Martin Lunt 18 Jun 2018 09:35am

Why integrated reporting is the way forward

Integrated Reporting – which encourages long-term thinking and value to society rather than short-term profit to shareholders – is the future of financial reporting, writes chartered accountant Martin Lunt

Caption: Martin Lunt explains why integrated reporting is the future of financial reporting

The International Integrated Reporting Council (IIRC) is a global coalition of regulators, investors, companies, standard setters and the accountancy profession. It has produced The International IR Framework (IRF), which explains integrated reporting (IR). The Big Four have all produced their own reports on how they see IR as the future for financial reporting.

IR aims to communicate the full range of factors used to create value, not just in the short term but also in the medium and long terms, thus moving beyond the short-termism endemic within enterprises. The IRF refers to these factors as the “capitals”, which can be categorised as financial, productive tangible fixed assets, intangible intellectual property, human and natural resources.

An IR is addressed to all stakeholders in an enterprise, not just the shareholders. The stakeholders include employees, customers, suppliers, business partners and the local community. An IR recognises that the value an enterprise creates not only benefits its owners but this wider community. An IR should provide an insight into the nature and quality of an enterprise’s relationships with these stakeholders, and how and to what extent the enterprise takes into account and responds to their legitimate needs and interests. The use of the term “value” and not “profit” in the IRF is relevant – profit belongs to the shareholders; value belongs to society.

The IRF is principles-based and therefore does not give a detailed description of the contents of an IR. If financial reporting is to meet the needs of all stakeholders, as the IRF suggests, then a statement of how value is created and distributed is required. Such a statement is the “value added statement” (VAS) and I believe these should be included in IRs. A VAS is necessary if an IR is to have a measure of performance that shows how the “capitals” have produced value. But two issues need to be addressed with VASs – the basis of preparation and the usefulness of the information. And there are numerous technical matters involved with the preparation. Value is an example.

The IRF does not define value, presumably it’s the value measurement normally used in financial reporting, the marginal utility theory. Alternative theories of value exist, for example the labour theory of value. The difference between these can be illustrated by fair value adjustments – do these create value or just transfer value? Similarly, interest received should not be considered part of the “value” created by an enterprise.

Another preparation matter is employees: salaries are shown inclusive of PAYE and NI in a profit and loss account. In a VAS, it may be argued that the share taken by an employee is net wages and the government share should include PAYE and NI. Where an enterprise includes welfare facilities, for example a gym, these could be included as part of the employees’ share.

Then there’s government: in a profit and loss account, the tax charge is company taxation. In a VAS the government share should also include other taxes, for example, business rates and employers’ NI, less any government grants received. A deeper analysis would include for example, road fund licenses and excise duties. Although taxation is shown as a distribution, it should be recognised that some is re-distributed to employees e.g. as working tax credit and the welfare state, and to entities (e.g. as investment allowances and the infrastructure). An understanding of these taxes can lead to a debate on the tax base and an appropriate level of company taxation.

The second issue is whether a VAS would be useful as part of an IR. Since IR is focussed on society as a whole, a VAS is useful as it can provide an insight into important trends in an economy. Examples include: employees and productivity. The low labour productivity in the UK economy has been a problem for a number of years. Data on this issue could be extracted from the VAS by dividing value added by the number of employees to give productivity in an individual company. A further problem may be the fall in the share of value added taken by employees – this may arise from the developing use of the “capital” in robotics and artificial intelligence. This has implications for unemployment, inequality and lack of demand in the economy. If the share taken by employees falls, then that of capital will rise.

A frequent argument is that finance capital can justify its return because of the risk it takes. However, in recent times part of that risk has been transferred to those “employees” who are regarded as self-employed, and those on zero hours contracts, who are not paid if there is no work, which was previously a risk of finance capital.

Accountants have been aware of the increasing value of intangible assets on company balance sheets. This is also reflected in the increasing value of the information content of products compared to their material value, for example the sophisticated software in a car. While developments in software undoubtedly add value, it may be argued that the patent laws are over-generous in protecting intellectual property rights and that licence and royalty fees are paid long after value has been created, and are thus part of value distributed and not an input to value created. These payments should be shown separately in a VAS and monitored as part of the “information” economy.

The appropriation section of a VAS shows the percentage taken by stakeholders. It is not the absolute percentages distributed to stakeholders that are important but how these change over time. The VAS is about understanding how the economy works at the enterprise level. This data can feed into national statistics and inform decisions at the national level.