Written by Robert Kugel     Posted March 6, 2007

Robert Kugel, CFA, is Vice President and Research Director for the Finance Performance Management practice of Ventana Research. He has been an equity research analyst at several firms, including First Albany Corporation, Morgan Stanley, and Drexel Burnham, as well as a consultant with McKinsey and Company. Rob was an Institutional Investor All-American Team member and on the Wall Street Journal All-Star list.

I used to be a securities analyst, so I know first hand what a pain it is to take the numbers from a company’s financial statements and get them into a spreadsheet for analysis. The SEC needs to make tagging financial statements mandatory, the sooner the better. But before that happens, public companies, their auditors, and securities analysts should get together to resolve the very nitty gritty problem of exactly which tags each company is going to use on their financial statements.

For a couple of years now, the SEC has had a voluntary XBRL tagging program but participation has been light. I think there are a couple of reasons for this, some of which stem from misperceptions on the corporate side, some of which stem from the immaturity of the of the taxonomy and software tools and some of which can be laid at the feet of the SEC. The good news is that the last two issues are being addressed through the SEC’s decision to invest money in completing the US GAAP taxonomy and overhauling the EDGAR database so investors can use it to do basic analyses using XBRL-enabled tools. The bad news is I believe that even when the work is completed, participation in a voluntary XBRL tagging program is not likely to be much higher than it is today.

As to the misperceptions issue, in the wake of Sarbanes-Oxley and accelerated filing deadlines, the SEC was reluctant to saddle public companies with another requirement. But how difficult would it be if tagging the basic financial statements were mandatory? I recently completed a bit of research to find this out. To do this, I used beta versions of Hitachi’s and Rivet’s tagging tools (time was short so I skipped using UB Matrix’s). I received minimal training from the software vendors, mostly in the form of short demonstrations. Realistically, though, it will take anywhere from one to five hours of initial training to prepare people who understand accounting and financial statements to use these tools. The amount of time will depend on their degree of familiarity with the basic concepts of how XBRL works, not a a deep understanding of taxonomic structures. Knowing how financial statements work is far more important.

I used seven public companies financial statements, representing a range of industries and from large and complex corporations to smaller and simpler ones. They were Administaff, Boeing, Brush Engineered Materials, General Electric, Gerber Scientific, Gray Television, and Kroger. One reason for choosing a range was to see how often it was necessary to create custom tags. While one of XBRL’s strengths is its extensibility, using custom tags for public company financial statements negates an important feature of XBRL tagging: enabling easy comparisons across companies financial statements.

It took slightly less than four hours to tag the first company’s (Boeing) quarterly income statement and balance sheet. It took an hour and a half to do the last (Brush Engineered Materials). We tagged only the balance sheet and income statement because the US GAAP cash flow taxonomy is far too incomplete. Of the group, General Electric was the most difficult, taking five hours because of the larger number of items that required tagging. (GE has both industrial and financial services segments and it presents these two elements and a consolidated view.) Based on our test, we estimate that on average, it will take the person responsible for tagging about five hours (plus or minus an hour or two) to become familiar enough with the tagging tool and the process itself to achieve basic proficiency. It will then take the person another five to 10 hours to do the initial tagging of the company’s basic financial statements.

Once that template is established, though, it should require no more than an hour or two each quarter (and for the proficient, probably less than that) to put the new numbers into the template and make whatever changes (if any) are needed to the financial statement’s structure. In addition, layers of review by internal resources and external auditors and initial setup time with the company’s financial publisher (typically Bowne, Donnelley, or Merrill) will consume some additional hours. In other words, we believe it would not be a burden if the SEC required all accelerated filers (companies that have US$70 million or more of public securities) to tag the basic financial statements in their periodic filings with XBRL.

That noted, I think the real barrier to companies going along with XBRL tagging is the uncertainty that would exist in their minds (and the minds of their auditors) about which tags to use and which they need to create.

Going though the tagging exercise, I tried to put myself in the position of a corporate vice president or director of public reporting. Those people will not look at making judgment calls about how to tag financial statement items as a career-building exercise. CFOs also don’t want to have one more thing requiring an auditor’s blessing and don’t relish the idea of having one more technical thing they are answerable for.

We expect auditors, if asked, to feel uncomfortable advising their clients. They may be inclined to choose a precise nonstandard tag to remove any chance that someone will consider the standard tag wrong. On the other hand, auditors would recognize that using too many nonstandard tags may create suspicion that the company is hiding something or that it will frustrate analysts trying to compare companies results side-by-side.

These concerns can be allayed with proper preparation. There should be an XBRL “dress rehearsal” before companies are required to tag their financial statements. After the newly updated and expanded taxonomies are completed, there should be a period of discussion among public companies, auditors, and securities analysts to work out the treatment of the financial statement line items. At a high level, a steering committee is needed to develop a process for identifying gaps between the U.S. taxonomy and specific items in each company’s reports. Industry-specific working groups consisting of public company representatives, securities analyst groups that focus on a specific industry, and industry-focused practice leaders in audit firms should collaborate to apply the process.

In the end, a set of recommendations from these working groups should be examined to see where additions to the U.S. GAAP taxonomy would be helpful, along with a set of specific guidelines for applying XBRL tags. This would complement some of the higher-level recommendations for applying XBRL that will be coming out over the next six to nine months.

Having the dress rehearsal before companies start tagging financial statements should eliminate most of the anxiety companies would experience if they had to make these decisions in a vacuum. It also will ensure the highest degree of accurate and useful standard tagging because all parties will have communicated their needs. Without the dialog, public companies are likely to be wary of the requirements and rightfully resist a mandatory requirement. Without the up-front discussion in a structured format, it will take several years to sort out the mess after mandatory tagging begins. Establishing a review process ahead of time will also be useful as XBRL tagging requirements expand to footnote items.

Tagging the basic financial statements would be the first step in a multi-year process that would extend tagging to the footnotes and proxy statement. It is imperative that this step be handled as a coordinated effort by companies, analysts, and auditors in a way to make a company’s implementation of the tagging process as easy and straightforward as possible. Failure to do so will increase resistance to making the process mandatory and complicate efforts to make tagging as comprehensive as it could be.

Add to Del.icio.us | Digg this

This entry was posted on Tuesday, March 6th, 2007 at 6:33 pm and is filed under General, . You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response, or trackback from your own site.