Digital Financial Reporting

Craig M. Lewis, Chief Economist and Director, Division of Risk, Strategy, and Financial Innovation
U.S. Securities & Exchange Commission, describes ways the SEC will use all that SEC XBRL financial information in his speech, Risk Modeling at the SEC: The Accounting Quality Model, to the FEI Committee on Finance and Information Technology.

There are two particular pieces of this speech which I would like to highlight.  First, this statement about The Accounting Quality Model:

While we have several projects in development, we are particularly excited about what we call an “Accounting Quality Model” (AQM).  This model is being designed to provide a set of quantitative analytics that could be used across the SEC to assess the degree to which registrants’ financial statements appear anomalous.

Anomalous.  Deviating from what is standard, normal, or expected.  Sticking out from the pack.  Seems like a great way to stick out of the pack is modeling things incorrectly where most SEC filers do model thing correctly (see this analysis for the 271 of 8289 who stick out to me and my dinky little Microsoft Access database application).

To provide a little bit of an example of what the Accounting Quality Model is and how it would be used, Mr. Lewis provides the following example related to how analysis of discretionary accruals and non-discretionary accruals can help detect earnings management:

Second, we need to understand generally where it is possible to discern the effects of earnings management.  Typically, they manifest in the discretionary choices that management can make under GAAP when reporting its financials.  In accounting jargon, total accruals are the difference between free cash flows and income before extraordinary items.  It is the difference between what accountants recognize as revenue and expenses and the actual cash flows available to shareholders.  We can decompose total accruals into two broad categories: discretionary accruals and non-discretionary accruals.  Non-discretionary accruals are accounting adjustments made in strict adherence to GAAP and are relatively objective.  Discretionary accruals however, may be subjective and require the preparer to exercise considerable accounting judgment.  As is generally recognized, this influence over the potential accrual values can allow for opportunities to, for example, smooth income and therefore, manage earnings.

What a great opportunity for filing agents and XBRL software vendors:  validation/verification processes which make sure an SEC filing does not stick out.

Measures, counter-measures.  The SEC will likely be hammering all that XBRL-based information. Clearly if the SEC processes cannot make heads or tails out of the information they will request a filer to correct their filing.  That will improve information quality for everyone, making all that information usable by automated processes.