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Wilson So is the Director of Hitachi Consulting Corporation XBRL Will Boost Narrative Reporting
Written by Bob Schneider Posted July 25, 2007
In a recent post, I gave an overview of a KPMG report that presents the thoughts of 11 financial leaders on key accounting issues (most notably, for our purposes, XBRL). A few days ago, I noted my disagreements with the thinking of one of the leaders, Philip Broadley, Group Finance Director of Prudential. If I can restate his points I hope impartially they are:
(1) XBRL will bias users against half-yearly statements and toward the shorter time-span quarterlies;
(2) XBRL will make users focus on the numbers alone, rather than explanation of the numbers;
(3) XBRL will exacerbate reporting differences among various financial jurisdictions by accentuating their different accounting cultures and traditions.
In my previous post, I dealt with item (1). In this post, I’ll discuss item (2), and follow up with a final post on (3).
Here’s how the authors report Broadley’s thoughts on XBRL and company numbers:
“The concept of XBRL, with its ability to pluck figures from a set of accounts and compare them with those from another company, doesn’t fit with the Broadley approach. Accounts should be for explanation rather than information. You need to report what management thinks, not just the numbers. I’d rather focus on getting the narrative reporting right than follow the XBRL approach.”
I don’t agree with any of this. Analysts will always compare the numbers of one firm with those of another; it’s what analysts do. The question is how well the numbers reflect actual business conditions and performance, and how comparable they are among different companies.
These are tasks for which interactive data is perfectly suited. If, in fact, there is an “XBRL approach” to financial reporting, it means that — by providing data that is more accurate than what has been historically offered by data aggregators, and by eliminating data re-keying and the inevitable accompanying errors — analysts will have much better data to work with, and much more time to refine those numbers to reflect business reality.
Not only will XBRL give analysts more time for focusing on “explanation” rather than “information,” it will also be integral to both the creation and analysis of the narrative reporting Broadley prefers.
Like many accounting terms, narrative reporting is defined in various ways. It commonly includes the Management Discussion & Analysis (MD&A) section of the 10-K. It can take in such items as the CEO’s letter in the annual report; discussion of strategy, objectives, legal proceedings, uses of capital, segment reporting, intangibles (such as the value of brand names and company reputation), and risk factors; and assessments of environmental, employee, and social conditions as they pertain to the company. Notably, it often encompasses the disclosure of key performance indicators (KPIs), which can be defined as “quantified measurements that reflect the critical success factors of an entity.”
In a speech last year to the SEC Government-Business Forum on Small Business Capital Formation, Peter Wallison of the American Enterprise Institute addressed the value of XBRL in narrative reporting:
“We shouldn’t leave the impression that interactive data is only useful for financial statement numbers. Interactive data, or XBRL, can also be used for text disclosures, and in the same way. As long as a text disclosure is consistently defined, it can be searched and displayed as easily as a number.
For example, many oil companies disclose their oil and natural gas reserves in their financial reports. This number usually appears in a footnote text discussion of the issue. As long as all companies define reserves and identify the text as a discussion of reserves, XBRL would allow a computer, in seconds, to compare all their reserves.
In the same way, XBRL will also make MD&A discussions in the prospectus more useful to investors by facilitating comparison between companies. For example, if an MD&A contains a discussion of market share, this data will also be searchable in all filings and displayed in seconds in a spread sheet. This will also make things easier for issuers, because the company’s data system can be structured to keep track of data on market share or reserves, and plug it in automatically as the 10-K is being prepared.”
Let’s look at narrative reporting in another jurisdiction: Britain. The Financial Reporting Council (FRC) is the UK’s “..independent regulator responsible for promoting confidence in corporate reporting and governance.” The Accounting Standards Board (ASB) is the operating body of the FRC responsible for issuing accounting standards. In January, the ASB published a review of narrative financial reporting by listed companies in the UK. In their press release on the study, the ASB cited four areas that required improvement, including (a) better disclosure of forward-looking information; and (b) better identification of KPIs, both financial and nonfinancial.
In my previous post questioning any bias of XBRL toward quarterlies over the half-yearly interim, I cited the essay of the leading audit chiefs and their call for a new reporting model with forward-looking information, versus the historical data now provided in financial reports. The audit chiefs see XBRL as central to this change:
Just as the Internet is rapidly changing the way individuals and businesses engage in commercial and social activities, a major project under way in the financial arena the Global XBRL Initiative promises to revolutionize the way investors, governments and companies themselves use, analyze and generate information. This global XBRL initiative, or perhaps other reporting-related technologies, are likely at some point to revolutionize the entire company reporting model what information is presented and how, and how it is audited. Clearly, a range of intangibles that are not well measured, or not measured at all, under current accounting conventions are driving company performance. Investors and other stakeholders in business information understandably want to know what those intangibles are, and how they might plausibly affect how businesses perform in the future.
Let’s look specifically at KPIs. Robert Eccles, an advisor to the Enhanced Business Reporting Consortium (EBRC), has written on this blog about his meeting with Chairman Cox in December 2006 “to talk about how XBRL could be extended into broader narrative reporting, such as for the MD&A and 10K, and for industry-specific key performance indicators.” Mr. Wallison does a nice job of portraying the importance of XBRL in EBR and the role of KPIs:
Finally, there is enhanced business reporting. I would be surprised if many of you have heard much about enhanced business reporting, or EBR, since the idea is still in the germination stage.
It’s an effort to make up for the deficiencies of GAAP that I described earlier by identifying the elements that drive increases in company value in each industry, and developing metrics that will measure a company’s performance with respect to each of these elements.
The value drivers are called key performance indicators (or KPIs), and once they are in place for an industry it will be possible to compare companies on this basis as well as their financial performance in GAAP terms.
The relationship between XBRL and EBR is very close. XBRL is about format; EBR is about substance. If the substance — the information about companies that goes beyond the financial statements — can be developed effectively, XBRL provides the format through which this information can be quickly and inexpensively searched and used.
In summary, I feel comfortable stating that:
(a) XBRL does support explanation, not mere information;
(b) XBRL can report what management thinks, not just the numbers; and
(c) When it comes to narrative reporting, XBRL is not part of the problem, but part of the solution.
Despite my strong feelings on the topic, I know other readers may well feel differently about these matters. I encourage you to post your thoughts by clicking the Comments link below.