Will Integrated Reporting improve sustainability?

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– Dr Dale Tweedie and Prof. Nonna Martinov-Bennie.

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If the Integrated Reporting Framework is successful in engaging business and investors, how – if at all – will this success affect sustainability?

This is the first of a series of short blogs that address this question, based on a new article published in the Social and Environmental Accountability Journal in February, 2015.

What is sustainability?

The word ‘sustainability’ has many different meaningsWe use the term to refer to a replicable and just use of social and natural resources. This is the ideal of sustainability made famous by the World Commission on Environment and Development’s definition of sustainability as ‘meet[ing] the needs of the present without compromising the ability of future generations to meet their own needs’.

One difficulty with assessing how the Integrated Reporting framework will affect sustainability is that the International Integrated Reporting Council (IIRC) itself uses the word ‘sustainable’ to mean two quite different things:

  • Sustained value creation; which refers to a company’s ability to continually create value over time; and
  • Natural and social sustainability; which refers to companies that consider how their actions are connected to, or impact, society and the environment.

These two ideas are linked, but they are not synonymous. For example, an energy company might profitably sustain itself extracting and selling fossil fuels for many years, without necessarily considering its impacts on global warming or accounting for the costs that future generations will bear.

How Integrated Reporting will not affect sustainability

Integrated Reports require companies to consider natural and social capital, but an Integrated Report is not a sustainability report.

Sustainability reports typically require businesses to explain more fully how their activities impact societies (e.g. work, health and safety reporting) and natural environments (e.g. recycling and energy use).

In a sense, Integrated Reporting does the reverse: An Integrated Report aims to better explain how society impacts business.

One partial but useful way of thinking about Integrated Reporting is as expanding companies’ balance sheets to better represent how companies depend on non-financial resources, including resources or ‘capitals’ the company does not or cannot own. For example, in an Integrated Report, social capital might reflect how companies’ supply chains and sales depend on a hidden web of trust and goodwill, as well as on its monetary wealth and physical assets.

But an Integrated Reporting ‘balance sheet’ is still organised from the companies’ point of view, rather than from external stakeholders’ view of how the company impacts them. More precisely, an Integrated Report is organised from the point of view of how social, natural and other capitals enable companies to create financial value, especially over the longer term.

So if Integrated Reporting is to improve sustainability, it can’t be in the same way as sustainability reports.

How Integrated Reporting might affect sustainability.

Integrated Reporting might affect sustainability if bringing new types of capital into mainstream business reporting and business models helps to improve how companies interact with their communities and natural environment; such as by being more responsive to harmful effects that are not priced into conventional markets.

Our recent article considers four possible ways that IR could impact natural and social sustainability in this way:

  • By changing how organisations communicate
  • By encouraging integrated thinking
  • By better representing stakeholders’ ‘legitimate interests and needs’
  • By better capturing the long-term impacts of how organisations use resources.

In our upcoming blogs, we will review each of these possibilities in more detail.

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Any comments or thoughts are most welcome.

Safety at Work: Policy meets performance

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???????????????????????????????????????????????????????????????????????????????????????????????????????????????????????discussion of Dr Sharron O’Neill’s research with Safe Work Australia in late 2014 – by WHS consultant Kevin Jones – highlighted how better WHS accounting might improve both work, health and safety (WHS) policy and performance.

Jones reported on the 2014 annual Australian Council of Trade Unions (ACTU) conference on occupational health and safety, which was held in Melbourne last October. The conference was addressed by the ALP Shadow Minister for Employment Relations: Brendan O’Connor MP.

According to Mr O’Conner, the Royal Commission into the Home Insulation Scheme risks distracting attention from broader deficiencies in the WHS laws that should ‘protect the interests of working people, particularly young workers’.

Whether legal reform can improve WHS outcomes is a matter of debate. Jones’s view is that the needed changes are:

unlikely to come through laws, particularly as OHS/WHS laws remain a State responsibility. Change will need to be attempted through modifying the public services’ processes of consultation and collaboration of safety-related matters.

However, the Shadow Minister also discussed the economic argument for improving WHS policy and performance, which suggests that WHS accounting has a critical role to play:

If you look at the costs that are borne by a community because of bad health and safety laws, on economic grounds you win the argument, leave aside the fact that you’ve torn a family or community apart because of injury or death.

If the economic grounds of WHS are indeed central to the public policy argument, then accounting needs to be able to bring the costs of WHS into both public policy discussions and organisations’ reports in a clear and comparable way.

As Dr O’Neill’s presentations on WHS reporting have shown, both financial and non-financial accounting has some way to go to adequately recognise either the community or organisational costs of WHS practices, or to effectively communicate good WHS practices to stakeholders.

But if the current standard of WHS reporting is part of the problem, then new WHS reporting mechanisms, which Dr O’Neill’s research is helping to develop, have the capacity to be an important part of the solution.

For more information on this research, or on improving WHS performance in your organisation, contact Dr O’Neill at: sharron.oneill@mq.edu.au.

Learning the Lessons: Alan Cameron on Audit Committees at the joint IGAP & CPA Australia Annual Forum.

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Camerron photoAlan Cameron AO used his address to the IGAP and CPA Australia Annual Forum in 2014 on ‘The evolving role of audit committees’ to draw lessons from the HIH and Centro cases for contemporary audit committees.

Cameron is current Chair of the ASX Corporate Governance Council and several large public companies, and also a former Deputy Chancellor of the University of Sydney.

He addressed the IGAP and CPA Australia Annual Forum in his personal capacity, drawing on his extensive experience to provide insights into what the Centro and HIH judgements reveal about good audit committee practice.

Cameron’s keynote address emphasised directors’ role in addressing governance issues early, rather than becoming ‘gatekeepers’ after the fact:

‘To me gatekeepers are auditors and regulators and other people who look at the results afterwards. I think directors are rather earlier in the line than gatekeepers’.

Looking back over the Centro and HIH cases, Cameron highlighted three key lessons for how boards and audit committees can best execute their functions.

  1. Keeping the board and audit committee separate

The HIH judgement underscored how audit committees need to meet separately from the board if the accounts are to be examined rigorously. In Cameron’s words:

‘If the whole board is involved in the work of the audit committee, the audit committee is not doing its job. Its job is to have a first detailed look and if the whole board is there all the time as a matter of routine that isn’t going to happen’.

‘To me a troubling aspect of the processes of the HIH audit committee was its practice of meeting before and effectively in the presence of the board. As a result of that practice it operated as little more than an extension of the board… I see that now all over the place’.

  1. Making time to review financial reports properly

Another impediment to rigorously examining the accounts is not allowing the audit committee and the board time to consider the financials properly. Among other issues, the HIH judgement criticised ‘the practice of the six monthly financial reports being considered by the audit committee, approved by the board and announced all on the same day’.

Not only do directors need time between meetings to adequately review the financial reports, they also need time to access the right people:

‘The audit committee should meet auditors in the absence of management before or in the course of each meeting or at least from time to time. The material should be distributed well in advance of a committee meeting’

  1. A clear audit committee charter

Cameron’s analysis of the HIH judgement also highlighted the absence of a clear role for the audit committee in that company. By contrast, a clear and detailed charter can help define and clarify the audit committee’s role:

‘The [HIH] charter is short and the terms of reference are couched in general language. They do not clearly define and establish the role and responsibilities of the committee and its relationship to the board. There is no evidence that the terms were reviewed annually to see that the committee in its role remained relevant to the needs of HIH. So I think the clear message from that is short might be dangerous. You do need to review it every year’.

Learning the Lessons

Although Cameron’s address focused on audit-committee practice, he also reminded participants of the whole board’s responsibilities under law:

‘Whilst an audit committee has an important role of monitoring oversight that is not to the exclusion of the role of a director to consider the financial accounts for him or herself’.

Cameron concluded by highlighting several practices that directors might adopt, including:

  • Insisting on reviewing paper copies of the reports;
  • Checking organisations’ systems for dealing with whistle-blowers; and
  • Paying attention to internal audit.

Ultimately though, Cameron stressed that there is no substitute for directors using their limited time to investigate the right issues:

‘We can set up all these structures, but if people don’t ask the right questions, and be appropriately sceptical, then you will still have these problems’

What does the market expect of audit committees? Michael Coleman at the joint IGAP & CPA Australia Annual Forum.

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MC picWhat does the market expect of audit committees? Increasingly, ‘everything’, Michael Coleman told the Annual Forum, held in October, 2014.

The joint IGAP and CPA Australia Annual Forum gathers leaders from industry, the accounting profession and academia to address key issues in contemporary governance and performance.

This year’s topic – ‘The  evolving role of audit committees’ – explored how audit committees are responding to rapidly evolving risks, liability, technological advancements and complexity in reporting, among a myriad of other challenges.

Coleman was Chair of the Financial Reporting Council (FRC), sits on a number of prestigious boards and has also had 30 years as an audit partner. He used his keynote address to highlight a potential expectations gap between what markets expect of audit committees and what directors can reasonably deliver.

Coleman highlighted several key challenges that audit committees are facing:

  • Changing expectations of regulators and the market; for example, that audit committees should be satisfied that auditors are doing their job or commenting on financial reviews;
  • A greater focus on risk; and
  • The proliferation of reports (e.g. Integrated Reporting).

A particular difficulty Coleman highlighted is the expectations for audit committees to form a judgement on audit quality:

“So whether it’s a good audit or not a good audit is a tough one and this is something that as audit committees we’re probably going to have to take a reasonable amount of time to consider.”

“We need to question amongst other things whether or not the auditor has been sufficiently sceptical. Now, how does an auditor demonstrate to the board that they’ve been sceptical?”

Coleman also highlighted how Australia has to some extent followed the United States trend of increasing the responsibilities of audit committees:

“In particular in my experience it’s become common for audit committees to approve fees over a certain level in relation to non-audit services provided by the auditor and audit committees have taken on a far more extensive role in relation to overseeing the financials.”

However, unlike in the United States, Australia still sees the audit committee as a sub-committee of the board:

“It’s not a separate creature, it’s not a separate animal and so therefore, and especially following Centro, we have the situation where boards, very, very rigorously in my experience, are actually as a whole considering the financials.

“The audit committee might look at the detail, but then the board as a whole still wishes to satisfy itself that it’s actually doing the right thing.”

Finally, Coleman observed how the expectations on audit committees would continue to evolve in the future with the release of a new auditing reporting standard in June 2016, which “will require the auditor’s report to include commentary on their key audit matters”. The new standards are likely to some interesting discussions, and to some changes to the dynamic of the relationship between the auditor and audit committee.

Communicating Safety: Avoiding common mistakes

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???????????????????????????????????????????????????????????????????????????????????????????????A discussion by James Harkness (for Zenergy Recruitment), headed Reporting on WHS: where companies go wrong, illustrates how IGAP’s Dr Sharron O’Neill’s research on work health and safety (WHS) can improve how organisations communicate their safety practices.

Harkness cites Dr O’Neill’s presentation at Safe Work Australia’s Virtual Seminar Series in October, which found a large gap between the WHS information stakeholders want and what annual reports provide.

Some common mistakes organisations make are:

  • Providing a generic statement of commitment to WHS, but without detailed information on WHS governance;
  • Failing to provide key lead and lag indicators, which can deliver important evidence on whether WHS practices are effective;
  • Providing limited evidence on whether audits and training sessions are effective;
  • A lack of consistent indicators and evidence e.g. Using different names for the same indicator, failing to define their indicators or failing to stick to their definitions;
  • Being reluctant to talk about the severity of injuries, effectively hiding the impact of gaps in companies’ health and safety systems; and
  • Building inaccurate narratives around their data.

By contrast, for best-practice WHS reporting in annual reports, organisations should:

  • Recognise who the users of the report are;
  • Clearly articulate their WHS vision;
  • Identify their critical risks;
  • Outline how risks are being managed; and
  • Acknowledge the consequences of failure;
  • Provide analysis where there has been a serious injury or illness: What happened, what was the cause, what is the lesson, what is being done to prevent this occurring again.

Where poor WHS reporting can be confusing or misleading, Dr O’Neill’s address highlighted how best-practice WHS reporting in annual reports can help instil confidence in an organisation’s WHS performance and practices in its stakeholders.

For more information on this research, or on improving WHS performance in your organisation, contact Dr O’Neill at: sharron.oneill@mq.edu.au.

Audit, Aristotle and the Clean Energy Regulator

The Clean Energy regulator used its Annual Audit and Assurance Workshops held earlier this year to emphasise the importance of audit to the agency. This including having two members of the regulator – Annie T. Brown and Michael D’Ascenzo – as keynote speakers to ‘reinforce the point that the Clean Energy Regulator takes its audit functions very seriously’.

IGAP’s Prof. Nonna Martinov-Bennie, who also sits on the Australian Auditing and Assurance Standards Board (AUASB), was also a keynote speaker.

Prof. Nonna Martinov-Bennie presented on the key audit concept of ‘professional scepticism’. The presentation was based on in-depth interviews with senior audit practitioners, and covered a number of aspects of professional scepticism and their practical implications. Prof Martinov-Bennie also highlighted the apparently conflicting views of audit scepticism as a relatively fixed character trait, but also a ‘skill’ that can be trained over time.

The presentation introduced an ‘Aristotelian’ idea of professional scepticism – developed in collaboration with A/Prof Dyball and Dr Dale Tweedie – which shows how these seemingly contradictory elements of audit scepticism might be resolved. Far from being simply ‘academic’, Prof. Martinov-Bennie outlined important practical implications of understanding audit scepticism in this way.

Prof. Martinov-Bennie and A/Prof Dyball also presented their research findings at the ICAA academic leadership series. Slides of both presentations are available below:

Clean Energy Regulator Presentation >

< ICAA Academic Series >

For more information on this research and analysis, contact: nonna.martinov-bennie@mq.edu.au

How Managing Tax Risk Impacts Tax Compliance

A recent study by Dr Catriona Lavermicocca, in the Department of Accounting and Corporate Governance at Macquarie University, and Professor Margaret McKerchar from the University of NSW, provides insight into the tax risk decision-makers and the tax risk management practices of large Australian companies.

????????????????????????????????????????????????????????????????????????????????????Benefits of Tax Risk Management

The study is based on in-depth interviews and a survey of tax decision makers from large Australian companies (turnover exceeding $250 million). It finds that companies that identify and manage tax risk improve their compliance behaviour in several ways:

  • Management of tax risks reduces the company’s acceptable level of tax risk;
  • Directors and tax decision-makers, including the CEO, CFO and tax manager, are more informed concerning the tax risk to which the company is exposed; and
  • In a majority of large companies, a tax risk management system identifies both non-compliance with the income tax laws and new opportunities to minimise income tax. It ensures that companies act on the tax issues they identify, and place greater importance on income tax compliance.

Tax Management Systems

Although identifying and managing tax risks does improve the income tax compliance behaviour of large companies, the study finds that the effects of managing tax risk depends on the specific tax risk management system.

Effective systems of managing tax risk improve the flow of information about tax risks within a company. More precisely, the systematic consideration of tax risk throughout a large company assists the company to achieving the tax risk profile it seeks.

Ultimately numerous factors, including pressure from shareholders and other stakeholders, influence the board’s decision about an acceptable tax risk profile. Nonetheless, this research found that a tax risk management system tends to lower the level of tax risk that company decision-makers find acceptable.

Understanding – not eliminating – tax risk

Tax adjustments and amendments still occur despite having a tax risk management system in place. These arise for various reasons, including ATO audits or when companies identify their own errors and make a voluntary correction.

Large companies also indicate that they are increasingly required to obtain the advice of an external tax specialist in an effort to minimise the risks associated with uncertainty and complexity of tax laws, despite the additional cost.

Whilst a tax risk management system cannot identify or control all external risks, the study shows that a documented and operationalised tax risk management system ensures that decision-makers are at least more aware of the tax risks they face.

– Dr Catriona Lavermicocca and Professor Margaret McKerchar