Wednesday, July 31, 2019

Sustainability Reports and the Limitations of ‘Limited’ Assurance

Editorial Note: We are delighted to publish the following article by Professor Michael Kraten of Houston Baptist University. It was originally published in this month’s issue of The CPA Journal; we thank Journal Editor-In-Chief Rick Kravitz (who is himself a frequent contributor to our blog) for permitting us to transmit the article to our Section members. We encourage our members to peruse the contents of this month’s issue at CPAJournal.com.

How many standards can a sustainability accountant possibly follow? Three dozen comprehensive standards are published by the Global Reporting Initiative (GRI), and 77 industry-specific standards are issued by the Sustainability Accounting Standards Board (SASB). In addition, 17 sets of metrics are promulgated within the Sustainability Development Goals (SDG) of the United Nations, 15 components of integrated reporting are defined by the International Integrated Reporting Council (IIRC), and the AICPA, not to be outdone, chimed in earlier this year with its new guide, Attestation Engagements on Sustainability Information.

Sustainability standards are growing in length and complexity; as a result, the length and complexity of corporate sustainability reports are growing as well. The 2018 sustainability report of Volkswagen (VW), for instance, runs at 108 pages. The report of its European rival Fiat Chrysler Automobiles (FCA) is much lengthier, at 148 pages.

Some analysts complain that such reports are filled with “green-washed” public relations content. Others disagree, claiming that the European Union’s Directive on nonfinancial reporting ensures that the sustainability content is meaningful on an individual report basis and comparable across multiple reports.

To be fair, the latter group of analysts can cite examples of meaningful and comparable data. VW’s report, for instance, includes a section entitled “GRI Content Index”; it cross-references its published data to the standards of the Global Reporting Initiative. FCA’s equivalent section, the “GRI Standards Content Index,” serves the same purpose.

But are readers of sustainability reports missing out if they only pay attention to the sustainability report data and the underlying standards? Should they also pay attention to the assurance letters issued by public accounting firms and printed in the reports? After all, if the assurance letters are not sufficient, then all of the information in the reports, greenwashed or substantive, is of dubious value.

Consider, in comparison, the annual financial statements of business entities. They would obviously be less useful if public accounting firms were to use extremely limited assurance procedures during their annual audits. Their assurance procedures would be even less useful if auditing firms could offer different levels of assurance to different clients.

Indeed, spending a little less time worrying about the data in the sustainability reports and a bit more time considering the limited assurance letters may lead to the conclusion that confidence in the validity of any of the report data may not be warranted.

Volkswagen

Consider, for instance, Volkswagen’s 2018 report. The table of contents lists a two-page “Independent Assurance Report” on pages 104 and 105. That assurance letter, issued by PricewaterhouseCoopers, is called “Independent Practitioner’s Report On A Limited Assurance Engagement On Non-Financial Reporting.” How much assurance does it actually convey?

The letter notes that PricewaterhouseCoopers is required to “plan and perform the assurance engagement to allow us [i.e., the CPA] to conclude with limited assurance that nothing has come to our attention that causes us to believe that the Company’s Non-financial Report … has not been prepared, in all material aspects, in accordance with” the relevant standards.”

This double-negative structure raises some flags. In essence, the CPA is only required to conclude that nothing came to his attention to cause a belief that something is not right. Metaphorically speaking, an ostrich that buries its head in the sand during a desert storm could satisfy that level of assurance about the weather.

The letter continues by listing eight assurance procedures that were performed by the CPA. It notes that PricewaterhouseCoopers obtained an understanding of the structure of the organization, conducted inquiries regarding the preparation process, analytically evaluated selected disclosures, compared selected disclosures, and so on. There are, however, almost no detailed disclosures of the nature of the inquiries that were made, the disclosures that were selected for analytical evaluation or comparison, or anything else. Interestingly, PricewaterhouseCoopers does list a single specific procedure in its letter; it notes that it performed an “assessment of the aggregation of Scope-3-GHG-emissions (categories 1 and 11) on group level.” That procedure may have been necessitated by Volkswagen’s recent global emissions scandal. (For more on the Volkswagen case, see “The Volkswagen Diesel Emissions Scandal and Accountability” by Daniel Jacobs and Lawrence P. Kalbers, on p. 16 of this issue.). Nevertheless, no other detailed procedure is disclosed in the report.

Finally, the letter concludes with a disclaimer that it “is not intended for any third parties to base any (financial) decision thereon. Our responsibility lies only with the Company. We do not assume any responsibility towards third parties.” Thus, PricewaterhouseCoopers’s letter is not designed to serve the needs of the readers of Volkswagen’s sustainability report, despite being the sole assurance letter that is included in that very report.

Incidentally, although Volkswagen’s 2017 sustainability report is comparable to its 2018 report, one cannot compare these two documents to its 2016 report. Although a synopsis of the 2016 report is posted online, the full 2016 report has been deleted from the Internet. It is left to readers to wonder what was in the full report and why it is no longer available.

Fiat Chrysler Automobiles (FCA)

Fiat Chrysler Automobiles’ table of contents likewise lists a two-page “Independent Auditor’s Report” on pages 139 and 140. That letter, issued by Deloitte, is called “Independent Auditor’s Report on the Sustainability Report.” Deloitte does not explain why it refers to itself as an auditor and not as a practitioner (as PricewaterhouseCoopers does).

Furthermore, Deloitte’s letter contains the same double negative language as PwC’s, concluding that “nothing has come to our attention that causes us to believe that the Sustainability Report … is not prepared, in all material aspects, in accordance with” the relevant standards.

The Deloitte letter lists seven bullet points of assurance procedures. Certain details are excluded from the Deloitte report but are included in the PricewaterhouseCoopers report, and vice versa. For example, PwC’s explicit statement about its GHG emissions assessment procedure is missing from Deloitte’s letter. Conversely, Deloitte’s letter explicitly refers to analyses performed on “minutes of the meetings,” and the receipt of a “representation letter signed by the legal representative” of Fiat Chrysler. Such language is missing from the PricewaterhouseCoopers letter.

Finally, Deloitte’s letter does not contain a warning that it “is not intended for any third parties to base any decision thereon,” or that Deloitte does “not assume any responsibility towards third parties.” PricewaterhouseCoopers’s letter, as noted above, includes these disclaimers.

The Limitations of Limited Assurance

Should stakeholders worry about these facts? On the one hand, it is important to keep in mind that the sustainability movement has succeeded in compelling global corporations to issue more than 100 pages of data each year. Even if significant portions of the reports are filled with green-washed information, the remaining (and perhaps some significant) portions of the reports may contain useful data.

On the other hand, it is also important to keep in mind that the limited assurance of these public accountant’s sustainability letters provides, in certain respects, even less assurance than detailed agreed-upon procedure letters. After all, an agreed-upon procedure letter contains detailed descriptions of the procedures that are performed and the findings that are produced by the procedures. In contrast, the limited assurance letters in these sustainability reports contain very little detailed information and only reach vague, double-negative conclusions regarding the findings.

Furthermore, the descriptions of the procedures in the letters are inconsistent from company to company, and the disclaimers regarding the use of the letters by third parties vary remarkably from firm to firm. Such inconsistencies and variations greatly reduce the value of the assurance reports, and thus of the sustainability data that are included in them.

Clearly, there are significant limitations to the limited assurance letters in the sustainability reports. Perhaps, in addition to lobbying for improvements in sustainability reporting standards, public interest advocates should consider lobbying for the development of more stringent sustainability assurance standards.

Tuesday, July 16, 2019

Accounting In The Food And Drink Industry

Editorial Note: We are delighted to publish the following editorial by Professor Lisa Jack of the University of Portsmouth in the United Kingdom. The content is representative of the quality of the material that our colleagues will share at our 2019 Annual Meeting in San Francisco next month.

We hope to see you there! As always, when you read the comments of our columnists, please keep in mind that they only speak for themselves. They are not expressing the positions of the AAA or of any other party.



Is it in the public interest to know about accounting in the food and drink industry? As one of the very few researchers in the discipline who study this field in depth, and I’ve been looking at the industry for nearly 20 years now, what I usually encounter is a vague idea that accounting in the area ‘cannot be that complicated’, something that runs philosophically with a general unawareness of what really goes into producing food and drink in a developed, capitalist country.

It’s not that people are generally disinterested in food and drink, and where it comes from. Yes, some schoolchildren and some adults take supermarket food for granted and are bemused to find that what they eat involves animals and plants (and chemicals). But the TV schedules, in the UK and Canada at least, are filled with people cooking and baking, and investigating ‘how things are made’, food scandals, diets and advising on how to reduce the costs of the weekly shop for families. Gastronomy, artisan foods, organic, vegan – all are taking new footholds and as Julie Guthman of UC Santa Barbara says very quickly become part of a capitalism that embodies (literally) the faults in the system. The domination of capitalist multi-retailers and food processing companies is directly implicated in policy on both obesity and healthy eating.

In fact, most of us have a reasonable general knowledge of food and some perception of what it costs to produce, distribute and sell. But it is a complicated industry, with complicated social interactions at play. The accounting is also complicated – and often under the radar. So, I want to touch first on how others have articulated the underlying problems and then on bringing forward some of the things I’ve found going on under that radar. In particular, here, I’m interested with others on how city dwellers (around 55% of the world’s population according to the UN, and set to rise to 68% by 2050) see food.

Michael Pollen (The Omnivore’s Dilemma) and Michael Carolan (The Real Cost of Cheap Food) are the other must reads in this area, along with Julie Guthman (Weighing In).

One of the most quoted and respected writers in the US is Wendell Berry (b.1934), this is an extract from ‘The Pleasures of Eating’.

I begin with the proposition that eating is an agricultural act. Eating ends the annual drama of the food economy that begins with planting and birth. Most eaters, however, are no longer aware that this is true. They think of food as an agricultural product, perhaps, but they do not think of themselves as participants in agriculture. They think of themselves as "consumers." If they think beyond that, they recognize that they are passive consumers. They buy what they want — or what they have been persuaded to want — within the limits of what they can get. They pay, mostly without protest, what they are charged. And they mostly ignore certain critical questions about the quality and the cost of what they are sold: How fresh is it? How pure or clean is it, how free of dangerous chemicals? How far was it transported, and what did transportation add to the cost? How much did manufacturing or packaging or advertising add to the cost? When the food product has been manufactured or "processed" or "precooked," how has that affected its quality or price or nutritional value?

Georg Simmel wrote in 1903 in ‘The metropolis and mental life’: “…the money economy that dominates the metropolis in which the last remnants of domestic production and direct barter of goods have been eradicated and in which the amount of production on direct personal order is reduced daily. Furthermore, [a] psychological intellectualist attitude and the economy are in such close integration that no-one is able to say whether it is the former that has affected the latter or vice-versa”. One result might be that living in a city makes one unaware of the cost of food production, and the effects of a demand for cheap food on suppliers and producers. The English writer Adrian Bell (1931) says that when he was a struggling farmer (having been a city-bred boy who chose an apprenticeship on a farm over other professions): “I began to realise, also, how much of the money which the consumer says he gives so plentifully, and of which the producer says he receives so sparingly, fell through the hole in the middle-man’s pocket into the gulf of wastage and wear-and-tear. What Mrs. Sinks of Surbiton doesn’t realise is that for the privilege of going out at any moment and buying a chicken ready for the oven, she has to pay for all those other times when the chicken was waiting for her and she doesn’t want it”.

This last quote is so relevant to what I hear in conversations that I have today. Consumers (or “individual eaters” for a less pejorative term these days) tell me at length either about how wicked it is that the supermarkets charge so much and make such large profits, or at length about how they are prepared to pay more in order to get quality, or fairness, or whatever, and how wicked it is that supermarkets charge so little for (junk) food. Producers, suppliers and retailers tell me about the difficulties of maintaining incredibly tight NET margins averaging around 1-2% of turnover, but I also find that increasingly, I am looking at the money that vanishes in between. I am also taken with looking, as Bell does, at the problem from the other side, the non-consumer side. Here in the UK, for example, food manufacturing, processing, distribution and selling accounts for some 29.5% of GDP, employs 14% of the workforce and accounts for £22bn of exports (including quite a lot of scotch whiskey). Yet, of the 6,000 companies in the industry (excluding farmers, around 2% of national production), 5,800 are small or mid-sized entities and nearly 1500 are teetering on the edge of insolvency.

What is included then, in a conversation about accounting and the public interest? A surprising number of topics, in fact, which include: subsidies and support from government; the public cost of deleterious consequences of the food industry – public in terms of social and environmental damage; individual costs in terms of health and well-being; pay inequality (there are attested reports of workers in supermarkets having to use foodbanks, whilst executives can be very highly remunerated); the whole cheap food debate linked to the real costs of production; power and capitalism, evinced in the extreme concentration of production and selling in the hands of a few businesses. These debates are already out there but I promised to discuss what things go under the radar, which is what I research. Here are three of them: commercial income; discounting in negotiations and the growth of food service. There is also the nature of narrow margins, marginal costing, performance measurement and risk assessment and their effect on the fairness of the industry*. Enough for a book, let alone one blog post, so I am just going to focus in on commercial income.

In the UK, the largest supermarket (Tesco) was acquitted on charges of fraud related to an overstatement of £250million in its profits. What is not in dispute is that the overstatement related to recognising commercial income in advance.

Following disquiet on its commercial income, the supermarket Morrisons in the UK started to lead the industry on disclosures of this activity in the annual report but only from 2014/15. The Germany-based discounter, Aldi (recently spotted in an outpost in Ames, Iowa and a significant rising player in the UK), states clearly that it does not use commercial income in its purchases.

In the US, as one BBC article reports, “According to Fitch, the credit rating agency, the payments are the equivalent to 8% of the cost of goods sold for the retailers, equal to virtually all their profit.”

So, what is commercial income? Briefly, it is income from suppliers to retailers. This, of course, should elicit the response ‘What, hang on a minute, customers pay suppliers, right, not the other way around?’ This is to fundamentally misunderstand the nature of multiple retailers (supermarkets). In fact, the new terminology handily loses the term ‘market’ but that is what they are offering and managing. Like a marketplace, you pay the market owner for a place and their ability to bring people in to buy. You might reward them for doing the latter well and for selling large quantities of your product. Commercial income, then, includes a raft of payments extracted from the supplier for the privilege of supplying – space, bonuses, discounts offered and so on. However, supermarkets are also now driven by customer demand (created largely by the supermarkets themselves) for full shelves, full choice all year around. Suppliers tied into the system, already taking the slimmest of margins for their products because the margin needed by the retailer to run their system is substantial, are bound to deliver in full, to specification, on time. For some supermarkets, the slightest infringement of this incurs penalties, also accounted for under ‘commercial income’. The supplier might well lose the payment for the consignment as well. An article in the British weekly industry publication in 2015, ‘The Grocer’ lists around 30 different types of commercial income.

Essentially, supermarket profits do not come from consumers, they come from suppliers. Link that with extended payment terms and it becomes clear why small and mid-size food companies, and their employees, are at risk. It is not a case of ‘supermarkets bad, suppliers/consumers good’. There are retailers have records of working to build long-term beneficial relationships with some suppliers and many consumers themselves prefer to shop under the radar than visibly in a local shop, and to have the perceived convenience. The job for accounting researchers is to help devise possible alternatives to enhancing profits that do not involve commercial income, low wages and non-affordable food. That really is a research challenge.