Consolidating non-financial data: why standards matter

Companies need good information, or data, to manage their business effectively. For companies with more than one office, plant, or location, such as subsidiaries, the information is dispersed throughout the organisation. To obtain a complete picture of performance, data must be collected and aggregated, or in accounting parlance, consolidated.

When it comes to disclosures, for information to be useful, it must be a true and fair representation of the entity as a whole – or minimally a clearly-defined set of activities – so that users understand exactly what it pertains to.

Aggregation or consolidation?

For accounting professionals, aggregation and consolidation are related yet distinct concepts:

• Aggregation refers to the summing of similar items (for example, revenues, salaries, number of employees, litres of water consumed) or summarisation of qualitative information within a single reporting entity.
• Consolidation refers to the combination of information from a parent and its controlled subsidiaries (each of which is its investee and a separate reporting entity as defined in IFRS 10) into a set of information that presents the group as a single economic entity. 

In other words, aggregation is what happens within an entity; consolidation is what happens at the group level for its entities under common control. While aggregation typically does not result in any netting out, consolidation does require netting of inter-company transactions, the principle being that only transactions involving an arm’s length party are disclosed by the group.

Aggregation and consolidation need to be further treated through a materiality lens, which is context-specific. Typically, local-level management operates at a more granular level, focused on operations under its responsibility, while group-level management operates at a higher level, considering the operations as a whole. Materiality judgements are made independently for each level; therefore, what may be material at the local (entity) level may or may not be material for the group.

For example, a multinational beverage company has production operations in three countries, creatively called A, B and C. Its beverage production requires significant quantities of water, both as a product ingredient and for plant operations.

Countries B and C have abundant supplies of water. However, country A is classified as a high water-stress location. Management in country A correctly deems water availability and consumption to be a material issue for the business, whereas management in countries B and C consider water to be a topic for monitoring for the foreseeable future.

On a consolidated basis, country A accounts for 10% (or €80M) of the company’s €800M in total revenues, but accounts for 15% of the group’s water consumption and 25% (or €5M) of its €20M in water costs.

At the level of country A, water is deemed a material risk because it places all revenue at risk should it no longer be accessible at the quantities and quality needed. However, at the group level, water is not deemed to be a material risk because the exposure in country A is mitigated by the option to readily increase production in countries B and C.

There may be other instances where consolidation doesn’t mitigate or reduce exposure to material issues identified at the entity level. Consider a company with at least one of its subsidiaries having identified the risk of human rights violations within its supply chain. This may well be enough to create a material reputational risk at the group level that could affect brand value, revenues, and profit.

What does this mean for disclosures?

The examples help to understand why reporting standards that prescribe consolidated information for a defined group or set of activities also contain requirements about the proper (dis)aggregation of information.

Useful (dis)aggregation is designed to promote understandability of a company’s disclosures by preventing the obscuring of material information. This can happen when information is either inappropriately disaggregated on a consolidated basis, or inappropriately aggregated such that the (dis)aggregating action hides information that would be important in the decision-making process of a user. As a good rule of thumb, the appropriate level of aggregation is correlated to the level adopted in the materiality assessment.

Standardise data under all management structures

Sustainability-related issues are often context-specific, so it follows that local management is ideally positioned to identify and manage their context-specific issues in a decentralised manner. This means that individual entities develop datasets that are relevant to their needs, including any specific jurisdictional requirements.

The challenge arises when individual entity datasets need to be aggregated or consolidated at the group level, and there are often inconsistent data definitions, formats, or even data collection frequencies.

Without organisation-wide data standardisation, this invariably leads to misaligned datasets and structures between the group’s entities. One obvious example is the use of metric vs imperial measurement systems.

To be clear, the problem is not having a decentralised management system for managing issues. The problem is a lack of dataset standardisation that simultaneously addresses the measurement of performance on sustainability-related issues at the local level in a way that can also be consolidated to measure performance at the group level. 

Standards really do matter

We know from financial reporting experience that when configuring systems to collect data, measure performance, and inform management decisions, finance professionals lean into recognised standards for guidance, including regulatory standards or those deemed “best practice”, nationally or internationally. In the absence of standards, or even clear best practices through benchmarks or peer comparisons, companies may come to question whether the issue at hand is properly understood and whether it is important for them to manage, measure, and disclose at all.

Even when a standard does exist, accounting professionals must seek to apply its underlying principles and intent, often requiring them to go beyond the mere words of the standard. Take for example the recognition of revenue as an agent or principal. Under the previous IAS 18 – Revenues standard, the lack of clarity, or specificity, within the text led to its inconsistent application among companies, too often resulting in overstated or distorted disclosures of revenues (sometimes including gross revenues, sometimes not).

The more conscientious companies recognised IAS 18’s lack of clarity for this transaction type and opted to apply the more rigorous standard under US GAAP to better understand how to apply the principle of revenue recognition when reselling a third-party entity’s goods or services. Effective 2018, the IFRS Foundation replaced IAS 18 with IFRS 15 – Revenue from Contracts with Customers, which clarified expected practice and ensured consistent application among companies, to the benefit of external users.

In practice, a standard minimally serves as a signpost to require at least a materiality assessment, and where something is deemed material, to manage, measure, and report upon appropriately. In the absence of a standard, one could conclude that a given issue is not material and, therefore, does not require further action. This would be a mistake.

The absence of a standard on a particular topic is more a reflection of the lag in the standard-setting process, which requires extensive due diligence and consultation that may take several years. If a topic is material to the business, the company must report on it whether there is a recognised standard or not, because it would reasonably affect both its business and its primary users’ decision-making (as per paragraph 1.2 of IFRS Conceptual Framework).

It can be said that standards provide a structured approach to help companies identify impacts, risks, and opportunities that require recognition, management, and reporting. In this respect, reporting standards go beyond the objective of providing users with comparable information, instead indirectly, yet ultimately, requiring companies to identify and manage the topics about which they need to provide information (see Figure 1).

Leverage existing accounting and data systems

Once the sustainability issue is identified and prioritised, the first step lies in understanding what data needs to be collected to report upon it. This is an essential step in the process of data collection, and is often described within a ‘basis for preparation and reporting’.

When the data points are known, accounting professionals can leverage their existing enterprise resource planning (ERP) and data management systems to capture sustainability-related information in a way that it can be aggregated, consolidated, and reported. In this respect, there is no need to reinvent the wheel.

Enterprise finance systems are already able to collect data, and various formats, from interconnected financial reporting books, such as those used for legal, external, or management reporting purposes. 

The chart of accounts determines whether a given accounting entry sits in one, two or all three sets of books. For example, intercompany sales are recognised in the local entity’s legal books but not in the group’s management or external disclosure books because they are eliminated. This is simply because intercompany sales are not considered arm’s length sales and therefore do not qualify as revenue for group reporting purposes. They are often adapted for management performance reporting purposes.

With the right standardised measures, processes, and systems throughout the organisation, aggregation or consolidation of sustainability data becomes simple math, no different than for other financial data.

That being said, embedding sustainability-related practices within the business means not only collecting more data, but also new and different sets of environmental, social, and governance (ESG) data dispersed within the organisation (for example, tCO2e, litres, cubic meters, rates and ratios, gigajoules, megawatt-hours, etc).

It is this expanded data collection effort that may highlight hidden data management deficiencies within the organisation, such as system versioning differences between the Group and its entities, and may even highlight the need for new information systems or architectural changes; an investment well worth making.

Wrapping it up

The standardisation of sustainability-related information enables companies to collect context-specific datasets that can also be consolidated to report group-level performance, to provide useful information to primary users of general purpose financial reports.

In practice, standards do more than that. They ultimately provide a structured approach to help companies identify impacts, risks, and opportunities that require recognition, management, and reporting at both the local level and the group level. They allow for materiality judgments to be made independently at the entity and group levels, while nevertheless being connected through the process of consolidation.