For the past 100 years or so financial reporting has been paper based. Only in the last 25-30 years have reports been created electronically in a word processor and then printed or saved to an electronic format such as PDF or HTML.
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But the information contained in PDF and HTML reports can still only be read by humans. Digital financial reporting, in contrast, makes much of this information readable by computers, vastly expanding the potential for automating creation and analysis of financial reports .
Such help from machines can reduce the time and therefore the costs of creating and consuming financial report information and improve its quality.
Some benefits of digital financial reporting
With machine readability of financial reports, computers can read the reported financial information, "understand" it, and help make sure mathematical computations are correct and intact throughout the report. They can compare reported information to mandated disclosure rules and make sure the report's creator complied with them. This is somewhat similar to how manually created disclosure checklists are used as memory joggers.
There are many benefits:
- Reported information can be easily reconfigured, reformatted and otherwise repurposed without rekeying to suit the specific needs of an analyst or regulator.
- Ambiguity is reduced because for a computer to make use of the information, that information cannot be ambiguous. Making the information easy for a computer to understand also makes it easier for humans to communicate more effectively.
- Processes can be reliably automated because computers can reliably move information through the workflow. Linking digital financial information together based on the meaning of the information can be much more reliable than trying to link physical locations within spreadsheets, which commonly change.
- Software can easily adapt itself to specific reporting scenarios and user preferences because it understands the information it is working with.
This is not to say that humans will no longer be involved in creating or consuming financial reports. Clearly, machines will never be able to exercise judgment, which remains something only humans can do.
No "magic" is involved here. Instead, digital financial reporting relies on well-understood IT practices, agreement on standard technical syntaxes and careful and clear articulation of already agreed-upon financial reporting rules in a form that computers can effectively understand.
Essentials of machine-readable financial reporting
Three things are needed to make financial information, or any information, for that matter, understandable by computers. First you need a technical syntax, in this case the Extensible Business Reporting Language (XBRL), a global standard format for expressing business information digitally. Second, you need to express the semantics of the domain you want the computer to understand. Semantics has to do with meaning: what are the important things in a business domain, such as financial reporting, and what are the important relations between the things that a computer must understand. Third, you need to express workflow or process rules so that the machines understand the correct protocol for exchanging and otherwise working with the information.
Ultimately, this is what the technical syntax, business domain semantics and process protocols are all about: exchanging financial information from one business system to another and both systems correctly and consistently understanding that information in the same way -- basically achieving a common understanding.
The U.S. Securities and Exchange Commission (SEC) is a pioneer in digital financial reporting. In 2009, it mandated that every public company that files financial information with the SEC do so digitally using the XBRL technical syntax. Domain semantics have been expressed for both U.S. Generally Accepted Accounting Principles (U.S. GAAP) and International Financial Reporting Standards (IFRS) in the form of XBRL.
Digital financial reporting still has a long way to go, however. Just as other business domains such as healthcare work to create process improvements by digitizing medical records, for example, these initiatives take time, money and lots of effort. Plus, these state-of-the-art technologies must be proven to work correctly before business users can fully employ them.
For the past 15 years, organizations such as the American Institute of Certified Public Accountants, the IFRS Foundation, software vendors and regulators such as the SEC have been working to create and perfect the necessary technical syntax, financial reporting domain semantics and workflow protocols to enable digital financial reporting.
Arguably, the boldest step toward digital financial reporting has been U.S. public company reporting to the SEC. Because of the nature of U.S. GAAP, the sophistication and complexity of financial reports created by public companies, and the desire to make use of their financial information, this use of digital financial reporting is a real test of its viability.
So far, complaints that working with XBRL is too complicated, that reported information has not been of high enough quality to make effective use of it and other struggles have called into question the SEC's experiment with digital financial reporting.
A professional assessment
Because all the digital financial reports of public companies are available to view for free, it is easy to try to work with them. As a professional accountant, I have been poking and prodding the information to better understand digital financial reporting, whether it works, how to make it work, and otherwise how to make use of the XBRL technical syntax.
My current assessment shows three important things. First, I have found that 90% or more of reported information correctly meets a set of seven minimal criteria. Second, although 90% meet the criteria, only 19% of financial reports meet all of them simultaneously. Third, 95% of all public company financial reports are within five or fewer mistakes of meeting 100% of the seven criteria.
More on financial reporting
Read a definition of financial reporting
See a guide to financial reporting software
Understand how IFRS works in ERP
What does all this mean?
For digital financial reporting to work, it cannot work 95% of the time and be considered to work correctly. Not even 98% is good enough. While 100% is an impossible goal for something created by humans, a level of 99.9% needs to be achieved. And it is achievable.
However, virtually all vendors of software for XBRL-based financial reporting have created tools for editing XBRL technical syntax, none of which leverage the business domain semantics at the appropriate level. These early software tools don't understand financial reporting nearly enough.
The primary cause of most of the quality issues and software not working at the financial reporting domain level is that not enough of the domain semantics are being expressed in computer-readable form. This is changing as more and more people come to understand the situation and more financial reporting metadata is expressed in computer-readable form.
While software interoperability at the XBRL technical syntax level is very high -- certainly above 99.9% -- pieces of the XBRL technical standard are still missing that are needed to express the necessary semantics in globally standard ways.
Nevertheless, digital financial reporting is not only inevitable, but imminent. As more software employs the power of semantics, the utility of digital financial reporting will be easier to see.
Digital financial reporting will ultimately change the work practices of accountants everywhere. Exactly when is hard to predict, but these changes are already well entrenched around the globe and should be on your radar.
About the author:
Charles Hoffman is considered to be the father of XBRL, the XML-based language for transmitting business and financial data that is widely used for financial reporting. A certified public accountant, he played important roles in creating the XBRL technical standards and developing XBRL-based taxonomies for U.S. GAAP and IFRS accounting standards. He is also author of the book XBRL for Dummies. Email him at CharlesHoffman@olywa.net, follow him on Twitter @CharlesHoffman, or visit his Digital Financial Reporting web site.