International Integrated Reporting Council (IIRC)
Organizations are aiming to adopt integrated reporting or include non-financial information in order to improve the quality of the information provided in the financial report (Figge, Hahn, Schaltegger & Wagner, 2002).
The International Integrated Reporting Council (IIRC) has provided an Integrated Reporting Framework for including non-financial information. However, organizations are encountering challenges in identifying the boundaries. The Framework provides guidelines for setting boundaries.
The materiality determination process is the basis for setting reporting boundaries. On the other hand, the Climate Disclosure Standards Board has published a discussion paper to explore options regarding the determination of organizational boundaries for reporting non-financial elements.
Six proposals have been delivered by CDSB. In this paper, the approaches of the two concepts have been discussed. The similarities and differences of the two approaches have been identified in this paper. Additionally, the role of accounting in providing non-financial information has been discussed.
Integrated Reporting Framework and Its Objective
Integrated Reporting (IR) helps in promoting a more proficient as well as cohesive methodology for corporate reporting. It basically emphasize on enhancing the quality of information available to the shareholders, who provide financial capital to the organization, so that they can be able to allocate the capital in an efficient and productive manner (Orens & Lybaert, 2007).
The International Integrated Reporting Council (IIRC) has a vision of creating a world where business practice will be embedded with integrated thinking. In both public and private sectors integrated reporting system must be adopted in order to improve the quality of information.
The principal rationale of an integrated reporting system is to elucidate to shareholders how an organization is involved in value creation. Additionally, the integrated reporting system benefits stakeholders such as local communities, business partners, employees, suppliers, customers, regulatory bodies, etc.
The integrated reporting framework has adopted an approach based on certain principles. It ensures a perfect balance between prescription and flexibility, which has identified disparity in the different circumstances of different organizations. It also enables an adequate level of comparability among the organizations to meet the need for relevant information (Alsaeed, 2006).
An integrated report will help in responding to the current requirements regarding compliance. Integrated reporting has been focusing on providing insight about the resources, relationships, or capital utilized and affected by an organization. Integrated reporting also demonstrates how an organization interacts with external circumstances and capital to create value over short, medium, and long periods of time (Perrini, 2006).
Reporting Boundary set By Integrated Reporting Framework
Materiality is considered an important principle of integrated reporting. According to this principle, the integrated report must disclose information regarding issues that have the substantial ability to affect the organization’s potential in order to create value for the company.
The Integrated Reporting Framework’s reporting boundary concept is based on the materiality determination process. IRF has considered two major aspects for determining the boundary of financial reporting.
One aspect is the financial reporting entity, which means the boundary set for the purpose of financial reporting. The second aspect is concerned about the risk, opportunity, and results associated with entities apart from the financial entity, which has a significant impact on the potential of the financial reporting entity to create value (Cerin, 2002).
The financial reporting entity is considered to be the major aspect of the reporting boundary. The major reason is that financial capital providers invest in the financial reporting entity and require all relevant information about it.
The financial reporting entity helps in serving the information provided in the financial statements as the reference or anchor to the other information represented in the integrated report. Apart from the parent organization, several entities play a major role in the determination of reporting boundaries (Moneva, Archel & Correa, 2006).
Subsidiaries, business partners, investors, and shareholders play major roles in setting the reporting boundary. Moreover, employees, suppliers, customers, local communities, etc., are major participants in determining the reporting boundaries.
The financial reporting entity is responsible for identifying the transactions or related events of subsidiaries, associates, joint ventures, etc., that will be included in the organization’s financial report (Soyka, 2013).
Another important aspect of determining the reporting boundary is to recognize the risks, opportunities and results associated with the other entities apart from the financial reporting entity which has major impact on the potential of financial reporting entities in value creation.
The other parties refer to the related parties of the stakeholders of the financial reporting. The major purpose of considering other entities beyond the financial reporting is to recognize risk, opportunities and results which have potential to materially affect the potential of the organization in value creation (Miller, Kurunmäki & O’Leary, 2008).
The stakeholders or entities within the reporting boundary do not have significant control or influence on the financial reporting entity (Liu & Anbumozhi, 2009). But, the risk, opportunities and results associated with entities must be considered by the financial reporting entity.
An example can be cited here to explain the topic vividly. If labor practices extensively contribute to value creation in a particular industry, the organizations of that industry must include relevant information about the labor practices in the disclosure of the integrated report (The International Integrated Reporting Council, 2013).
(Source: (The International Integrated Reporting Council, 2013))
Proposal of Boundary Setting in Financial Reporting by Climate Disclosure Standards Board
Climate Disclosure Standards Board has published a discussion paper in order to explore the options regarding determination of organizational boundaries for reporting of the non-financial elements. The paper has focused upon distinguish the responsibility from the control as well as results of the corporate activities.
It vividly indicates the reconciliation methodology for preparing financial reports with non-financial information. Climate Disclosure Standards Board has presented six proposals for developing organizational boundaries to ensure the inclusion of non-financial information in financial reports. Each proposal will be discussed to analyze the boundaries proposed by CDSB.
Analysis of Proposal 1:
Proposal 1 emphasizes clarifying the linkage among the objectives of inclusion of non-financial information in financial reports, materiality and the audience for reporting as well as boundary setting. It has been identified that a tension between the requirement of consulting with the view of the stakeholders regarding materiality and they also recognize the limitations of some events or matters which can be influenced or controlled by the organization.
The objective of including non-financial information in the financial report is to inform investors about the utilization of resources to create value. Hence, CDSB has argued that the boundaries of each organization must be aligned with the boundaries of financial reporting.
However, the objective of non-financial reporting is to communicate to society about the environmental and social accountability and stewardship of the company (Riley, Pearson & Trompeter, 2003). Hence, the boundary may be extended to the activities and entities which are directly non-related to the organization and do not have control or influence over the organizational activities.
Hence, it can be concluded that CDSB has proposed to extend the boundary of financial reporting beyond the financial reporting entity and include the entities or activities which affect the organization or in simple terms, it includes the society and environment.
It is rational to apply the boundaries of mainstream financial reporting to non-financial reporting. In some cases of the impact of business activity beyond the boundary of the financial reporting must be considered (Climate Disclosure Standards Board, 2014).
Analysis of Proposal 2:
The second proposal emphasizes developing a standardized approach for setting organizational boundaries. It has been found that non-financial information is prepared at different levels, such as facility, activity, and entity. The major reason is that regulators specify different levels, and organizations have to obey them.
Climate Disclosure Standards Board has identified the need to disclose non-financial information along with financial statements. The financial reports are prepared by complying with the requirements indicated in the International Financial Standards.
Hence, consolidation of the statements is also required for other reporting requirements. It has clearly indicated the need for an equal reporting rule, which will adopted at the global level. If the companies prepare reports disclosing non financial information according to the national or local it will be different in each country and each business.
Hence, it will not be possible to compare those reports (Healy & Palepu, 2001). The problem will be significant in case of the large conglomerates. Hence, CDBS has effectively identified the need for a single and standardized approach for boundary settings in non-financial reporting.
Analysis of Proposal 3:
Proposal 3, mentioned in the discussion paper, has extensively emphasized the characteristics of the boundary setting in the disclosure of non-financial information. A financial report is constituted of financial statements such as a balance sheet, profit and loss statement, cash flow statement, etc.
The balance sheet of a company depicts the organization’s assets and liabilities for a particular accounting period. On the other hand, the profit and loss statement, also known as the comprehensive income statement, demonstrates the outcomes of the operating activities within the financial reporting period.
Hence, it has been proposed that non-financial reporting must be aligned with the preparation of the comprehensive income statement (Sievers, Mokwa & Keienburg, 2013).
This proposal is found to be rational as non-financial reporting is responsible for reflecting the utilized resources in the particular accounting year, the same as the profit and loss statement depicting the income and expenditure for that year (Cheng, Green, Conradie, Konishi & Romi, 2014).
Analysis of Proposal 4:
The fourth proposal of CDBS emphasizes resource disclosure. In sustainable business, it is important to ensure responsible resource utilization.
CDBS has appropriately identified the importance of disclosing resource use. Hence, it has been proposed that organizations provide information regarding resource use and the outcomes of utilizing those resources in the context of conducting business activities (Ifac.org, 2014).
Analysis of Proposal 5:
The fifth boundary-setting proposal by CDBS has emphasized leasing issues associated with reporting non-financial information. It has been proposed that a distinction should not be made between operating leases and financial leases for reporting non-financial information.
Assets and resources need to be reported along with their outcomes from utilization of the resources. In a financial lease, the equipment is owned by the company or lessee at the end of the period. Hence, it is shown on the asset side of the balance sheet. On the other hand, in an operating lease, the equipment has to be returned to the leaser.
Analysis of Proposal 6:
The sixth proposal delivered by CDBS emphasizes disclosing the relevant policies or policies adopted for preparing the consolidated reports, including non-financial information, as an explanatory note.
Financial statements are provided along with explanatory notes in financial reports. The explanatory notes help elucidate the standards or policies on which financial reports are based and explain how the standards have been applied (Moneva, Archel & Correa, 2006).
Hence, it would be rational to adopt a similar approach of adding explanatory notes for preparing the non-financial statements. This would help in understanding how the organizations have determined the boundary and what has been included in it.
Potential Conflicts
Analyzing the perspectives of both the Integrated Reporting Framework (IRF) and Climate Disclosure Standards Board (CDSB) in identifying the organization’s boundary regarding the provision of non-financial information, it has been identified that there are a few points that differentiate the two frameworks.
According to the IRF, materiality has been the major concern for determining the organization’s boundary. It has included the concepts of risk, opportunity, and results for identifying related parties and boundaries.
On the other hand, in its proposals, CDSB has emphasized clarifying the linkage between the aims of non-financial reporting, the audience for reporting, boundary setting, and materiality.
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