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Financial Reporting Brief

April 2016

Our featured article for April is 'A Focus on Non-Financial Reporting' with Brendan Sheridan commenting on EU and other developments with regard to non-financial reporting which heighten the focus on matters including the impact on entities of their assessment of environmental, social and governance issues.

A Focus on Non-Financial Reporting

Our March article commented on Integrated Reporting (IR) and how it has worked its way forward from ‘headlines to trendlines’.

IR is a tool for the better articulation of an entity’s strategy with integrated thinking being fundamental to IR, enabling a better understanding of the factors that may materially affect an organisation’s ability to create value over time. Business owners and directors should ask such questions as – are we satisfied with the sustainability of business operations, including management’s assessment of environmental, social and governance issues.

The report of the Global Reporting Impact (GRI) on the ‘Sustainability and Reporting 2025’ Project, published in March 2016, comments ‘we are now on the cusp of a new era: the way we capture, analyse and use sustainability data is about to be transformed. We are moving from an era where sustainability information is collected and reported, to an era in which stakeholders – including the companies themselves – are using the information to learn more about their organisations, the risks and opportunities and learning to make better decisions’.

Sustainability and corporate responsibility reporting is the subject of a number of international frameworks, as well as many frameworks in individual countries. International frameworks include: -

  • The UN Global Compact
  • The OECD’s Guidelines for Multinational Enterprises
  • The Global Reporting Initiative

All of this is consistent with the initiatives being taken by the European Commission with its Directive on disclosure of non-financial and diversity information by large groups and companies addressing environmental, social and governance issues. The Directive was published in 2014 and has to be transposed into national law by December 2016, with application by all undertakings within the scope of the Directive for the financial year beginning on or after 1 January 2017.

European Requirements

From 2017 onwards, over 6,000 European public interest entities, those with more than 500 employees, will be required to include in their management report a non-financial statement containing information relating to, as a minimum: -

  • Environmental matters
  • Social and employee matters
  • Respect for human rights
  • Anti-corruption and bribery matters

The Directive also establishes that the non-financial statement shall include:

  • A brief description of the undertaking’s business model
  • A description of the policies pursued by the undertaking in relation to those matters, including due diligence processes implemented
  • The outcome of those policies
  • The principal risks relating to those matters linked to the undertaking’s operations including, where relevant and proportionate, its business relationships, products or services which are likely to cause adverse impacts in those areas, and how the undertaking manages those risks
  • Non-financial key performance indicators relevant to the particular business

The Directive has been designed in a non-prescriptive manner, and leaves significant flexibility for companies to apply their national frameworks, or international frameworks such as those referred to earlier.

In the UK, the Department for Business, Innovation and Skills (BIS) has produced a consultation document, call for views, on effective reporting alongside proposals to implement UK requirements. The EU framework is broadly similar to the current UK Companies Act framework but BIS identify a number of differences which show that there will be additional and/or amended disclosures on implementation. Legislation has yet to be enacted in Ireland.

In January 2016 the EC has launched a public consultation to collect views from stakeholders regarding non-binding guidance on the methodology for reporting non-financial information in accordance with the Directive.

FEE Position Paper

The Federation of European Accountants (FEE) has published a position paper highlighting the requirements of the Directive and setting out what the Directive means in practice. It addresses the concept of the value of the non-financial information disclosed. NFI is vital to annual reports because it informs the decisions of investors and other stakeholders. It gives valuable insight on internal and external policies, visions and values, risk management, and perspectives on the business as a whole. These highlight the stability and robustness of the undertaking, and its ability to be profitable in the future. The World Economic Forum’s ‘The Global Risk Report 2016’ highlights that most macro-trends and risks that could affect an undertaking in the future are non-financial.

The FEE position paper highlights that non-financial matters have to be disclosed to the ‘extent necessary for an understanding of an undertaking’s development, performance, position and impact of its activity’. This is further expanded on in the preamble which states that information should be provided ‘in relation to matters that stand out as being most likely to bring about the materialisation of principal risks or severe impacts, along with those that have already materialised. The severity of such impacts should be judged by their materiality and gravity.’ The ‘minimum matters’ stipulated by the Directive should be understood as a categorisation to help undertakings identify material matters, hence the ‘comply or explain’ approach. FEE also believes that it is crucial that the criteria and the internal processes for deciding on NFI materiality are properly disclosed. Undertakings should disclose how relevant issues have been identified and evaluated on their potential impact on the undertaking and that all material issues are disclosed.

The real potential for NFI reporting comes from providing context for financial disclosures by integrating financial and non-financial information, thereby producing a holistic view of the undertaking’s business. The FEE position paper includes one example for each of the different matters specified in the Directive which are primarily based on how undertakings are currently dealing with these matters in their corporate reporting, primarily under such frameworks as IR or the GRI Guidelines.

Global Reporting Initiative (GRI)

The GRI ‘Sustainability and Reporting 2025’ Project, referred to earlier, sets out to investigate the future of reporting and questions whether sustainability issues deemed critical for business and society are still not adequately tackled. These issues include climate change, destruction of ecosystems, resources and contamination management, wealth concentration and human rights abuses. To advance the global sustainability agenda, the GRI endeavours to ensure that the true value of sustainability data is recognised and accessible to all.

The next phase of ‘Sustainability and Reporting 2025’ will explore the following questions, amongst others: -

  • How do we liberate data from sustainability reports and other disclosures to be used by decision makers and other stakeholders?
  • Although sustainability reports are annual, sustainability information has to be used by decision makers in everyday processes. How can we transition from annual to almost real-time disclosures?
  • How useful would a single ‘data source’ for sustainability-related information be in order to move the sustainability agenda forward?

Developments in governance structures will require companies to react quickly and coherently, in a more interactive way, transforming the way they engage with stakeholders.

Conclusion

The EC Directive represents the most significant European legislative initiative in respect of environmental, social and governance disclosures in many years and is likely to have a significant impact on the non-financial information reporting of many of the companies affected.

The accountancy profession is well placed to establish the bridge between non-financial and financial information and to interpret the information produced. This must however be within the context of a holistic approach to integrated thinking by an entity with regard to its strategy and business model.

With a host of new financial reporting developments either having arrived or coming down the tracks, entities are dealing with significant reporting challenges. Many of them will also have to address the developing requirements in relation to non-financial reporting.

Those who commit time and resources will reap the benefit of being well prepared to deal with the many challenges.

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