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Mainstream reporting is ineffective as an accountability instrument for shareholders, says Simon Zadek
So the emperor has no clothes after all. After being encouraged for so long to be awed by the sophistication of today’s financial reporting, the heads of the big six accounting firms have come clean. The financial reporting model they have helped to build, and on which they have nurtured their businesses, is bust (EP8, issue 7, p1).
This timely and highly material disclosure is all mixed up in the transatlantic contest between rule and principle-based accounting. But this is more than a gang-fight over which approach can best deliver assurance on basic compliance. Today’s financial reporting is failing to provide data on the drivers that create business value, the holy grail of financial analysis.
Business drivers are all ultimately non-financial. It is how businesses deal with diverse non-financials such as customer service or climate change that drive reputation, innovation and, in the end, profitability. Mainstream financial reporting is failing to capture these parameters, and offers few methodological insights into how to measure the likelihood of businesses creating value.
Like most ‘disruptive innovations’, the most significant developments are emerging from the margins, the practice of sustainability reporting and assurance. Here, leading businesses are experimenting with new measures of non-financial performance and associated assurance and reporting methods, notably AccountAbility’s AA1000 Assurance Standard and the Global Reporting Initiative’s G3.
An unintended outcome has been an increasingly sophisticated set of processes and metrics measuring the impact of these so-called non-financials on business performance. What is being redefined is how business, guided by its understanding of its risks and opportunities, and overseen by auditors, lawyers and other advisers, decides what is ‘material’.
Financial reporting has to be reinvented for the 21st century if it is to be an effective accountability instrument for shareholders. This requires that financial reporting accounts for the broader sustainability ‘intangibles’ that will shape tomorrow’s business models and success. This is not a side question to the furore between advocates of US and European accounting models. It is central to the credibility of any future financial reporting model.
Mainstream auditors have recently been active in delivering services in the sustainability arena. Now is the time for them to invite others to engage in rewriting the rulebook on financial reporting. Such collaboration will have dramatic implications for tomorrow’s standards institutions. An evolution in the governance of these institutions is long overdue. Crucially, they will move towards multi-stakeholder approaches that reduce their dependence on the primary financial beneficiaries of standards developed, in favour of those impacted by their implementation.
Simon Zadek is AccountAbility’s chief executive and co-author of The materiality report, aligning strategy, performance and reporting which is available for download at www.accountability21.net
So the emperor has no clothes after all. After being encouraged for so long to be awed by the sophistication of today’s financial reporting, the heads of the big six accounting firms have come clean. The financial reporting model they have helped to build, and on which they have nurtured their businesses, is bust (EP8, issue 7, p1).
This timely and highly material disclosure is all mixed up in the transatlantic contest between rule and principle-based accounting. But this is more than a gang-fight over which approach can best deliver assurance on basic compliance. Today’s financial reporting is failing to provide data on the drivers that create business value, the holy grail of financial analysis.
Business drivers are all ultimately non-financial. It is how businesses deal with diverse non-financials such as customer service or climate change that drive reputation, innovation and, in the end, profitability. Mainstream financial reporting is failing to capture these parameters, and offers few methodological insights into how to measure the likelihood of businesses creating value.
Like most ‘disruptive innovations’, the most significant developments are emerging from the margins, the practice of sustainability reporting and assurance. Here, leading businesses are experimenting with new measures of non-financial performance and associated assurance and reporting methods, notably AccountAbility’s AA1000 Assurance Standard and the Global Reporting Initiative’s G3.
An unintended outcome has been an increasingly sophisticated set of processes and metrics measuring the impact of these so-called non-financials on business performance. What is being redefined is how business, guided by its understanding of its risks and opportunities, and overseen by auditors, lawyers and other advisers, decides what is ‘material’.
Financial reporting has to be reinvented for the 21st century if it is to be an effective accountability instrument for shareholders. This requires that financial reporting accounts for the broader sustainability ‘intangibles’ that will shape tomorrow’s business models and success. This is not a side question to the furore between advocates of US and European accounting models. It is central to the credibility of any future financial reporting model.
Mainstream auditors have recently been active in delivering services in the sustainability arena. Now is the time for them to invite others to engage in rewriting the rulebook on financial reporting. Such collaboration will have dramatic implications for tomorrow’s standards institutions. An evolution in the governance of these institutions is long overdue. Crucially, they will move towards multi-stakeholder approaches that reduce their dependence on the primary financial beneficiaries of standards developed, in favour of those impacted by their implementation.
Simon Zadek is AccountAbility’s chief executive and co-author of The materiality report, aligning strategy, performance and reporting which is available for download at www.accountability21.net
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