Digital Financial Reporting

There is increasing talk about the need for quality SEC XBRL filings but there is less information on exactly how to create a quality SEC XBRL filing. Some pushing validation services say that their validation is key to achieving quality. Some feel that quality is not even important because the SEC does not require anything beyond the validation you must pass to submit your XBRL filing to the SEC. Others say quality is not important because few investors use the SEC XBRL information.

What constitutes quality?

The ultimate test of quality is whether the SEC XBRL information is usable in an automated manner.  After all, what is the point of spending millions of dollars articulating all this financial information in XBRL if it is useless? Using one report, leveraging the interactive characteristics of XBRL, comparing a company over time, comparing companies. XBRL's utility is the ultimate testament of the quality of SEC XBRL filings.

I have been pushing for quality for quite some time, well before it was even in fashion. I have also spent a significant amount of time trying to figure out exactly what "quality" means when it comes to an SEC XBRL filing. This is what I have learned about quality.

To start, this information is based on empirical evidence. I do eat my own dog food.  This is the latest iteration of what I think quality XBRL looks like, I call it a reference implementation of an SEC XBRL filings. Now BE CAREFUL HERE!!! This is both a work in progress and I consider this an ideal XBRL filing and not necessarily what you would want to file with the SEC.  There are a few things I am trying to determine beyond SEC XBRL. This prototype filing is close to what I would file with the SEC and it can help you figure out how to get where you want to be, but like I said, this is still a work in progress and I am working toward an even higher goal.  That said, the example can be quite useful in seeing what a quality SEC XBRL filing might look like.

So, these are my thoughts on quality which I will try and reference to my reference implementation to endeavor to explain each piece of the quality puzzle.

Defining quality

This is my definition of quality SEC XBRL filing: A business user of the paper or HTML version of the financial information and the XBRL version of the financial information will reach the same conclusions.

Paper, HTML, Word, Excel, PDF and XBRL are all mediums. Different mediums have different characteristics, paper has different characteristics than XBRL. If you are working with a medium, you need to understand the characteristics of that medium.  Most accountants understand how to create a financial statement using the paper, HTML, or Word mediums. They are less skilled at using the XBRL medium. So, quality of an SEC XBRL financial statement involves the proper use of the XBRL medium to articulate the financial information you are communicating. The message should be the same as the message one might glean from reading a paper-based financial report, at a minimum.

Unique characteristic of XBRL: computers can read it

The unique aspect of XBRL is that a computer can read the information. Whereas a human is required to make sure that 100% of the information expressed using the medium of paper, HTML, Excel, Word, PDF or other medium that a computer cannot understand; XBRL is different in that a computer CAN understand the information expressed in the XBRL medium.

Can a computer understand 100% of that information? No way.  That will never happen. But there are many things that a computer can understand.  As such, automated validation of information expressed within XBRL is possible.  That (a) reduces the cost of verifying the information and (b) frees humans to focus on things that a computer cannot handle.

What is even more interesting is that because XBRL is a global standard, your report can be read by someone elses software application.  For example, XBRL Cloud validates every SEC XBRL filing and reports the results. So does XBRL US with their consistency suite. The Firefox XBRL viewer add on can be used to read your report. Other software will likely appear. So, SEC XBRL filings can be consumed by any application which supports the standard, particularly since the SEC XBRL filings are all public information.

Automated verification a computer can perform

The following are the automated verification or validation which XBRL can perform. Humans still play a role in some of these. I will cross reference the type of validation to a set of four categories which I have heard automated validation placed into: correctness, completeness, consistency, and accuracy. I will also provide examples of this validation where I can.

• Edgar filer manual (EFM) validation. This is the only validation required to pass a filing into the SEC. But this is far from what is necessary to tell whether your financial information is correct. There are different interpretations in SEC EFM validation. That is why XBRL Cloud validation is different than SEC XBRL validation required for submission.  Here is the validation results for the reference implementation for the XBRL Cloud EFM validation, provided complements of XBRL Cloud. This covers XBRL syntax validation, SEC specific validation requirements which includes meta data related, some light semantics. (Relates to: correctness, consistency, completeness)
• Information model validation. Tests to be sure you are creating things such as your [Table]s, [Roll Forward]s, roll ups, and hierarchies consistent with the US GAAP Taxonomy. Doing so is specified in the US GAAP Taxonomy Architecture. This helps make sure your extension taxonomies are consistent with the US GAAP Taxonomy and with other SEC XBRL filers. For example, section 4.5 covers how [Table]s are to be created. I don't have a validation report for this, but this shows what the reference implementation taxonomy looks like which follows the US GAAP Taxonomy information model. (Relates to: consistency)
• 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. For example, putting an income statement line item on the balance sheet is illogical. Or, adding a concept at the same level as "Assets" and "Liabilities and Equity" on the balance sheet might not make much sense. (Relates to: consistency)
• 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". Financial integrity is discussed here.   For example, does your balance sheet have "Assets", "Liabilities and Equity", does your balance sheet balance, and do all the line items add up correctly? That is financial integrity, just like a paper based financial statement. (Relates to: correctness, consistency, completeness, accuracy)
• Financial integrity validation between [Table]s. Tests to be sure that explicit/implicit [Table]s are properly related to one another. For example, the balance sheet ties to the statement of changes in equity.  The cash flow statement cash account needs to tie to the balance sheet.  Disclosure details need to tie the financial statement line items. (Relates to: correctness, consistency, accuracy)
• Internal consistency. When I originally created my reference implementation I did not have access to the XBRL US consistency suite.  I asked that model be run through that suite of tests and the consistency suite pointed out that the reported issued shares was less than the reported authorized shares, which is impossible.  Internal consistency relates to the consistency between reported facts within an XBRL report.
• Computations validation. A type of consistency is whether all the numbers foot, cross cast or otherwise tick and tie.  XBRL calculations offers some help here, for example here is the validation report for the reference implementation which shows that things add up.  But there are things that XBRL calculations cannot test, something else must be used.  For example, [Roll Forwards], dimensional aggregations, and other more complex computations. Need to be verified whether the SEC tests these or not.  This XBRL Formula linkbase is used to test the reference implementation, here are the passing results. (Relates to: accuracy)
• Consistency with prior period filings. The ending balances in your period 1 filing will become the beginning balances in your period 2 filing. Automated validationests to see if the current period filing beginning balances tie to the prior period filing ending balances are possible. (Relates to: correctness, consistency, completeness, accuracy)
• Disclosure checklist validation. Also sometimes referred to as reportability rules, these tests help to make sure your disclosures are complete.  For example, if PPE is reported, you have to include your PPE policies and PPE disclosures. This has less value for a financial which is already complete, when making modifications for new disclosures this can add value. (Relates to: completeness)
• Industry standards validation. Are industry practices being followed if the applicable industry is different than US GAAP for commercial and industrial companies. (Relates to: correctness, consistency, completeness)
• Rendering validation. Does your SEC filing render correctly, using the SEC previewer for SEC filings. 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)
• 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)
• Best practices validation. Other common practices. (Relates to: correctness, consistency, completeness, accuracy)

Should accountants REALLY have to do all this?

Should accountants have to deal with things like XBRL syntax validation and making sure your HTML ampersands are double escaped in your SEC XBRL filings? No.  Computers should do all this behind the scenes and these sorts of things should just happen. But software is not mature enough yet to hide these technical things from accountants.

The marginal value of some of these validations is higher than others currently. That will change as software improves and the marginal effort to employ these validations decreases.

Should you care about all these things?

Do you care if your financial reports tick, tie, cross cast, foot, etc?  Sure you do.  Should you care about your XBRL? Why wouldn't you care?  You are responsible for it.  Besides, look at it this way.  XBRL will eventually be the only thing you will be filings with the SEC at some point and you will be legally liable for your SEC XBRL filing. Do you think you should care about it?

Eventually you will care.  You may as well get the quality where you want it while the SEC limits your legal liability. Why wait until you are liable to figure out how to master the medium you will likely be using in the future.

Longer term view

The longer term view you take, the more it makes sense to deal with the quality of your XBRL based financial report sooner rather than later.  We are paving the last mile of finance, after all.

Did I miss any opportunities to automate validation of a financial report? If so, please let me know.

Consider this statement:

"In the first hundred years of active life, it has been described as a menace and a blessing, a blight and a godsend, as a savior of our countryside and cities, and as their curse, as socially divisive and the greatest social leveler. It has been worshipped and reviled, celebrated and scorned."

No, the quote is not talking about XBRL, it is talking about the automobile. Here is another quote from an article which talks about the history of the automobile:

And as you would expect, the politicians of the day displayed a total lack of vision.

I think that XBRL was lucky in that we happened to find many visionaries such as leaders within the Association of Dutch Water Boards, the U.S. Federal Deposit Insurance Corporation, the Committee of European Banking Supervisors, the U.S. Securities and Exchange Commission, the Australian SBR Project, the National Tax Agency of Japan, the Tokyo Stock Exchange, the Japan Financial Services Agency, the MIX Market and others to consider what XBRL might offer.

This Machiavelli quote has always been a favorite of mine:

"It must be remembered that there is nothing more difficult to plan, more doubtful of success, nor more dangerous to manage than a new system. For the initiator has the enmity of all who would profit by the preservation of the old institution and merely lukewarm defenders in those who gain by the new ones. "
— Niccolò Machiavelli

Consider this quote by Wilbur Wright:

"I confess that in 1901, I said to my brother Orville that man would not fly for 50 years.... Ever since, I have distrusted myself and avoided all predictions." —Wilbur Wright, 1908

One of my favorite pieces which helps one to tune their perspective is an article which appeared in The Futurist (July-August 1995), Peering into the Future with Wilbur and Orville Wright, On the brink of a new age, two inventors debate their innovation's potential, by Malcolm Wells. Here is part of Wilbur and Orville's discussion:

WILBUR

Orville, when you get that strut repaired, I want to talk to you about the commercial value of these machines. What I mean to say is, aside from putting on demonstrations at fairgrounds, do you really think there's any money to be made from flying?

ORVILLE

Are you serious? Airplanes are going to carry millions of passengers someday. And thousands of wagonloads of freight, too.

WILBUR

Come on, now, Orville, talk sense. Even a flying machine 10 times bigger than ours couldn't carry more than 20 people. And I doubt that they'd even be willing to sit out there. Imagine women and children traveling that way.

ORVILLE

Not on the wings, Wilbur; inside. There'll be enclosed cabins with soft seats and carpet on the floor.

WILBUR

And electric lights, too, I suppose. You really are a crackpot.

read more...

Will the last mile of finance get a face lift? Every day it seems that more and more evidence that some pretty big changes might be coming. No one knows for sure.  Maybe there is nothing to all this. But then again, maybe there is.

You know, it is really amazing what one can find on the Web. How did we ever survive without it?

I was looking for something and stumbled upon a study written by Nico Bouwkamp, Understanding Technological Transitions in History and Lessons Learned for a Hydrogen-Refueling Infrastructure.

The study looks at the dynamics of the transition from steam to the internal combustion engine and the transition from fixed line to wireless telephones, looking for clues which those pushing hydrogen as a fuel source.

There is a section of the report, Dynamics of the Innovation Process, which summarizes the factors that influence the rate of adoption. The author says in part,

The rate of adoption is set by the characteristics of an innovation, which are not only objective measures but also reflect the perceptions of potential adopters in the market.
Diffusion research shows that there are five main characteristics that dictate the rate of adoption and which all have to do with how potential adopters perceive the market.

Here are those five characteristics:

• Relative advantage is the degree to which an individual perceives the innovation as superior over the existing technology it replaces.
• Compatibility stands for the degree to which the innovation fits existing values, experiences and needs.
• Complexity is the level to which an innovation is perceived as difficult to understand and use.
• Trialability is the extent to which an innovation can be experimented with before it is adopted.
• Observability is the degree to which the adoption and advantages of an innovation are visible for others than the potential adopter.

Perhaps there are lessons those trying to help XBRL achieve critical mass might learn from how other technologies achieved that state.

Wired Magazine published an article, Algorithms Take Control of Wall Street, which explains how Wall Street is ruled by thousands of little algorithms. You can listen to an interview with one of the authors, Felix Salmon, on National Public Radio's Fresh Air: How High-Frequency Trading Is Changing Wall Street, (about 20 minutes).

Per the Wired article, by some estimates computer-aided high-frequency trading now accounts for approximately 70 percent of stock market total trade volume.

What drives these computers, these little algorithms? Information.

The article points out that Dow Jones launched a new data service called Lexicon which sends real-time financial news to professional investors. Many of the "professional investors" which subscribe to Lexicon are not humans, rather they are these computer algorithms.

Will these algorithms find the SEC XBRL information beneficial? Maybe. I would even go as far as saying probably at least a little. After all the information is only released quarterly. I am no expert on what information drives Wall Street decisions, time will tell if this information is helpful. But if 70 percent of the trades are made by computers rather than humans, could it be the case that the type of information needed might change?  Are financial statements as we know them obsolete, perhaps to be replaced by Twitter tweets of thousands of fragments of information which investor relations departments use to disclose company information? How will that information be audited? Who knows, but this is certainly interesting stuff which raises a lot of questions in my mind.

And what about this.  I have worked in two other "markets": specialty lumber and produce.  Both were quite interesting and had different dynamics. Few of us realize or pay much attention to the fact that the price of a box of lettuce can fluctuate between $3 a box and $26 a box and how that fluctuation can impact consumers and others in the supply chain.

The stock markets have probably spent millions, if not billions on all the infrastructure to make that supply chain work, to get to the point where automated computer driven trading is even possible. What if the costs of this infrastructure dropped substantially so that other markets, such as specialty lumber and produce, could afford such technology?

That is exactly what XBRL does. When I worked in the produce industry, the little company I worked for created some pretty impressive stuff using PCAnywhere, dial up phone connections, CSV data formats, and Microsoft Access 1.0. We still had lots of additional opportunities and lots of tasks where we interfaced with the outside world was done via FAX machines and telephone calls, but internally we had it together more than most.  But this was in the early 1990s.  I would love to go back there now and see what I could do using the Internet, web servers, XBRL, and all these other new tools we have at our disposal.

In chapter 7 of my book XBRL for Dummies I talk about business information supply chains. If this stuff is interesting to you there is a lot more information there.  XBRL is making automated computer business information exchange more cost effective for more than just financial reporting. These little algorithms will be working in lots of other industries performing lots of mundane tasks which humans perform today because it is not cost effective to automate those processes.  XBRL changes that. Not all processes will be automated, just the ones which make sense or the parts of processes where human judgement is not necessary.

What can you automate in your supply chain?

Jon Rowden and Mike Willis of PricewaterhouseCoopers have writen a white paper for the Financial Executives Research Foundation (FERF) titled Making Sense of XBRL In the US and the UK. This is a summary of what the paper discusses:

There can be no doubt that XBRL (eXtensible Business Reporting Language) has become a hot topic for financial executives in the U.S. and also overseas. Many are already familiar, perhaps painfully so, with the SEC's XBRL reporting mandate for issuers and the requirements relating to 10-K annual reports and quarterly filings. This article from Financial Executives Research Foundation looks at what is happening in the United Kingdom, where the tax authorities have introduced an XBRL requirement that affects all companies required to file a tax return. In this article, Jon Rowden and Mike Willis from PwC highlight how the UK mandate differs in some key aspects from the SEC requirement, how the UK requirements are being addressed and outline a wider agenda of considerations for financial executives in the U.S. and elsewhere, prompted by the introduction of XBRL by regulators around the globe.

With 1.6 million legal entities affected by this requirement for accounting periods after April 1, 2010, the use of XBRL takes yet another step forward following the lead of the US SEC, US FDIC, and many others around the globe. The white paper is worth reading discussing the "last mile" of reporting processes, why XBRL and iXBRL are a catalyst for change, common pushbacks and the wider agenda for CFOs and audit committees.