BLOG:  Digital Financial Reporting

This is a blog for information relating to digital financial reporting.  It is for innovators and early adopters who are ushering in a new era of digital financial reporting.

Much of the information contained in this blog is summarized, condensed, better organized and articulated in my book XBRL for Dummies and in the three documents on this digital financial reporting page.

Public Company Conformance to Fundamental Relations Grows to 61.9 Percent

Back in April 2014 as part of the minimum criteria testing I was doing, I observed that the percentage of public company filings which conformed to all of the fundamental accounting concept relations was 25.6% (1711 filers).

Last month I pointed out that the percentage of public companies which conformed to all of these relations was 53.1% (3863 filers).

I ran the same test for the last filing of every public company which reports to the SEC today and the percentage that conform to all of the fundamental accounting concept relations is now at 61.9% (4334 filers). You can see the graphic below which breaks this information out by generator (filing agent or software used).

This rapid growth rate is expected to continue for three reasons:

  1. These relations between fundamental accounting concept relations is not really controversial and it is increasingly easy to understand and correct the errors.
  2. I have provided a substantial amount of information here which helps those who want to correct these issues. This recently added analysis shows that each of these tests can precisely detect not only nonconformance to these relations, but also generally the reason for nonconformance.
  3. I know of at least one commercial implementation of software which can be used to detect and therefore correct these issues, XBRL Cloud. This testing will appear on XBRL Cloud's Edgar Dashboard at some point.

If you look at the numbers below and compare them to the prior results you will see that pretty much every generator is improving.  I pester software vendors to include this testing in their products to help them understand that their software can help external financial reporting managers avoid errors like these.  But more importantly, I am trying to get software vendors to realize that this is only the tip of a much, much bigger iceberg. This is a digital disclosure checklist summary which I created several months ago. This shows you where things are headed.

These rules may seem annoying to software vendors.  I can tell you two things.  First, external financial reporting managers already have to comply with these rules. They are just doing so using time consuming and expensive manual processes.  Second, automate these tasks by leveraging the XBRL-based structured information and you will provide something very useful: reducing the risk of noncompliance.

It is these rules which will make the quality of public company financial information submitted to the SEC to be at a level to make it safely, reliably, predictably usable by machine-based automated processes. If you don't understand digital financial reporting, the risk of becoming a relic of the past is increasing every day.

(Click image for larger view)If you don't want to become a relic of the past era of paper-based financial reporting, understand how digital financial reporting really works.  Digital financial reporting is not only inevitable, it is imminent.

If you want to understand the moving parts and you can walk through an Excel macro, the prototype Excel application on a link at the bottom of this page can help you understand the important moving pieces.

Digital is not software, it is a mindset!

Options for Dealing with Line Items that Bounce Around Income Statement

Those who study financial reporting might find this information rather interesting, both accountants who prepare financial statements and analysts who interpret those statements.  You can find additional information in this analysis here.  While this analysis focuses on "Income (Loss) from Equity Method Investments", these same ideas apply to other financial statement line items.

Here are the facts as I see and understand them.  Not all economic entities have investments which are accounted for using the equity method, but if an entity does then they most likely report "Income (Loss) from Equity Method Investments". (This is another reference for equity method accounting.) The accounting standards state that this line item must be "reported as a single line item on the income statement."  The SEC has additional information as to how this line item is reported in Reg S-X. The FASB Accounting Standards Codification (ASC) summarizes what they think Reg S-X says.

So, I challenge you to sort through all those reference materials to figure out exactly how the line item "Income (loss) from equity method investments" should be reported.  In addition to reading through all that material, here is other information which I gathered:

  1. Multiple sources confirm that while the accounting literature states that this line item must be reported as a single and separate line item, WHERE it must be disclosed is not as clear.
  2. Some reference material states that reporting this line item with the other "separately reported items" such as discontinued operations and extraordinary items is the best practice.
  3. The US GAAP XBRL Taxonomy represents this line item in two ways: before taxes as a separate line item and after taxes as a separate line item.
  4. One highly regarded accountant that I talked to says that this should ONLY be reported and ALWAYS be reported after taxes because the line item can be used to manipulate the effective tax rate.

So, now let us see exactly how public companies report this information.  Per an analysis of 9,679 XBRL-based financial filings, 1,048 or about 11% of economic entities reported this line item.  Of that 1,048 this is where they reported that line item in their income statement:

  • 624 entities (60%) reported the line item before tax directly as part of income (loss) from continuing operations before tax
  • 110 entities (10%) reported the line item after tax
  • 128 entities (12%) reported the line item as part of nonoperating income (expense)
  • 20 entities (2%) reported the line item as part of revenues
  • 10 entities (less than 1%) reported the line item as part of costs and expenses
  • 8 entities (less than 1%) reported the line item as part of operating expenses
  • 2 entities (less than 1%) reported the line item as a sibling to income tax expense (benefit)
  • 60 entities (6%) created an extension concept and the line item rolls up to that extension concept
  • 86 entities (8%) did something else which was not directly analyzed so exact placement is unknown

The first thing that I learned when I did this analysis is that I did not really understand that this variability was even allowed.  Intuitively as a professional accountant, I was surprised.  Other accountants I spoke with were likewise surprised that income (loss) from equity method investments could be included within revenues.  And I am not saying that any of these reporting entities did anything wrong.  I am simply making an observation.

These observations raise the following questions in my mind.

  1. What is the purpose of this line item bouncing around the income statement so much?  Is there a legitimate reason why entities which use US GAAP have so much flexibility with this line item and not nearly the flexibility with other line items? (I have not analyzed 100% of all the fundamental accounting concepts yet, but this line item has the most variability that I have seen thus far.)
  2. Why exactly does this variability exist for this line item, but other line items do not have so much variability?  Are the accounting standards ambiguous?  Was it a conscious choice to allow this variability, or was it caused by a sloppily written accounting standard?
  3. What would happen if someone like the SEC or FASB would say, "This line item always goes after tax with other special reporting items, similar to discontinued operations and extraordinary items."  Could the FASB or SEC do this?  Should the FASB or SEC do this?  Would analysts be happy about this or would they not like this to be forced into one slot on the income statement?  I really don't know the appropriate answer to this question, but it seems to be a reasonable question.
  4. Chevron includes income (loss) from equity method investments within revenues, you can see this on their income statement. Chevron did not feel the need to create an extension concept for us-gaap:Revenues.  Chevron clearly changed the definition of that concept by including that line item within revenues.  Should Chevron have created an extension concept?
  5. Exxon did pretty much exactly the same thing Chevron did, including income (loss) from equity method investments as part of revenues, but then the DID create an extension concept to express revenues which included that concept.  Who is right, Chevron or Exxon?  Are both approaches allowable?  Should both approaches be allowable, extend or not extend?
  6. Caterpillar reported income (loss) from equity method investments after tax, they created an extension concept cat:ProfitOfConsolidatedCompanies with the definition "Income (Loss) from Continuing Operations less Income Taxes and before Income (Loss) from Equity Method Investments" because they feel they moved income (loss) from equity method investments.
  7. Most of the other 110 who reported this information after tax did NOT create an extension concept.

What is the most interesting about this analysis is the fact that you can even perform this analysis and do so very effeciently and effectively.  How?  XBRL-enabled structured information.  Each financial report alone and all financial reports collectively are data in a database which can be queried, sorted, sliced, diced.  That has huge value.

Accountants work hard to represent information within a financial report.  Sometimes the reference materials they have to work with are more ambiguous than one would prefer.  One thing that is not ambiguous is what reporting entities actually do.  External financial reporting managers pay people like Big 4 consultants a lot of money to sort through reporting issues.  Smaller CPA firms have to likewise understand how to create financial reports.  Actual financial reports are, in my view, the best resource for understanding how to create a financial report.

Certified public accountants have a duty and responsibility to improve the art of accounting. Improving the art of accounting enhances the profession of accounting. Certified public accountants have a duty to serve the public interest. The needs of both the reporting entities who create reports and the investors/analysts who use the reports must be balanced.

To employ the tools of XBRL-based digital financial reporting correctly, professional accountants need to learn the tool of digital financial reporting correctly.  The rules are slightly different for human and machine-readable information than they are for human-only readable information the profession has been dealing with for 100 years.  Making the change is not hard, it is just a little different. Machines are not smart, they are dumb.  Machines only act smart if smart people make the machined serve their needs.

Personally, I don't understand all the answers, but I think I have a lot of very, very good questions.

Posted on Tuesday, October 14, 2014 at 08:17AM by Registered CommenterCharlie in | CommentsPost a Comment | EmailEmail | PrintPrint

Understanding How to Make Digital Financial Reporting Work

I don't know, perhaps I am missing something.  But, how long do you think that public companies are going to tolerate spending millions of dollars going through an exercise to structure information using XBRL and the information is not of a quality that makes it generally useful?

What do you think the probability is of expanding the market for digital financial reports beyond the 10,000 or so US public companies who are required to use it to the some 30 million private companies in the US and as I understand it 100 million private companies globally if digital financial reports don't work?  That probability would be ZERO.

Now, I really don't blame anyone for not believing me that the market for digital financial reporting could be ever be in the realm of 30 million to 100 million entities.  Given the fact that pretty much zero SEC filers like their software for creating XBRL and given the poor quality of reported financial information available, why would you believe me? Who would ever think that digital financial reporting could provide benefits?

But what if I am right?  What if the quality of public company XBRL-based financial filings does improve? What if using structured information actually did provide value? What if XBRL-based digital financial reporting could be made to work?

If you don't think a market of 30 to 100 million businesses is achievable, stop reading this, I am sure there are some good cat videos on YouTube that you can watch.  If you are inspired enough to want to know how to make digital financial reporting work and maybe provide software which is useful, works, and provides value to those creating and consuming financial information, here is some good information for you.

On the page of my blog Understanding SEC XBRL Financial Filings I have summarized issues which cause each of the fundamental accounting concept conformance rules to fail.  I have also provided information about why filings do conform to those rules.  With the information I am providing, you can basically walk through the entire process of making use of the reported information of XBRL-based financial filings and see for yourself what works, what does not work, and why it does or does not work.

Probably the most useful thing is the overview document which helps you interpret what you are looking at.

I pointed out that the quality of SEC XBRL financial filings in terms of conformance to the fundamental accounting concepts has moved from 25.6% to 53.1%.  I predict that by March 1, 2015 (after the year end 10-K filings are in) the conformance rate will be 75% or higher.  The rate of conformance will continue to gradually but consistently and with an increasing pace improve. These are not pie in the sky guesses.  These predictions are based on good information about things that are already happening.

While this improvement is only one small battle in terms of getting the total quality where it needs to be, it is an important battle.  The reason is that everyone and anyone will be able to see exactly what impacts the quality of XBRL-based financial filings in positive ways and what impacts the quality XBRL-based financial filings in negative ways.

And this is not just SEC XBRL-based financial filings.  Those are only a means to an end.  Because all of this information is available publically everything about this discussion is transparent.  The truth is easy to understand, all you need to know is where to look.

Remember, XBRL is a means to an end.  None of this is about XBRL really, it is about the benefits of structured information.  It is about taking what can only be human-based manual processes today and making some of those processes that can be performed by machines.  It is about increasing compliance.  It is about reducing risk of noncompliance.  It is about making something complicated just a little less complicated.  And, should someone want to press the "Save as XBRL..." button in their software, fine.  There are zero mandates necessary to expand the market of digital financial reporting.  But what is necessary is software that provides real value and that really works.

What really baffles me is why the members of XBRL International and others don't understand that it is in their interest to collaborate to create the necessary inroads into the financial reporting market.  Step 1: collaborate and create an XBRL-based structured approach to creating a digital financial report and MAKE SURE IT WORKS CORRECTLY.  Step 2: compete.  The enemy right now is not each other. The enemy is the status quo.

Posted on Sunday, October 12, 2014 at 09:07AM by Registered CommenterCharlie in | CommentsPost a Comment | EmailEmail | PrintPrint

Conformance to Fundamental Accounting Concept Relations Doubles

(Note that information on discovering and correcting issues found by using the fundamental accounting concept tests can be found here.)

Two incredibly positive things have happened with regard to SEC XBRL-based financial filing quality. First, as part of my minimum criteria testing for fiscal year 2013, my data shows that 1,711 of 6,674 or 25.6% of all filers passed all of the fundamental accounting concept relations tests.

I just ran that same test and the rate is 53.1%!  A total of 3,863 filings from the complete set of 7,274 SEC filers who filed a 10-Q for fiscal year 2014/2015 pass 100% of the fundamental accounting concept relations tests.

This is the breakdown by generator that my data shows: (note that this is approximatly that same breakdown as of March 2014; it is an approximation because it shows all of the minimum criteria)

(Click for a larger view)

The second positive thing is that XBRL Cloud has implemented my fundamental accounting concepts relations tests within their EDGAR Dashboard.  Currently, only XBRL Cloud customers have access to the validation results as it is in BETA, from what I understand the fundamental accounting concept validation will make its way to the publicly available dashboard page eventually.

Now, these fundamental accounting concept relations validation results have only been avaiable for less than a week or so.  That is important to know because that means most of the filers have not had their filings corrected as of the time my testing was done.  What that means, it seems to me, is that there will be yet another significant increase in conformance to the fundamental accounting concept relations as XBRL Cloud customers make use of these new tests.  I would assume that XBRL Cloud has a lot of customers, therefore there should be a lot more filings which conform to the fundamental accounting concept relations rules.

That means three things:

  1. There will be even more pressure on the half that don't follow these basic relations which no one really disputes.
  2. Data quality will rise as a result.
  3. Less human effort will be required to fix broken data thus doing the necessary expensive manual work to correct the bad data will cost significantly less.

Not sure if you are following me.  But fundamentally it means this: the business model of data aggregators is about to shift.  It will cheaper to fix the broken XBRL-based data than it will be to continue with the legacy approaches to making this data available.

I really don't know what caused the conformance to the fundamental accounting concept relations to increase so dramatically.  I would like to think that my pestering software vendors and filing agents had something to do with it. publishing the same data probably helped. A few other software vendors implemented these also.  Nothing that the FASB or SEC has done would explain this dramatic increase.

What do you think explains the dramatic quality increase?

Posted on Wednesday, October 1, 2014 at 01:14PM by Registered CommenterCharlie in | CommentsPost a Comment | EmailEmail | PrintPrint

Reasons Why Fundamental Accounting Concept Tests Fail

There are exactly three possible reasons why a relation between the high-level fundamental accounting concepts fails:
  1. Error in filing: The public company SEC XBRL-based financial report which reports some fact or facts does so incorrectly; a fact is wrong or a relation between facts is wrong or is interpreted differently than was anticipated for some reason
  2. Error in base taxonomy: The US GAAP XBRL Taxonomy expresses a concept which is used to report a fact does so incorrectly which is an error or does so ambiguously so that there are different interpretations by those using the taxonomy or some important or common concept is missing altogether
  3. Error in mapping or impute metadata: The metadata used by the software algorithm to compute or otherwise interpret the fundamental accounting concepts or the relations between those concepts is in error or are interpreted differently by different software creators

If there is any issue detected by software applications in the high-level fundamental accounting concept relations, it becomes impossible to then safely use that information without a human getting involved to determine the reason why the anomaly has occurred. And this does not mean using the fundamental accounting concepts; this means using any information in the entire report becomes risky.

As such, it is these high-level fundamental accounting concept relations which serve as a solid base upon which other relations are then built.  For example, if the accounting equation is known to be true which is "Assets = Liabilities and Equity", then next obvious question is does assets foot and does liabilities and equity foot.

Further, prudence dictates that using financial information in SEC XBRL financial filings should not be a guessing game.  Software vendors must write algorithms and create metadata which enables them to make use of machine readable financial information.  If untangling and otherwise deciphering this information is too complicated for them, then it increases the probability that different software vendors will create different metadata and software algorithms, and therefore different software applications will give different answers to exactly the same question.

Therefore, the safe, reliable, predictable, repeatable use of the facts reported within a machine readable digital financial report demands that the high-level fundamental accounting concept relations to be 100% satisfied.  Or said another way, deriving some set of high-level concepts so that facts reported within a machine readable digital financial report can then be safely, reliably, predictably, and repeatedly be sent to automated downstream processes is essential to using any information in that machine readable report.

In order to communicate with someone else about this information it is critical to use consistent terminology so that both parties understand what is being communicated in the same way.  If parties communicating have different understandings of specific words, communication does not really take place.  The following are specific terms which are used and the definitions of these terms.

There is a difference between a fact, the interpretation of a fact, knowledge, and an opinion.

  • Fact: a thing that is indisputably the case or situation
  • Interpretation: the action of explaining the meaning of some fact or set of facts
  • Knowledge: believe in some fact or facts which can be justified using evidence, justified true belief
  • Opinion: a view or judgment formed about something, not necessarily based on fact or knowledge

When attorneys argue a case one of the first things they do is try and agree on the facts, the items about the case which are not in dispute. When an interpretation is agreed to by both attorneys, that interpretation becomes a fact.  If both parties in a case agree on some set of facts it can be said that both attorneys have knowledge of the facts, generally both parties agree when there is evidence which can be used to justify that knowledge.  Everything else which cannot be agreed to becomes an opinion which is then argued in the case.

Evidence is provided but the parties don't agree on the evidence or they can dispute evidence with different interpretations of facts.

Sometimes it is a useful thing to create a shared reality to achieve a specific purpose: To arrive at a shared common enough view such that most of our working purposes, so that reality does appear to be objective and stable.

  • Standard: used or accepted as normal or average; something established by authority, custom, or general consent as a model or example
  • Arbitrary: based on random choice or personal whim, rather than any reason or system; depending on individual discretion (as of a judge) and not fixed by law
Computers are dumb machines. Computers only appear smart when humans create standards and agree to do things in a similar manner in order to achieve some higher purpose.  In the process of agreeing, it is important to understand the difference between what is important and what is unimportant in the process of agreeing:
  • Nuance: a subtle difference in or shade of meaning, expression, or sound; a subtle distinction or variation
  • Subtle: so delicate or precise as to be difficult to analyze or describe; hard to notice or see : not obvious
  • Negligible: so small or unimportant as to be not worth considering; insignificant; so small or unimportant or of so little consequence as to warrant little or no attention
Nuances and subtle differences are important things that matter. Negligible things are unimportant and do not matter.  The difference between what is a nuance or a subtle difference and what is negligible many times takes professional judgment.
  • Objective: not influenced by personal feelings or opinions in considering and representing facts; based on facts rather than feelings or opinions : not influenced by feelings
  • Subjective: based on or influenced by personal feelings, tastes, or opinions; based on feelings or opinions rather than facts; relating to the way a person experiences things in his or her own mind
  • Judgment: the ability to make considered decisions or come to sensible conclusions; an opinion or decision that is based on careful thought
I say again, computers are dumb.  Computers only appear smart when humans create standards and agree to do things in a similar manner in order to achieve some higher purpose.  In the process of agreeing, it is important to understand the difference between what is important and what is unimportant in the process of agreeing:
  • Explicit: stated clearly and in detail, leaving no room for confusion or doubt; very clear and complete : leaving no doubt about the meaning
  • Implicit: implied though not plainly expressed; understood though not clearly or directly stated
  • Ambiguous: open to more than one interpretation; having a double meaning; able to be understood in more than one way;  having more than one possible meaning; not expressed or understood clearly
  • Impute: assign (a value) to something by inference from the value of the products or processes to which it contributes;

Sometimes things are required, other times things are a choice.  Yet in other times setting some policy eliminates certain options which could have been considered.

  • Policy: a course or principle of action adopted or proposed by a government, party, business, or individual; definite course or method of action selected from among alternatives and in light of given conditions to guide and determine present and future decisions 
  • Requirement: a thing that is needed or wanted; something that is needed or that must be done
  • Choice: an act of selecting or making a decision when faced with two or more possibilities; the act of choosing : the act of picking or deciding between two or more possibilities
  • Option: a thing that is or may be chosen; the opportunity or ability to choose something or to choose between two or more things

Agreed upon standard interpretations are critical to making a system work safely, reliably, predictably, and in a manner which can be repeated over and over without error.  Philosophical or theoretical debates, trying to satisfy all arbitrary options, trying to meet every unimportant negligible situation, confusing what is objective and what is subjective, confusing policies with requirements and with choices only make something which could be sophisticated but simple into something which is complex, confusing, and can never be made to work.

Some people might believe that there is one absolute reality and that reality is their reality and that everything about their reality is important and they can compromise on nothing.   Some people insist that everything involves judgment and that nothing is in any way subjective.  But this is to miss the point. The point being:

A shared view of reality which is clearly interpretable and understood to achieve the purpose of meaningfully exchanging information so that time is reduced, costs are reduced, and information quality improves provides a benefit.

The goal is to arrive at some equilibrium, to balance the duality, to recognize that there is no singular objective reality but in spite of that, if we create a common enough shared reality to achieve some specific and agreed upon working purpose and considers important nuances and subtleties machines can be made to do useful work.

To make reality of the financial reporting domain appear to be objective and stable in certain specific and agreed upon ways in order to fulfill some higher purpose.  The purpose is to enable a machine to read and interpret certain basic information such that manual human work can be effectively eliminated and that higher-level interpretations are then possible.

So basically, public companies should want their financial reports to be fundamentally decipherable and consistently interpreted at some fundamental level.  If reported information is not fundamentally interpretable, there is no foundation upon which to build.

Why information cannot be interpreted by automated processes is excellent evidence in determining what is necessary to make information interpretable by automated processes.  Even better, comparing two or more interpretations against each other is really the only way to assure that interpretations can be consistent.

What can be interpreted can grow.  But it can only grow as fast as the business rules, the tests, which prove consistent interpretation.  If business rules are not provided, what is there to test how information was interpreted?  The fundamental accounting concepts are both a base level of interpretation and a very good clue as to what is needed to correctly interpret more aspects of a digital financial report.  The fundamental accounting concepts are an important building block.

And so these other things are just steps in the interpretation process.  The "minimum criteria" is for making base use of reported facts. The base expands based on expanding buiness rules. To the extent business rules assure that information is correct, is to the extent that interpretation of information can occur.

So, the issues pointed out by fundamental accounting concept tests are interpretation issues.  If a process stumbles in an attempt to interpret information, that is a strong clue that something is wrong.  It could be filer error, taxonomy error, or metadata/algorithm error.  The processes is to agree which category caused the process to stumble, fix that error, and try again.  When interpretation software does not stumble, then the system is in equilibrium.

Filings are publically available, the US GAAP XBRL Taxonomy is publically available, and the metadata used by software algorithms created by software vendors should be publicly available.   Any arguments people have need to be directed at one of those three things: the filing, the taxonomy, or the other metadata.

Examining each also provides clues where things can be made less complex.  Why are so many mappings necessary, can some be eliminated?  Why are impute rules so complicated, can't they be simplified?

Posted on Sunday, September 28, 2014 at 09:37AM by Registered CommenterCharlie in | CommentsPost a Comment | EmailEmail | PrintPrint
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