Financial and sustainability reporting – the search for the best attainable version of the truth

We discuss the evolution of sustainability reporting.

Key points

• Connectivity between financial reporting and sustainability reporting is a key priority for investors.
• Management commentary is likely to be the bridge between financial and sustainability reporting.
• When sustainability standards are adopted, from 2024 onwards, all stakeholders can look forward to something much closer to the ‘best attainable version of the truth’ about corporate activities.

“I think all good reporting is the same thing – the best attainable version of the truth.” This quote, from Carl Bernstein, the investigative journalist who, along with Bob Woodward, reported on the 1972 Watergate scandal, is just as applicable to corporate reporting as it is to journalism in general.

This article considers two types of corporate reporting: financial reporting and sustainability reporting. Both have a lot in common, providing stakeholders with information about the performance, position and, increasingly, the prospects of a business.

However, I would like to highlight three key differences:

1. Materiality. Financial materiality considers the investor’s perspective and asks whether information would influence a decision. Sustainable materiality is a hotly debated topic: the ISSB (International Sustainability Standards Board) has adopted the same definition as used in financial reporting; however, the EU (European Union) has adopted a wider definition, based on double materiality, which includes the impact of the company on the environment and people. I like the concept of dynamic materiality: some information which is financially immaterial today may become financially material tomorrow. This is particularly the case for negative externalities, such as pollution, which may not be taxed today but are likely to be taxed in the future. In this case, a sustainability report will inform stakeholders about a potential rather than an actual financial liability.

2. Maturity. Accounting records date back thousands of years, with cuneiform tablets recording commodities found from ancient Mesopotamia. Accountancy as a profession emerged in the UK during the Industrial Revolution with the growth of limited liability companies. Sustainability information, in many cases, has yet to be recorded, and standards of what should be reported are being developed now. Unlike financial reporting, we do not know exactly how sustainability information will be used. Assurance is a key issue, because there is no established sustainability audit profession and the nature of a sustainability audit is quite different from an audit of the financial statements: sustainability information is more qualitative, more forward-looking and more estimate-based than financial information. Common standards and third-party assurance are needed to mitigate the risk of greenwashing.

3. Scope. Financial reporting is bounded by the legal entities that form part of a group and this determination has been audited. Sustainability reporting, using the widest definition, has no boundary, in that any impact on the environment or people is potentially in scope. This creates a big challenge for data capture and assurance. Gathering information along the value chain is needed to estimate Scope 3 CO2 emissions and to assess the risks of modern slavery. Some of this information exists on spreadsheets, but more will be integrated into ERP (enterprise resource planning) systems so that reliable reporting can be automated, and potentially shared along the value chain.

Connectivity between financial reporting and sustainability reporting is a key priority as investors and other stakeholders do not want to hear mixed messages. Management commentary is likely to be the key bridge between financial and sustainability reporting. Within the financial statements, there are quite a few linkages between two types of reporting, such as goodwill impairment tests, environment provisions, segmental reporting, and useful economic life assumptions. For example, if the energy transition plan has been accelerated, this needs to be reflected in new assumptions when measuring the decommissioning liability or assessing the remaining useful lives of assets.

During the dot.com boom, over 20 years ago, I recall what sounded like a futuristic vision that mass marketing would one day be replaced by ‘one-to-one’ marketing because companies would have so much information about individual customers. Fast forward to today and personalised marketing is a reality: for example, Tesco’s Clubcard offers vary depending on individual transaction patterns.

Similarly, sustainability reporting sounds somewhat futuristic, especially when you compare it to established financial reporting. My view of sustainability reporting is that, as with personalised marketing, the future may arrive sooner than some people think, as developments are taking place so rapidly. When sustainability standards are adopted, from 2024 onwards, all stakeholders can look forward to something much closer to the ‘best attainable version of the truth’ about corporate activities.

Authors

Jeremy Stuber

Global research analyst, specialist research team