Staying focused while reporting holistically
September 2016 User View by Lisa French, Chief Technical Officer, International Integrated Reporting Council (IIRC), London and Stathis Gould, Head of Professional Accountants in Business and Integrated Reporting, International Federation of Accountants (IFAC), New York
THE IIRC’s International <IR> Framework requires that an integrated report explain the factors that affect the organization’s ability to create value over time. Focusing on core matters encourages meaningful and manageable reports that support decisions.
We recognize that the concept of value is highly subjective. Some organizations express value solely in the context of financial returns. Others view the concept more broadly, perhaps in terms of fulfilling unmet market needs or advancing a particular mission. Recognizing that interpretations vary, the International <IR> Framework is non-prescriptive, but highlights that value created for the organization (enabling financial returns to providers of financial capital) is linked to value created for others, including key stakeholders and society at large.
The emphasis on material matters improves decision-making by users of integrated reports by:
• Focusing attention on core issues managed by the organization
• Limiting extraneous information
• Supporting concise, digestible content.
Applying the definition of materiality is as much an exercise in excluding immaterial items as it is identifying and disclosing material matters. This benefits both the users and preparers of integrated reports. The Framework’s dual emphasis on materiality and conciseness seeks to avoid information overload and obfuscation of core issues. This leads to a sounder understanding of the organization, its value creation process and the management of that process.
Some find it challenging to navigate the range of materiality definitions across reporting regulations, standards and frameworks. It is important to understand the role of context and perspective as foundations for materiality definitions and assessments. The frames of reference for applying the concept vary across different report forms (for example financial reporting, sustainability reporting and integrated reporting). Attributes such as purpose, audience and scope vary, leading to different considerations in determining materiality.
In the context of Integrated Reporting, the materiality determination process considers the following parameters:
Purpose. To explain to providers of financial capital how the organization creates value over time.
Audience. Primarily providers of financial capital. Others interested in the organization’s ability to create value will also benefit from the integrated report.
Scope. Generally, how strategy, governance, performance and prospects – together with external factors – influence the organization’s ability to create value. Where possible, information should be framed in terms of implications on future value creation, rather than only in terms of what is or has been.
The materiality approach in Integrated Reporting differs from that in pure financial reporting, where the subject matter is more precisely prescribed in international and national reporting standards. In financial reporting, the scope of information included is anchored to financial matters; therefore, so too are materiality decisions.
A common challenge expressed by organizations is that they apply a regulated and legal definition of materiality for financial and regulatory reporting, on the one hand, but another in the context of voluntary reporting, on the other. To manage this challenge, organizations can improve the efficiency of their business reporting by identifying where report strands are mutually supportive. For example, in applying their duty to disclose information under securities or corporate law, the board, supported by management, should consider how regulatory disclosures relate to the integrated report. Or, viewed the other way around, matters flagged as material in Integrated Reporting may be subject to disclosure under company and securities law.
Other frameworks can support the evaluation of content for integrated reports. International Financial Reporting Standards and accounting standards established by national standard setters can be used to compile financial information. Similarly, the Global Reporting Initiative’s Sustainability Reporting Guidelines and the Sustainability Accounting Standards Board’s sector-specific standards support the preparation of sustainability-related disclosures. Issue-specific standards, such as the WRI/WBCSD Greenhouse Gas Protocol, can also help organizations compile key disclosures.
A materiality determination process should start by determining the parameters of the process. A logical starting point is to identify the activities, performance and impacts of the financial reporting entity. This includes the subsidiaries, joint ventures and investments over which the organization has control or significant influence. But examining the financial reporting entity alone can be limiting, particularly when the ability to create value is significantly affected by supply chain activities. Integrated Reporting requires that organizations think beyond traditional financial reporting boundaries to consider the fuller range of factors that influence value creation.
Having established the parameters of the materiality determination process, including the entities, activities and stakeholders to be considered, the organization follows three steps to filter key topics. The process involves identifying, evaluating and prioritizing relevant matters. To identify relevant matters, we advise reporters to consider issues that:
• Could substantively affect value creation
• Link to strategy, governance, performance or prospects
• Are important to key stakeholders
• Form the basis of boardroom discussions
• May intensify or lead to opportunity loss if left unchecked
Matters that might be relatively easy to address in the short term but which may, if left unchecked, become more damaging or difficult to address in the medium or long term need to be included in the population of relevant matters. Matters are not excluded on the basis that the organization does not wish to address them or does not know how to deal with them.
The above list recognizes that matters relevant to value creation are typically discussed at board meetings. Such matters will often be addressed in the context of the organization’s value creation process or its strategic themes and objectives. It must be added, however, that the process of identifying and understanding relevant matters is dynamic. Matters on the board’s agenda will not necessarily be complete at any given time, and stakeholders may have changing expectations, needs and interests. The current board agenda cannot necessarily be considered a full picture of all relevant matters.
The IIRC emphasizes the importance of evaluating the possible magnitude of a relevant matter’s effect, in addition to its likelihood of occurrence. Note that the magnitude is not necessarily expressed in financial terms or, for that matter, in quantitative terms. Evaluating the magnitude of effect involves a consideration of: (i) quantitative and qualitative factors, (ii) financial, operational, strategic, reputational and regulatory perspectives, (iii) area of the effect, be it internal or external, and (iv) time frame of the effect. Once the population of important matters is identified, they are prioritized based on their magnitude.
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