New Movement on Business Reporting/Corporate Communication - Australian experience from the implementation of IFRS

Michael BRAY
Within the last five years, interest in business reporting in Australia has grown tremendously. The time for business reporting is now.

Business reporting is about reporting the business strategy and the business model that implements the strategy (business processes, resources, and infrastructure). It includes the reporting of performance in implementing business strategy, and reporting insights into past performance and future performance prospects to the capital markets. It involves looking at the capital markets and working with them as they make decisions about capital allocation.

Most researchers in the business reporting movement became interested in it after seeing the limitations of financial statements for capital markets based on U.S. GAAP, Australian GAAP, Japanese GAAP, or international standards. These are not very effective tools for capital allocation-oriented reports, although they are helpful for looking at the past and accountability. Business reporting on the other hand is important in that it allows capital markets to take a long term view about allocating capital.

Some people say that business reporting standards will take a long time to implement in every industry. That need not be the case. The business reporting framework has been prepared and adopted quickly in many businesses. The XBRL taxonomy which will allow business reporting to be implemented by individual businesses is done. Industry KPI libraries are done or in progress. These are libraries which put in place business reporting frameworks for particular industries and allow companies to use Extensible Business Reporting Language (XBRL) to design business reports for themselves. The World Intellectual Capital Initiative (WICI) is ready to govern business reporting processes. The business reporting movement is alive and well, and someday people will look back and realize that it was at this time that the tipping point was reached.

We understand that putting business reporting into place is a complex procedure. There have been a number of initiatives developed around the world in the last 10 years on this. Interestingly, even if different terms and approaches have been used, as an example of the process of scientific discovery, each initiative has come to a very similar conclusion. In the United States, we have seen the creation of the Enhanced Business Reporting Consortium (EBRC); in Australia, we have seen the Business Reporting Advisory Panel; and international accounting firms such as Price Waterhouse Coopers and KPMG have developed business reporting frameworks. The issue at the moment is that there is some fragmentation present in these initiatives, and there are some gaps in coverage within different countries. There is a need to bring efforts together to accelerate progress. This is the role of WICI.

Defining the roles and responsibilities of people in the global business reporting movement is something we are now working on. We have seen an increase of interest in corporate responsibility reporting in the last ten years. This is a very important movement and has produced a number of excellent reports. Unfortunately, we have not seen similar reports for capital markets. Capital markets should be informed of CSR initiatives. I do not mean to imply that CSR reports are a necessary ingredient for business reporting, but the inclusion of CSR reports in business reports would help to bring different systems together.

For instance, one important thing which has not yet come through to business reporting or financial reporting from CSR reporting is the issue of sustainability. The methods by which a mining company, for example, explores for new resources, builds a mine, and extracts ore and sells it, and the sustainability of these methods, are all important factors that need to be considered when thinking about long-term capital allocation. One of the things that the business reporting community needs to do in the short-term is integrate financial reporting and CSR reporting with business strategies and business models.

Business reporting is not just about the accounting profession. It is about business. It is about anyone who participates in the capital markets - everyone has a role and responsibility in relation to business reporting. Industry groups, regulators, academics, organizations such as METI, organizations such as RIETI - everyone has a role. I believe that the spread of the business reporting movement through global capital markets will lead to much more efficient and effective resource allocation and help markets to achieve sustainability.

The business reporting movement is absolutely essential to the operation of capital markets. Financial reporting has a very important role and always will have, but it is only part of the story. We need to move ahead in a more integrated way. One of the things that can help us do that is the implementation of International Financial Reporting Standards (IFRS). I would like to ask Penny Stragalinos to now talk about Australia's experience in doing so.

Penny STRAGALINOS
Japan is at the beginning of its journey toward implementing IFRS. In Australia, we implemented IFRS about five years ago, adopting them in 2005. We spent two or three years prior to that getting ready, getting processes and systems in place, and facilitating education across the corporate sector to help people understand IFRS. Looking back, while the implementation of IFRS seemed like a huge task before 2005, I feel the transition actually went quite well. Clients invested the right amount of time and resources into planning, we helped to educate the capital markets, and the analyst community and investors worked to understand the implications of IFRS and factor that into their investment models - in retrospect the whole process went smoothly.

Before IFRS we had Australian GAAP. It was a principle-based system. Moving from one principle-based system to IFRS was not as challenging as it would have been if we were in the United States. The United States has a very rule-based system, so I suspect its transition will be harder than it was in Australia.

In terms of unintended consequences, while IFRS certainly helped towards the achievement of a global reporting language, in implementing IFRS I think we find that there are still some limitations to it. These limitations are what have taken us down this journey to business reporting.

One of the unintended consequences include the fact that some of the accounting standards, including the financial instruments accounting standard, were written with the financial services sector in mind, and we have found that some of our clients in different sectors, such as mining or manufacturing, have experienced some unintended accounting consequences. There has been considerable debate regarding the adoption of the financial instruments standards.

Country-specific rules are another challenge we are dealing with. The main objective of IFRS is to achieve a globally consistent reporting language. As it has been applied in some countries, they have chosen to modify IFRS. In Australia, in the first couple of years we did so as well - we included some Australian-specific accounting options because we saw it as too difficult to make the full leap to IFRS. As time has passed, we have removed them, so our application of IFRS is true IFRS. However, I believe this remains as one of the global challenges for IFRS. When it is adopted in Japan, there should be no country-specific amendments which break down the international consistency of IFRS.

The biggest complaints that we hear about IFRS have to do with its volume and complexity. Some of the accounting standards are extremely complex, and this has made it very difficult for our clients to understand the requirements. In particular, it has also made it difficult for investors and analysts to understand the numbers and the disclosures that are being provided. The focus area at the moment is in fair value accounting. There has been enormous complexity around fair value accounting, and the global financial crisis really brought this to the forefront. Many are now questioning the effectiveness of financial reporting using a fair-value basis to reflect the health and performance of companies.

All of the issues I just mentioned have led to what we are calling "workarounds." Because the accounting standards require a lot of disclosure and complexity, some of our clients have decided to create alternative processes to better explain to the market their financial performance. These include measures such as summary business reports. While financial statements might be 150 pages long and feature a lot of detail and complexity, companies are now producing 10 page summaries which extract the highlights of their financial performance. This is an unfortunate outcome of the complexity of IFRS, because there is now little consistency between companies.

One of the other workarounds that has been adopted in Australia is the concept of "underlying profits." This is the practice of taking your statutory profit and reconciling it to an underlying profit. For example, taking statutory profit and deducting fair-value adjustments and non-recurring items to get a new figure for underlying profit. This is done so that the investment community can better understand a company's performance. This is an unfortunate byproduct which companies have been forced to implement in order to better communicate to the investment community.

The absence of a disclosure framework is also a challenge. While we have an overall accounting conceptual framework with IFRS, we do not have a disclosure framework. What we currently have are quite prescriptive disclosure requirements, and that has led to additional complexity and volume in financial statements. Addressing this issue is one of the current projects of the International Accounting Standards Board (IASB), but the IASB has a number of other projects on its agenda as well, and this one is not likely to be completed in the near future.

The IFRS experience in Australia generally has been very positive. We adopted it for all companies, whether they were listed or unlisted, SMEs or large companies. I believe this was a good move. However, there are some limitations which the current financial reporting model does not address. We think that business reporting will help with some of these limitations.

Michael BRAY
Allow me to now talk about the history of the business reporting movement. The movement started with a paper released by the Institute of Chartered Accountants in Australia (ICAA) in 2002. After that, the ICAA formed its Broad Based Business Reporting Advisory Panel with organizations representing the capital markets such as the Australian Investor Relations Association. The Panel features representation across the capital markets reporting supply chain. Other groups that have started work on the issue include the World Energy Congresses, as business reporting is a critical part of the investment needs of the world's energy sector. The Society for Knowledge Economics is another group - they are working with CPA Australia. Australia's securities commission, the Australian Stock Exchange, and the Financial Reporting Council of the Australian government all support business reporting measures. Private accounting firms such as KPMG and PwC are cooperating together on business reporting as well. With so many groups now working on the issue, the time has come to create an organization which can focus on each party's efforts. I believe that organization should be an Australian chapter of WICI.

I would now like to ask Ms. Stragalinos to tell you about the work of the Capital Markets Reporting Innovation Group (CAMRIG). We are pursuing KPMG projects to further business reporting.

Penny STRAGALINOS
In the last 12 months CAMRIG has been focusing its research on the topic of business reporting.

Our first project is what we have named "The Vision Paper." It is a brief paper of 10 pages which pulls together all of the literature and all of the thinking on this broad topic, and discusses how each participant involved in this topic is taking this issue forward.

The next project that we are working on is "The Financial Reporting Improvement Paper." It highlights some of the limitations in IFRS and looks into financial statement disclosures, discusses what is reported to the capital markets, and provides recommendations on how financial statements can be improved in certain areas which are of particular importance to the investment community, such as risk management disclosures in light of the global financial crisis, and also capital management disclosures.

The third paper is on management commentary. The Management Commentary exposure draft is currently out for comment. It deals with what companies communicate to capital markets, and discusses the way in which companies describe their performance. One of the items we recommend is that this commentary should be forward-looking. It needs to give some guidance, if not quantitative at least qualitative, as to the future performance of the company. This paper also provides some recommendations on the implementation of the exposure draft.

The next paper we are working on is on sustainable capital allocation. This paper focuses on CSR reporting, sustainability reporting, and how improvements can be made to this reporting so that more useful information can be provided to the capital markets.

The last project that we have been working on is what we call "The Real-time Reporting Paper." This paper deals with technology, and how it can be used to help with the delivery of financial reporting information. It includes tools such as XBRL, and the Australian initiative known as Standardized Business Reporting (SBR), which is business-to-government reporting. We are looking into how this system can be expanded to allow for business reporting in real time.

In relation to all these projects, we have developed a communications plan about how we will discuss these topics with our clients, with the analyst community, and with other interested parties. We will be facilitating a capital markets reporting summit with other interested parties to discuss some of the papers that we are in the process of developing so that we may take the debate further.

Michael BRAY
We have also started a Mining Industry KPI Taxonomy Project which I would like to talk a little about. This is part of an initiative to bring together the leading companies of particular industries to focus on reporting procedures. We believe that the mining sector is particularly important if we are going to bring BRIC countries into the movement, because mining is so important in those countries.

Q: Intangible assets present a very difficult problem. How can a taxonomy of intellectual assets be introduced through business reporting? One problem we face when thinking about this issue is the disclosure of valuable assets to the public - disclosing intellectual property (IP) assets may involve the disclosure of trade secrets.

Michael BRAY
The business reporting approach is about reporting strategies and the business model; it is about looking at processes, responses, and infrastructure. As we develop business reporting, we are gaining insights about what IP reporting models might look like in the future if business reporting is spread throughout the world. However, business reporting today is not about forecasts, and it is not about providing values. It is about providing information which would not be available in the capital markets about company strategies and business models at the deepest parts of the organization, information on topics such as research and development, innovation and capacity. It includes key performance indicators. It is not value-based. I do not think that in the business reporting movement we are expecting to see IP balance sheets. Our research indicates that the capital markets do not want that. The capital markets have their own views and assumptions on the market environment which have a bearing on what the value of IP means. I do not think this is an area into which the business reporting movement will be moving soon.

Q: Under IFRS, disclosure is done on a principle-basis. In other words, companies have flexibility, but at the same time, they have responsibilities. I believe that this means that much closer communication between investors and companies is now necessary. It is usually thought that if information is not important for investors it can be kept as a secret. What kind of communication is used in practice in Australia? How can we strike a balance between keeping corporate secrets and meeting investor requirements?

Michael BRAY
There are usually about seven major objections to business reporting when it is raised, and the possibility of giving away sensitive information is almost always one of those. It depends on how you work with your clients and the organization's reporting strategy. It is true that with business reporting, there is a risk of some commercial damage being caused through the disclosure of information that might be secret. However, on the other hand, there is a potentially large reward for disclosing the same information to the capital markets. It allows for less assumption and extrapolation when financial models are created. I am sure that everyone can think of a case in which a financial model was created based on misguided assumptions or extrapolations - things like "last year's sales plus a percentage." Businesses do not work this way. The past is often not a guide for the long-term future. If the aspiration for business reporting is to pinpoint more precisely where capital should be allocated in the long-term, then information needs to be reported.

When we discuss this with companies we typically talk about when the net benefit of disclosing a particular piece of information will be realized. The net benefit comes when you are sure that the capital markets are going to use a piece of information to make more precise models and decisions. On the way to implementing business reporting, there is always a lot of internal experimentation, and there is always a lot of discussion with key capital markets players. These discussions usually cover topics such as how good capital market models are, how they are built, and whether capital market players are prepared to use a certain really important piece of information or not. The judgment usually is that you should report a piece of information, even if it is a little sensitive, when you have confidence that the capital markets will use the information with precision in their decision making.

Q: I believe that companies would be much more flexible in their willingness to communicate with investors if they faced the threat of regulation. Is there already a regulatory scheme in place in Australia for business reporting?

Michael BRAY
This is another one of the objections that people make. Usually they ask, "Why would anyone do this if there is no safe harbor protection?" Legislators and regulators must be a critical part of the business reporting movement. That is why in Australia we have involved our Treasury. What people usually realize as the business reporting movement evolves in their country is that financial reporting models have not shown good results up to this point, especially in light of the financial crisis. Furthermore, people begin to realize that the business reporting model has real potential to help us avoid a future crisis. Once this is realized, regulators typically become more interested in getting involved in the movement.

So the answer is that controls are critical for business reporting. They allow for the provision of better information, and hence better capital allocation.

Q: You have in the past stated that you are interested in the connection between environmental issues and accounting. Could you explain how global warming is related to accounting and business reporting?

Michael BRAY
The sustainability reporting and CSR reporting movements have accomplished tremendous things, but the end game at the moment is not in the capital markets. The challenge that business reporting has before it is to convince the capital markets to demand reporting about sustainability, including issues related to global warming and climate change matters. Taking a holistic view of business reporting, it becomes very clear that business practices which take into account environmental, social, and government matters, are actually better business practices. They help core business processes work more efficiently. A mining company that is really thinking about these sorts of things when it develops new resources is going to be more efficient and effective at its core business operations, for instance.

Q: If the environmental issues which concern a company include extra-financial topics, are these covered by business reporting as well?

Michael BRAY
If a company is developing a reporting strategy, it should try to make sure that rewards for performance are in line with performance. Rewards are about capital, reputations, and licences to operate. Reporting strategies should aim to ensure that capital is allocated with a reasonable cost that is in line with the business strategy, and make sure that companies are able to keep their reputation in tact, and thus it should include information on environmental issues.

Q: What are the main incentives for introducing IFRS? Given the cost of producing more paperwork for IFRS and that the standards are difficult to understand for normal people, why would a company begin using IFRS?

Penny STRAGALINOS
In Australia, IFRS was mandated by the government. Although the introduction of IFRS means some short-term cost, there is a long-term benefit to using a reporting system which is understood by global capital markets. The benefits are far greater than the initial short-term cost of implementing IFRS.

IFRS allows for easier comparisons between Australian companies and their global competitors which use IFRS. The introduction of IFRS can therefore assist in attracting capital.

Q: How many nations are now using IFRS? What is your prospective for the next five or ten years?

Penny STRAGALINOS
Quite a few countries are using IFRS, including the countries of the European Union. The United States has declared that it will make a decision about moving to IFRS in the future, and has already made concessions to global companies allowing them to report in IFRS instead of U.S. GAAP. I think we are well past the stage where IFRS has become the generally accepted global accounting framework.

Q: In Australia, you introduced IFRS for every company, including non-listed SMEs. How do these companies deal with IFRS? Are SMEs motivated to implement holistic business reporting?

Michael BRAY
Business reporting is valuable to any organization you might think of, including SMEs and non-profit organizations. It works in all different forms.

Penny STRAGALINOS
IFRS has been applied to unlisted companies and SMEs, and obviously they did need more support for the transition. In Australia we have two disclosure frameworks. If you are a small organization you can choose to not have some of the more complicated disclosures in your accounts. This reduces the burden on SMEs.