Written by Troy Paredes Posted on September 26, 2007

Troy Paredes is a professor at Washington University School of Law, where he teaches corporations, securities regulation, and corporate finance. Mr. Paredes has written on a wide range of topics, including securities regulation, executive compensation, and hedge funds. Before joining Washington University’s faculty, Mr. Paredes was a corporate and regulatory lawyer. He is a graduate of Yale Law School.

The federal securities laws are all about disclosure. Mandatory disclosure is intended to give investors the information they need that is, to make markets more transparent so that investors can assess for themselves how best to allocate their capital. By arming the market with information, mandatory disclosure is designed to promote informed investor decision making and, relatedly, boost investor confidence and result in more efficient securities markets. Further, once mandatory disclosure empowers investors with information, there is no need for the government to engage in more substantive securities regulation that might find the government passing on the merits of a particular issuer and its securities. This full-disclosure philosophy has animated the Securities Act of 1933 and the Securities Exchange Act of 1934 since they were first adopted over 70 years ago.

The practical challenge has been in turning the philosophy of mandatory disclosure into an actual regulatory regime that works. Two things are needed for a disclosure-based regime like the federal securities laws to promote transparency. First, information has to be disclosed. That is relatively straightforward in concept, although deciding what exactly should be disclosed isn’t always so easy. Second, and too often overlooked, is that the users of information must be able to use mandated disclosures effectively. In other words, investors, analysts, and others must not only have access to information, but must be able to search, process, and interpret what is disclosed relatively easily and at low cost. Disclosures that aren’t understandable don’t do much good. A recent report by Robert Pozen, who is heading the SEC Advisory Committee on Improvements to Financial Reporting, has embellished on this point. He explained in a recent Discussion Paper for the Advisory Committee (”Discussion Paper”) that users of financial information want:

–To understand the financial reports, at the level of detail that is desired by each type of user;
–To be able to rely on the integrity of the financial reports (and not be told later they were incomplete, misleading, or actually wrong);
–The financial reports to reflect the economic substance of the business, regardless of technical rules;
–Financial reports to reflect, to the extent feasible, actual changes in market values from period to period; and
–The reports to be delivered in a format that makes it easy to compare one company to another.

Likewise, in the mid-1990s, the SEC’s Task Force on Disclosure Simplification remarked in its report that disclosures must be understandable, complete and timely. It is hard to disagree with this assessment.

The enduring question is how best to achieve more understandable, complete, and timely disclosures. Asked differently, under what circumstances does disclosure actually advance transparency?

When more transparency is called for, the typical regulatory response is to require more disclosure. Indeed, the federal securities laws mandate that companies disclose oodles of information. For example, companies must make extensive disclosures in their registration statements, annual reports, quarterly reports, and proxies, the principal filings a public company must make with the SEC. More information must be disclosed now than ever. Additionally, many companies voluntarily disclose even more information than the law requires.

However, it is not enough simply to call for more disclosure. (In fact, as a result of so-called information overload, it is possible that users of information may make worse decisions when faced with more and more information, in which event more disclosure may actually lead to less transparency.) To promote transparency, it is also important to focus on the presentation and formatting of what is disclosed.

There are numerous ways to reformat disclosures so they are more understandable and thus more useful. One simple technique, which the SEC has increasingly used, is to require disclosure through graphs, charts, and tables. The SEC’s executive compensation disclosure requirements illustrate the possibilities. Another example is plain English, which requires that certain disclosures be made in “plain English” (as opposed to legalese).

The leading initiative that SEC Chairman Cox has been pushing to promote transparency since he got to the SEC is XBRL. Chairman Cox, correctly in my view, sees XBRL as holding out promise for meaningfully revamping how disclosures are formatted and presented and thus for increasing the value of what is disclosed. Without question, the technicalities of XBRL are challenging. Not least of all, an agreed-to set of tags must be crafted. Further, any time there is a change in disclosure, some legal uncertainty is introduced. And with legal uncertainty comes concern about legal liability.

The potential benefits of XBRL, however, are considerable. XBRL makes it cheaper and easier for investors and other users of information to access information. It’s just not the ability to access information that matters. Anybody can relatively easily access an issuer’s disclosures by looking at the issuer’s most recent quarterly or annual report on line. The next step is the ability to manipulate the information that is available. XBRL will effectively allow a user to package the information that is disclosed as the user sees fit given its interests and objectives. Again, as Pozen recently put it in his Discussion Paper:

The SEC is engaged in a major project to introduce interactive data tagging technology for the informational content of financial reports, such as through the use of XBRL, so that users have the ability to quickly and easily focus on the important information they desire in these reports. Moreover, tagging of information may allow investors to customize their needs based on their desired level of detail. The tagging of information can be focused on performance metrics for carrying out the strategy of a specific company and could be designed along the lines of a balanced scorecard. The tagging of information can be organized into a variety of standard formats for key performance indicators (KPIs) organized by industry. . . .

If XBRL is successfully extended from tagging financial information to tagging narrative disclosures, its benefits are even greater. Management’s Discussion and Analysis of Financial Condition and Results of Operations (MD&A) is a particularly key set of disclosures that a company makes in its SEC filings. However, the MD&A is narrative and, given that the MD&A can run several pages, it can be difficult to wade through and digest in a timely manner. Alan Beller, when he was Director of the SEC’s Division of Corporation Finance, suggested that companies give a summary of the full-blown MD&A. As Beller reportedly put it, Current MD&A goes on endlessly about stuff that investors can find on the balance sheet. They don’t need 10 pages of elevator music. Unfortunately, elevator music is often what investors and analysts get. Not only do the users not need this noise, but the elevator music can obscure the important information that investors and other users do want. The ability to tag MD&A disclosures could render this information much more valuable to investors, analysts, and others.

The bottom line is that XBRL makes the same body of information much more searchable and understandable. Consequently, XBRL should lead to more transparency and thus better decision-making by users.

Written by Michael Ohata     Posted on September 19, 2007

Michael Ohata is Chair of the International Steering Committee of XBRL International and Senior Director of Reporting Standards for Microsoft Finance.

In the U.S., it sure feels like the tipping point of widespread XBRL filing with the Securities and Exchange Commission hovers just around a corner or two or three. SEC Chairman Christopher Cox recently announced mutual funds joining the Voluntary Filing Program — Allegiant Advantage Fund, American Funds Europacific Growth Fund, Muhlenkamp Fund, and Vanguard 500 Index Fund. And the NYSE Euronext piles on as the first stock exchange to furnish its 10-Q.

Also really interesting is the SEC Advisory Committee on Improvements to Financial Reporting chaired by Robert Pozen. It includes a subcommittee on delivering financial information that will focus on tagging information. Folks in XBRL International, the organization that has developed the standard, seem to hold communal breath: we want that approved format, we want some mandate. Projects around the world wait for the watershed event.

It all seems so easy to push for the ruling. Meanwhile, Financial Executives International, specifically its Committee on Finance and Information Technology, shared a discussion with the SEC and XBRL US, Inc., even as they sweat over the XBRL US GAAP taxonomy (many thanks and recognition for all the organizations behind this effort). The dialogue raises a broad question: How do we thoughtfully and effectively manage the requirement for XBRL filing in the US over time?

This thing of ours XBRL has moved beyond hype and evangelism it has got to. The market collaboration and dialogue that includes the SEC reflects the growing focus on how this thing of ours gets implemented. XBRL adoption goes beyond XBRL International’s efforts it is for us to collectively collaborate and solve.

Written by Kurt Ramin     Posted on September 12, 2007

Kurt Ramin is Chairman (Emeritus) XBRL International and a consultant to the International Accounting Standards Committee Foundation (IASCF).

In my post last week, I applauded the SEC for establishing its Advisory Committee on Improvements to Financial Reporting, which seeks to reduce unnecessary complexity in financial statements and make information more useful and understandable for investors. In this post I will describe an approach to financial reporting that I believe will help accomplish both these objectives.

In my early days as an apprentice in Germany, I had to memorize the common German chart of accounts, which had structure but was still complex and inflexible (no XML at that time). So I developed my own system.  I always separated quantitative business information into five, easy-to-understand segments:

People expenses, including benefits, stock options, travel, and other people-related expenses;
Tangible fixed assets (i.e., physical infrastructure), including leases if the asset is used over a relatively long period of time;
Product expenses with no allocations (direct expenses only, based on unit tracing and tracking);
Financial assets and liabilities (including income taxes, interest income, and expense);
Communication expenses (including intangibles), such as advertising, marketing, legal, and other reputation-related assets and liabilities.

We can create net assets (i.e, equities) for all of these segments and prepare a Statement of Changes in Net Assets available to shareowners. Unit tracking is relatively easy for the first three categories (people, physical assets, and products). Valuations can be at various levels (historical cost, current value, etc.), and these valuations are used as a base for management reporting as well. It allows for multilevel reporting and unit-tracking based controls. The lumping of all product-related expenses into a cost of sales category is certainly outdated.

Financial assets lend themselves to current valuation, avoiding the need for “recycling” or a holding tank approach (recycling is reporting the same item of income, expense, gain, or loss in two different periods in two different performance measures — for example, in other gains and losses and subsequently in the results of operating activities).

The communication section is the most difficult one to trace and assess, because assigning meaningful units of account is often complex. I suggest the use of current valuation to lessen the effect on the current mixed-attribute model. Note that cash flows in this category are often more dispersed from the transaction event than in the other categories. One single event (e.g., lawsuit or product announcement) can have a large effect on market caps.

The above segmentation is more similar to the direct method of cash flow reporting than the indirect method (IAS 7):

People Expenses: cash paid to suppliers and employees
Tangible Fixed Assets: cash flow from investing activities
Product Expenses: cash receipts from customers, less cash paid to suppliers
Financial Assets and Liabilities: cash flow from financing

In 2001, the newly formed International Accounting Standards Board (IASB) started a project on reporting financial performance with an initial focus on the income statement.  It later renamed the project to its current title financial statement presentation to reflect that it encompasses all six of the financial statements, which are:

1. Statement of Financial Position, beginning of period
2. Statement of Financial Position, end of period
3. Recognized Income and Expense for period
4. Statement of Changes in Equity
5. Statement of Cash Flows for period
6. Notes comprising significant accounting policies and other explanatory information

The FASB has had similar projects on its agenda for a long time (Comprehensive Income).

I suggest the use of segmentation (i.e., the five categories as described above) in five of the six financial statements. The Statement of Changes in Equity should be a summary (net) of the five categories plus a detailed analysis of the transactions with owners per period.

Notes and other significant explanatory information should be aligned to the segment they belong (e.g., pension accounting policies and disclosures to people expense). XBRL is ideally suited to do this. The appropriate taxonomy could be set up that way. Just to give you a feel for how this would work: the IFRS taxonomy has about 2,000 valuation elements and 2,000 disclosure elements, but they are obviously aligned in a structure based on the current standards literature. Business reporting ratios (EBR) have to be aligned accordingly.

Revenue recognition and lease accounting are probably one of the most discussed and complex current reporting areas. As a mandatory audit procedure we confirm accounts receivable. Why not confirm revenue and leases to ensure mirror-image accounting as well? (see my comments on RosettaNet in Part 1 of this article).  When performing quality reviews in my old days as an auditor, I discovered in one case that both sides accounted for the same transaction as a capital lease!  The various VAT schemes around the globe and especially in Europe already indirectly confirm revenue.

Currently the FASB is completing their codification of the literature project. This laudable project will shed more light on the principles-versus-rules debate.

We need both principles and rules. That’s where the extensibility of XBRL comes in. If we can map input data from XBRL GL to IFRS SME to XBRL IFRS and then to the codified US GAAP literature, we have come a long way in converging international financial reporting.

I compared the topical structure of the US codification project to the IFRS SME exposure draft. The main topics overlap for the most part; however, they are arranged in different order. There are 38 SME topics (from scope and concepts to transition to the IFRS for SMEs). The US GAAP codification has the following structure:

1. General Principles and Objectives
2. Overall Financial Reporting Presentation and Display Matters
3. Assets
4. Liabilities
5. Equity
6. Revenue
7. Expenses
8. Broad Transactional Categories
9. Industry Sections

Obviously, the next logical step would be to codify the current IFRS literature (standards and interpretations) and align it to the US GAAP codified literature and SME exposure draft. The current IFRS (incorporating International Accounting Standards, or IAS) includes 41 IASs (some are deleted) and 8 IFRSs (http://www.iasb.org/). There is already a derivation table in the SME exposure draft indicating the source (i.e., a particular IAS or IFRS).

The main literature (codified US GAAP, IFRS) is available in XML on the same platform (Sigma-link) and it would be interesting to map it as detailed as possible to the segmentation I have suggested. We would need to add a general category to my schema to park items of general principles and industry-specific rules from US GAAP.

For years I have advocated these formats and shown the following chart (right-click the thumbnail below and Open in a new window or tab):

Note that the information is broken down into quantity and value. Modern ERP and GPS systems are allowing us to trace and track quantities worldwide, from suppliers to customers and within an entity. Business combinations can be traced separately and we can look at consolidations in various formats (consolidated entities and de-consolidated entities). The drill-down power of XBRL will make some of the current accounting principles (business combinations, currency translation vs. currency transactions) easier to apply.

I recently attended a presentation given by a senior accounting officer of ARAMCO (arguably the most valuable company in the world). Besides showing us how they are tracking their ships with Global Positioning Systems (GPS), he walked us through the best SAP implementation I have ever seen. Their system could easily map to any XBRL taxonomy, either US GAAP or IFRS. In fact, they just changed their reporting from US GAAP to IFRS. It is also clear that systems (SAP, Oracle, and others) in combination with data warehousing will play a major role in the reform of financial and business reporting. XBRL will be an important factor in that process as well. (Right-click the thumbnail below and Open in a new window or tab.)

With XBRL we started a revolution in business and financial reporting. Different international environments (multiple currencies, different languages spoken) remain a challenge for business communication around the globe. However, we have come a long way of tracking and tracing information to allow for a more transparent business world. XBRL is assisting us to tackle these remaining problems of communication as well. We never had a farther reach and richness of data before. We just need to use the tools to make it more understandable.

Written by Kurt Ramin    Posted September 5, 2007

Kurt Ramin is Chairman (Emeritus) XBRL International and a consultant to the International Accounting Standards Committee Foundation (IASCF).

On August 2, the SEC Advisory Committee on Improvements to Financial Reporting held its first meeting. The Committee was formed to study the financial reporting system with the goals of reducing unnecessary complexity and making information more useful and understandable for investors.

The Committee is a significant and refreshing development to watch. In his welcoming remarks, Chairman Cox outlined several areas of emphasis:

The current approach to setting financial accounting and reporting standards;
The current process of regulating compliance with those standards;
Factors that may drive unnecessary complexity and reduce transparency; and
Any lessons that can be learned from growing use of international accounting standards.

Importantly, Mr. Cox stated:

I’ve also asked the Committee, as part of its consideration of the U.S. financial reporting system, to focus on how technology can help address accounting complexity by making financial information more useful to a greater number of investors. Through the power of interactive data, the opportunity exists to redesign the financial reporting system to deliver precisely the type and level of information that each individual investor needs (emphasis added).

The focus on technology is clear. There is also an emphasis on global standard-setting and the more complex compliance issues. If we are looking at a global solution, we need to keep it fairly simple owing to the various un-converged legal systems (especially recognition and de-recognition of assets and liabilities) and international localization problems. Perhaps that’s what Conrad Hewitt, Chief Accountant of the SEC, had in mind when he suggested to committee members to “think outside the box.”

What is financial reporting in essence? It is the data aggregation of invoices received, internal allocations, and entity billings. In addition, there are explanations (i.e. disclosures) on the more important aspects of these transactions.

Invoices and transactions can always be broken down into units (usually quantities) times a particular value (usually in a specific currency).  Historically, values were used to allow for the addition of various quantities (measured in liters, gallons, meters, etc.) and bridge the inability to add these units. Now, with modern unit tracking devices (we know where the units are!), we have more flexibility to measure performance at interim stages. We link the units to the various value files at a particular time.

This makes the accounting process much simpler, because we don’t have to carry the values through all the processes all the time. It brings back the “events approach” to basic accounting theory pioneered by George Sorter in the 1960’s. We just didn’t have the computing power then to trace, aggregate, sort, and combine what modern ERP and data warehousing systems allow us now. With the power of XBRL, we can even link the numerous and currently splintered disclosures and management commentaries to specific units and events (e.g. all people-related explanations — such as turnover, pension expenses, stock options, employee benefits, performance, etc. — to the “unit” people).

We still have the problem of deciding at what level of detail we would like to trace these units. This will vary among different industries (e.g., more detailed in pharmaceuticals than perhaps in retail).  The important thing is that we are trying, at data entry level, to have standardized units of accounts.

I call these ‘unit feeder systems’ for XBRL. There are attempts in various industries to standardize units of measure along vertical industry lines. RosettaNet PIPs allow trading partners of all sizes to connect electronically to process transactions and move information within their extended supply chains.  I also see RosettaNet being leveraged with other standards such as RFID and EPC so that you can not only get information on the ‘what’ and ‘where,’ but also the ‘how,’” says Manish Modi of Oracle.

In the financial and capital markets areas these feeder systems are, for example, MDDL (Market Data Description Language), FIXML (Financial Information eXchange Markup Language), and FpML (Financial Products Markup Language). The technical people are working on SCA (Standardized Service Component Architecture) to make system components more interchangeable.

The current financial statement structure has historically grown into a patchwork of difficult-to-understand information, at least for the average investor (for a historical explanation of the development of international accounting standards see Kirsch and Camfferman-Zeff; see also IASPlus).  Unfortunately, XBRL taxonomies have to reflect this structure and actually have to use more complicated technical structures (e.g. tuples, dimensions, rendering tools, etc.) to follow the patchwork.

Given these difficulties with current financial statements, it is time to heed Mr. Hewitt’s call “to think outside the box” and create new solutions to age-old accounting problems. In Part II of this article, I will suggest a different approach to financial reporting that seeks to do exactly that.

Written by Dr. James Canton    Posted on September 5, 2007

Dr. James Canton is CEO and Chairman of the Institute for Global Futures, a think tank he founded in 1990. He is a renowned global futurist, social scientist, keynote presenter, author, and visionary business advisor. He is a Senior Fellow at the Center for Research in Innovation at the Kellogg School of Management and serves on Motorola’s Visionary Advisory Board. Dr. Canton will be giving a presentation on September 14 titled NextFinance: Meeting the Future at the Hitachi-sponsored WIRED NextFest 2007, which will be held September 13-16 at the Los Angeles Convention Center.

Accelerating change and radical innovations are reshaping the business landscape. Innovation is the key driver of competitive advantage. New industries, products, and services will emerge such as clean tech, nano-manufacturing, always-on Internet, on-demand pharmaceuticals, personalized medicine, personal security, Web 2.0 media, and alternative energy, to name a few. There are massive challenges and opportunities that confront business and society as we step into the 21st century. How will we manage climate change? What will be the impact of 100 new mega-cities? How will the next generation of Web 2.0 businesses compete? How business leaders and companies prepare for the future the emerging threats and opportunities is the central focus of my practice at the Institute for Global Futures.

At the same time, complexity in business is increasing and the need for more transparent business process tools are in demand. Managing the transaction knowledge space across time zones, geographies, and markets will be a challenge that few companies have mastered today. Many burgeoning industries are global and have global customers, supply chains, and partners. New tools that provide faster information that can support better decision-making are needed.

I think that XBRL can be a powerful tool for better transparency, managing the global enterprise, and increasing competitive value by streamlining all kinds of information. The full potential in a world of always-on networks, virtualization, and pervasive mobility demands that people have access 24/7 to their business-critical data. XBRL will enable this access and more.

I have been an early advocate of XBRL for a number of years. At first XBRL was viewed as solely a financial management tool. In this era of real-time business, global competition, and super-fast innovation, I think the future potential to use XBRL goes well beyond finance. I think that any company that wants to maintain a future competitive advantage will want to explore the potential use of this tool.