Beyond the Balance Sheet

March 01, 2015

California CPA: March/April 2015

Non-financial, Material Disclosures and the Quest for Sustainability

By Brad J. Monterio

Disclosure needs have evolved beyond traditional financials over the past two decades to better meet today’s needs of investors, analysts, regulators and other stakeholders. Consider the recent growth in non-financial disclosures about material, decision-useful environmental, social and governance (ESG) factors; as well as the rise in corporate social responsibility (CSR), sustainability and integrated reports.

Stakeholders—those with a vested interested in the actions, performance results and impacts of companies—want more three-dimensional information that indicates a company’s overall contribution to society’s sustainability. This is causing corporates to move beyond simply reporting on financial performance to include information about environmental impact and use of natural resources, labor practices, compensation models, community engagement, social programs, business models, strategy, plans for future growth and economic value, and so much more.

In short, this enhanced information set is intended to help stakeholders more accurately determine whether a business should have a “license to operate” and is sustainable for the long term.

Millions of small private businesses that are supply chain partners with publicly traded companies are increasingly being required to disclose sustainability information to government agencies and public companies (e.g., disclosures about conflict minerals, human trafficking, child labor). This is not merely a “big company” or public company issue. And California CPAs in these businesses need to take notice.

A Paradigm Flip: Value Outside the Financials
This quest for sustainability information is supported by Ocean Tomo’s 2010 study, Intangible Asset Market Value, which found that more than 80 percent of a company’s value today is seen outside of the financial reports in these other areas. This is a paradigm shift from just three decades earlier, indicating a comparatively rapid change within the much longer, 100-year history of financial reporting. The move toward non-financial disclosures is occurring on a global scale, with capital markets worldwide seeing similar, increased demand from stakeholders for material disclosures that include extra-financial information.

The growth in non-financial, sustainability disclosures benefits stakeholders by giving them a more comprehensive set of inputs to make decisions. However, this burgeoning area also introduces challenges, particularly for regulatory bodies charged with protecting the public interest. In the United States, the SEC serves this role, ensuring that the investing public has real-time access to reliable and relevant material information for investment decisions.

SEC Oversees Material Disclosure, Both Financial and Non-financial
As described on the SEC website, “The mission of the SEC is to protect investors, maintain fair, orderly, and efficient markets, and facilitate capital formation … The laws and rules that govern the securities industry in the United States derive from a simple and straightforward concept: all investors, whether large institutions or private individuals, should have access to certain basic facts about an investment prior to buying it, and so long as they hold it.”

To achieve its mission, the SEC requires public companies to disclose material information to the public. Although it does not mandate or require disclosure of any specific non-financial metrics in 10-K and related regulatory compliance filings, it does require material disclosures that can include information about ESG or non-financial factors.

In other words, companies must disclose information of a material nature, whether financial or not. Is this a de facto “requirement” to disclose non-financial, material data to the public in the absence of an SEC regulatory mandate? If it quacks like a duck …

An Additional Challenge: Equilibrium
Given the relative newness of material, non-financial information in corporate sustainability disclosures, there is inequality between the level of market trust in disclosed, independently verified financial data and that of a non-financial nature. External financial compliance reporting is a mature practice among U.S. corporations trusted by investors, analysts, regulators and other stakeholders. This process includes:

• SEC-mandated financial disclosures flow through the information supply chain to investors, analysts and stakeholders under a well-established EDGAR filing process.
• U.S. accounting standards, set by the Financial Accounting Standards Board, used by public companies to disclose financial information to the investing public, ensure consistency and comparability of financial disclosures.
• Public accounting firms provide independent assurance of financial disclosures to gain trust and reliability in the disclosed information.

Contrast this trusted financial disclosure process with that of non-financial sustainability information and the inequalities become apparent: 
• Although material, non-financial information can be disclosed through SEC filings, it is not clear where and how this should/could be reported in the filings. 
• FASB does not set accounting standards regarding non-financial, sustainability topics, calling into question the ability of investors and other stakeholders to understand how sustainability information is derived or calculated, not to mention the distrust and lack of consistency and comparability resulting from the absence of a uniform accounting standard for reporting on sustainability topics.

Independent assurance around sustainability disclosures also is an emerging area, with Big Four firms providing opinions on sustainability reports in some markets around the world. However, this is not widely practiced, and there is not a uniform standard for assurance of this information. As with the lack of accounting standards for sustainability topics, this breeds distrust—or at least skepticism—of sustainability disclosures.

Non-financial sustainability disclosures are an emerging area about which companies, supply chains and external stakeholders are still learning. These disclosures need to come into equilibrium with financial disclosures to enjoy the same level of trust and reliability for investment decision-making and performance comparisons. Today, there is an organization to help do just that.

Emergence of the Sustainability Accounting Standards Board 
Formed just a few short years ago and based in San Francisco, the Sustainability Accounting Standards Board fills a void in the standard setting process to bring consistency, comparability and trust to sustainability disclosures by U.S. public companies. This goes a long way toward bringing equilibrium to sustainability disclosures and their financial siblings.

SASB’s mission is to develop and disseminate accounting standards on sustainability topics along with disclosure guidance (across 10 sectors and 80-plus industries) to help public companies disclose material, decision-useful information to investors. Its accounting standards on sustainability topics provide companies with standardized accounting metrics to account for performance on industry-level sustainability topics. When making disclosure on sustainability topics, companies adopting SASB’s accounting standards will help to ensure that disclosure is standardized and therefore useful, relevant, comparable—and can be assured by an independent third party.

SASB standards are designed for disclosures to be included within existing mandatory SEC filings (e.g., within the MD&A section), including forms 10-K and 20-F that are filed using the mature, well-understood EDGAR system.

Strategic alignment with existing corporate disclosures (e.g., 10-K) is intended to leverage familiarity with MD&A and these disclosures to lower barriers to adoption of sustainability accounting standards and the associated reporting burden for the additional non-financial disclosures. It also builds upon corporate familiarity and trust in the SEC EDGAR filing process to help companies overcome the learning curve for sustainability disclosures more quickly.

I sat down recently with Doug Park, SASB director of legal policy and outreach, to talk about the organization and sustainability reporting. Park leads the development of SASB’s positions on legal and regulatory matters and engages with lawyers, governance professionals, CPAs, board members and others on 
these issues.

Q: What is SASB’s role in sustainability reporting?
SASB envisions a world where a shared understanding of corporate sustainability performance allows companies and investors to make informed decisions that drive value and improve sustainability outcomes. The SASB uses evidence and stakeholder participation to develop standards for U.S. public companies to disclose material sustainability information to investors. Since the SASB follows the Supreme Court definition of materiality, it provides the only sustainability reporting approach that is intended for, and appropriate for, use in U.S. securities filings.

Q: Why is SASB important?
There are several reasons. First, SASB is creating industry-specific accounting standards for disclosing sustainability information that are likely to constitute material information for companies in that industry. Second, the standards are intended to help companies disclose material information in SEC filings as appropriate. Third, companies can use SASB standards to manage and improve their performance on sustainability factors that affect their ability to create value. Fourth, investors can use information that companies disclose using SASB standards to better understand risk and opportunity, thereby allocating capital more efficiently.

Q: What is SASB working on?
SASB is focused on standards development and market adoption. We’re on schedule to release the first version of standards for all sectors in the first quarter of 2016. With respect to market adoption, we’re developing initiatives and products to help companies, investors and their advisers implement SASB standards. Examples include the SASB implementation and user guides, which will help companies incorporate SASB standards into their existing disclosure controls and procedures, internal management systems, and materiality analyses; the Standards Navigator, an online tool that presents SASB standards in digital format and provides a search tool and a convenient place to provide feedback on the standards; and the Data Provider Partnership Program, where data aggregation partners will offer investors access to corporate performance data reported using the SASB standards.

Q: Why now for sustainability reporting?
Sustainability reporting has gained momentum because of changes in the world in which companies do business. Resource constraints, globalization and environmental degradation impact a company’s cost structures, risks and opportunities, and ability to create value over the long term. Investors are increasingly demanding sustainability information from companies because they understand that sustainability performance affects financial performance. Executives increasingly see sustainability as a core strategic risk and opportunity. Emerging regulation of greenhouse gas emissions and cybersecurity, as well as the passage sustainability disclosure requirements by the European Union and by stock exchanges, motivate sustainability reporting.

Q: What is the role of CPAs in sustainability reporting?
CPAs play a critical role in effective sustainability reporting. Sustainability reporting requires effective disclosure controls and procedures, internal audit, the application of sustainability information to improve management practice and assurance. CPAs can help ensure that all of these activities are carried out smoothly.

Q: How does sustainability reporting impact small companies and their key advisers, including CPAs?
Small companies will be expected to provide sustainability reports as more and more large companies do so. Small companies may have different types of shareholders and stakeholders, but sustainability reporting is valuable to all types of organizations. Key advisers, like CPAs, will need to learn how to help their clients understand the issues, challenges and benefits of sustainability reporting.

Q: Where can CPAs learn more about sustainability and sustainability reporting? 
CPAs can learn more from professional organizations, including CalCPA. Other professional organizations such as the CFA Institute and American Bar Association offer webinars and articles on sustainability and sustainability reporting. The Big Four have burgeoning practices in sustainability that provide information on these topics. Finally, SASB is creating programs to help key advisers like CPAs understand sustainability as they advise their clients on sustainability reporting. Examples include the SASB Professional Certificate, which is under development, our webinar series and other upcoming education opportunities.

Begin at the Beginning
As a first step into the world of sustainability reporting, visit the SASB website to begin learning about its conceptual framework containing accounting standards for sustainability topics and disclosure guidance. You will be able to download its various provisional standards and browse through the standards using its Standards Navigator tool.
Brad J. Monterio is managing director of Colcomgroup, a consulting firm offering XBRL, CSR, sustainability and integrated reporting advisory services, and serves on several not-for-profit boards and committees dealing with corporate reporting standards.

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