Published 08/10/11

Financial Reporting: No Longer the Stuff of Fairy Tales

August 2011

“’When I use a word,’ Humpty Dumpty said, in a rather scornful tone, ‘it means just what I choose it to mean – neither more nor less.’”

The quote comes from the sequel to Alice in Wonderland, but it could easily have summed up the financial statements that Enron, WorldCom, and other companies filed with the Securities and Exchange Commission (SEC) before they collapsed.

By making words mean what the companies’ executives wanted them to mean, the statements concealed the problems that sank Enron and WorldCom, ruined investors, and helped plunge the country into a recession. At WorldCom, operating expenses were disguised as capital expenditures to boost reported profits. At Enron, devastating losses were hidden in private partnerships to bolster the company’s bottom line.

The Enron and WorldCom debacles were followed six years later by the collapse of Lehman Brothers, the bank bailout, the real estate crash, and ensuing financial crisis. To many, especially the SEC’s critics in Congress, it looked as if history was repeating itself, with regulators again falling down on the job.

But, while events were leading to the recent recession, a revolutionary computerized financial reporting standard was being promoted by Professor of Accounting Saeed J. Roohani, Ph.D., and his colleagues in the international accounting community. The new system, called XBRL, for eXtensible Business Reporting Language, has the potential, Professor Roohani says, of putting a stop to the kind of unreliable information that led to the last two financial crises. It makes it possible to define the terms used in financial reports with a specificity that makes fudging the results difficult, thus preventing another Humpty-Dumpty-style crash.

“The capital markets react to information that we provide,” Roohani says. So any tool you have must provide information that’s first, reliable; second, timely, maybe up-to-the minute information, or daily information. “That’s going to be rewarded in the capital markets,” he says. 

Once Upon a Time

XBRL is based on XML, a set of rules for encoding documents in a form that can be read by computers. Designed to transport data over the Web, it has greater capabilities than HTML, the computer language used to display content on the Internet. XML can also supply context, define the dates, words, and numbers contained in a document, and, in the process, explain what everything means. This is important for the functionality of global supply chain management (GSCM).

In 1998, when XML was introduced, Roohani along with a handful of people in the accounting community who saw its potential. If the definitions XML was capable of standardizing financial reporting, he and others believed, investors would have a powerful new tool for keeping an eye on the companies they put money into. Today, every word, number, and date reported by companies using XBRL would be comparable to every word, number, and date reported by other companies using the computer markup language, eliminating a lot of the guesswork that made regulating publicly traded companies like Enron and WorldCom a burdensome job.

Happily Ever After?

It took about 10 years for Roohani and the organization he is a member of, XBRL International, to get XBRL adopted as the new common language of financial reporting. Two different versions of XBRL exist, one for the United States (US GAAP XBRL), the other overseas (IFRS XBRL). “The challenge for us was to work with the governments around the globe, work with stock markets around the globe, work with accounting standard-setters around the globe, work with accounting professionals who do audits, taxes, or whatever around the globe, and convince them that this is the way to go, this is the best way to serve all of us.”

Roohani says, “Invariably, every single time that we have a financial crisis, Congress asked the SEC, ‘What happened to you? Are you sleeping there?’

“The SEC says, ‘We don’t have resources. We don’t have people. These are 12,000 companies that are coming in, filing four times a year, and we don’t have enough people to look at this paperwork.’  Information submitted to the SEC in XBRL format is instantly available for analysis by the SEC staff - no more re-keying data from reports to Excel for analysis.

XBRL offered a solution. In this country, the challenge of getting regulators to adopt XBRL was greatly facilitated by Congressional dissatisfaction with the SEC's financial data handling process.

The new financial reporting language is being phased in at all publicly traded companies in the U.S. starting 2009; and in most developed economies around the globe.           

It wasn’t easy. And the job isn’t finished yet.  But, not being able to analyze financial reports and compare them in a timely manner is no longer an excuse for investors, analysts or the regulators such as the SEC.