Will Integrated Reporting improve sustainability? Part III – Integrated Thinking

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dreamstime_s_33567037Dr Dale Tweedie and Prof. Nonna Martinov-Bennie.

This is the third of five blogs on whether and how Integrated Reporting might contribute to sustainability.

In this blog, we consider the International Integrated Reporting’s Council’s (IIRC) objective of promoting ‘integrated thinking’.

In a sense, integrated thinking is more fundamental to Integrated Reporting than the final report itself, because the IIRC has defined Integrated Reporting as ‘a process founded on integrated thinking’.

In other word, the primary function of the Integrated Report is to communicate the changes in outlook and organisational practice that Integrated Reporting processes should have generated.

What is integrated thinking?

The IIRC defines integrated thinking as ‘the active consideration by an organisation of the relationships between its various operating units’.

As we explore in a recent article, integrated thinking has two main parts:

  1. Understanding and dialogue that stretches across an organisation’s operating units. For example, reporting and assurance on carbon emissions in mining operations might facilitate integrated thinking by requiring the accounting team to collaborate with scientific experts to measure and document carbon output.
  2. A more holistic understanding of how the organisation interacts with internal and external stakeholders. In particular, the IIRC claims that integrated thinking involves a ‘fuller consideration of stakeholders’ legitimate needs and interests’.

This suggests that integrated thinking should change both how managers see their organisation and how their organisation functions. Indeed, these two types of changes are inextricably linked: Integrated reporting should help managers better understand their organisations precisely because it stimulates more open dialogue across its constituent parts (or ‘silos’) and external stakeholders.

What are the implications for sustainability?

Early research has questioned whether integrated reporting is so far creating the type of changes the IIRC envisages. For instance, Stubbs and Higgin’s (2014) study of early adopters found incremental changes to sustainability reporting practices, rather than the more extensive and transformative organisational changes that integrated thinking seems to imply. A recent IIRC report also finds incremental changes in many organisations, but emphasizes the potential for integrated thinking to emerge over time. One of the IIRC’s participants suggests that – in practical terms – integrated thinking typically develops through producing multiple integrated reports.  

Nonetheless, it is possible to identify both positive and negative aspects of the IIRC’s approach to integrated thinking for sustainability.

POSTIVE: The IIRC’s emphasis on Integrated thinking is entirely consistent with its focus on improving how organisations communicate. Since a key part of integrated thinking is understanding other stakeholders’ views and interests, integrated thinking might improve organisations’ awareness – and the awareness of managers in particular – of sustainability issues.

NEGATIVE: Integrated thinking is a relatively weak accountability mechanism, because whether integrated thinking is occurring, and how well, cannot be directly disclosed, measured or audited (despite the IIRC’s growing focus on assurance). For example, integrated thinking may prompt management to better understand the ‘legitimate needs and interests’ of their organisations’ workers. However, it is difficult to measure or enforce this understanding, especially compared to the Global Reporting Initiatives requirement for organisations to report against International Labour Organisation benchmarks.

Moreover, and as previously discussed, the IIRC is yet to clarify what concrete processes organisations should use to engage their stakeholders. Hence, more could be done to explain what management can do to gain the broader understanding of stakeholders’ views and interests that integrated thinking entails.

In our next blog, we will consider in more detail to what extent Integrated Reporting might improve sustainability by capturing stakeholders’ ‘legitimate interests and needs’ better than alternative reporting frameworks.

As always, any comments or thoughts most welcome. If you wish to be e-mailed future blogs, please subscribe to this blog.

Economic Inequality: Where are the accountants?

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dreamstime_s_53174060Dr Dale Tweedie and Dr James Hazelton

Rising inequality in income and wealth is one of the biggest contemporary social and economic concerns, but accountants have been surprisingly quiet on this issue.

Concerns over economic inequality

The growth of economic inequality is increasingly a topic of public debate in countries like the United Kingdom, the United States and Australia.

Numerous influential – and typically conservative – economic institutions have now identified growing income inequality as a critical economic and social issue. The World Economic Forum listed deepening income inequality as number one on its top ten trends of 2015, and describes growing inequality as a threat to global economic growth, social cohesion and sustainability. The International Monetary Fund has reported that inequality in developed nations is at its highest level in decades, with ‘significant implications for growth and macroeconomic stability.’ There is also growing evidence of serious and widespread social harms from economic inequality, with economic inequality being linked to social ills ranging from poor physical and mental health to drug addiction to rates of violent crime.

Public debates over inequality have created an all too-rare cross-over between academic research and public concerns. French economist Thomas Piketty’s 685 page treatise on economic inequality was a surprise hit of 2014, reaching the top of the New York Times’ best-seller list. While Piketty’s analysis of the causes of economic inequality is hotly disputed, there is little challenge to his finding that income inequality has sharply risen in most developed nations since the 1970s. For example, in the United States, Piketty reports that the top decile’s share of national income grew from just under 35% in 1970 to almost half by 2010.

A role for accountants?

Despite growing evidence of the economic and social costs of inequality, accountants have had little involvement in either public or academic debates. However, as we observe in a recent article (50 free e-copies here), there are key contributions that accountants could make to public discussions

First, as Piketty and others have argued, both public deliberation and informed public policy about economic inequality requires greater global transparency about who owns economic wealth and receives economic income. Whatever else it may be, accounting is a vehicle – albeit imperfect – for understanding and promoting transparency. Accountants might therefore add their voice to calls to improve public access to economic information, such as in the recent debate over whether taxes paid by resource companies to governments should be disclosed.

Second, key debates about the equity of income distribution, such as ongoing critiques of the pay of executives (especially CEOs), are closely connected to corporate governance. While economists have proposed macro level policies like a progressive tax on capital (Piketty) and a minimum basic income, seriously addressing inequality will invariably need to address how resources are managed and distributed within corporations. Accountants have the expertise to evaluate existing corporate accountability mechanisms and propose workable alternatives. These proposals could complement the broader macroeconomic agenda that economists like Piketty put forward.

What do you think?

Is there is a role for accountants on economic inequality? And if so, what do accountants – or accounting – have to say?

Accounting for inequality will be the subject of a special session of the Australasian Centre for Social and Environmental Accounting Research (CSEAR) Conference, which will be held at Macquarie University, Sydney in 2015, and also a special section of the Accounting, Auditing and Accountability Journal.

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

Why governance can’t ignore safety

A recent Four Corner’s report (screened 3/2/2014) on road safety and the heavy vehicle transport industry in Australia revealed the human toll of work-related accidents: 242 people killed in truck-related accidents, and many more injured, in just one year. According to Four Corners, safer work practices might have avoided many of these tragic events.

The Four Corners exposé highlights, in two interrelated ways, the fundamental importance of work health and safety (WHS) to all businesses.

truck_givewayphot1. Effective business governance includes effective governance of WHS.

The new WHS Act (enacted in all States but WA and VIC) requires all officers of a business or undertaking (PCBU) to exercise due diligence so as to ensure the health and safety of workers. The Act explicitly requires all businesses to provide safe systems of work – including safe equipment, safe processes and work methods (such as appropriate rosters, supervision, instruction etc.).

The Four Corners program drew particular attention to the potential health and safety implications of deferred maintenance. This is especially relevant to accountants, given their role in allocating budgets for maintenance programs. Moreover, recent research suggests that accountants are less likely than operational personnel such as engineers to perceive maintenance as even having been ‘deferred’.

2. Health and safety risks requirement management along the entire supply chain.

The Four Corners program also documented how a fatal incident on Sydney’s North Shore in October 2013 prompted an external safety investigation into the Cootes transport fleet. Impacting along the supply chain, this incident resulted in retail fuel shortages along the east coast while road safety checks were carried out on hundreds of Cootes vehicles. For example:

Frustrated Melbourne motorists again faced empty bowsers for some types of fuel or complete service station shutdowns today because of disrupted deliveries, with about 25 Caltex, 30 per cent of BP and a number of Shell ­outlets affected. BP spokesman Jamie Jardine said the company would have difficulty maintaining fuel supplies until all of the [Cootes] trucks were back on the road. (Herald Sun, October 10, 2013)

The vehicle checks identified more than 200 defects, many being major defects in safety critical systems such as brakes, steering and suspension. Three months on, the transport company has this week announced the loss of a major contract with Shell to distribute its fuel. The potential for safety issues to pose a risk to the well-being of workers’ and bystanders is clear. These events further demonstrate the potential for poor safety to also impact on the financial performance of both suppliers and purchasers.

Safety and Corporate Responsibility: Systemic Issues

Concerns over the role of payments, subcontracting, incentives and safety are not new. Similar issues raised by the NSW Staysafe Inquiry into Road Safety almost a decade ago, formed the basis of a research note published in the Accounting, Auditing and Accountability Journal in 2007 by IGAP researcher Dr Sharron O’Neill.

The pervasive nature of this problem raises serious questions, explored by Four Corners, about the sustainability of heavy transport business model and the corporate responsibility of business practices. Low wage rates for contractors and drivers coupled with increasing fuel and other transport costs were reported to still be providing incentives for long hours and excessive speed.

Four corners identified two factors motivating these unsafe behaviours.

1. Some drivers reported being directed by transport managers to meet “impossible deadlines”. Importantly, prosecutions and fines for subsequent speeding and log book infringements were falling on the drivers rather than those employers and companies who direct the systems of work. This alludes to a critical disconnect in enforcement processes that appears at odds with the legislated accountability of PCBUs under both the WHS Act (as outlined above) and the chain of responsibility legislation introduced by the National Heavy Vehicle Regulator. The latter suggests,

All parties in the road transport supply chain can be held responsible for their actions (or inactions) relating to breaches of the road transport, fatigue, speed, mass, dimension and load restraint laws.

If you consign, pack, load or receive goods as part of your business, you could be held legally liable for breaches of road transport laws even though you have no direct role in driving or operating a heavy vehicle.

2. Four Corners reported that unsustainably low wage rates lead drivers to work long hours to make a reasonable income. The Road Safety Remuneration Tribunal, established under the previous federal government in 2012, had proposed to examine pay and conditions and ensure ‘safe rates’ for heavy vehicle drivers. However, the future of ‘safe’ remuneration is already in doubt following a Federal Government review of the Tribunal which is due to be handed down by April 2014.

All in all, heavy vehicle safety is a complex problem with significant accounting and corporate social responsibility implications. We now wait to see the outcome of the government’s inquiry, and the response by the retail and transport industries to the Four Corners report. One would hope appropriate changes can be implemented before more lives are lost.

– Dr S O’Neill and Dr D Tweedie.

Podcasts: Ethics and the Professional Accountant

dreamstime_m_16826054In 2013 CPA Australia’s In the Black magazine hosted a series of informative and entertaining podcasts on ethical behaviour and the professional identity of accountants, with Professor Sally Gunz.

Sally is Professor of Professional Ethics and Business Law at the University of Waterloo in Canada, and the Director of the Centre for Accounting Ethics. She visited Macquarie University’s International Governance and Performance (IGAP) Research Centre in mid-2013, and discussed ethics with Dr Eva Tsahuridu, Policy Adviser at CPA Australia.

The pod-casts cover three themes:

1. common ethical challenges.

2. ethical obligations; and

2. professional trust, obligation and crises of consciousness;

This series explores ethical challenges facing professional accountants across different industries, including in public practice, not-for-profits, business and the public sector.

For Professor Gunz, the common ethical obligation for all professional accountants to consider is serving the public interest:

“It always comes back to the ultimate responsibility to serve the public. You have to remember as a professional of any stripe that even though you may act as a manager many times, you’re different from a manager.”

“You have additional responsibilities. You ultimately have the responsibility to your profession, which translates to serving the public.”

“You are there because of that responsibility. And when push comes to shove, if you don’t remember that, the question is, ‘Why are you there?’”

A good question to consider heading into 2014.

What promotes confidence and trust in the audit function?

Confidence in the financial reporting of established and emerging firms, the credibility of the audit function and perceptions of audit quality are critical to the success of the Australian economy, argue Professor Nonna Martinov-Bennie and Dr Alan Kilgore from IGAP, in an article published in the October 2012 edition of Think and Grow Rich.

?????????????????????????????????????????????????????????????????????????????Increased Scrutiny of Audit

In the wake of corporate collapses and the Global Financial Crisis,  what actually constitutes a high quality audit has come under public and regulatory scrutiny. This has most recently taken form in the establishment of the Advisory Committee on the Auditing Profession in the United States, and the release of key frameworks and documents internationally, including:

  • the International Auditing and Assurance Standards Board (IAASB)’s consultation paper: A Framework for Audit Quality (2013);
  • the Public Company Accounting Oversight Board’s Strategic Plan: Improving the Relevance and Quality of the Audit for the Protection and Benefit of Investors (2012);
  • the European Commission’s (EC) Green Paper Audit Policy: Lessons from the Crisis  (2010);
  • Audit Quality in Australia – A Strategic Review (2010); and
  • the Audit Quality Framework (2008) in the United Kingdom.

As Martinov-Bennie and Kilgore argue, the credibility of the audit function plays an important role in establishing and maintaining an effective and efficient capital market. There are public and private benefits to these efficiencies: the equitable distribution of investment gains; reliable financial statements that encourage a broader range of investors; and the potential for higher investment returns through reducing financial statement risk.

Key Audit Quality Attributes – The Audit Team

However, as highlighted in a recent study by Kilgore and colleagues, with representative users of audit services (audit committee members, financial analysts, and fund managers), perceptions of quality also play an important role in maintaining trust and credibility in the audit function.

The study established that factors relating to the audit team were perceived to be relatively more important than factors related to the audit firm. More specifically, perceptions of five key audit team attributes were found to be relatively more important than perceptions of audit firm attributes such as audit quality assurance review and audit firm industry experience; namely:

  1. the partner / manager attention to the audit
  2. the manager knowledge of the client industry;
  3. knowledge and experience of the audit team;
  4. communication between the audit team and client; and
  5. the partner knowledge of the client industry.

Only audit firm size was considered relatively more important than these five audit team attributes.

In another project, commissioned by Association of Chartered Certified Accountants (ACCA), Dr Kilgore, Prof Martinov-Bennie and Associate Professor Sue Wright are currently undertaking research on perceptions of audit quality among other stakeholders. Preliminary results suggest that while different stakeholder groups have different views, audit team characteristics remain important to perceptions of audit quality.

Implications and Future Research

The implications of these findings are important at both national and international levels for the audit profession, regulators, and standards setters, and for efforts aimed at improving the effectiveness and integrity of the audit process. These findings are particularly important  for regulatory and professional accounting bodies working to improve audit quality, since they have tended to focus on audit firm factors, in lieu of (perceptions of) audit team expertise and experience. Combined, the findings suggest that not only do different stakeholders have different perceptions of the key drivers of audit quality, but also that audit quality is viewed by market participants as a multi-dimensional construct. In trying to better understand what makes a quality audit, we really need to know more about the people who actually perform them.

Four ideas for improving Integrated Reporting

The International Integrated Reporting Council (IIRC) recently completed the consultation period for its draft version of the International Integrated Reporting (<IR>) framework, with <IR> ‘Version 1’ to be released in December. IGAP researchers Dr Dale Tweedie and Prof. Nonna Martinov-Bennie raised four ideas for the IIRC to consider in its revisions.

????????????????????????????????????????????????????????????????????????????????????????1. Clarifying the relationship between <IR> and other reporting systems

The IIRC’s ‘value-creation’ approach to non-financial reporting is very different from the ‘impact-assessment’ approach used by the Global Reporting Initiative (GRI). Users of <IR> would benefit from greater guidance on how <IR> and GRI4 can be complementary in a practical reporting context; for example, by clarifying differences in the materiality determination processes of <IR> and GRI4 and which – if any – takes precedence.

2. Acknowledge and address stakeholder conflicts

The IIRC’s view that the interests of providers of financial capital – the primary audience of <IR> – and other stakeholders will align over the long term overlooks potential conflicts between these groups, and so how conflicts should be reported. An example in Australia is coal seam gas (CSG) exploration, which promises significant financial benefits to mining and energy organisations, but which other stakeholders have claimed is a long-term risk (e.g. to primary production and water supply). Given this perceived conflict, what should be reported by organisations engaged in CSG exploration? Further clarity on the ‘legitimate needs, interest and expectations’ of other stakeholders that an <IR> should acknowledge would help address these kinds of issues.

3. Increase comparability through a stronger ‘core’

As our earlier blog discussed, while a principles-based framework is a useful method of avoiding boiler-plate disclosures, <IR>s need sufficient commonalities to be comparable over time and between organisations. Providing a stronger ‘core’ of reporting requirements and methods, best practice guidance (e.g. on carbon reporting) and definitions of key terms could encourage comparability without sacrificing the principles-based approach.

4. Governance as accountability

The draft <IR> framework asks each organisation to explain how its ‘governance structure support[s] its ability to create value in the short, medium and long term’. While good governance is part of value creation, the key features of governance are accountability, transparency and ethics, which are fundamental to ensuring that the value that organisations create is managed and distributed in appropriate ways. Following the King Reports in South Africa, <IR> could play a greater role in emphasising and communicating the importance of these aspects of governance.