Digital Financial Reporting

In my last post I pointed out that financial integrity needs to exist in financial reports whether the financial report exists in the medium of paper or in the medium of XBRL.

In this post I want to elaborate on what financial integrity is.

I want to look at defining "financial integrity" by summarizing all the different inputs I have, looking at them, and then coming up with one concise definition.  These are the inputs I have.

A Broad Definition

Financial integrity can be broadly defined as making sure a financial report is correct, consistent, complete, accurate and other such overarching terms. While these terms do encompass a great deal, this definition is still too vague.

Taking an XBRL Validation Perspective

Drilling down a little more and taking more of an XBRL perspective of financial integrity, I put together a list of the different types of XBRL validation which needs to be performed in order to make sure financial information expressed in the medium XBRL is correct, consistent, complete, and accurate. Below I have provided that list, a brief explanation of the item, and reconciled the list item to the overarching terms: 

• Edgar filer manual (EFM) validation. Tends to be more syntax related, meta data related, some light semantics. (Relates to: correctness, consistency, completeness)
• US GAAP Taxonomy information model validation. Tests to be sure you are creating this such as your [Table]s, [Roll Forward]s, roll ups, and hierarchies consistent with the US GAAP Taxonomy. (Relates to: consistency)
• US GAAP Taxonomy extension points and extensibility rules validation. Tests to see if where you are extending the US GAAP Taxonomy is appropriate and if you are creating logical extensions. (Relates to: consistency)
• US GAAP financial integrity validation within a [Table]. Tests to be sure that each [Table], be that [Table] explicitly defined or implied, is "internally consistent and correct". (Relates to: correctness, consistency, completeness, accuracy)
• US GAAP financial integrity validation between [Table]s. Tests to be sure that explicit/implicit [Table]s are properly related to one another. (Relates to: correctness, consistency, accuracy)
• Industry standards validation. Are industry practices being followed if the applicable industry is different than US GAAP. (Relates to: correctness, consistency, completeness)
• SEC previewer rendering validation. Test to see how the XBRL instance renders within the SEC previewer. (Relates to: consistency)
• Comparability validation. Tests to see how well an XBRL filing can be compared to a similar XBRL filing. (Relates to: consistency)
• Business rules validation. Tests to be sure all computations are expressed and work correctly including roll ups, roll forwards, dimensional aggregations, and other more complex computations. (Relates to: accuracy)
• Disclosure checklist validation. Tests to be sure that all required disclosures exist. (Relates to: completeness)
• Key performance indicators validation. Tests for wild fluctuations against internal benchmarks and industry averages.  Much like an auditor's variance analysis. (Relates to: correctness, consistency, accuracy)
• Comparison to prior period filings validation. Tests to see if the current period filing beginning balances tie to the prior period filing ending balances. (Relates to: correctness, consistency, completeness, accuracy)
• Best practices validation. Other common practices. (Relates to: correctness, consistency, completeness, accuracy)

An Auditor's Perspective

I used to be an auditor long, long ago. One of the final steps in issuing a financial report is making sure all the pieces tie together. This is my short list of the types of things I would have to look for.

• Balance sheet. Does the balance sheet balance? Does everything foot? Does equity tie to the statement of changes in equity. Does cash tie to the cash flow statement?
• Income statement. Does everything foot? Does net income tie to the statement of changes in equity? Does net income tie to the cash flow statement?
• Cash flow statement. Does everything foot? Does cash tie to the balance sheet. Does net income tie to the income statement? Do the increases (decreases) in current assets and liabilities tie to the balance sheet changes?
• Statement of changes in equity.  Does everything foot? Does equity tie to the balance sheet? Does net income tie to the income statement?

Again, this is a the short list, but you should get the point.

FDIC Validation Process

This may seem odd, but I think this should be included.  I learned a lot about verifying financial reports from working on the XBRL implementation by the FDIC (US Federal Deposit Insurance Corporation). The FDIC has somewhere between 1800 and 3600 business rules (I have heard both numbers, not sure which is right) that every bank call report must pass before the report is even excepted by the FDIC as a submission.  This is in addition to all the XBRL syntax validation and the other FDIC filing requirements.  Some of these business rules are made available to filers, others are "secret" rules that the FDIC uses for regulation purposes and does not make available to filing banks. Another class of rule the FDIC has is something they call "reportability rules". Those rules are driven by the type of filer.  Things like, "If you are this type of filer, then you have to report this...." and "If you report this....; then you have to report this...."

Defining Financial Integrity

OK, so this is my take on the definition of financial integrity. Sure, things need to be complete, consistent, correct, and accurate. But first you need a framework to work within. When you build a boat you start by building laying the keel.  When you build a house you start by laying the foundation. If the keel of the boat is sound or the foundation of the house is sound, then you are off to a good start.  But if you don't lay that keel correctly or lay a true foundation to a house, you will never be able to create a good boat or a architecturally sound house.

This is the foundation of a financial report (this is for US GAAP):

• Balance sheet. The balance sheet always has the concepts "Assets" and "Liabilities and Equity". The value of both of those concepts MUST have the same value (i.e. the balance sheet balances.). Depending on the industry you might have "Current Assets" and "Current Liabilities" (i.e. a classified balance sheet). The computations for "Assets" and "Liabilities and Equity" foot. (In XBRL terms, you have XBRL calculations which prove that the balance sheet computations add up correctly, things roll up.) One could hang other things off the "Assets" and "Liabilities and Equity"; but you definitely have those two concepts and anything that does hang off those concepts adds up correctly.
• Income statement. It seems that there are two concepts what every company will always have: (1) "Income (Loss) from Continuing Operations before Equity Method Investments, Income Taxes, Extraordinary Items, Cumulative Effects of Changes in Accounting Principles, Noncontrolling Interest", (2) "Earnings Per Share, Basic".  There is a "step down" in the income statement, companies only have the steps if they have that component.  The components are: Income from Equity Method Investments, Discontinued Operations, Extraordinary Items, Cumulative Effect of Change in Accounting Principle.  If you have a noncontrolling interest, then net income is also broken down by what goes to the parent and what goes to the noncontrolling interest. If you have preferred dividends you need to break those out.  You may, or may not, break Income from Continuing Operations out for Gross Profit.  But, it seems that (a) one always has Income from Continuing Operations (i.e. if they don't, are they a viable business?), (b) some easy to figure out step down of net income, and (c) earnings per basic share.  (If I am wrong on this, this is the statement where I am probably making a mistake.  There may be a better way of explaining this.)
• Cash flow statement. Every company has the concept "Cash and Cash Equivalents, Period Increase (Decrease)" (per the US GAAP Taxonomy) or I call it "Net Cash Flows".  That concept can be broken down into three other concepts: Net cash flows from operating activities, Net cash flows from investing activities, and Net Cash Flows from Financing Activities.  Companies will highly likely have operating cash flows, it could be that they have no financing or investing cash flows.  It is conceivable that they don't have operating cash flows because they are not operating companies. There are two other things which could be included in "Net Cash Flows": Effect of exchange rate on Cash and Net Cash Flows from discontinued operations.  Now, discontinued operations could be configured in a number of different ways, but it is always a part of "Net Cash Flows".  Effect of exchange rate on cash is a different story, I am getting two different messages.  Fine, one must be true.  Either it is ALWAYS part of "Net Cash Flows" (this is what I see in 99% of filings) or it could be part of the reconciliation of cash (i.e. not part of "Net Cash Flow").  Whatever concept is used for "cash" in the cash flow statement must be the same concept used on the balance sheet. This business rule is ALWAYS true: "Beginning Cash + Net Cash Flows = Ending Cash".  (Or, alternatively, if exchange gain is NOT part of "Net Cash Flows"; then: "Beginning Cash + Net Cash Flows + Effect of Exchange Rate on Cash = Ending Cash")
• Statement of Changes in Equity. The beginning and ending balances tie to the balance sheet. Net income shown in this roll forward ties to the income statement.  (All the statement of changes in equity is, is a bunch of [Roll Forward]s.  There is a [Roll Forward] for every equity account and shares and there is a [Roll Forward] for all the periods shown on the balance sheet.
• Policies. Some policies relate to financial statement line items.  Some don't. If they do tie to a line item, the fact that it does tie should be expressed.
• Disclosures. Some disclosures relate to financial statement line items.  Some don't.  The ones that do tie to those line items (i.e. they are the same XBRL concept in the statement and in the disclosure). If the disclosure is supposed to foot, some business rule exists to show that (either an XBRL calculation or an XBRL formula).  Things that should be tied together are tied together, be they because they relate to the same class of stock, same entity, same class of some other line item, or in some other thing which should be tied together.

So that is the "keel" or "foundation" of a financial report, be that report expressed in the medium "paper" or in the medium "XBRL".  Clearly, whatever medium is used, XBRL or paper, the information communicated must be interpreted the same by the user of the information because it is the same information.  If that cannot happen, XBRL will never be able to replace paper and therefore paper will always need to exist.

Maybe I don't have the foundation properly expressed or 100% adequately expressed. That is not really the point here.  If I don't have it right or adequate, fine, define it correctly and define it adequately and let that be the foundation.  If there is no foundation, comparability will never happen.  And if comparability cannot happen, what is the point of tagging all this information in XBRL?  Seems to me that is the goal here, to enable easier comparability at some level.  I am not really trying to define the level of comparability.  The marketplace will do that.  But, it seems to me that this base is pretty hard to dispute. This is pretty much meat and potatoes, it seems to me.

If I am wrong and US GAAP is not even comparability at this level, then it seems we have other issues to deal with.

So that is what I see.  What are your thoughts? Do you have a better definition of financial integrity or believe that financial integrity is not important?  Post a comment.

A financial statement is not an arbitrary set of numbers/text. A financial statement has what I refer to as "financial integrity". By financial integrity I mean that the relations within a financial statement are sound.  For example, the balance sheet balances, the statement of changes in equity beginning and ending balances tie to the balance sheet, net income per the income statement ties to the statement of changes in equity and the cash flow statement, the proper policies and disclosures exist for line items which are used on the primary financials, and so forth.

These relations are so ingrained in accountants that they tend to disappear into the background when an accountant thinks about financial statements.  Of course the financial report ticks, ties, foots, cross casts; otherwise it would not be a financial statement.

But how does a financial report become sound, having financial integrity as I have described above? When a financial statement is created using Microsoft Word, is it Word which makes sure all the relations are sound and that financial integrity exists? No. Word knows nothing about financial reports other than how to format them and organize them into tables.  Word understands how to present things.

Microsoft Word and the printed paper report do nothing to enforce financial integrity.  An accountant who understands the relations uses the paper report to read the numbers and other contents and then uses his/her skills in accounting and usually a calculator to make sure everything adds up. Why does the accountant need to manually go through this process?  Because Word cannot help and the medium paper cannot help, other than show the accountant the information of the report.

This changes significantly with XBRL. In fact, because of the way XBRL is created after the paper or HTML version of the financial report today; XBRL is seen more of a nuisance than a helpful asset.

Here is what changes: 

1. First off, XBRL is a different type of medium. The XBRL medium has different characteristics than paper. One of the characteristics is that computer programs can read the information in the XBRL and understand what the information means. Because computer programs can read and understand the information; the computer program can enforce financial integrity rules rather than an accountant having to do it in many cases.
2. Because the financial information is expressed in the XBRL medium an accountant has to either (a) understands the rules of using the medium or (b) have a piece of computer software which understands the rules of the medium in order to articulate the financial information in the XBRL medium correctly. Clearly the paper financial report and the XBRL financial report need to communicate the same meaning.
3. Because computer applications can read the information and the business rules which make sure the information has financial integrity; investors and analysts can use those same rules within analysis software to help them analyze financial information.

Again, when I say financial integrity and business rules, I am not talking about XBRL syntax rules such as "all ampersands within a text block need to be double escaped." These sorts of syntax rules and even some business semantics rules enforced by say SEC Edgar filer manual validation such as XBRL Cloud are critical; but business users should never need to deal with these sorts of things. These rules should be hidden deeply in software which simply will not let users generate the wrong syntax.

What I mean by financial integrity relates to things such as the correctness, accuracy, consistency, and completeness of the financial information. Consider this sample SEC XBRL filing which I have created. I have taken great care to make sure the HTML has financial integrity. The XBRL medium version of the report must likewise have financial integrity.

I have taken great care in creating the XBRL version. Regretfully, like most other software out there these days the software does not really help you create the XBRL with financial integrity.  Instead, I have to run validation reports to test the report after it is created.

What validation did I perform? Here is a list:

• Edgar Filer Manual validation (complements of XBRL Cloud), which shows that I have zero errors.
• XBRL calculations validation (complements of UBmatrix) which shows that certain computations add up.
• XBRL formulas validation (complements of UBmatrix) which shows that other more complex computations add up such as roll forwards and aggregations of dimensional information. (Note that there are 24 such business rules.)
• XBRL US consistency checks (complements of XBRL US) which checks for internal consistency of the information. (I don't have a physical report yet, hoping to get that. When my XBRL instance was first run against these consistency checks I discovered that my outstanding shares and issued shares of common stock did not properly relate and that I did not include earnings per share in my example which is a required disclosure for public companies). I still may have some errors in this category, this testing is not 100% complete as of yet.)
• Manual review. There is still that manual review that needs to take place, cannot get around that.

While achieving financial integrity today can be challenging because these sorts of business rules are not broadly available, few software applications support things like XBRL Formula validation (there are some), and the XBRL medium is not well understood by accountants; it is possible to do substantially better than most SEC XBRL filers are doing today. The first step is realizing that this not only can but must be achieved to make the information useful to those using the information for analysis.

In my next blog post I will provide an explanation of specific financial integrity rules at the high levels of a financial report.  If you look at the XBRL Formula linkbase file of the example you can see most of these rules. The problem with that is the raw formulas can be challenging for accountants to read. Don't worry about that in the long term, software will make that much easier.

There is this feature of XBRL which I refer to as "hypercube jumping". You can experience hypercube jumping, at least an initial instantiation of it, by using a software application which supports this feature such as the Firefox XBRL viewer add on, a properly created XBRL instance, and a properly modeled XBRL taxonomy. If you want to actually walk through this, this blog post will help you do that.

What I am starting to recognize that the term hypercube jumping is likely not the right term. Hypercubes are only a piece of the puzzle and in fact, you really don't even need explicit hypercubes at all but this works with the implied structures within XBRL as long as you model your meta data correctly.

Are you lost already?  Well, I probably won't help you grasp all this; the fact is I am trying to figure it all out myself.  A lot of people refer to the things I am talking about as "drill down" or "aggregation" of information.  But it seem to me that it goes way, way beyond that.

To help you visualize, consider the graphic below.  This is a tesseract. Look at this graphic and think about Excel pivot tables.

3D rotating tesseract (from Wikipedia)

Paper has only two dimensions, rows and columns. Add a third dimension to that and you get a cube. You can only view a three dimensional cube on a two dimensional surface by holding one of the dimensions static like what a slicer does in say an Excel pivot table or by repeating sets of rows and columns multiple times within a paper report. Now a computer screen is not limited to two dimensions so it can display three dimensions with no problem.

But what if you have four dimensions? Or heck, what about ten dimensions?

What does all this have to do with hypercube jumping or drilling down into data? Well, I am not totally sure but what I seem to see is this.  If you look at the graphic above, you will note that the object fits together, you don't have stray lines ending nowhere in space and things like that. What I am seeing more and more is that it is all about the data model.  If you get the data model correct, you can do all sorts of interesting things.

Imagine having a financial report which "looks" like the graphic above.  (Work with me here and use your imagination.) Imagine being able to pivot, slice, dice, drill down, drill across, drill side-to-side from one place in a financial report to another place in a report.  Imagine that your "report" is actually a set of financial reports for an entire industry sector and you can cross the bounds of the report or the entity because you are not limited by the physical bounds of paper or the limit of two dimensions which limits what paper can express.

Syntax is really not that important, as long as you can easily convert and move form one syntax to another. There have been never ending debates about things like the pros and cons of things like tuples and dimensions. During those debates a minority of people say that those things don't matter.  I am starting to grasp what they were talking about.

Any accountant or financial analyst can tell you that there is a rich set of relations contained within and between the many pieces which make up a financial report. Leveraging these relations will change the way we interact with this information.  The first step is articulating the many relations in a way that a computer can easily and properly grasp.  XBRL is one syntax for doing this. Proper data models is what enables things like hypercube jumping.

All this will be easier to grasp when more software exists to see these ideas in action.

Another construction crew has shown up in the ongoing project to build the last mile of finance: SAP. Well, they were actually on the project site before, but they seem to be bringing in additional heavy equipment. A couple of days ago it was announced that SAP is acquiring disclosure management solutions from cundus AG. It seems that SAP is doing this to better compete with Oracle's and IBM's offerings to the market.

So we have IBM, Oracle, and SAP in the game. These three companies can move some dirt! I wonder where the middle market software vendors are.  It will be interesting to see who ends up succeeding and who ends up as road kill.

Microsoft PowerPivot helps one see the possibilities which something like XBRL enables. PowerPivot is an Excel add in with gives users the flexibility they need but at the same time gives the IT department the control they need. This videohelps you get an understanding of PowerPivot. (Gemini was the initial name for PowerPivot.) This videoshows how and information mashup can be put together.

I have not tried PowerPivot yet, you need Office 2010 to use it. But now I am very motivated to upgrade and try this free Excel add in. Mr. Excel in the second video says this about PowerPivot:

"Greatest thing I have seen coming from Microsoft in 15 years."

Imagine a PowerPivot "database" (not sure what to call it) which combines information internal to your organization and information external to your organization working seamlessly together to help you manage some aspect of your business supply chain. I have heard this called "external analytics".  Your data set is connected to other data sets external to your organization.  Perhaps the SEC XBRL data set as an example of one publicly available standardized set of information.

Not interested in public company financial information?  That is not the point. While the SEC XBRL data set itself might not be useful to you, think of other data sets which could be useful.

There are four overarching trends which work together to make this sort of vision possible:

• The Internet. If we were not all connected together there would be less of a possibility to be able to exchange information because of the expense of doing so. Lots of people exchanged information before the Internet existed, now anyone can exchange information with anyone else for pennies. I am talking about the Internet here, not the Web. If you don't understand the difference, you definitely want to read about how the Web is dead.
• Model based reporting. Business intelligence (BI) applications are growing in popularity. One example of this is how BI applications are changing the last mile of finance. One of the core pieces of BI is use of the multidimensional model which provides flexibility.  You can use the same piece of information in different ways. The important piece here is not BI, it is the flexibility of the multidimensional model. This OLAP Council white paperhelps you understand why the multidimensional model is important.
• Structured, standard data formats. Unstructured information such as a word processing document or HTML file or PDF file makes reusing the information in those files impossible. But structured information can be put into a database and reusing it is quite easy. But you need your database to connect to someone else's databaes. So if one database is going to be connected to another database; what is the standard database format which you are going to use? Well, of course, it is your database format, right?  Well, others with different database formats would likely disagree. There is no standard database format. Nor should there be. But, you have to somehow link systems together and you need some syntax to do that. XML, RDF/OWL, XBRL, CSV, it really makes little difference.  As long as the format is understood, technically anything can be integrated.
• Semantic and process interoperability. In addition to the technical interoperability, you still need semantic interoperability and process interoperabilityto achieve business system to business system integration. An example of this is how I can use my Apple iMac and create a video in iMovie and then upload it to Google's YouTube.com.  Two different applications, two different companies, working together seamlessly.

All this sound mind-numbingly complicated to you?  Don't worry about it.  That is what technical people do, they make stuff like this work. What is important to understand is that fundamental changes are coming to business processes.  One example is financial reporting.

Don't be fooled into thinking that the SEC's little experiment with XBRL is a misguided regulatory mandate which does little more that add unnecessary costs to a process which works fine today. The SEC is being quite progressive, not something one might expect from a government agency. What the SEC is doing is only part of a larger global trend started by little regulators like the Dutch Association of Water Board as early as 2004 and bigger regulators like the Federal Deposit Insurance Corporation (FDIC), and others. These government regulators are only priming the pump.

While I do think PowerPivot has its short comings such as it requires you to have Excel (i.e. it is proprietary to one vendors software) and it cannot be used to create content, only report on content and it seems to be focused on numeric information (i.e. I have not seen it handle textual information); PowerPivot is a very nice piece of software which helps one see the possibilities.