CHAPTER SIX

Future reporting: the object and value supply chain

CONSIDER THE FUTURE, PARTICULARLY IN RELATION to the means by which business reporting occurs is likely to occur. This is certain to take greater advantage of new technology. More importantly, with increasing interest in business reporting, a more conscientious way of displaying information will evolve. In addition, there will be greater integrity expected, and demonstrated, in the business reporting process. What follows is a view of that eventuality, one that will see greater attention being paid to objects, as well as to the related data.

Object identification and mapping

Consider the importance of object identification. Currently, the mapping of objects is a huge issue in the IT sector and is generating significant revenue for the software companies. Basically, mapping is the process matching certain aspects in two separate data models, or databases. This can facilitate data integration, including the seamless exchange of information, between companies, such as the transmission of purchase orders and invoices.

However, there is a lack of standards, as well as different metrics. Consider, for instance, metrification in most countries, but not for all. Plus, there is the issue of multiple currencies. For entities, especially those engaged in international trade or that are multinational, there is substantial data duplication. Plus, all information changes when there is a shift in the currency exchange rate. Even something supposedly as simple as buying a pair of shoes can expose the buyer to difficulties as there is no universal standard for identifying shoe sizes, as Figure 6.1 indicates.

FIGURE 6.1 Indicative shoe sizing around the world.

Source: Adapted from various sources

Perhaps at a more business-focused level, consider the many measures that can require conversion – see www.onlineconversion.com.

This site carries more than 5,000 units and 50,000 conversions. The related conversion pages and categories are as follows:

• Acceleration
  • Many different acceleration constants. g-unit, metre/square second, and more
• Angles
  • Gradients, Radians, Degrees, Minutes, Seconds, Points, and more
• Area
  • Square centimetre, Square metre, Square inch, Square foot, Square mile, Square kilometre, Acres, Circles, and more
• Astronomical
  • Astronomical unit, light-years, parsecs, and more
• Clothing
  • Convert clothing sizes between many different countries
• Computers and Electronics
  • Various conversions and calculators related to computers and electronics
• Cooking
  • Various cooking volume conversions, including Drop, Dash, Pinch, Teaspoons, Tablespoons, Cups, etc. Plus other cooking conversions such as butter weight, and gas mark temperatures
• Date/Time
  • Several different converters and calculators related to dates and times
• Density
  • kg/cubic metre, lbm/cubic foot, lbm/gallon, aluminum, copper, gold, water, and more
• Energy
  • Joules, BTU, calories, electronvolt, erg, kilowatt hour, therm, toe, tce, and more
• Finance
  • Several calculators and conversions related to finance
• Flow Rate
  • Many different flow rate conversions. Includes separate pages for mass-based, volume-based, and mole based flow rates
• Force
  • Dyne, gram-force, poundals, newtons, pounds, kgm-force, and more
• Frequency
  • Hertz, cycles per second, revolutions per second, degrees per second, radians per second, many and more
• Length/Distance
  • Millimetres, centimeters, inches, feet, yards, meters, kilometres, miles, mils, rods, fathoms, nautical miles, and more
• Light
  • Conversion calculators for illuminance and luminance
• Mapping
  • Many calculators and converters related to mapping and navigation
• Miscellaneous
  • Several calculators and conversions that didn't fit any other category
• Numbers
  • Number conversions and information. Base conversion, SI Standard prefixes, American and British naming conventions, and more
• Objects and Shapes
  • Various calculators for finding volume, area, and surface area for various different objects and shapes
• Power
  • Watts, BTU/hour, foot-lbs/second, horsepower, kilowatts, and more
• Pressure
  • dyne/sq cm, Pascal, poundal/sq foot, Torr, inch H2O, inch mercury, and more
• Speed
  • centimetres/second, metres/second, kilometres/hour, feet/second, feet/minute, miles/hour, knots, mach, and more
• Temperature
  • Celsius, Fahrenheit, Rankine, Reaumur, and Kelvin
• Torque
  • Pound-force foot, pound-force inch, kilogram-force meter, and newton meter
• Viscosity
  • Poise, centipoise, water, oil, glycerin, and more
• Volume
  • Liquid and dry, litres, fluid ounces, pints, quarts, gallons, millilitre/cc, barrels, gill, hogshead, and more
• Weight/Mass
  • Kilograms, ounces, pounds, troy pounds, stones, tons, and more.

Object recognition and tracking

Object recognition, and associated comparisons, is another field that is recent but has attracted a strong following. Digital photography and imaging, as well as related storage and retrieval, can work wonders. This leads to object tracking, such as of people, products and assets, as well as the financials and the way that all of this information is communicated.

A key consideration in relation to the financials is that the valuation approach for movable objects is different than for non-movable objects, such as real estate. As such, we can see that each entity will need to define its own objects as they are likely to differ for, say, a manufacturer compared with a retailer. Certainly, this applies to the banking industry and other aspects of the finance sector employed to highlight the use of objects and related reporting.

Sustainability

Given the widespread impact of the unforgettable global financial crisis, increasingly the finance sector is in line to be affected by factors of sustainability, as well as its intensifying social and environmental risks and impacts. As a direct consequence, financial institutions must pay more attention to sustainability programmes that are shaped and driven by factors such as corporate strategies, policies, goals and initiatives. In turn, these are based on drivers of economic, social and environmental risk, as well as financial return, natural resources, in addition to reputation. Sustainability programmes ensure that, amid environmental, social and economic uncertainty, an organisation is able to adapt and thereby remain viable for the long-term interest of its owners.

Financial reporting systems will play a major part in watching the sector's progress towards sustainable policy adoption. This would include IT system integrations, making financial flows more transparent and increasing pressure for implementing a less speculative global currency model. Appropriate accounting and reporting systems are needed urgently. Plus, these must have a global reach in tracking and valuing financial products if the financial sector is to play a critical role as a catalyst and integrator in moving other global financial reporting initiatives forward. Parallels can be drawn for other industries from the views presented below.

A changing agenda

We now understand the intellectual argument that natural capital (land, air, water and living organisms in particular) provides significant value to society and the economy. But it is not recognised or accounted for accordingly. What does this mean for the finance sector? Let's explore the type of risks that financial institutions should begin to think about when it comes to natural capital. 

• Credit risks: the default of investments can be caused by risks associated with natural capital and this can also prompt inaccurate information affecting counterparts. Collateral risk is central to this as banks don't have the means of recognising the loss of natural capital and what this means in relation to their investments. 
• Operational risks: these are most serious when it comes to an acceleration of natural disasters, or the effects of ecological degradation on business outputs, such as agriculture. Losses are a probable outcome. 
• Reputation risks: being associated with financing an entity that is involved in major ecological liabilities bears increased risk. Once a financial institution loses its reputation in this manner, it is very difficult to build that back up.

These risks, and others, are recognised inherently by the 2010 UN-sponsored study on ‘The Economics of Ecosystems and Biodiversity' (also referred to as the TEEB initiative – see www.teebweb.org). Even so, the finance sector must pioneer fundamental changes in how it estimates and analyses risks. It is more than likely that some within the finance sector will be hit harder than others. The insurance sector represents a particular case in point where exposure to natural capital risk is more pronounced, especially due to accelerating climate and environmental risks.

It must be said that the lack of agreement on valuation mechanisms and metrics is a barrier. Yet banks today use a wide range of instruments. These must be brought together in a systematic way, such as in a financial sector tool kit that addresses natural capital. This would also identify good examples of the financial instruments, the institutional processes and the valuation mechanisms that are already implemented.

Key innovation trends in the sector

Investors can play a forward-thinking role in treating natural capital issues as drivers of shareholder value. There are several areas where some innovation is taking place and where effort is needed by the industry to accelerate necessary change.

Benchmarking

The Natural Value Initiative (see www.naturalvalueinitiative.org) is a leading example of benchmarking. It found that out of 31 companies analysed in the food, beverage and tobacco sectors, only one was particularly mature in its approach to natural capital. Benchmarking companies in the responsible investment research industry are developing fast. But these entities are trying to cover a large number of companies by way of predominantly public information that is available.

It is noteworthy that a study released by the UN-backed Principles for Responsible Investment (PRI) and the UN Environment Programme Finance Initiative (UNEP FI) estimated that global environmental damage caused by human activity in 2008 represented a monetary value of $6.6 trillion, ­equivalent to 11 per cent of global gross domestic product (GDP). Major financial companies, such as Bloomberg, Thomson Reuters' Asset4 and Risk Analytics, are now getting into this space. Even so, attention also needs to be given to what is being benchmarked as different companies are good at various elements. Many smaller entities, such as AccountAbility (www.accountability.org) and Gaia-Metrics (www.gaia-metrics.com) are helping clients to benchmark information or provide standards and tools. In turn, this leads to better reports.

Valuation and risk

Banks, the investment sector and insurance companies have developed excellent risk and valuation models. The various environmental risk factors must be embedded into the general risk policies, and this needs to be beyond what, so far, is kept within the boundaries of project finance (for example, Equator Principles). Frankly, there is still too much focus on externalities. Consequently, valuations must be more object, entity and business model-centred.

Awareness

Reputation is still the leading driver of change in the finance sector. Examples of ecosystem failures as drivers of change are rare. Civil society and NGOs are playing an important role in highlighting the issue. But their strategies could also be more effective at targeting the right stories related to risk and opportunity for the finance sector. It is vital, therefore, to bring an operational risk perspective as well as hard business case numbers to the story, and to any associated campaigning. It stands to reason that an individual event, such as the BP oil spill in the Gulf of Mexico, can have a significant impact upon single investments and related industries. 

Knowledge barriers

There is a need to accelerate translation of the biodiversity and natural capital issue into business language and associated cultures. A key consideration here is that the older generation of financiers today does not fully understand, or relate to, the language of ecologists, climatologists and earth scientists. In some areas of the finance sector, the type of scientific data that is developed by assorted earth scientists can cause financial analysts to feel discomfort, confusion and apathy. In relation to this issue, North American Electric Reliability Corporation (www.nerc.com) is looking at collaboration on ­biodiversity ­information between the academic sector and the finance sector. There is also an urgent need to bridge the worlds of science-based policy on ‘ecological infrastructures' (for instance, what is the optimum level of ecological balance?) and financial investment (for instance, how does this ecological equilibrium translate into economic and financial values?).

Accounting and reporting

Financial reporting is reliant on underpinning standards and there is also a need for standardisation in how natural capital accounts are measured and integrated into financial statements. NGOs and investors have different ways of doing this, thereby making it difficult to know whether we are comparing like with like.

Several models, such as that of the Global Reporting Initiative (www.globalreporting.org), are now proposing solutions to the disclosure and reporting of natural capital accounts, based on sustainability. However, these efforts need to engage more thoroughly with accounting bodies and financial regulators in order to experiment with enhancing the regulations and standards. One huge issue here is that the public sector (which has most nature assets ‘under management') does not report consistently. Also, while International Public Sector Accounting Standards (IPSAS) are starting to appear in public sector reporting (see www.ifac.org), it is a slow process of adoption. IPSAS are based on globally accepted IFRS and there is no real reason why the necessary implementation of appropriate standards cannot be accelerated. Furthermore, adoption of IPSAS would have an enormous and positive effect on modernising totally outdated, and fragmented, income tax laws in most countries. One other standard that could benefit considerably from the ‘modernisation' of standards is the System of National Accounts (SNA), which currently focuses too much on boundary definitions instead of object tracking and valuations.

As a positive sign of possible progress, the need to have more global overarching standards is already identified with the emergence of the International Integrated Reporting Committee initiative (www.integratedreporting.org).

Financial institutions, in particular global banks, with their worldwide operations and huge capital asset base, could serve as a driver and catalyst to utilise emerging reporting systems, such as the GRI. By so doing, the banks would serve as a leading example in terms of better integrated reporting and a new way forward in relation to financial reporting. In effect, financial ­institutions are trailblazers in utilising the fair value model and, with it, these ­entities can lead worldwide accounting convergence. Certainly, the debate around fair value accounting has highlighted the need for global harmonisation of asset and liability valuations. However, banks are weak in object tracking, as evidenced by recent mortgage failures where it was difficult for banks to trace obligations back to the original owners through the intervening multiple layers of securitisation.

In this regard, consider the massive asset holding of global banks. Of particular interest is the asset level of Deutsche Bank, which fell by nearly $1 trillion from $3.1 trillion in 2008 to $2.2 trillion in 2009. Remarkably, there was no reasonable explanation in the annual report or other pronouncements for such a significant reduction. This is indicative of weak accounting regulations in that a sizable bank can avoid any justification for a more than obvious drop in its assets.

IT infrastructure

Financial institutions are proven leaders in developing global risk models, but demonstrate less success in using global IT platforms similar to what ERP system packages have done for the industrial sector.

While this is cause for concern, and for necessary change, there is increasing pressure for worldwide system improvements. For example, see the daily news on system changes and improvements on www.finextra.com and the SEC ‘Senior Supervisors Group Issues Report on Risk Appetite Frameworks and IT Infrastructure' in the SEC News Digest, Issue 2010-242, available at www.sec.gov/news/digest/2010/dig122310.htm. Global IT structures will lead to essential consolidation in the finance sector and new business models will emerge as a direct consequence. Hopefully, this will result in less speculation (particularly in relation to currencies) and enhance trust in reported numbers generated by the sector.

In addition, financial institutions can learn from industrial applications of object tracking and support the development and improvements in valuation standards, for instance, those promoted by the International Valuation Standards Council (www.ivsc.org). The separation of objects and valuation could, in effect, be a new way forward in financial reporting.

Business reporting

Regarding the separation of object tracking and valuation, it is worthwhile to compare the financial statements of an industrial/consumer goods ­company, such as BDF Nivea (BDF), and a financial institution, such as Deutsche Bank (DB), with respect to their reporting on people, products, infrastructure, financial assets and intangibles. It is noteworthy that both are IFRS-reporting companies.

Besides the relative size and volume of their presentations (2009 Annual Report: DB: 434 pages; BDF: 134 pages), a comparison indicates that the major differences in the reporting are as follows:

• better GRI and sustainability, as well as product and infrastructure reporting by BDF (Object tracking);
• more sophisticated reporting on financial instruments and currency reporting by DB (Value reporting);
• weak metrics on people and intangible reporting by both companies (Object reporting).

Separating unit and value flow in the supply chain

The mixed attribute model, which pulls together historical and fair values in the same financial statement (see the SEC report to Congress at www.sec.gov/news/studies/2008/marktomarket123008.pdf, page A-7), is one of the culprits in making financial reporting difficult to understand. Separating unit flow and value flow would be one way forward in order to bridge business reporting and reporting on nature. On a microlevel, there is much more unit data available regarding ecosystems and biodiversity than there is value data. In business, particularly in the finance world, it is the other way around as there is greater focus on value flow in order to capture risk and uncertainty. In this regard, consider huge general reserves and re-insurance of insurance companies.

Objects x Value = better business reporting

It is worth contemplating, at this point, that electronic transfer and tracking systems (especially XBRL in combination with radio frequency identification (RFID), GPS and other useful applications) create a global, intelligent chart of accounts that can help to make information, whether business-related or otherwise, more useful for stakeholder purposes.

With modern technology, such as geo-tagging and photo-mechanical object recognition, we are now able to track and find any number of objects in the business supply chain. Thereby, relativity becomes apparent when any objects are identified and monitored. Consider Figure 6.2, in which objects and values are shown to be incompatible, in as much as the measurements and respective tools differ considerably.

FIGURE 6.2 Objects x Value – the great divide. Reproduced by permission of the Stichting Global Reporting Initiative.

Whether objects are apples, customers, capital items, stock holdings or deliveries, all of these can be monitored and managed with considerable ease. Recognition tools include pictures, barcodes, XBRL tags, RFID and contracts. Particularly, all identifiable objects can be aligned and valued in order to support improved decision making. Of course, value is a monetary measure, which can require tools that include present value and market value.

The combination of these two elements – objects and value – is considered below. Before we proceed, however, it is necessary for any reporting entity to consider, and conclude, the nature of its reporting boundaries. That is to say, there is need for clarity as to the entity and related stakeholders. This is best expressed diagrammatically, as in Figure 6.3.

FIGURE 6.3 Where to draw a reporting boundary? Reproduced by permission of the Stichting Global Reporting Initiative.

Source: GRI Boundary Protocol, Global Reporting Initiative (GRI), January 2005, page 3.
Note: The entities listed here are examples only.

As we can see, central to the figure is the reporting organisation. All others can be considered as stakeholders, although these are related directly to the value chain, as per the left-hand-side scale, showing entities that are upstream and downstream. Of course, other stakeholders, such as employees and interest groups, can also exist.

In the context of this figure, the right-hand-side scale shows the extent to which the identified stakeholders have any influence or control over the reporting entity. This is not a matter of debate here. However, any reporting entity must consider its independence in drafting business reports. Furthermore, there must be clarity as to the boundaries related to objects. For instance, there is a need for business entities to obey a couple of rules to set the boundaries – for example, every entity must make an individual decision on how to define objects within their entity. Thus, objects entering and leaving the entity could have different object definitions.

Take a moment to review the details of Figure 6.4, which brings together objects and value in connecting non-financial information with financial reporting.

FIGURE 6.4 Objects x Value–connecting non-financial information with financial reporting.

In relation to the defining objects, note that some industries already have defined object definitions for their entire supply chain (for example, RosettaNet – see www.rosettanet.org). Outsourcing and cloud computing are other ways to coordinate object definitions within industries. Unmovable (fixed) objects can employ different tracking devices than movable (variable) objects. This is inferred in Figure 6.4 in relation to so-called location information that might require the GPS, satellite-based navigation system, to track and monitor the location of particular objects.

As for values, in addition to valuation tools such as present value, other information sources are available to business reporting entities. These sources include current market prices, as well as any other market data, plus databases, such as eBay and Amazon.

One significant aspect of proper business reporting is tracking supply chain activity. This is especially important when considering the transfer of ownership of objects, as well as probable shifts in related location. Furthermore, objects and valuation, when combined, can have an impact upon cash flow in relation to related determination and reconciliation. As well, there is the temporal element whereby, through the passing of time, objects (such as assets) can be reclassified, such as through recognition and de-recognition.

More specifically, with regard to business reporting, consider the income statement in which objects can be broken down into the following business/financial reporting areas:

• people (number of people × rates, benefits, etc.);
• tangible assets and infrastructure (number of cash-generating units × fair value, value in use);
• products and services (stock-keeping units × price);
• financial assets and liabilities (contracts, currency units × fair value);
• intangibles and communication (identifiable units × fair value).

These objects can be aligned to valuation files (such as fair values, historical costs and cash flow points). At a particular point in time and when required, the objects can be multiplied with the appropriate value files to avoid mixing apples and oranges, as occurs in the mixed attribute model.

For the balance sheet, in relation to the better definition of objects, plus greater clarity on related values, this can lead to a review as to how capital items are presented. For instance, these can be categorised in terms of six areas, introduced by Integrated Reporting <IR> (see later). Also, see www.rosettanet.org. Suffice it to say that this organisation sees capital as being manufactured, human, financial, intellectual, natural and social.

This segregation lends itself well to the alignment of biodiversity and ecosystem data with financial and business information. Dependencies and any impact on business, such as from the use of subsoil assets, as well as the pollution of water, air and earth, could be better explained. Instead of the current silo approach, business reporting and reporting on biodiversity and ecosystems could be integrated. Sustainability reporting is still something of a stepchild of other reporting needs as it lacks timeliness, seriousness and enforcement.

The final component of Figure 6.4 is valuation, with which there are associated a number of issues, relating to currency conversion, the determination of fair value, and valuation standards as per the International Valuation Standards Council (IVSC), introduced in Part II. Also, see www.ivsc.org. Of course, historical costs can also prove to be problematic when reckoning the value of some objects.

Aligning business reporting and sustainability reporting through disclosure

Most often materials, resources and other valuable information are spread widely, within an organisation, as well as externally. Once all of this is ­organised into meaningful segments (such as objects and sub-objects), the associated unit and value flow can be analysed. Pieces of information (now referred to as objects) that might be difficult to explain could, at a minimum, be aligned to a particular sector (for example, social networks and their influence in the people section of any so-called financial report). Then an indicative value can be given as an attribute in the form of a reporting disclosure.

Modern content analysis tools, such as Gaia Metrics' SDR Data Prep, can help us to find, sort and adjust information in internal company documents, as well as external publications, and align them (in terms of who, where and when) in accordance with a meaningful taxonomy or reporting system. Once we organise information into meaningful segments (such as objects and sub-objects) we can analyse the unit and value flow. Pieces of information (objects) that might be difficult to explain could be, at a minimum, aligned to a particular sector (e.g. social networks and their influence could be explained in the people section) and an indicative value (or method of valuation) could be given as an attribute in a disclosure or satellite accounts.

With this approach, other management and reporting methods can be advanced as well. Variance analysis and rolling forecasts are among the most frequently used tools in business management. We can compare and analyse business objects to ‘best practices' and standards. Legacy systems (untrained people, outdated equipment, ‘pollution'-causing products, outdated laws and regulations, etc.) can be aligned to current valuation on an opportunity-cost basis.

Needless to say, this approach would be a way forward to coordinate various tax systems and improve their application. It is easy to imagine that legal concepts and systems will be affected by these new approaches in global business and financial reporting. An example of this systematic and effective approach is provided in Figure 6.5, and subsets thereof, all of which are reproduced by permission of Gaia Metrics.

FIGURE 6.5 Content analysis with human filtering. Reproduced by permission of Gaia Metrics.

Figure 6.5A Hierarchy for basic navigation. Reproduced by permission of Gaia Metrics.

Figure 6.5B List of documents found. Reproduced by permission of Gaia Metrics.

Figure 6.5C User rating of auto-selected text. Reproduced by permission of Gaia Metrics.

As the heading to this figure suggests, this application involves a human interface in ranking and flagging the results of any search. We can see each component of that figure in more detail next.

For instance, the left side of the screen, as appears above, shows a tree view of the hierarchy for basic navigation. In the main part of the screen, the top table shows a list of ‘hits' of any search, such as documents that contain the concept in the search parameters related to the selected tree to the left.

The list of documents found include assorted details, such as the title, the weight of the result, the number of matching sections, as well as the source URL. The second (and middle) table shows the details of where and how many times the given concept occurs in the ‘hit' document. This is also known as a ‘span'.

Finally, the lower area of the screen, as appears above, shows details about the selected span as summarised in the middle table. This is where a human filter can score the span and also add a description for why they scored it the way they did. That adds to the effectiveness of subsequent searches, increasingly so over time and through additional interrogations of all objects and related information. Not shown here, is the possibility for the user to hand-select for fine-tuning a fragment within the full text.

Call for action – the way forward

Financial institutions are going through major changes in relation to determining the current usefulness and future form of their business models. In the process, these significant and influential entities must pay more attention to sustainability reporting. Nature, with its plentiful metrics and financial institutions, with their extensive knowledge of risk assessment and valuations can become a powerful combination, as well as a catalysing factor, in improving financial and business reporting.

Note: The previous section was based upon Ramin, K. and Reiman, C. (2011), ‘Natural Capital: The Finance Sector & Financial Reporting – Catalysing Action?', in R. Schatz (ed.), Trust Meltdown II, Media Tenor International, Beirut, New York, London, launched at the World Economic Forum, Davos-Klosters, Switzerland, 25 January, pp. 17–26; reprinted in The Malaysian Accountant, journal of the Malaysian Institute of Certified Public Accountants, March – April 2011, pp. 10–15.