A change in the weather?: IFRS and integrated reporting

Thoughts on a recent speech by IASB Chair Hans Hoogervorst

Titled The IASB and Integrated Reporting, it didn’t initially make much impact on me. But then a recent column by Robert Bruce made me think again. Here’s part of what Bruce says:

  • Fifteen years ago it was felt…that the concepts of management commentary were not central to the IASB’s task. It was felt that it would be useful to explain the effects of IFRSs but it was not core to the IASB’s purpose. A Practice Statement was produced in 2010 but was seen as having limited effect. Again in 2015, there were echoes of this mindset in the IFRS Foundation’s views that suggested that the Board should not broaden the scope of its work into areas outside the boundaries of traditional reporting. But the wind seems to have changed course. And what the IASB Chairman said recently…has signaled a change in the weather….It is time for change. And as Hoogervorst put it: ‘We are especially well placed to make sure there is a good fit and connectivity between financial reports and non­financial information which I believe to be essential to the success of integrated reporting’. These are encouraging words. Now more than ever people need integrated reporting­-style reporting. This consistent approach with management commentary would be very helpful.

I think that when I initially read the speech, I probably put more weight on Hoogervorst’s closing paragraph:

  • I would like to close with two comments of caution, however. First, if we decide to update our Practice Statement, I believe it will have to remain non-mandatory. This is the only way integrated reporting can succeed. More important, I would like to reiterate that we have made no decisions and the Board needs to reflect on this very carefully. We have a history of biting off more than we can chew so we are being very careful about adding anything to our work plan.

I suppose I’m unconvinced that updates to a non-mandatory practice statement will have a great effect on anything in the foreseeable future. Bruce is certainly right about the limited stature of the current version of it. It’s so far down the IFRS rankings that it’s basically submerged (somewhere after page B2700 in Part B of the bound volume) and for companies that are subject to any kind of local regulatory MD&A-type requirement, it’s just too high level to add anything (perhaps it could be demonstrated that the practice statement has had more impact in jurisdictions with no such requirement, I don’t know). An upgraded practice statement would perhaps constitute a nice symbol, but in the absence of any compelling reason for following it, wouldn’t be likely in itself to cause a major rethink by entities, if they aren’t already motivated to take a progressive approach to their disclosures (perhaps I’m missing something, but I’m not sure why integrated reporting can only succeed if it’s non-mandatory, as he seems to say…)

Other aspects of Hoogervorst’s speech suggest an inherent reluctance to do anything that might even conceivably undermine the perceived primacy of financial statements in the reporting hierarchy:

  • (first)…because financial reporting is primarily—but certainly not exclusively— backward looking, it offers the most tangible evidence of a company’s performance. The income statement will remain the ‘hardest’ and most comparable source of information for investors…(second)…in the course of time, all value creation—also the focus of integrated reporting—will ultimately pass through the financial statements, although often with a considerable time lag. For these reasons, the financial statements will most likely remain the main anchor for investors and creditors in evaluating a company’s performance.

But on the first point, it’s plain that investors regularly assign sky-high valuations to companies whose historical income statement doesn’t even remotely support that assessment – Tesla being a prominent current example. However “hard” the information in the income statement might be, it’s still just one data point among many, and perhaps not a very compelling one in situations where the past doesn’t appear to provide a strong basis for forming expectations about the future.

The second point is also debatable, if you consider it against the way the <IR> Framework discusses value, emphasizing for instance that “the ability of an organization to create value for itself…is interrelated with the value the organization creates for stakeholders and society at large through a wide range of activities, interactions and relationships” and noting that value is:

  • unlikely to be created through the maximization of one capital while disregarding the others. For example, the maximization of financial capital (e.g., profit) at the expense of human capital (e.g., through inappropriate human resource policies and practices) is unlikely to maximize value for the organization in the longer term

I don’t think we can assert that this kind of weighting of different value measures would ever pass through the statements in any meaningful way, absent a huge sea change in how intangible assets are recognized and measured.

None of this means that Hoogervorst’s speech isn’t to be welcomed. But to detect in it a meaningful change in the weather may speak to over-excitable forecasting…

The opinions expressed are solely those of the author

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