Bob Schneider is a Partner in 
Wilson So is the Director of Hitachi America, Ltd. Financial Reporting Reform and XBRL (Part 2)
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 The lumping of all product-related expenses into a cost of sales category is certainly outdated.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.