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
