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Why is a 3-way match important in XBRL?

While speaking at the 2011 Year-End SEC Conference in Phoenix earlier this month, and this week at the same program here in Silicon Valley, an interesting question came up. Despite filers’ efforts to match their HTML financial submission to the rendered version (vendor’s viewer or reviewers’ guide), the SEC and XBRL US continue to report numerous data quality and consistency issues on XBRL submissions.

Where is this disconnect? This two-way comparison is akin to comparing two static spreadsheets without regard for a third element: the underlying raw data and interrelationships of the facts. As a result, XBRL data may be entered incorrectly with the wrong mapping or signage, or unit or calculation errors.

The importance of a three-way match
In accounting, we substantiate a financial obligation by matching three documents: an invoice, a valid purchase order and a receiving document. Similarly, in the world of XBRL, a three-way match of the three key documents—HTML submission, SEC Private Previewer and the metadata, with final verification against the metadata (the underlying raw data in the instance document)—is key to a successful filing. As the SEC says, “the rendered version of the Interactive Data File may be a useful tool to help determine the completeness of your data, but is not the best mechanism to check the accuracy of the tags selected or other underlying details.”

What you see is not always what you get
Often the signs in your HTML and viewer are presented with brackets due to negated labels, but the raw data in the instance document should almost always be tagged as positive numbers. The U.S. GAAP taxonomy is designed to reflect a natural or absolute balance. Think about general ledger systems, which show debits and credits rather than positives and negatives. It’s helpful to think about XBRL in this way. If you see a negative number in the raw data, ask whether it makes sense for the balance to be negative. Always check the definition and determine if this element should be one-way (always positive, like revenue and expense) or two-way (increase/decrease, gain/loss, proceeds/payments, profit/loss and so on).

Three-way match = completeness + accuracy
Whether you use a bolt-on or a built-in solution, the three-way match is critical to the XBRL control process. Work with your service providers or software tool to extract contextual metadata from the instance and other linkbases to perform the following common errors review: (1) negative values, (2) units and (3) negated labels and calculation links. This will allow a complete review of selected elements and determination of whether the data has been entered correctly.

Quality XBRL data is of paramount importance as key stakeholders (such as regulators, data aggregators, analysts, investors, filers and auditors) begin to use and rely upon XBRL data for business decisions. It is ultimately the filer’s responsibility to ensure that the underlying metadata is complete, accurate, and consistently mapped to allow data consumption software to tell the right story.

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Will you be ready when XBRL limited liability expires?

The SEC XBRL mandate provides for a period of limited liability of either two years following a filer’s initial XBRL filing date or October 31, 2014, whichever comes first. During this time, XBRL exhibits are deemed as “furnished” instead of “filed.” Under this modified-liability safe harbor provision, the company is protected as long as its compliance efforts are in good faith and any known errors are corrected promptly after discovery. However, when the limited liability window closes, XBRL exhibits will have the same liability provisions as regular filings under the antifraud provisions of the Securities Law. In the event of a misstatement or omission of a material fact in the XBRL files, the company along with its officers and directors can be held legally liable and be subjected to civil and criminal liability.

What should you consider before your limited liability expires? At a minimum, if your XBRL exhibits fall outside of the financial reporting process, you should have disclosure control and procedures (DC&P) in place on your XBRL creation process (see “Do Auditors Care About XBRL?”). However, as XBRL technology becomes integrated into the close process, the preparation of financial statements may become interdependent with the interactive data tagging process. When this happens, the company and its auditors should evaluate the XBRL controls under SOX 404.

Are there broader risks your CFO and audit committee need to consider? Absolutely! The Committee of Sponsoring Organizations of the Treadway Commission (COSO) expands on internal control, and provides a comprehensive framework on the broader subject of enterprise risk management.  In order to design an effective framework to meet the strategic, operations, reporting and compliance needs of XBRL, consider applying the following essential components.

Control environment: When appropriate, involve your CFO and audit committee with every aspect of your XBRL strategy, including process and controls, risk and opportunities. Be proactive and ask your audit committee for an AICPA agreed-upon procedures (AUP) to review XBRL files for accuracy and data quality. (See my earlier post on the importance of an AUP.)

Objective setting: Since XBRL technology is here to stay, how can you best leverage the power of XBRL to drive effectiveness and efficiency beyond external transparency? The logical next step is to explore opportunities that go beyond SEC compliance, such as the existing XBRL Global Ledger Taxonomy and the evolving Risk and Controls Taxonomy, to enhance internal transparency, operational performance and risk management objectives.

Risk assessment and response: What filing is subjected to XBRL tagging? The answer is: it depends. While the requirements for Form 10-K, 10-Q and 8-K are clear, the XBRL rules for registration statements can be tricky, especially with respect to the S-1 resale registration statement and the shelf registration statement on Form S-3. A best practice is to develop a documentation guide based on authoritative standards, such as SEC rules, the Edgar Filer Manual, SEC FAQs, SEC CD&Is, XBRL US GAAP Taxonomy Preparers Guide and resolutions from the XBRL US Best Practices/Data Quality Working Group, to ensure compliance.

In the absence of formal SEC guidance, it is important to establish a policy to assess material XBRL errors and a process to determine whether an amendment filing is required (for details, see this post.)

Control activities: To address data quality and compliance issues, stay current with the latest AICPA exposure draft on XBRL quality attributes of completeness, accuracy, proper mapping and structure. For each of these attributes, assess what could go wrong and implement a safety net and control environment to mitigate risk of errors.

Monitoring: Always keep abreast of latest developments and best practices from the SEC and XBRL US to avoid last-minute surprises. As XBRL standards evolve, monitoring is crucial to a quality filing. Likewise, when the SEC approves a new taxonomy, consider the advantages of early adoption and put a migration plan in place. Involve your internal audit function or a professional service firm to implement a continuous quality assurance program and perform corrective actions.

Information and communication: Benchmark your tag selection and extensions to your peer or industry group, thus enhancing comparability and transparency of your XBRL data. Collaborate with your industry group to collectively drive and shape the taxonomy. Communication is vital as you continue to redesign the close process and simplify SEC disclosures to streamline XBRL efficiency. (For tips, see “Less Is More: the Art of XBRL.”) Always get buy-in from internal and external stakeholders—you want to properly set expectations to avoid unwelcome surprises.

There is no one-size-fits-all approach to designing a quality XBRL filing. Regardless of limited liability protection, each company should manage XBRL risks within its risk appetite, define a comprehensive process to identify all the “what could go wrong” events, and provide an XBRL quality assurance framework.

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On the menu: IFRS and “diet” IFRS

Ever thought moving to International Financial Reporting Standards (IFRS) would make financial reporting easier for small private companies? Think again. In 2009, after several years of due diligence, the International Accounting Standards Board issued a less-robust set of accounting guidance—kind of a “diet” IFRS—for small and medium-size entities (SMEs). Just recently, the IASB requested feedback on draft implementation guidance on IFRS for SMEs. Progress.

As for the United States, it’s a slow grind. We have long been considering whether there should be a separate set of accounting guidance for private companies, sometimes referred to as “baby GAAP.” The FASB established a Small Business Advisory group in 2004 and a Private Company Financial Reporting Committee in 2007, both of which were supposed to help develop new standards, giving consideration to private companies. Neither has been very successful. In 2009, the Blue Ribbon Panel was formed, composed of members of the FASB, American Institute of Certified Public Accountants, and National Association of State Boards of Accountancy to address private company reporting needs. The panel issued a formal report last January, and based on those recommendations, the FASB has been taking steps to further address the need. Earlier this month, the Financial Accounting Foundation published a plan for addressing private company financial reporting, but the proposal doesn’t include establishing a separate board for private companies, as suggested by the Blue Ribbon Panel. And so we wait. Ho-hum.

But now (at last) the much-anticipated SEC decision regarding incorporating IFRS into the U.S. reporting structure is expected by the end of the year, which may have private companies heaving a sigh of relief. What’s different about the less-robust IFRS guidance? For one, they’ve eliminated topics that aren’t relevant for smaller entities, including EPS guidance, quarterly financial reporting and operating segment disclosures. In addition, where full IFRS guidance allows accounting policy choices, IFRS for SMEs allows only the easier option. Probably the most notable difference is simpler standards for recognizing and measuring assets, liabilities, income and expense items, such as amortizing goodwill and expensing all borrowing and R&D costs. Along with simpler standards come fewer disclosures too! And to further reduce the burden to smaller companies, the revisions to these IFRSs are limited to once every three years—an accounting guidance sabbatical, if you will. Nice.

IFRS transition guidance for SMEs is still a work in process, and that guidance may limit some of the options, but nonetheless would still mean less accounting and reporting rigor by private companies. So for U.S. private companies, relief may come from the incorporation of IFRS, before “baby GAAP” ever comes to fruition … and unexpected benefit of IFRS.

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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.

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Zynga’s IPO hiccup: why they got it right in the end

We tend to assume the worst when we hear the words “material weakness,” and for public companies required to comply with the Sarbanes-Oxley Act, it’s certainly not good news. But in terms of Zynga’s hiccup last week, in which the social media company restated revenues during its IPO filing process, it’s not as bad as it might seem. What did Zynga do, and why it was right in the end? We can draw a lesson from this tale.

First, full disclaimer: RoseRyan has had the honor of working with Zynga on discrete projects, and we respect the work of our colleagues there. We weren’t involved in the work leading up to their IPO (but would have loved that).

Zynga’s situation: they are not alone
Last week, Zynga filed an amendment to its S-1 registration statement, which included restating revenue for the quarter ended March 2011. Here’s why they had to restate:

A portion of Zynga’s revenue is derived from the sale of virtual goods. In accordance with today’s accounting literature, the up-front customer payments for these virtual goods are to be recognized as revenue over the estimated customer relationship period, and the company recognizes this revenue over the average playing period of paying players.

So far so good, right? Not quite. Unfortunately, Zynga did not update its estimates for playing periods associated with two of its games. The result: too little revenue was recognized, and for the March 2011 quarter, the difference was material enough to require that they restate their financial results.

Zynga is not alone in the challenges it faces in pre-IPO finance and accounting work. With innovative business models popping up every day and a continually changing accounting landscape, many companies find themselves in similar situations. The difference is that most of them resolve issues like these before their initial S-1. For Zynga, identifying the issue in the middle of its SEC filing process put them under a huge public microscope.

Material weakness: yes or no?
Zynga’s amended S-1 filing disclosed the restatement snafu as a “material weakness” in its internal control structure in the context of its risk factors. In other words, they highlighted the issue as an example of one way in which the accuracy of their financial statements could be at risk. As with most companies, this risk factor is just one of a laundry list of risk disclosures provided to investors.

Technically speaking, Zynga is not yet required to comply with the reporting requirements relating to internal controls. And once they go public, they’ll have until their second annual report to tackle this reporting requirement. In the meantime, however, they are still required to maintain effective internal controls to ensure accuracy in their financial statements.

Having said all that, I believe calling out their material weakness was the right thing to do. Putting their cards on the table shows that Zynga takes this mistake seriously, and transparent financial disclosure certainly builds credibility and trust with investors and analysts.

Moral of the story
If you’re planning an IPO, start early and give yourself enough time to sweep under the bed and take care of those dust bunnies before you’re under the microscope. Investing in preparation will pay dividends … we promise.

At RoseRyan we live and breathe these issues every day. We know most companies aren’t there—and I mean the vast majority. But we keep talking about it, pushing our clients in this direction and helping with their housecleaning.

And we give kudos to companies like Zynga that provide transparency to the issues they face.

To learn more about what we advise for pre-IPO companies, check out our recent intelligence reports, IPO in Your Future? and Ace Your IPO Filing.

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Do auditors care about XBRL?

When I talk with finance executives about implementing XBRL, nearly everyone asks, “What will auditors be looking for? Do they care about XBRL?” The answer is no, they don’t. But they do care about your controls, and that relates directly to how you design and document your due diligence in XBRL creation process. Ultimately, as XBRL gets built into your close process, the more it may start to fall into the SOX environment.

While XBRL exhibits are not subject to SOX 404 internal controls over financial reporting, they are nevertheless subject to disclosure controls and procedures (DC&P). This means that management is responsible for the implementation of controls over the XBRL creation process as well as documentation that the DC&P are performed and reviewed. How can companies provide evidence to their auditors that management, including the CEO and CFO, have evaluated the effectiveness of the design and operation of DC&P?

To design proper DC&P controls, you first need to ask, “How do you know your XBRL files are complete, accurate, consistently mapped and comply with the mandated XBRL structure?” A best practice is to develop an XBRL technical and compliance checklist to document every aspect of your XBRL creation process, from taxonomy mapping and appropriate extensions to common error reviews, technical and SEC validations, structure compliance issues. You may also want to involve your disclosure or audit committee in the review and consideration of your DC&P process and get them on board with your XBRL strategy.

As XBRL technology becomes more embedded into your overall financial reporting process and integrated into the creation and preparation of your financial statements, XBRL controls may start to fall within the scope of SOX 404. As this happens, you should reevaluate your XBRL controls under SOX 404 framework.

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A mismatched set of semi-global accounting standards—was that our goal?

Conceptually, a single set of high-quality global accounting standards sounds great: every company in every country follows the same rules and reports financial information in the same light. And with a growing number of countries adopting International Financial Reporting Standards (IFRS), it’s no wonder that IFRS is touted as “the” set of standards that can help us accomplish this goal. But the design and execution of this concept has presented insurmountable challenges, and the solutions being offered up leave much to be desired in terms of accomplishing the original goal … a single set of standards.

Adoption turns to endorsement. The SEC’s proposed roadmap issued in late 2008 considered adoption of IFRS, while the most recent SEC staff paper issued last May is considering an endorsement protocol, which would allow the FASB and SEC to cherry-pick the standards issued by the Internal Accounting Standards Board (IASB) and possibly supplement them with additional guidance.

Convergence becomes less converged. The FASB and IASB have been working together to converge the guidance of newly issued standards since they entered into the Norwalk agreement in 2002. However, some of the boards’ first major joint projects, including stock-based compensation and purchase accounting, resulted in substantial convergence upon issuance of the final standards—most of the guidance is the same but key differences remain. While their respective drafts of the proposed revenue recognition guidance are very close (after more than 10 years of effort, I might add), there are a number of differences of opinion in terms of other standards in the works, including leases, consolidation and insurance contracts. Speculation is that the best we’ll get here is also substantial convergence … if that.

Input adds to confusion. In early July, the SEC held a roundtable session to help evaluate the possible incorporation of IFRS into the U.S. reporting structure. The roundtable consisted of three panels of investors, smaller public companies and regulators. The result: a very mixed bag of reactions. The investor panel generally supported incorporation of IFRS but raised concerns about consistency in the application of the IASB’s principles-based standards. The panel of small public companies said the costs of such a substantial change outweighed the benefits. And then there was the regulatory panel, which ranged from cautiously supportive to very much against IFRS incorporation.

The SEC is still expected to make a decision by the end of this year about whether to incorporate IFRS and if so, how and when. Although nothing has been decided yet, it appears we are headed toward IFRS—International Financial Reporting Sometimes.

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Sales of private shares presenting new challenges; SEC reviewing rules

Last month, SEC chairman Mary Shapiro told the House Oversight Committee that the commission is reviewing the rules and restrictions surrounding the sale of private company stock. Current restrictions include, among others, a limit of 500 shareholders and the prohibition of general solicitation.

The SEC’s increased scrutiny of private company stock sales is the result of the increased visibility of these transactions, as shares of  Facebook, Zynga, Twitter and other highly anticipated IPO candidates are in high demand and are being resold to other individuals or entities. New Internet-based platforms, such as SharesPost and Second Market, that connect buyers and sellers in these private transactions are also upping the ante. (There’s a good look at the issues in the New York Times’ Dealbook blog.)

Companies and boards are responding in different ways to this pressure. Some, for example, are placing additional restrictions on private stock transactions or implementing new governance and internal control policies.

Where this is heading and what actions the SEC might take are up in the air, though the SEC said it’s considering loosening some restrictions, eliminating certain disclosure requirements, restricting communications in IPOs, and other measures. All parties—sellers, buyers and regulators—have their own agendas and responsibilities. But it’s certain that oversight and administration of private company stock sales will be an increasingly common challenge for company management and finance teams.

However it plays out, if you’re a company with privately held shares, you’ll need to consider a number of strategic and administrative issues, including:

  • Exercising the right of first refusal and other considerations such as co-sale rights
  • Control and knowledge of the shareholder base
  • Implications on your 409A valuations and future stock option pricing
  • The need for trading windows around the transactions
  • Implementing an insider trading policy
  • Defining what information will be released to new purchasers
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XBRL words to the wise: get a move on!

My colleague Mary Allen observed in her December post that most companies are experiencing rude awakenings when they realize the incredible number of hours needed for XBRL tagging, and she cautioned against relying on a printer’s accounting expertise to get through the project.

As time goes by, her words are looking more and more wise.

With that said, here are a few observations that may help make your experience a little less stressful.

Allow enough time: Whether you’re just starting with block tagging or are in the process of detail tagging, build some cushion into your timeline for unexpected issues. Also, with Phase II filers going to detail tagging and Phase III filers starting block tagging, the printer’s bandwidth may be taxed and turnaround time may be longer than normal. Be sure to discuss your new timetable with key stakeholders such as your disclosure committee, audit committee and investor relations department.

Map to the taxonomy: The 2011 U.S. GAAP taxonomy was recently released, which added 1,800 new tags and deleted 500 old tags. Remapping the 2009 taxonomy to the 2011 taxonomy can be time consuming. This is also an opportunity to revisit some of the custom tags you may have used and change to a standard tag that is now included in the 2011 release. (Note that while March filers were allowed to use the 2009 taxonomy, we believe the SEC will be expecting June filers to use the 2011 taxonomy.)

 

 

Use best practices: No matter which taxonomy you use, it’s critical to really understand what rolls up into the line item components in your financial statements when choosing which tags to use. No printer knows your financials and footnotes like you do. Don’t just rely on the label title, look at the actual definition—it is key. A firm like RoseRyan will understand your financials and make appropriate choices.

Do your own research to identify your own tags independent of what your printer comes up with. It’s time consuming, but getting tags right the first time provides a strong foundation to move forward.

Start detail tagging early: As a rule of thumb, detail tagging will take three to five times the effort that block tagging takes. Start early! Companies are taking a fresh look at how they present certain disclosures and are making changes to streamline the XBRL process. For example, data previously reported in a text format may now be disclosed in a table, and data that was once disclosed in multiple footnotes may be consolidated so it’s only tagged once.

Common errors include using a custom tag when a standard tag will suffice or choosing tags that define your data too broadly or too narrowly. In particular, using custom tags dilutes the value of interactive data, which is to allow investors to quickly find information and accurately compare it to other companies or trends. To avoid too many custom tags, you might take a look at peer companies to see what tags they are using.

Resources constrained? If your head is spinning just thinking about all this, remember that RoseRyan is a phone call away. We have plenty of XBRL experience, and can help with as much, or as little, as you need—check out our XBRL services.

Got XBRL war stories? Submit a comment to this post and share your challenges and tips.

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XBRL tagging: lessons from the first wave

This past fall I attended a panel discussion presented by the SEC Professionals Group on detailed XBRL tagging. Overall it was very helpful and provided great insight into what other companies experienced for their first experience with detailed tagging.

The incredible workload surprised all of the panel members, who were primarily SEC reporting managers and controllers from high-tech companies that were part of the Group One XBRL. This first group had to prepare detailed tagged financial statements and footnotes (versus block tagging), so the panel included some of the first companies who experienced the joys and the trauma of detailed XBRL tagging.

Common pain points for these companies: the huge volume of work involved in the detailed tagging (an average of ~250 hours in prep/review/validation) in addition to their normal filing process; incredibly long turnaround times for changes from the printers (six to seven days in some cases); many errors in tags chosen by the printers; and subpar quality on work outsourced by the printers.

The lessons learned reflect my own work with XBRL: start the process early, and leave plenty of time for review; don’t rely on printers’ accounting expertise (you know your financials and footnotes better than they do); the responsibility for the accuracy of the XBRL filing resides with you, not the printer; and have a really solid methodology for tracking changes. Finally, do a test run to make sure the results meet your expectations.

Keep these things in mind, and things will go a lot more smoothly.

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