12 Dec 2018 10:17am

Evolving an accounting ecosystem

The profession has an essential role to play in evolving an ecosystem that suits the new capitalism. Lesley Meall outlines how

Caption: Image: Getty Image

Trust in business, institutions, organisations and economic systems has been spiralling downwards for some time, and the accountancy profession has not been left untouched – or untarnished. But the profession is acknowledging the issues it faces and is considering and taking positive steps to address the trust deficit. A new capitalism is emerging and accountants are helping to shape this and their roles in it, by building a more accountable company reporting model.

The profession is looking away from the traditional historical picture of financial reporting and its audit to a future where deeper, broader company reporting is part of a new and enhanced trust ecosystem. It is considering culture and the role of business in addressing matters like inequality and sustainability; as well as trying to keep corporations honest. This is evident in ICAEW’s responses to the intense government and public scrutiny of audit and financial reporting that followed the failures of Carillion.

“2018 will be remembered as a pivotal year for our profession; one in which the crisis in public trust reached fever pitch, along with the need to instigate and embrace fundamental change,” says Michael Izza, ICAEW chief executive. Working with stakeholder groups, ICAEW is exploring how to enhance audit quality, its continued utility and relevance in changing business and economic conditions and supporting an Audit Quality Forum independent review of the purpose, scope and evolution of audit.

Evolving with expectations

Evolution is essential. “In our rapidly changing world with expanding social pressures, exponential technological change, growing populations and changing expectations, audit has an increasingly important role to play in providing trust in the capital markets and a growing accountability to wider society,” says Gilly Lord, head of audit strategy and transformation at PwC. Trust in audit and its assurance of company reporting may never before have mattered quite so much.

However, responsibility for the trust ecosystem does not begin and end with audit. “All ecosystem participants should be reflecting on the corporate information that people use for decision-making,” says Lord. This information set is much broader than the historical financial picture that has long dominated company reporting. Society today wants information on more than just the financial performance and position of a company.

Existing accounting frameworks contain a vision of the world, but they exclude a lot. “The evolution of capitalism will force an evolution in accounting. The profession has to consider what representation of the world is needed to enable decision-making that speaks better to the public’s concerns about the state of our societies and the natural environment,” says Richard Spencer, head of ICAEW sustainability. “What is excluded gets damaged.” That’s why ICAEW has added the UN Sustainable Development Goals and integrated reporting to its syllabi.

Enabling better decision-making

Interaction between non-financial and financial information and how this is reported and presented influence decision-making. Richard Howitt, chief executive of the International Integrated Reporting Initiative, says: “Integrated reporting builds trust by giving authentic information about the broader impact of the company – and the six capitals.” These are financial, human, intellectual and manufactured capital, social and relationship capital, and natural capital.

“A natural capital approach broadens the scope, quantity and quality of the information that organisations consider when they make decisions,” says Mark Gough, executive director of the Natural Capital Coalition, which is hosted at Chartered Accountants’ Hall.

“Understanding how your business depends on the natural world is essential for making informed decisions; for addressing risks in supply chains and investments; and developing opportunities for new products and business models.”

Accountants are in a strong position to help organisations to recognise that their dependencies on natural capital can provide a more complete picture of the true performance and viability of an organisation and that a failure to take this approach can leave businesses open to poor decision- making that assumes unnecessary risks. The profession can also help reframe the conversation around vulnerable groups in society such as the homeless, the elderly and refugees.

“The focus on economic value creation and the dominance of market norms in social policy means that the most vulnerable become invisible and social norms of an ethical, humanitarian, or quality of life character are crowded out,” says Spencer. “This means we know so little about homelessness in a way that matters.

There was an article in The Spectator that struck me. It noted that not only are the deaths of home- less people not investigated, they are not even counted. ICAEW is working with academics at Exeter University on research into accounting for the vulnerable, beginning with homeless- ness as a way of making them visible and to inform better decisions.” Regulators and legislators are also raising the bar for company reporting and minimising unnecessary risk (particularly in systemically important companies).

The UK Financial Reporting Council (FRC) is encouraging better disclosure of alternative performance measures; it recently revised its Guidance on the Strategic Report; and there is new legislation in The Companies (Miscellaneous Reporting) Regulations 2018.

The purpose of the strategic report is to inform and help shareholders assess how directors (at certain entities) have performed their duty to promote the success of the company under section 172 (s172) of the Companies Act 2006. The revised strategic report guidance places a greater focus on this, because the FRC believes that integrating non-financial information into the strategic report is a key part of telling a company’s story.

This guidance has also been updated to reflect the new legislation in the miscellaneous reporting regulations. From January 2019 they require a strategic report statement from large companies describing how their directors have performed their s172 duty to promote the success of the company. For example, by considering the interests of employees, suppliers, customers and other stakeholders, as well as impacts on the community and environment.

Moving with the times

“The revisions to the Guidance on the Strategic Report complement recent changes to the FRC’s Corporate Governance Code and as a package will contribute to enhancing trust and transparency in business,” says Paul George, the FRC’s executive director for corporate governance and reporting. The FRC wants to stimulate board-level discussions on how companies are considering various factors to ensure their business is sustainable over the long term.

“The whole trust ecosystem needs to move with the times,” says Lord, urging companies to commit to transparent and trustworthy corpo- rate reporting and disclosing what matters. “For example, companies need to address matters such as diversity and inequality through robust disclosures,” says Lord – and not just because of laws and regulations. “At PwC we disclosed our pay gap figures long before we were required to as we believe this is an area where honest and open disclosure can accelerate change.”

These sentiments are echoed by Hywel Ball, EY’s UK & Ireland managing partner for assurance and UK head of audit. “We recognise that trust in business is declining and, while not wholly responsible, a lack of transparency around company reporting is the way value is measured and communicated needs to closely align with its source and potential long-term impact perhaps contributing to the disconnect,” he adds, while noting another significant contributing factor: “The shape of value has changed.”

The way value is measured and communicated needs to closely align with its source and potential long-term impact.

Fresh thinking

In 2015, EY started to develop its own long-term value framework, before joining forces with the Coalition for Inclusive Capitalism on The Embankment Project (EPIC), an initiative looking at how all companies can better measure and communicate the long-term value they create [for more detail on EPIC see our interview in this issue with Lady Lynn Forester de Rothschild].

“The aim is to help companies to deliver trusted information to their key stakeholders in order to help improve the allocation of capital for the long term,” explains Ball. “The Embankment Project is a proof of concept for our original thinking,” he adds.

“At the end of this process, we aim to have agreed a common set of comparable metrics that will be better suited to measuring long- term value – and hopefully adopted industry-wide.” But a trust ecosystem for a more inclusive capitalism will require even more changes in what and how companies report.

The growth of so called big data and other digital technology developments (see box) are reshaping the landscape of what is possible and necessary. The financial reporting system was created in an industrial age, when physical assets made up the core of a company’s balance sheet. Growth of the knowledge economy means that more of a company’s value now lies in its intangible assets such as brand, culture and intellectual property. Ball says: “The time is ripe for change.”

Company futures

The private company as a legal entity, separate from its owners, has been one of the success stories of capitalism. But the ways in which companies operate is changing and some of the new business models emerging raise all sorts of thorny questions for those involved as buyers, sellers, owners, contractors, workers and the accountants advising them.

Existing systems of employment law and tax have developed along with the traditional form of capitalism, but they are struggling to keep up with “platform capitalism”. Companies such as Uber blur the line between employees and independent contractors; companies including eBay raise questions about the business status and tax liabilities of their “customers”.

However, while trust is diminishing in established economic systems and institutions, the distributed trust model of platforms is in the ascendancy. Airbnb has made us comfortable opening our homes to strangers; Zopa has made us comfortable lending money to strangers. This has profound implications for capitalism, its established power structures and any new trust ecosystem that could be built.