, ,

Sizing up material XBRL errors using a 4-D hypercube

When I was presenting at the Silicon Valley Accountants’ Mastering Financial Reporting’s Last Mile conference, this question was raised: “What constitutes a material error in XBRL if the HTML document can be relied upon?” According to the SEC, even if the HTML financial statements are error-free but the corresponding XBRL exhibit has a material error, you must file an amendment to correct the error promptly. In addition, you may voluntarily disclose that the XBRL exhibit should not be relied on either under Item 7.01 or Item 8.01 of Form 8-K.

So the issue here is what constitutes a material XBRL error requiring an amendment? In the absence of specific guidance, we can infer materiality using a quantitative and qualitative analysis from existing accounting literature. Over the decades, the accounting profession has developed quantitative thresholds as rules of thumb for misstatements or omissions. For example, an error that falls under a 5 percent threshold is deemed immaterial. Similarly, for disclosure, other accounting authorities cite guidelines ranging from 1 percent to 10 percent as being not material. Aside from these quantitative yardsticks, the accounting literature views materiality in the light of “surrounding circumstances” if it is probable that a reasonable person will rely on the information to make judgments. This is analogous to how we think of material information in securities law, if there is a substantial likelihood that a reasonable investor would consider it important to an investment decision or if it would alter the “total mix” of available information about a company.

So what defines a material error in the world of XBRL? Let’s model this concept in a multidimensional hypercube similar to an Excel pivot table. To determine materiality in XBRL language, an error should be segmented by dimensions in a metadata model with axis, domain and members. Simply put, material errors should be evaluated based on (1) size; (2) error type (completeness, mapping, accuracy and structure); (3) users of the XBRL information (investors, analysts, and regulators); and (4) relevant facts that impact judgment.

Not all material XBRL errors are created equal: the relative magnitude of a material error may vary, depending on the users, the type of error and how the information was relied on under the relevant facts and circumstances. For example, incomplete tagging, such as missing financial data schedules, may be material in the eyes of investors, analysts and regulators. As a result, this type of error would generally warrant an amended filing. On the other hand, missing calculation links or other structural errors are technical XBRL errors, a clear violation of the SEC Edgar Filer Manual. But is it a material error that requires an amendment? To make that determination, we have to put ourselves in the shoes of the reasonable investor. Would the investor be misled by this technical structural error or was this information useful and nice to have from a data consumption standpoint? Likewise, size alone should not determine materiality. Large errors may be small problems and small errors may be big problems.

While the accounting profession has provided very helpful guidance on materiality, ultimately, when it comes to material XBRL errors, it may lie in the eyes of the beholders: the investors, analysts, regulators and jurors in a court of law—there is no “bright line test” when it comes to materiality in accounting rules or our legal system. If somehow, somewhere there is a probability that someone will be affected by relying on your XBRL exhibit in their decision, then materiality is subject to a 4-D hypercube model analysis of size, error type, data consumers and surrounding circumstances.

/by

RoseRyan makes 2011 top 100 women-owned businesses list

Last year was our first year to be named to the San Francisco Business Times’ list of the 100 largest women-owned businesses in the Bay Area. And we’re proud to be listed again, coming in at No. 44. In the East Bay, we’re No. 23. Both lists are based on 2010 revenue. If you’re a subscriber, you can see what it’s all about in the Sept. 23 edition on the Business Times website.

“It’s inspiring to be in such great company as RoseRyan continues to grow and expand our business lines,” says founder Kathy Ryan. “Our business model, which is to offer our top-shelf consultants a dynamic range of engagements, intellectual challenges and the right work/life balance, sprang from my own needs as a working woman. It’s gratifying to see RoseRyan recognized in this way.”

/by

A clean financial model design leads to efficient forecasting

There is no fixed form for a financial model, as it is always tailored for the type of business, and various models serve different purposes. However, a good design that is easy to follow and allows smooth data flow has a big impact on the model’s scalability and efficiency of use.

An integrated model that contains BS, PL and CFS is usually desirable for forecasting, as it reflects a more complete picture of the business. I’d like to share a few ideas in structuring this type of model. There is no right or wrong—the best structure is defined by the business and how good users feel about it.

Keep it neat and simple. Try to minimize the number of tabs, as long as the source data and inputs are categorized organically to support the final output. Navigating through too many tabs will make it hard to find your way back. Keeping similar information in the same tab can enhance efficiency and accuracy. I’ve seen models break output financials into BS, PL and CFS by month, quarter and year, which ends up creating nine tabs for similar information. Instead, data can be sorted into two tabs: a master sheet with BS, PL and CFS by month, which serves as a data pool; and a reporting tab customized to the layout you wish to see, such as financials by quarter, by year or both, with ratios and so on. You may also find that consolidating BS, PL and CFS into one tab will enhance visibility of data links.

Place assumptions in applicable worksheets. You may often see modelers put all assumptions in one tab in an effort to keep things looking neat and tidy. However, when the model grows larger and more complex, the artificially created inter-sheet links will require extra time to navigate and extra effort to scale or revise. For example, in most cases, you will have an operating expenses tab that contains numerous line items that don’t share the same assumption, input and projection method. Creating assumption columns next to these items will give you a straight look of how the projections are made. Be sure to shade the cells so you don’t miss the input areas.

Set up a warning system to trap errors. Ensure all data tie out and reconcile. It is critical to set up cross-check, total tie-out rules to ensure accuracy when flowing through tabs. Conditionally format  any unreconciled data or imbalance in red so you won’t miss it. Since BS often sees imbalance, placing these rules is essential to identify errors at each step and correct them so you don’t walk into a disaster.

Ultimately, the goal is to achieve simplicity in structure so people can follow it easily—to make it look like a book and read like a book. By doing so, you will help users—the CEO, CFO, COO and other top executives—see a much clearer future picture of the business and be able to make better decisions.

/by
,

XBRL AUP = quality assurance = market value (CFOs and audit committees take note)

Should you ask your audit committee to evaluate your XBRL files for completeness, mapping, accuracy and structure under an agreed-upon procedures (AUP) engagement in accordance with the principles and criteria set by the AICPA? I get asked this question all the time, especially by companies whose limited liability is expiring. But everybody should consider AUP for their XBRL.

Why? In the absence of a mandatory audit assurance, an AUP engagement helps ensure that XBRL data brings meaningful value and transparency to the investment community.

Even if your audit committee has adopted a wait-and-see attitude, analysts and investors may be making investment decisions about your company that may be based on substandard and inconsistent data quality. For example, the SEC found several significant and recurring errors by large accelerated filers during the first two months of 2011. The most prevalent data-quality issues revolved around negative values, extended elements and tagging completeness.

Says XBRL US: “In the over 14,900 XBRL submissions to date, over 145,000 data issues have been identified related to the use of the XBRL US GAAP Taxonomy. These inconsistencies include incorrect signs, missing concepts and concepts used incorrectly.“

While a formal AUP is not required, it is best to have a mock AUP environment that ensures compliance of your XBRL-formatted information. A recent trend is for companies to leverage their internal audit function or professional service firm to implement a mock AUP environment to be better prepared for the formal AUP engagement.

What exactly is AUP?
First, an AUP engagement doesn’t deliver an audit opinion. The practitioner performs agreed-upon procedures and assessments, and then reports findings, alternatives and recommendations in a letter to management and the audit committee.

An AUP ensures the completeness, accuracy, proper mapping and structure of your XBRL files. These are the four important aspects of XBRL, according to the AICPA’s latest exposure draft for the XBRL process. Here is what an AUP engagement covers.

Completeness Do you have a procedure to ensure that all required source information is tagged in XBRL? For example, a few commonly missed tags are significant accounting policies embedded throughout footnotes, spelled out amounts and superscript footnotes.

Mapping Even though finding data-quality issues on proper mapping can be aided by software-assisted search and benchmarking analytical tools, at the end of the day, this core process can be subjective: choosing the narrowest tag and assessing materiality can be an art rather than a science. Likewise, the SEC considers mapping to be the most critical part of the XBRL quality control process, but there are no software tools that can detect this type of error prior to filing.

Accuracy Even if common data-quality issues, such as negative values, are flagged by software tools, you still need to assess their validity based on financial facts and the specific circumstances for comparative quarters and year-to-date periods.

Structure Technical validation errors of this type tend to be black-and-white and can be detected by third-party SEC and EDGAR validation tools prior to submission to the SEC.

AUP = quality assurance = market value
Whether you have a built-in versus a bolt-on XBRL solution, you need quality assurance over your XBRL data. Some AUP steps can be accomplished with software tools, while other procedures require professional judgment. Automated tools can only help you so much in highlighting inconsistencies and the usual suspects. Ultimately, you need to tell your company’s story by choosing the tag that best maps to the underlying transaction and translates that fact into meaningful information.

Because investors rely on your XBRL data to make investment decisions, it is ultimately your responsibility to avoid errors before they are disseminated to the public. Aside from compliance, the real benefit of XBRL is increased transparency and comparability, which can in turn increase the value of your stock when the analyst community gains more confidence in your XBRL data.

Learn more about RoseRyan’s XBRL expertise.

/by
,

Cleantech survey findings consistent with word on the street

RoseRyan recently completed the second annual State of Cleantech Survey with our partners KPMG, Barney & Barney and Arbor Advisors. In general, the findings are very consistent with what we are hearing from clients. Cleantech ventures are still being funded but investors are keeping a cautious eye out due to macroeconomic issues. Although there have been some high-profile flops (Solyndra) there have also been many successes (Tesla). The Valley continues to produce high-profile cleantech success stories, and I anticipate there will be some big wins in the coming year.

Some of our key findings include:

  • The overall outlook for venture funding is optimistic, with 67 percent of survey respondents saying they are extremely, very, or somewhat optimistic.
  • The outlook for cleantech growth in Northern California is strong, with fully 50 percent saying they are extremely/very optimistic.
  • The two biggest trends are an increase in M&A and the expansion of large multinationals into cleantech.
  • The greatest challenge is gaining access to capital.
  • Regarding personnel, cleantech demand is highest for engineering support.

All of my clients are highly optimistic about the future of cleantech. Most believe that if they had greater access to capital at attractive terms they would be able to expand their business rapidly. Some sectors, including solar and lighting, are growing rapidly and are being impacted by the advent of strong Chinese competitors, while others, including energy efficiency and storage, are growing at a steadier pace. Big multinationals are biding their time trying to predict who the winners and losers are going to be.

I fully expect the pace of innovation to continue as the federal stimulus–funded clients approach their second and third years post-funding. The cleantech market is showing some signs of maturity and funding infrastructures are improving. Although the frothiness of the past may be mellowing, the overall market is growing at a nice, sustainable pace.

In the coming year expect some big news in biofuels and electric vehicles spaces…it should be interesting to watch!

You can download a PDF of the 2011 Cleantech Survey report or read the news release.

/by
,

Seminar: Managing Risk—Accounting and Currency Issues for Life Sciences Companies

Please join us September 27 in San Carlos for a free seminar tackling two pressing topics affecting biotech and medical device companies: new accounting rules and managing foreign exchange risk.

New accounting rules are here—and more are coming
This year the Financial Accounting Standards Board introduced several new accounting rules that affect life sciences companies—and FASB has many more changes planned. Maureen Earley, a RoseRyan technical accounting guru, will review the practical implications and give you an inside look at what’s on deck.

International clinical trials bring foreign currency risks
Managing foreign currency exposure on international clinical trials is becoming increasingly important for life sciences companies. Nick Bennenbroek, a Wells Fargo economist and head of the bank’s currency strategy, will discuss where things are heading and how best to manage foreign exchange risk.

The program will be held 8–10 a.m. at Wells Fargo Insurance Services, 959 Skyway Road, San Carlos. It includes breakfast and time for networking.

 

Register here.

Need more information? Please contact Eve Murto.

/by

Seminar: New Accounting Issues Affecting Technology Companies

RoseRyan and Silicon Valley Bank are pleased to present “New Accounting Issues Affecting Technology Companies” September 29 in Santa Clara. Technical accounting pro Maureen Earley will review the practical implications for technology companies of several new accounting rules introduced in 2011. She’ll also pull back the curtain and give you a peek at what’s next. If you work in finance at a private technology company, you’ll want to know how these new rules affect the information you provide to your company, investors, board and even your lenders.

What you’ll learn:

  • Revenue recognition accounting changes for 2011
  • Financial Accounting Standards Board rule changes in the pipeline
  • Common accounting issues for VC-backed technology companies

The program is free, and will be held 4–5:15 p.m., followed by a networking reception, at Silicon Valley Bank, 3005 Tasman Drive, Santa Clara.

Register here.

Need more information? Please send an email to Eve Murto.

/by

Global accounting standards need more than just U.S. adoption

Everyone supports a single set of global accounting standards, and there is a big spotlight on the United States and its pending decision process to adopt or incorporate IFRS into its reporting structure. However, there is a lot more to achieving global accounting standards than just adoption of standards.

The United States does not hold the key, as many indicate in their comments to an SEC staff paper (PDF) that proposes one possible method of incorporation of IFRS in the United States. (The paper was released in May; the comment period officially closed July 31.) Respondents point out that ensuring that the principles-based accounting guidance is consistently applied is up to regulatory agencies and others responsible for oversight of the financial reporting in jurisdictions around the world.

“Among other things, differences in language (and translation), culture, reporting cycles, legal and tax systems will unavoidably affect how global accounting standards are interpreted and applied to some degree,” Financial Executives International (FEI) comments point out.

PricewaterhouseCoopers responded with concerns regarding consistent application. Its comments state, “achieving the vision requires both the adoption of IFRS in all significant capital markets and enhanced cooperation and coordination among national regulators, the International Accounting Standards Board (IASB) and its interpretive body, preparers, and auditors in order to facilitate the consistent application of IFRS.”

The American Institute of Certified Public Accountants sounded a similar note in its response, encouraging the Public Company Accounting Oversight Board (PCAOB) to pursue greater harmonization of auditing standards with its international counterpart, the International Auditing and Assurance Standards Board.

Even the IASB itself acknowledges this issue. In April, the IFRS Foundation issued its Trustees’ Strategy Review report (PDF) on its ongoing strategy as a global accounting standard setter, in which they identified steps to help ensure the consistent application of IFRSs. These steps include:

  • Provide additional application guidance and examples.
  • Work with securities regulators, audit regulators and other standard setters to identify divergence in practice and consider improvement to standard or interpretative guidance.
  • Enlist IFRS Foundation to education and content services aimed at promotoing consistent application.
  • Indentify jurisdictions where IFRSs are being modified and encourage transparent reporting of divergence.
  • Seek assistance from other public authorities to assist in achieving this objective.

So while the world sits and waits for the United States to hurry up and make a decision about incorporation of IFRS, there is still a lot that could be done by other agencies to promote a single set of global accounting standards.

/by
,

Less is more: the art of XBRL

It’s been observed that detailed tagging can create up to 10 times more tagging concepts than block tagging. Does it mean 10 times the work? It depends. There’s no doubt that detailed tagging creates more complexity, but the workload doesn’t have to grow exponentially.

Why? You can’t simplify XBRL itself, but you can simplify your disclosures. Not all data are created equal—different data points do not necessarily deliver the same value to users and investors. Streamlining your 10-Q and 10-K filings will not only make life easier for you downstream, it can also translate to real value and transparency for your company.

Before you roll your tags forward for the next quarter, whether for block or for detailed tagging, repeat the mantra, “simplify, simplify, simplify,” and consider these tips for boosting your XBRL data efficiency:

Apply your SEC S-X rules for required line items. Determine which line items must be broken out for each financial statement and condense the others, if possible. Check for all comparative periods and your 10-K to ensure consistency.

Maintain the accounting concept in its pure form. Use the narrowest tag definition to map your accounting concept and consider reclassifying immaterial items into a general or miscellaneous category. This will enable “flow-through” elements (facts that appear in multiple places) to tie-out between your core financials and footnotes throughout your XBRL files.

Restructure footnotes and mirror them in accordance with the taxonomy hierarchy. This will avoid the use of unnecessary extensions on footnotes (for example, you might be able to consolidate the different types of stockholders’ equity into one footnote).

Centralize your significant accounting policy under one footnote. Identify all your significant accounting policies embedded in other footnotes and consider reorganizing them into one central footnote to facilitate review and tagging completeness.

Convert numbers within narratives to tables. A picture (or table) is worth a thousand words. This will enhance presentation, tagging completeness and efficiencies.

Last but not least: whatever you do, always get buy-in from your auditors, disclosure/audit committee and investor relations team—you want to reset expectations to avoid surprising them.

There is no cookie-cutter approach to redesigning your SEC filings—it’s more of an art than a science. Remember, it’s quality, not quantity, that counts.

However you look at it, when it comes to XBRL, less is indeed more.

 

/by
,

Not all controls are equal: a fresh look at SOX 404

In my work with smaller companies I’m seeing that there’s still much more they can do to strengthen their control environment, create efficiencies and reduce compliance costs in their SOX 404 program by taking a top-down risk-based approach—focusing more effort in higher-risk areas and relying on preventive and monitoring controls in lower-risk areas.

While the Dodd-Frank Act of 2010 eliminated the requirement of an external audit of financial reporting controls for nonaccelerated and small-company filers (companies with a public float of less than $75 million), they still need to document, test and certify valid internal controls. And they have to comply with the same complex accounting requirements (revenue recognition, equity accounting, inventory and asset valuation, etc.) that big companies do, but often they have limited technical accounting resources.

If you’re in this category (and even if you’re not), you should take a fresh look each year to identify the processes and controls that pose the greatest risks for errors in your financial statements. When you know where your greatest risks lie, you should spend the most time and resources evaluating the design and operating effectiveness of controls in those areas, and spend less time on those you’ve identifed as lower risk.

Similarly, small companies don’t always have a second set of eyes to review the accounting for highly complex transactions, so it might make sense to consider having an outside expert assist in their review—you can bring in accounting expertise only when you need it and reduce your risk of error.

Because management has greater visibility of activity across the organization in smaller companies, you have the opportunity to identify and leverage entity-level (monitoring) controls that mitigate financial statement risks for lower-risk processes. As an example, you could rely on monitoring controls such as account reconciliations rather than multiple transactional controls. Relying on monitoring controls that are performed on a weekly, monthly or quarterly basis will require less testing than transactional-level controls, saving time and money.

Taking a risk-based approach to SOX 404 gives companies a real opportunity to focus on what matters most and improve ongoing processes. As a bonus, you can save time and money, too.

/by