the organisation’s reputation, conditions imposed on the organisation’s social licence to operate, and the imposition of supply chain conditions, or legal requirements. When these interactions, activities, and relationships are material to the organisation’s ability to create value for itself, they should be included in the integrated report. This includes taking account of the extent to which effects on resources have been externalized (i.e. the costs or other effects on resources that are not owned by the organisation).
Externalities may of course be positive or negative, i.e. they may result in a net increase or decrease to the value embodied in the capitals/resources. Externalities may ultimately increase or decrease value created for the organisation; therefore providers of financial capital need information about material externalities to assess their effects and allocate resources accordingly. Because value is created over different time scales and for different stakeholders through different resources, it is unlikely to be created through the maximisation of one resource to the detriment of others. For example, the maximisation of financial capital (e.g., profit) at the expense of human capital (e.g., through inappropriate human resource policies and practices) is unlikely to maximize value for the organisation in the longer term.
All organisations depend on various types of asset/resource for their success and sustainability. These assets/resources are stocks of value that are increased, decreased or transformed through the activities and outputs of the organisation. For example, an organisation’s financial capital is increased when it makes a profit, and the quality of its human capital is improved when employees become better trained.
The overall stock of resources is not fixed over time. There is a constant flow between and within them as they are increased, decreased or transformed. For example, when an organisation improves its human capital through employee training, the related training costs reduce its financial capital. The effect is that financial capital has been transformed into human capital. Although this example is apparently simple and presented only from the organisation’s perspective, it nonetheless demonstrates the continuous interaction and transformation between the capitals. Expenditure on training (Learning and Development) should result in improved productivity, which will in turn serve to increase the organisation’s financial capital. This raises the question of whether expenditure on training should be viewed as a cost or an investment in the organisation’s future sustainability. Many, arguably most, activities cause increases, decreases or transformations that are far more complex than the example given and involve a broader mix of resources, or of components within a particular resource. Although organisations aim to create value overall, this can involve the diminution of the value stored in some resources, resulting in a net decrease to the overall stock of assets/resources. In many cases, whether the net effect is an increase or decrease, or neither, i.e. when value is preserved will depend on the perspective chosen; as in the above example, employees and employers may value training differently. In the Framework, the term value creation includes instances when the overall stock of capitals/resources is unchanged or decreased.
The capitals contained within the Framework, which can also be described as assets/resources, are defined by the IIRC as:
• Financial capital – The pool of funds that is: available to an organisation for use in the production of goods, or the provision of services o obtained through financing, such as debt, equity or grants, or generated through operations or investments;
• Manufactured capital – Manufactured physical objects (as distinct from natural physical objects) that are available to an organisation for use in the production of goods, or the provision of services, including: buildings and equipment, infrastructure (such as roads, ports, bridges, and waste and water treatment;
• Intellectual capital – Organisational, knowledge-based intangibles, including:
o Intellectual property, such as patents, copyrights, software, rights and licences; and,
o Organisational capital such as tacit knowledge, systems, procedures and protocols.
• Human capital – People’s behaviours, competencies, capabilities and experience, and their motivations to innovate, including their:
o Alignment with and support for an organisation’s governance framework, risk management approach, and ethical values;
o Ability to understand, develop and implement an organisation’s strategy; and,
o Loyalties and motivations for improving processes, goods and services, including their ability to lead, manage and collaborate.
• Social and relationship capital – The institutions and the relationships within and between communities, groups of stakeholders and other networks, and the ability to share information to enhance individual and collective well-being. Social and relationship capital includes:
o Shared norms, and common values and behaviours;
o Key stakeholder relationships, and the trust and willingness to engage that an organisation has developed and strives to build and protect with external stakeholders;
o Intangibles associated with the brand and reputation that an organisation has developed; and,
o An organisation’s social licence to operate.
• Natural capital – All renewable and non-renewable environmental resources and processes that provide goods or services that support the past, current or future prosperity of an organisation. It includes: air, water, land, minerals and forests; and, biodiversity and eco-system health.
Not all are of equal relevance, or applicability to all organisations. While most organisations interact with all the capitals/resources to some degree, these interactions may be relatively minor, or so indirect that they are not sufficiently important to include in the integrated report .
The Framework does not require an integrated report to adopt the categories identified above or to be structured along the lines of the capitals. Rather, the primary reason for including the capitals in the Framework is to serve:
1. As part of the theoretical underpinning for the concept of value creation; and,
2. As a guideline for ensuring organisations consider all the forms of capital they use or affect.
Organisations may and almost certainly will categorise the capitals differently. For example, relationships with external stakeholders and the intangibles associated with brand and reputation (both identified as part of social and relationship capital), might be considered by some organisations to be separate capitals, part of other capitals or cutting across a number of individual capitals. Similarly, some organisations define intellectual capital as comprising what they identify as human, structural and relational capitals; a concatenation that may be inappropriate. If you accept the generally acknowledged premise that people (Human capital) represent any organisation’s greatest asset then treating human capital as a sub-set of intellectual capital serves to devalue the organisation’s greatest asset; an organisation’s intellectual capital is largely derived from its human capital. Regardless of how an organisation categorises the capitals for its own purposes, the categories identified in the Framework are to be used as a guideline to ensure the organisation does not overlook a capital that it uses or affects.
Those charged with an organisation’s governance are responsible for creating an appropriate oversight structure that also supports the ability of the organisation to create value. At the core of the organisation is its business model, which draws on various capitals as inputs and, through its business activities, converts them to outputs (products, services, by-products and waste). The organisation’s activities and its outputs lead to outcomes in terms of effects on the capitals. The capacity of the business model to adapt to changes (e.g., in the availability, quality and affordability of inputs) can affect the organisation’s longer term viability. Encouraging a culture of innovation is often a key business activity in terms of generating new products and services that anticipate/respond to customer demand, introducing efficiencies and better use of technology, substituting inputs to minimize adverse social or environmental effects, and finding alternative uses for outputs.
Outcomes are the internal and external consequences (positive and negative) for the resources as a result of an organisation’s (business) activities and outputs. Continuous monitoring and analysis of the external environment in the context of the organisation’s mission and vision identifies risks and opportunities relevant to the organisation, its strategy and its business model. The organisation’s strategy identifies how it intends to mitigate or manage risks and maximize opportunities. It sets out strategic objectives and strategies to achieve them, which are implemented through resource allocation plans.
Every organisation needs information about its performance, which involves setting up measurement and monitoring systems to provide information for decision-making. The value creation process is not static; regular review of each component and its interactions with other components, and a focus on the organisation’s outlook, lead to revision and refinement to improve all the components.