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Understanding the Basic Mechanics of a Financial Report

Digital financial reports contain thousands and sometimes many thousands of individual pieces or structures.  These structures, commonly formatted in machine-readable form using XBRL, are used to represent the information contained in the digital financial report. There are two different aspects of these details that are important to recognize:

  • objective aspects which are mechanical and do not require judgment and therefore can be managed using automated machine-based processes.
  • subjective aspects which require the professional judgment of a skilled accountant, therefore they must be managed by humans.

These objective mechanical aspects are distinct from the subjective aspects which require professional judgment.  The mechanical aspects relate to the things and relations between the things in a digital financial report.  These mechanical aspects are governed by logic, common sense, and the rules of math.  These mechanical aspects are what makes up a financial report. 

The subjective aspects tend to have more to do with which things should be put into the financial report, some aspects of the values of those things, how the values are measured, and so forth.  Here are some examples to help you understand the difference:

  • Which economic entities have to provide a financial report has to do with laws that exist, sometimes the interpretation of those laws.  There are both objective and subjective aspects to this.
  • When a when report has to be provided can be a little subjective, but also tend to be mostly objective.
  • What goes into the financial report, what disclosures, is a little objective in that every financial report contains a balance sheet, income statement, cash flow statement, and so on.
  • What type of balance sheet, classified or unclassified, has some subjective aspects to it but depending on the industry of the reporting entity, the rules tend to specify whether the balance sheet needs to be classified or unclassified.
  • Which line items need to be reported on the balance sheet and where has both subjective and objective aspects to that decision but is mostly driven by what stuff a reporting entity has.
  • How the values of what is reported are measured has mostly subjective aspects and some objective aspects.

But now consider the physical report itself.  These are the very basic mechanical things and relations between those things which make up a digital financial report:

  • Economic or accounting entity which creates a report; while it can be subjective to determine what will make up the economic or accounting entity which will report, ultimately whatever entity that is can be identified.
  • Report which is created by an entity which contain a set of components; ultimately there is some physical report.
  • Facts are reported within the report; ultimately someone will decide which facts are reported and some set of reported facts will end up in the report.
  • Component which contains or groups a sets of facts; ultimately whatever facts are reported can be grouped into sets.
  • Characteristics which describe and distinguish facts contained within a component from other facts; ultimately facts need to be described and distinguished from other facts.
  • Blocks which is a part of a component, a component is made up of one to many blocks; ultimately it can be useful or perhaps even necessary to refer to subsets of facts. (The notion of a block is necessary to achieve certain objectives.)
  • Relations pattern which describe how one thing is related to another thing; ultimately there are basic patterns which all relations can be grouped:
    • whole-part type relations where something composed exactly of their parts and nothing else or more where the parts add up to the whole
    • is-a type relation where something describes but does not add up mathematically
    • part-of type relations which describe something that is part of something else.
    • has-part type relations which specify that something has something else.
  • Properties of an economic/accounting entity, report, component, block, fact, characteristic, or relation pattern

It may not be natural for accounting professionals to think about financial reports in this manner, basically given names to the structures of a financial report.  Professional accountants creating these reports don't consciously think of a financial report in this manner, nor do financial analysts using these reports.

However, information technology professionals creating software for business professionals need to be aware of these mechanical things and relations between things which make up a financial report in order to create software useful to business professionals.  This is how the information technology professionals get computers which are machines to perform work.

Empowered by software which properly manages the mechanical aspects of a financial report; professional accountants no longer need to deal with these mindless mechanical aspects of creating such reports.  Professional accountants are freed to employ their professional skills which are impossible to automate, areas which require the professional judgment of a skilled human.

Other side benefits are increased quality by removing humans from mechanical processes which humans are really not that good at but computers can perform well.

So exactly what can be automated?

Mike Willis, a PWC partner, wrote an article Disclosure management: Streamlining the Last Mile explains how software applications can enable a streamlining of current “last mile” manual financial report assembly and review processes.  He points out that companies can increase net benefits by gaining a clear understanding of common areas where opportunities exist for financial reporting process enhancement. This is a summary of what a disclosure management system needs to do, per Mike Willis:

An effective Disclosure Management implementation should enable many of the capabilities and process enhancements such as:

  • Automated Spreadsheet Assembly;
  • Automated Report Assembly;
  • Automated Report Validation;
  • Automated Narrative Text Generation;
  • Contextual Review Process;
  • Automated XBRL Reports;
  • Automated Benchmarking;
  • Explicit References;
  • Collaborative Review Processes;
  • Virtual Service Center.

What Mike Willis is pointing out is only the tip of a much bigger iceberg in my view.  In another blog post I pointed out specific categories of benefits:

  • Reliable repurposing of information: Reported information can be easily and reliably reconfigured, reformatted and otherwise repurposed without rekeying to suit the specific needs of an analyst or regulator.
  • Reduced ambiguity: Ambiguity is reduced because for a computer to make use of the information, that information cannot be ambiguous. Making the information easy for a computer to understand also makes it easier for humans to communicate more effectively.
  • Reliable automated workflow: Processes can be reliably automated because computers can reliably move information through the workflow. Linking digital financial information together based on the meaning of the information can be much more reliable than trying to link physical locations within spreadsheets, which commonly change.
  • Adaptable software: Software can easily adapt itself to specific reporting scenarios and user preferences because it understands the information it is working with.

A while back I wrote a blog post describing how accounting work practices would be changed because of structured formats such as XBRL.  I showed parallels between digital financial reports and CAD/CAM (computer aided design, computer aided manufacturing).  This is one thing that I pointed out:

Architectural objects have a relationship to one another and interact with each other intelligently. For example, a window has a relationship to the wall that contains it. If you move or delete the wall, the window reacts accordingly.

In addition, intelligent architectural objects maintain dynamic links with construction documents and specifications, resulting in more accurate project deliverables. When someone deletes or modifies a door, for example, the door schedule can be automatically updated. Spaces and areas update automatically when certain elements are changed, calculations such as square footage are always up to date.

While the first paragraph which points out that there is a relation between a window and a wall is interesting; it is the second paragraph which is the most important to understand.  CAD/CAM changed the ways architects, designers, and engineers worked in very fundamental ways.

Financial reporting is poised for a similar change enabled by structured formats such as XBRL.  But for this change to occur, information technology professionals need to build the right software for accounting professionals.  A first step in that process for information technology professionals is to understand the basic mechanics of a financial report.

Things like the Financial Report Semantics and Dynamics Theory and the Financial Report Ontology help information technology professionals both understand and leverage basic and more advanced mechanical aspects of a financial report.

Posted on Saturday, February 7, 2015 at 10:39AM by Registered CommenterCharlie in | CommentsPost a Comment

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