Understanding Quality of SEC XBRL Financial Filings
Wednesday, April 10, 2013 at 07:49AM
Charlie in Creating Investor Friendly SEC XBRL Filings

Verification that a financial report is "valid" is not a mystery.  Accountants have been doing this for years.  However something very significant has changed.  In the past, this verification process was a 100% manual process.  Green eye shades, 10 key calculators, and deep accounting knowledge required by all who undertook this process.  And because the process was so manual and because humans make mistakes, no matter how hard one tried things always slip through the cracks.

But now because financial reports can be read by a computer software application because of the structured nature of the financial report, such as a digital financial report expressed using XBRL, many things change. Many parts of the verification process can be automated such as checking mathematical computations and "if...then" type checks, "IF you have this financial statement line item, THEN you must provide this policy and this disclosure."

Another thing has changed.  All those financial reports which were here-to-for verified using only human processes can now have automated processes applied to them very effeciently and effectively.  All sorts of automated processes such as what is being called the SEC "RoboCop" or accounting quality model. Likely many interesting things will be discovered which have been missed before by humans.

While there are many interesting and sophisticated processes which will likely be thrown against financial reports in the coming years because they have become digital, below are the basics of creating a quality digital financial report such as an SEC XBRL financial filing.

Thinking through the process of verification

Let us start with fundamentals. Verification is the process of research, examination, and other tasks and steps required to prove or establish validity; evidence that establishes or confirms the accuracy or truth of something. Verification is a formal assertion of validity.

Validity can be defined as being well grounded; producing the desired result; free from logical flaw; based on sound reasoning; cogent; faithful.

Validity when it comes to a financial report is, arguably, that such a financial report is a true and fair or a faithful representation of a reporting entities financial and nonfinancial information articulated by such a financial report. Looking at this backwards - an untrue or an unfair report - is certainly not desirable. (Don't confuse true and fair as used here with the term "presented fairly" as used by auditors, we are discussing something different here.)

A financial report can be said to be valid if it possesses certain traits which can be defined in general terms and for clarity are listed below to bring them into the reader's mind. (These terms are highlighted in the AICPA Statement of Position 09-1 Performing Agreed-Upon Procedures Engagements That Address the Completeness, Accuracy, or Consistency of XBRL-Tagged Data, http://bit.ly/XIoqxv ):

Assurance on XBRL instance document: A conceptual framework of assertions (see http://bit.ly/VjHwdG) points out the need for a framework for verifying the appropriateness of a digital financial report.
While these four notions which relate to the "trueness" and "fairness" must exist for every fact reported by a financial report, they also need to exist when considering the financial report in its entirety and the relations between reported facts. Further, it would seem to be appropriate to add the term "sensible" and perhaps even "logical" to this list. Clearly digital financial reports should be both sensible and logical.

Two other notions help bring the notion of trueness and fairness of information at the fact and at the report level into focus, looking at the financial report holistically:

To an accountant the notions of verification and validity and that a financial report must be complete, correct, consistent, and accurate as defined above are a statement of the obvious. Perhaps accountants have never really thought about the verification process in these terms, but accountants get this.  Accountants have performed these tasks for hundreds of years. This is not new to accountants. Further, these traits which a financial report must possess are the obligations of those creating these reports; they are not options. Accountants don't pick and choose whether a financial report is to be true and fair; those traits must be true by definition.

What is new is that now accountants must rely on software to help them fulfill this obligation.

True and fair representation in more specific terms

Looking at the verification process in more specific terms, arguably the following would hold to be true of a financial report which represents the financial information of a reporting entity:

Verification will always include both automated and manual processes.  Automating processes can improve quality and reduce costs.  But, not all processes can be automated.  The judgement of an accountant cannot be automated.

What are your ideas about what a quality financial report looks like?  If you have improvements to these ideas or of you have better ideas I would like to understand those ideas and why you believe they are better.

Article originally appeared on Intelligent XBRL-based structured digital financial reporting using US GAAP and IFRS (http://xbrl.squarespace.com/).
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