Digital Financial Reporting

In my last blog post I pointed out a set of fundamental accounting relations which exists for all financial statements.  These relations focused on the primary financial statements.  This blog post expands on that idea.

So, I created a form in an analysis application which I had and put all these high-level concepts on that form.  You can see a screen shot of that below (click on the image below to get a larger image):

Fundamental accounting relations

Within the analysis tool which I created using Microsoft Access, I both hooked all these concepts together and I also put in check values to be sure the relations were correct.

Now, granted, not one SEC filer reports every one of the totals or line items that I provide for.  For example, if a reporting entity does not have an equity method investment, it is not going to have "Income from equity method investments" and it will not report the concept "Income before equity method investments".  So the line items which they do show depends on the line items which they have and therefore report.

However, that does not change where "Income from equity method investments" WOULD go.  I just provide all these placeholders.  Accountants creating a financial statement cannot move this stuff around.  For example, an accountant simply cannot include "Income from equity method investments" within Gross Profit, Nonoperating income (loss); there is exactly one appropriate spot for that line item.

There are only two areas of this set of concepts that I am having slight problems fitting the puzzle pieces together.  The first is the line items which make up "Operating income (loss)". There is such a wide variety of line items and subtotals provided that this is a bit of a challenge.  There is also one significant error that about 50 SEC filers make.  What the filers do is take the concept "Interest and Debt Expense" which is basically a category of expenses and "repurposing it" (in my view misusing it) as a line item within a different category, "Nonoperating income (expense)".  That is like using the concept "Assets" within the liabilities section of a balance sheet.  And so this area is a bit challenging.

Another area where this model does not quite work correctly is the cash flow statement and the placement of "Exchange gains (losses)" in that statement.  There are two different approaches SEC filers take. The first approach includes the exchange gains (losses) within the computation of "Net cash flow", contributing to that total.  Well over 98% of SEC filers use this approach.  A small minority of SEC filers include "Exchange gains (losses)" within the roll forward of the cash and cash equivalents beginning and ending balance.  I have pointed out this issue previously.  Some accountants I talk to consider this an error on the part of the filers in creating their financial reports.  Others acknowledge an ambiguity within US GAAP which could lead to this second interpretation used by the minority of SEC filers.  There is no real business reason for having two approaches to where this line item should show up.  OK, so that means there are two possible representations for that particular line item.  Fine.  That does not break the idea of the existence of these fundamental accounting relations.

And so there really is not just one representation.  If a reporting entity provides an unclassified balance sheet, they won't report current assets or liabilities.  No big deal, just a slightly different representation.  Same thing for whether a filer provides a single-step or multi-step income statement.  That does not change every fundamental relation, it only changes a small handful.  Likewise if a filer reports using net assets instead of equity, like a small number of SEC filers do.  These are all just minor adjustments to this underlying representation, it does not break the representation.

Another thing that I did was provide a wiki page which captures the concepts and relations which I am using.  You can get to these fundamental accounting relations here.  If you have any other relations which you want to add, go for it.  If there are any that you disagree with, post a comment to the discussion page.

Thus far, no one has made a sensible argument against any of these relations.  Also, the SEC filings that I have support the existence of these relations.  Again, not every SEC filer has all of these relations; but there is not one SEC filing that I have seen which leads me to believe that I have any of these relations incorrect.