Distinguishing Between the "Art" and "Science" of SEC XBRL Financial Filings
Saturday, August 10, 2013 at 07:40AM
Charlie in Becoming an XBRL Master Craftsman

Beware: RoboCop is on patrol. And the number 1 item on the list for staying off the SEC radar and avoiding additional scrutiny is "Check your work".

“Check your work.” When asked how companies can minimize the risk that their company is flagged, Mr. Lewis responded succinctly: “I would say check your work.”  Because RoboCop is an automated system looking for oddities, it is unable to account for mistakes made.  This is particularly important because the AQM relies on the newly-mandated XBRL data which is prone to mistakes by the inexperienced. Sloppy entries could land your company’s filing at the top of the list for close examination.

Too often I hear the generalizations such as "financial reporting is subjective" as the justification for what amount to obvious errors to those who understand how XBRL truly works. Is financial reporting subjective? Well, there are some subjective aspects to financial reporting.  But everything about financial reporting is not subjective. By "subjective" I mean that your opinion counts; professional judgment must be considered.  This is as contrast to "objective" where there is no room for your opinion, professional or otherwise.

Every aspect of financial reporting is not subjective.  Yes, financial reporting does have some, or even many, aspects which are subjective.  But not everything about financial reporting is subjective.

Understanding what is an error in an SEC XBRL financial filing starts with understanding what is "science" and objective and what is "art" and is truly subjective, where you can have a preference or an opinion.  If you think about it, if you create a global standard and then make everything about that global standard a matter of opinion and then let 8,000 public companies use that global standard, what exactly is the point of having a "standard".

How XBRL works is not subjective at all.  It is called the "XBRL Technical Specification" for a reason.  It is objective, it is not subject to the whim of those who use the standard. Specifications specify.

Now, specifications are written by humans and humans make mistakes. And that is why XBRL has a conformance suite.  A conformance suite is a set of tests which show both positive examples and negative or "contra-examples" to help people agree on how something like the XBRL technical specification actually works. There is no art involved here.

And don't confuse "art" with ambiguity.   Specifications try to state explicitly and in detail how things work.  Sometimes a specification can be ambiguous meaning that two different people can reach two different conclusions as to what is "right" and therefore both conclusions reached are right.  This is not "art", this is not "subjective", this is an error in the specification.  Specifications take great strides to eliminate ambiguities.  But specifications are created by humans and humans make mistakes.  So, writing specifications such as the XBRL technical specification is a process.  But an ambiguity in a specification is not an opening for subjectivity; it is an error in the specification.

While 99.9% of all SEC XBRL financial filings comply with the XBRL technical specification, only 97.9% comply with the representation structure or "model structure".  That is still a very high number, but there is about 2% of filings which deviate from the proper model structure rules.  Does this mean that how models can be structured is more subjective?  No.  What it means is that about 98% of SEC XBRL financial filers follow those rules and 2% do not.  By model structure I mean the relations between the major pieces which make up an XBRL taxonomy: Networks, [Table]s, [Axis], [Member]s, [Line Items], [Abstract]s, and Concepts.  How these report element categories relate to one another is not subjective at all.  It is not "art".  Those relations are science and not open to interpretation.

These model structure relations are somewhat documented in the US GAAP Taxonomy Architecture and even by the XBRL International Abstract Model 2.0. But the real proof that they exist is that 97.9% of SEC XBRL financial filers follow these rules.  All one needs to do is go look at the other 2.1%, see specifically why they are not following the rules and you can determine if they made a mistake.

The same with relations such as "Assets = Liabilities and Equity", the accounting equation.  So what, accountants can exercise judgement at to whether the accounting equation is true?  No, they cannot.  By definition that business rule is true.  Additional proof is that 99.4% of SEC XBRL financial filings follow that business rule.

In fact, 98% of SEC XBRL financial filings follow that and 20 other fundamental business rules and report 51 fundamental accounting concepts in their financial reports. What accountant would argue that financial statements have balance sheets when 99% of financial statements can be shown to have balance sheets, or that balance sheets have "assets", they have "liabilities and equty" when 99% of balance sheets can be shown to have such concepts, or that balance sheets balance?  This is not subjective, this is not art; this is science.

Assets foot.  Any accountant care to make an argument aganist that statement?  Well, 92.8% of all SEC XBRL financial filings have balance sheets which have assets which foot. What about the 7.2% who don't.  Subjective? Art?  Nope.  Errors.  This becomes interesting when you can show a correlation between the software product used to create an SEC XBRL financial filing and whether assets on the balance sheet foots.

Liabilities and equity, net income (loss), and net cash flow likewise each foot.  Any accountant care to disagree with that statement?  Science, not art.

When 99.2% of SEC XBRL financial filers can make their root reporting entity clearly identifiable and .8% cannot, is that caused by accountants judgement?  Sorry, that would be an error.  Again, all one needs to do is go look at each of the 58 SEC XBRL financial filings where you could not identify the root reporting entity, determine why, and then understand the rational behind not clearly identifying that root reporting entity.

Now, most of the examples above relate to the primary financial statements.  However, the line of thinking relates to the disclosures as well.  For example, consider the disclosure of long-term debt instruments.  You can refer to this reporting template for that disclosure. How much sense would it make if each long-term debt instrument did not provide an amount of that debt instrument?  How about not providing a way to identify the debt instrument and distinguish one debt instrument from another debt instrument.  That part is science.

But now we get to the art of financial reporting. While it is true that there is no judgment necessary to recognize that you must provide an amount of each debt instrument and some way to differentiate one debt instrument from another; it is subjective as to which of the many, many other important pieces of information needs to be disclosed to make the financial information truly meaningful.  If you go to this link and look at lines 353 to 458 which shows numerous other possible pieces of information which might be disclosed; you see where judgement, you see where the "art" of financial reporting starts to fit into the equation.

So yes, it is subjective, there is art in understanding which of those many other facts need to be provide with the amount of each long-term debt instrument and with the information used to differentiate one debt instrument from another.

Which disclosure to provide is also very subjective in many cases, but not all cases.  For example, whether a balance sheet is necessary is rarely open for discussion; but sometimes because you could provide a statement of net assets.  Whether long-term debt maturities must be disclosures is not subjective really. But whether to include or not include other disclosures can be highly subjective.

Qualitative disclosures (as compared to quantitative disclosures) are generally very subjective.  (Here is information to understand the difference.) And so, there are a lot of things about qualitative disclosures which can be very subjective, where professional judgment comes into play.  But there are still items which are purely objective, which provide somewhat of a "framework" for all of the qualitative information to fit into.

This is not to say that all quantitative disclosures are objective; they are not.

And so, the bottom line here is that trying to lump all anomalies into the "art" of financial reporting, the area where accountants can apply their professional judgment is not appropriate.  Being able to differentiate between where science is applied and where art is applied is crucial to creating an SEC XBRL financial filing correctly.  Not understanding what is art and what is science is inviting errors to creep into your SEC XBRL financial filing.  This can be dangerous because RoboCop is on patrol.

Article originally appeared on XBRL-based structured digital financial reporting (http://xbrl.squarespace.com/).
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