Digital Financial Reporting

I have pretty much proven the conceptual model of a financial report bottom up.  Now I am going to also prove it top down.  What this achieves is enabling me to simplify the model and allowing only best practices proven by empirical evidence.

Financial reporting schemes are important, therefore they should be elegant to look at and easy to use.  The accounting equation is a simple, elegant, and very useful and proven tool.  Every financial reporting scheme builds on that rock-solid foundation.  But when basic relations and terminology are vague, ambiguous, or otherwise unclear then financial reports can end up being convoluted messes that are not useful.  In order for professional accountants to exercise good professional judgement accounting and reporting standards should be crystal clear.  Today, standards setters do a pretty good job, but there is room for improvement.

How do I know there is room for improvement?  Read on.

There are many different financial reporting schemes, for example: US GAAP, IFRS, FRF for SMEs, IPSAS, GAS.  Here is a list of financial reporting schemes.  Comparing and contrasting these is interesting and helps one tune my skills as a master craftsmen.

Each financial reporting scheme has a conceptual framework.  Here are the conceptual frameworks for the following financial reporting schemes: US GAAP; IFRS; FRF for SMEs; IPSAS; GAS.

I compared the high-level financial report elements for those five financial reporting schemes.  They are mostly the same in terms of the elements that they define.  But there are some differences.  Now, the definitions of the elements tend to be different even if the name of the element is different.

So, for example, here are the financial report elements defined by FRF for SMEs (to understand more about FRF for SMEs see here) either explicitly or implicitly within the definition of another element: (for specifics see here)

• Net Income
• Investments by Owners
• Distributions to Owners
• Assets
• Liabilities
• Equity
• Revenues
• Expenses
• Gains
• Losses

For quick reference, here are screen shots of the high-level elements of each of these five reporting schemes:

• US GAAP (or see pages 24–133 of the free PDF above); here is documentation from an intermediate accounting textbook.
• IFRS (or see page 2 of PDF above);
• FRF for SMEs (see page 21 in the free PDF above);
• IPSAS (or see page 15 in the PDF above but you have to register);
• GAS (see page 3 in the free PDF)

Now, at the very highest level, all financial reporting schemes are fundamentally the same and use the accounting equation: Assets = Liabilities and Equity. (If you don't understand this, watch this video.)

Financial reporting schemes are fundamentally based on the accounting equation and double entry bookkeeping which was invented in about 1211 and documented in 1496.

So why is any of this important? First, it is important to understand that the elements of a financial report are interrelated.  You cannot change any one single number and expect the report to "tick and tie" and "cross cast and foot".  There are roll up and roll forward relations that tie all the report pieces together.

Unmodified CORE-00: I represented the high-level financial report elements of FRF for SMEs in XBRL without modifying the concepts, I call CORE-00. Here are the high-level concepts of FRF for SMEs. That is just a flat list of the report elements. (Raw XBRL | Inline XBRL | Human Readable)

Enhanced CORE-01: But, I want to represent all of the relations.  To do that, I had to enhance the FRF for SMEs high-level elements, adding two elements: Liabilities and Equity and Net Cash Flow.  I am not sure why FRF for SMEs did not define net cash flow. In fact, the only reporting scheme which defines Net Cash Flow as a high-level element is IPSAS. Here are the now 12 high-level elements.  And here are the balance sheet, income statement, cash flow statement, and changes in equity. (You can browse around and have a look at what you want using this link.) (Raw XBRL | Inline XBRL | Human Readable)

Now, don't be pedantic and miss the point. We are looking at the bigger picture here folks!  The point is (a) that there are mathematical relations that inter-related all of the four reports and (b) all my mathematical computations work as was expected.  You can see the relations by looking at the report, but here is a separate summary of all those mathematical relations.  Yes, I agree that it barely looks like a set of financial statements.

Further Enhanced CORE-02: So, I don't exactly know how the FASB, IASB, GASB, IPSASB, or other standards setter determines where "high-level elements" end and "lower-level elements" begin.  But, for what I am trying to do, I need just a little more detail.  And so, I added a few more elements so the total is now up to 23.  But I don't think that anyone would dispute any of these additional 11 concepts that I added.  Here is a list of my further enhanced core elements of a financial report. Note that the statements are looking more like a financial report:  Balance sheet, income statement, cash flow statement, changes in equity. Again, you can browse all the pieces here and you can look at the mathematical relations here. (Raw XBRL | Inline XBRL | Human Readable)

Accounting Equation (Very basic example): XBRL instance | Human Readable

Conceptual Framework (Enhanced example): XBRL instance | Human Readable | Taxonomy | Assertions

BOTTOM LINE: And so I can keep doing what I am doing until I create 100% of the disclosures that would be created when reporting under FRF for SMEs (which I am actually doing) and as I am doing that, I am proving that all of the expected relations are is as expected.  Further, if this works for FRF for SMEs, then why in the world would it not also work for US GAAP, IFRS, IPSAS, GAS, or any other financial reporting scheme?

Why are getting reports right so critical?  Well, if the reports do not fundamentally work correctly than what value do XBRL-based digital financial reports have to anyone?  The SEC mandating public companies to provide XBRL-based financial reports is one thing.  If they don't work correctly and/or don't provide benefits to the report creators, why waste your time with XBRL-based reports?  Sure, those mandated to provide the reports will jump through the required hoops they need to jump through for a regulator; but no one else will use them.

Secondly, by understanding the high-level model one can then create software that takes advantage of that model and makes the entire process of creating such reports easier for professional accountants.

INTERESTING OBSERVATION: Finally, I have an interesting observation.  When you (a) look through the conceptual frameworks created by standards setters and more importantly (b) compare the different conceptual frameworks created by different standards setters you start to really see the many, many inconsistencies, flaws, poor organization, and other such issues in these important financial reporting schemes.

Sorting through these important accounting standards is not about professional judgement.  Many accountants think that they are exercising judgment when working through the inconsistencies and flaws.  But that is not exercising judgement.  Exercising judgement is about understanding the real and clearly stated differences between, say, a "current asset" and a "noncurrent asset" and then applying professional expertise to determine the proper classification.

There are a lot of reporting and accounting mistakes in the financial reports created by US public companies.  The accountants that create those public company reports are the best of the best.  And given the amount of scruteny public company reports get (i.e. they are publicly available); if public company reports have mistakes, where do you think the private company financial reports might be in terms of quality?

Anyway, that is all for now.  Stay tuned to watch a new era of financial reporting appear right before your eyes!