Digital Financial Reporting

Critical to understanding XBRL is the ability to differentiate between an "open taxonomy" and a "closed taxonomy" information exchange.  This blog post sheds light on these important differences. Now, I am not certain that I have the graphics that I provide below 100% correct.  But that is the path down which I am headed: to get these visualizations which explain the important differences as precise as possible.  Any ideas or other feedback would be greatly appreciated.

Why is the distinction between an open and closed taxonomy so important? Because it helps one understand what it takes to make a business system which exchanges information work reliably, predictably, correctly, effectively, be easy to use, and so forth.

Goal: Meaningful information exchange between business users

First off I want to be clear on the goal which is the meaningful exchange of business information by business professionals.  What does it take have a meaningful exchange of information? 

The only way a meaningful exchange of information can occur is the prior existence of agreed upon semantics and syntax rules. (Workflow rules are also important.)

Another term used by others to describe meaningful information is "actionable information". Actionable information is information:

• from a trusted source,
• about something that’s important to you, and
• that, once known to you, will impel you to take action.

Another piece of the puzzle is that we want a business user to be able to exchange information and we want to do this using automated processes as opposed to humans having to get involved in the process. And so, the system needs to be:

• cost effective
• easy to use by business users
• robust
• reliable
• repeatable
• predictable
• scalable
• secure
• auditable (in many cases)

And so the goal is to enable business information exchange across business systems by a business user.

Business users and business systems have been exchanging information using automated processes for years and years.  However now two things are different.  First, rather than technical people needing to get involved to automate these processes (which they can do with one arm tied behind their back), business people need to do this without the IT department.  Why?  Ask yourself why business people like the personal computer and the electronic spreadsheet. Reduced costs, control over their processes.

(Note: you can see the entire graphic by clicking on the images below.)

Open taxonomy

An open taxonomy is a taxonomy where the creator of information can change the taxonomy. For example, the SEC XBRL financial reporting system uses an open taxonomy. Achieving meaningful information exchange is significantly harder using an open taxonomy than a closed taxonomy. This blog post explains why.

Basically, because additional information can be added to the system, the creator of that additional information and the consumer of that information need to make sure they are on the same page.  

Open taxonomy

Exchanging information with an open taxonomy has never really been achieved as I understand it.  Most information exchanges use closed taxonomies.

This is one of the reasons that the US SEC's use of XBRL for public company financial filings is so interesting, and so hard.  If the SEC pulls this off, this will be a new approach to exchanging information.  Rather than using closed taxonomies which I will explain next and are basically forms; information exchanges can be as rock-solid as closed taxonomy information exchanges but also richer in nature.

Is business information exchange using an open taxonomy an enlightened view or a disillusion? Well, I guess time will tell for sure.  But, it is my personal observation that information exchange via an open taxonomy can work.  Clearly you cannot have those expressing information randomly spewing out whatever they might desire.  Information creation must be controlled.  How much control?  That is a balance.  Too formal and the system might not be usable by business users and therefore such a system will fail.  Too little control and the information will be garbage and unusable.  Striking the appropriate, practical balance is necessary.

Closed taxonomy

When the system is closed, meaning the creators of information cannot add anything to the taxonomy, information exchange is much easier because it is much easier to control the quality of the information. But on the down side, closed systems are more like "forms".  You lose information richness because information needs to be packed into some predefined form.

For example, the FDIC system is a closed taxonomy. Call reports are forms. 

Closed taxonomy

Trusted exchange

Worth mentioning is what I call a "trusted exchange".  With a trusted exchange, the user of the information assumes that the information which they are using is correct and therefore takes no steps to verify the correctness of the information before they use it.

I am not sure about this but I think a trusted exchange can work with both an open taxonomy or a closed taxonomy. The graphic shows a closed taxonomy only.  Although, I am not sure if open taxonomies and trusting the information go together.  More work is needed to figure out if trusting information where you have an open taxonomy will work. 

Bottom line

I quess the bottom line is that whether XBRL is an enlightened view or a disillusion will be determined by the success or failure of a system such as the SEC XBRL financial filings. Creators of business information "spewing out whatever they want" will clearly not work.  Some amount of control is necessary. It seems to me that if information exchange using an open taxonomy is achieved, the XBRL community will have provided something which is incredibly useful.  Not just useful for financial reporting, but something generally useful.