The key role accountants will play in the shifting definition of value

As the components of a company’s value change, the role of finance must adapt to what it reports and how it manages tangible and intangible assets. That shift was underscored with the release of new global sustainability standards by the International Sustainability Standards Board, and it’s the topic of this episode of the JofA podcast.

Ash Noah, CPA, CGMA, FCMA, managing director—Management Accounting and ESG for AICPA & CIMA, together as the Association of International Certified Professional Accountants, explains briefly what the two standards are and what he sees changing for organizations going forward, in the U.S. and elsewhere.

Noah wrote a blog in May about the new imperative for accountants related to reporting on environmental, social and governance (ESG) factors.

In this episode, he goes into more detail about what the new standards mean for business and the profession.

What you’ll learn from this episode:

• Noah’s description of what is addressed in the new standards, IFRS S1 and IFRS S2.
• Details on types of intangible assets.
• How the release of the standards is likely to affect U.S. companies.
• The AICPA & CIMA vision around the standards, according to Noah.
• How the role of finance changes with the release of the standards.

Play the episode below or read the edited transcript:

To comment on this episode or to suggest an idea for another episode, contact Neil Amato at Neil.Amato@aicpa-cima.com.

Transcript

Neil Amato: Welcome back to the Journal of Accountancy podcast. This is your host, Neil Amato. I am joined for this episode by a longtime colleague, his name is Ash Noah. He is managing director– Management Accounting and ESG for AICPA & CIMA. Ash, first welcome to the Journal of Accountancy podcast. We’re happy to have you today.

Ash Noah: Neil, thank you very much. I am absolutely delighted to be back again and talking to you.

Amato: Great. The feeling is mutual. We are one day past the release of the International Sustainability Standards Board’s first sustainability standards, named S1 and S2. They were released on Monday, June 26. We’re recording the morning of June 27. Ash, first, now that the standards are out, there are some people who are maybe just learning this news on our show. What are some high-level things they should know about the standards?

Noah: Yesterday was an absolutely groundbreaking day in terms of the first sustainability standards across internationally to be released. IFRS S1, around the general aspects of how an entity operates and particularly with regards to its governance, its strategy, its risk management processes, and also about the metrics and targets that it uses to address and report sustainability-related risks and opportunities.

S1 really refers to these four aspects, and it considers that as its core content. It really is providing the readers of the information to understand how an entity’s sustainability-related risks and opportunities are assessed, how they are monitored, and how they’re managed. Anything that is to do with the general requirements are addressed in S1.

The IFRS S2 is more specific, and it is around the requirement of an entity to disclose information about climate, specifically climate-related risks and opportunities. Again, the idea is really that it’s decision-useful in regards to general-purpose financial reports for making decisions relating to providing resources to the entity. The IFRS S2 is specifically around requiring an entity to disclose the information that relates to its climate risks and any opportunities that could be reasonably expected to affect this entity’s operations. If it affects the entity’s cash flows or if this affects the entity’s ability to access finance. If it impacts its cost of capital in the short, medium, or long term as the entity faces these climate-related risks. It’s very specifically decision-useful information for investors and really helps the investing community to assess the risks and opportunities that climate-related risks pose to an entity.

These are the first two off the block. Obviously, the whole issue around carbon and greenhouse gas emissions are on top of the agenda with regards to getting the standard to the market. It’s unprecedented really to get these IFRS standards issued so quickly from draft to an exposure draft for comments, receiving the comments, and now issuing the standards. Normally, it could take anything between three to five years, and this has happened in the last 18 months. The speed of the delivery and implementation has been very, very impressive.

Amato: In an article about a month before the standards’ release on the AICPA & CIMA site, you wrote in part, “The direction of travel is clear in terms of the breadth of information companies will now have to report.” You said there are significant implications in areas such as enterprise resource planning systems, data controls, risk management, and materiality. Would you like to talk some more about those in detail?

Noah: Yes, sure. At a high level, what these standards really mean is that the CFO’s office, the finance function, now has standards that require it to measure, record and report, and disclose certain information, and that information is if it is financially material to the entity. The minute a standard comes into place, the requirement to report as a part of the financials becomes a CFO’s responsibility. Now, it impacts the company’s operations. It impacts the company’s valuation. It impacts how the investors look at the entity.

Really when we look at the implications, the high-level implication is that finance and the CFO’s office has to turn to really considering the intangible assets. We’ve always looked at the total valuation of a company and we’ve understood — this is generalizing, and it’s generalizing from S&P 500 — about 90% of the value of a company is in its intangible assets. It’s in its social capital and relationship capital. It’s in its human capital, the workforce. It’s in its intellectual capital, which again comes from the ability of the workforce to execute, to take a product from raw materials to finished goods, or to take a product from design to delivery.

These are all part of its intellectual capital, but none of this is actually in the balance sheet. For the first time, because of these standards being issued, the attention of the CFOs and the finance function, which used to predominantly be on the financial capital and the manufactured capital on the P&L, the balance sheet, and the cash flow has to shift beyond that into intangibles and how these intangibles start to affect that valuation of the company, and how financially material incidents or financially material impacts would affect its business model. An issue around climate change could fundamentally impact an organization’s business model. It could be the availability of fresh water that impacts a beverage company. These type of implications are even more important now as the company will have to start reporting on it.

That is what the major shift is in terms of implications for the finance professional, that a finance professional as CFO has to start considering the material ESG factors that are beyond financial operations and anything that impacts their social license, their relationships with the regulator, or the relationships with their customers and suppliers. All of these environmental scans that might impact the entity’s strategy and the business model, have to be on the radar of the finance function and CFOs. That translates into, “OK, now how does that impact business operations? How does that impact our decision-making? How does that impact our supply chain?” All these wider aspects which may not have been predominantly the focus of the CFO become important. Now the mandate of the finance function and the role of the finance function is going beyond their core finance areas.

Amato: These are global standards. Certainly they’re going to affect organizations in different regions, different countries, in different ways. But what do you think will be the impact on U.S. organizations?

Noah: Neil, we know we are waiting for the SEC to issue their requirements around climate reporting. The draft has been out there for consultation, but we have no idea on timelines. But regardless of what the SEC requires, the U.S. companies who have worldwide operations will be impacted by IFRS S1 and S2. Globally, IFRS has been adopted by around 140 jurisdictions and countries around the world. We expect that there would be a similar rate of adoption. It will take time, but the way the ISSB is positioning the standards is that it will be the baseline in terms of this is the minimum requirement, and each jurisdiction can then add on its own layers of requirement. It’s no different to financial reporting standards where you have IFRS and then you’ll have some local GAAP which adds on to that baseline. That’s how we see it being adopted across the globe.

U.S. companies who have operations or who are listed in other stock exchanges around the world will feel the impact because as the standards become law and as they become a requirement in these jurisdictions, U.S. companies will have to comply with the standards and the reporting that is required by those entities in those countries. So U.S. companies will not be protected from it in that way.

But also generally Neil, this is the way the world is moving toward. They want to provide transparency. Investors are demanding transparency, and countries and the regulators want that transparency around sustainability management. How are companies managing their materially financial sustainable impacts? How good are they at managing sustainability will have a massive impact on the way the market views them and values them. U.S. companies might start off voluntarily, and many have already. There are several reporting entities that provide sustainability information in their reporting. A standard enables comparability, it enables consistency, and it really becomes decision-useful information for the investor. The U.S. companies need to bear that in mind, and several already have and have moved toward sustainability reporting. But this will happen more and more as U.S. companies will be required to report this based on their operations in other parts of the world.

Amato: The Association, AICPA & CIMA, has definitely had a role in the standards. But going forward, what would you say is AICPA & CIMA’s vision around the standards?

Noah: Yeah, you’re right, Neil. We did provide our inputs to the exposure drafts. We were involved at the high levels in advising ISSB. Our CEO, Barry Melancon, has been very actively involved, and also our global head of ESG, Jeremy Osborn, is a part of the technical committees. We have a role to play with regards to how the standards are formulated, commenting on them, providing advice, et cetera.

But in terms of our strategic vision as regards a professional accountancy body, it’s really to enhance the skillsets and position the accounting and finance professionals as leaders in the ESG space with regards to leading and guiding their organizations to understanding the sustainability impacts, and really enabling these organizations to create sustainable value over the short, medium, and long term. That’s what we’re trying to enable finance and accountancy professionals to do, and we want to build that capacity and capability for them to be able to do that.

As I said before, we want to be the leading voice, we are influencing the formulation of the standards, we are supporting the development and adoption of a single global sustainability standard because that is good for business. We want to position the CPA as the preferred provider of sustainability assurance and any related advisory services.

With regards to management accountants, where I sit and what I manage, we really want to enable the management accountants to maximize value creation. The value creation, as I mentioned before, happens by the management of the tangible assets and the intangible assets. Really enabling them in terms of decision-making towards effective allocation and deployment of capital, of resources and relationships, and enabling their organizations to integrate sustainability matters into their strategy and their business models. That really is our vision for the management accounting side. Really the Association itself is focused on delivering its own sustainability commitments. We would like to position ourselves as the role model for the profession.

Amato: Again, it’s just early days, even early hours, 24 hours about, since the official release of these standards, but any closing thought and analysis as we wrap up today?

Noah: Neil, I would like to position the S1 and S2 release not just as something that the CFOs and finance professionals need to be aware of in terms of the reporting requirements. I think the reporting requirements are really an outcome with regards to the impact of the standards. Finance professionals really need to consider that these standards have wide-ranging impacts on their entire organization.

I might have said this before, but in conclusion I would repeat this, that these standards are going to impact an entity’s business model. It will impact their strategy and the execution of their strategy because the implications of value creation have changed. The meaning of value is going beyond profits and margins and cash flow. Value is becoming a stakeholder issue rather than just shareholder profit. That shift is something that finance professionals really need to understand and manage. It’s really critical in terms of how they bring value to their organizations.

Neil, I believe this is a significant opportunity for finance to really participate in the implementation of these standards but also in terms of creating value and really harnessing the opportunities that organizations come across as they adopt a more sustainable business model.

Amato: I think that’s an excellent way to close. Ash, thank you very much.

Noah: Thank you, Neil. Always delighted to join you and speak to you about things that are important to the profession.