Digital Financial Reporting

I have pretty much proven the conceptual model of a financial report bottom up.  Now I am going to also prove it top down.  What this achieves is enabling me to simplify the model and allowing only best practices proven by empirical evidence.

Financial reporting schemes are important, therefore they should be elegant to look at and easy to use.  The accounting equation is a simple, elegant, and very useful and proven tool.  Every financial reporting scheme builds on that rock-solid foundation.  But when basic relations and terminology are vague, ambiguous, or otherwise unclear then financial reports can end up being convoluted messes that are not useful.  In order for professional accountants to exercise good professional judgement accounting and reporting standards should be crystal clear.  Today, standards setters do a pretty good job, but there is room for improvement.

How do I know there is room for improvement?  Read on.

There are many different financial reporting schemes, for example: US GAAP, IFRS, FRF for SMEs, IPSAS, GAS.  Here is a list of financial reporting schemes.  Comparing and contrasting these is interesting and helps one tune my skills as a master craftsmen.

Each financial reporting scheme has a conceptual framework.  Here are the conceptual frameworks for the following financial reporting schemes: US GAAP; IFRS; FRF for SMEs; IPSAS; GAS.

I compared the high-level financial report elements for those five financial reporting schemes.  They are mostly the same in terms of the elements that they define.  But there are some differences.  Now, the definitions of the elements tend to be different even if the name of the element is different.

So, for example, here are the financial report elements defined by FRF for SMEs (to understand more about FRF for SMEs see here) either explicitly or implicitly within the definition of another element: (for specifics see here)

• Net Income
• Investments by Owners
• Distributions to Owners
• Assets
• Liabilities
• Equity
• Revenues
• Expenses
• Gains
• Losses

For quick reference, here are screen shots of the high-level elements of each of these five reporting schemes:

• US GAAP (or see pages 24–133 of the free PDF above); here is documentation from an intermediate accounting textbook.
• IFRS (or see page 2 of PDF above);
• FRF for SMEs (see page 21 in the free PDF above);
• IPSAS (or see page 15 in the PDF above but you have to register);
• GAS (see page 3 in the free PDF)

Now, at the very highest level, all financial reporting schemes are fundamentally the same and use the accounting equation: Assets = Liabilities and Equity. (If you don't understand this, watch this video.)

Financial reporting schemes are fundamentally based on the accounting equation and double entry bookkeeping which was invented in about 1211 and documented in 1496.

So why is any of this important? First, it is important to understand that the elements of a financial report are interrelated.  You cannot change any one single number and expect the report to "tick and tie" and "cross cast and foot".  There are roll up and roll forward relations that tie all the report pieces together.

Unmodified CORE-00: I represented the high-level financial report elements of FRF for SMEs in XBRL without modifying the concepts, I call CORE-00. Here are the high-level concepts of FRF for SMEs. That is just a flat list of the report elements. (Raw XBRL | Inline XBRL | Human Readable)

Enhanced CORE-01: But, I want to represent all of the relations.  To do that, I had to enhance the FRF for SMEs high-level elements, adding two elements: Liabilities and Equity and Net Cash Flow.  I am not sure why FRF for SMEs did not define net cash flow. In fact, the only reporting scheme which defines Net Cash Flow as a high-level element is IPSAS. Here are the now 12 high-level elements.  And here are the balance sheet, income statement, cash flow statement, and changes in equity. (You can browse around and have a look at what you want using this link.) (Raw XBRL | Inline XBRL | Human Readable)

Now, don't be pedantic and miss the point. We are looking at the bigger picture here folks!  The point is (a) that there are mathematical relations that inter-related all of the four reports and (b) all my mathematical computations work as was expected.  You can see the relations by looking at the report, but here is a separate summary of all those mathematical relations.  Yes, I agree that it barely looks like a set of financial statements.

Further Enhanced CORE-02: So, I don't exactly know how the FASB, IASB, GASB, IPSASB, or other standards setter determines where "high-level elements" end and "lower-level elements" begin.  But, for what I am trying to do, I need just a little more detail.  And so, I added a few more elements so the total is now up to 23.  But I don't think that anyone would dispute any of these additional 11 concepts that I added.  Here is a list of my further enhanced core elements of a financial report. Note that the statements are looking more like a financial report:  Balance sheet, income statement, cash flow statement, changes in equity. Again, you can browse all the pieces here and you can look at the mathematical relations here. (Raw XBRL | Inline XBRL | Human Readable)

Accounting Equation (Very basic example): XBRL instance | Human Readable

Conceptual Framework (Enhanced example): XBRL instance | Human Readable | Taxonomy | Assertions

BOTTOM LINE: And so I can keep doing what I am doing until I create 100% of the disclosures that would be created when reporting under FRF for SMEs (which I am actually doing) and as I am doing that, I am proving that all of the expected relations are is as expected.  Further, if this works for FRF for SMEs, then why in the world would it not also work for US GAAP, IFRS, IPSAS, GAS, or any other financial reporting scheme?

Why are getting reports right so critical?  Well, if the reports do not fundamentally work correctly than what value do XBRL-based digital financial reports have to anyone?  The SEC mandating public companies to provide XBRL-based financial reports is one thing.  If they don't work correctly and/or don't provide benefits to the report creators, why waste your time with XBRL-based reports?  Sure, those mandated to provide the reports will jump through the required hoops they need to jump through for a regulator; but no one else will use them.

Secondly, by understanding the high-level model one can then create software that takes advantage of that model and makes the entire process of creating such reports easier for professional accountants.

INTERESTING OBSERVATION: Finally, I have an interesting observation.  When you (a) look through the conceptual frameworks created by standards setters and more importantly (b) compare the different conceptual frameworks created by different standards setters you start to really see the many, many inconsistencies, flaws, poor organization, and other such issues in these important financial reporting schemes.

Sorting through these important accounting standards is not about professional judgement.  Many accountants think that they are exercising judgment when working through the inconsistencies and flaws.  But that is not exercising judgement.  Exercising judgement is about understanding the real and clearly stated differences between, say, a "current asset" and a "noncurrent asset" and then applying professional expertise to determine the proper classification.

There are a lot of reporting and accounting mistakes in the financial reports created by US public companies.  The accountants that create those public company reports are the best of the best.  And given the amount of scruteny public company reports get (i.e. they are publicly available); if public company reports have mistakes, where do you think the private company financial reports might be in terms of quality?

Anyway, that is all for now.  Stay tuned to watch a new era of financial reporting appear right before your eyes!

Successful engineering is all about understanding how and why things break or fail so that all issues can be fixed so that ultimately nothing breaks or fails.  I have spent 10 years breaking things and understanding failures in order to understand how to not let them break/fail.

As I mentioned in another blog post, the American Institute of Certified Public Accountants (AICPA) publishes a free, open reporting framework for small and medium sized companies that report but are not required to use US GAAP. That financial reporting framework is called FRF for SMEs™.  This short video explains the framework. This is a brief description of the framework provided by the AICPA:

The FRF for SMEs framework provides efficient, meaningful financial statements without needless complexity or cost for those SMEs that are not required to issue GAAP-based reports. The FRF for SMEs framework is a cost-beneficial solution for owner-managers and others who need financial statements that are prepared in a consistent and reliable manner in accordance with a framework that has undergone public comment and professional scrutiny. The accounting principles composing the FRF for SMEs reporting option are intended to be the most appropriate for the preparation of small business financial statements based on the needs of the financial statement users and cost-benefit considerations. Accounting principles in the FRF for SMEs framework are responsive to the well-documented issues and concerns stakeholders currently encounter when preparing financial statements for small private businesses.

I am going to create a high-quality XBRL taxonomy (really an ontology-like thing) for FRF for SMEs;

FRF for SMEs Ontology.

The FRF for SMEs Ontology will follow the informally described open source framework that I created but more importantly it will also follow the OMG's upcoming Standard Business Report Model (SBRM).  I will use this ontology to both exercise and test the SBRM.

Here is the most current version of the knowledge graph for FRF for SMEs.

Why am I doing this?

There are a number of reasons that I am creating this FRF for SMEs ontology:

• To synthesize 20 years of learning.
• The reporting framework is freely available and documentation is good.
• There are 20 million potential users of the framework (not sure how many companies actually use the reporting scheme).
• The reporting scheme has all of the variability characteristics of US GAAP and IFRS.
• To provide an ultra high quality XBRL taxonomy that can be used to raise questions about the approach taken by the very important US GAAP XBRL Taxonomy and IFRS XBRL Taxonomy.
• To help software vendors get their heads around XBRL-based digital financial reporting.
• To provide the metadata for a software application that I am helping to create called Pesseract.  Pesseract is an expert system for constructing a financial report.
• To help some additional software vendors tune their software.
• To help people see the possibilities of having high-quality curated metadata.
• To help people compare and contrast different approaches to creating XBRL taxonomies.
• To help introduce the benefits of XBRL-based reports to private companies.
• To provide information for academics to study.
• To create a complete system that works for those 20 million private companies to report to banks in support of commercial loans.

If you don't know why you might want to get involved in this project, you might want to read this document. If you want to get involved, contact me via email or LinkedIn.  If you have any suggestions or questions, I am always looking for good ideas.

If you want to follow the blog posts related to the FRF for SMEs, follow this category on my blog.

You don't need to understand anything about XBRL to contribute to this project.  All you need to do is have an understanding of financial reporting.  Professional accountants can both learn and contribute by creating a podcast, creating a YouTube video, creating commentary about or interpretations of FRF for SMEs, making sure the information in the ontology is correctly conveyed, providing examples of reporting use cases that need to be provided for by the ontology, etc.  Again, contact me if interested.

Steven M. Bragg, CPA, author of GAAP Guidebook (which is an excellent resource) publishes a series of podcasts related to accounting topics, The Accounting Best Practices Podcast.

Here is one podcast example, Bragg's Laws of Accounting.

Here is a podcast on XBRL, XBRL Tagging.

Here is a podcast on Artificial Intelligence: How AI might impact the accounting department.

When you want to represent a reporting scheme within an XBRL taxonomy; I am recognizing that there are three XBRL taxonomy creation approaches.  I have documented the three approaches in this PDF.  The following is an explanation of the essence of each of the three approaches:

• Top-Down XBRL Taxonomy Creation Approach: You start by listing all the topics of a reporting scheme; you then list each of the possible disclosures for each of those topics; you create the networks into which each disclosure will be placed in the XBRL taxonomy; you create the report elements that will be used to represent the disclosures; you create the rules used to explain and verify against the explanation for each disclosure; you create a template to test each of the disclosures; and you finally create a reference implementation which combines all of the templates to test to be sure the disclosures interact with one another appropriately and that there are no inconsistencies or contradictions.
• Bottom-up XBRL Taxonomy Creation Approach: You start by creating the primitive report elements which will be used to create each disclosure; next you organize those report elements into individual disclosures; then you organize each of the disclosures into XBRL networks and topics to help you work with the many individual disclosures.  Again, you test by creating a template for each individual disclosure and then you combine a set of templates which would be used together into a reference implementation to test the entire XBRL taxonomy.
• Iteration XBRL Taxonomy Creation Approach: You start by generally taking an existing XBRL taxonomy, templates, reference implementation, list of disclosures, list of topics, rules, etc., all of which are known to work correctly; you then modify that existing XBRL taxonomy by adding, deleting, or editing its pieces until you turn the existing XBRL taxonomy pieces into what it is that you want.  (This might seem like a bit of an odd approach, but if you really think about this approach it actually makes a lot of sense.)

Note that when I say "XBRL Taxonomy" I am really talking about creating an ontology-like thing which is explained here using this open source framework.

The American Institute of Certified Public Accountants (AICPA) publishes a financial reporting framework, Financial Reporting Framework for SMEs.  Documentation for the framework can be found here.  I created a prototype XBRL taxonomy for this framework way back in 2013.  I might have another look at that.

• Framework
• Introduction to FRF for SMEs
• Illustrative financial statements
• Disclosure checklist

OK, so here is the beginnings of a machine-readable ontology that describes how to create a report using FRF for SMEs.

Much more to come, so stay tuned! Follow this blog category to stay informed. (Note that this US GAAP Financial Report Ontology is an example of where the FRF for SMEs is going)