Three Years to Get Moving on XBRL

Anyone closely following the Securities and Exchange Commission has long known that sooner or later, the agency would order companies to start filing financial reports using XBRL technology.

Well, it seems the SEC has opted for sooner.

Under a plan unveiled last week, the largest 500 public companies in the United States would start submitting financial reports using eXtensible Business Reporting Language one year from now. Other large filers would follow in 2010, and all remaining companies in 2011.

The SEC’s three sitting commissioners (two seats are vacant) approved the proposal unanimously. It now enters a 60-day comment period, and any final rule will likely be revised from what was presented last week. Still, SEC Chairman Christopher Cox has made XBRL the centerpiece of his legacy as chairman, and approval of some sort of mandate is almost certain. When that happens, it will be the most profound change to financial reporting since passage of the Sarbanes-Oxley Act in 2002.

XBRL observers say the SEC’s three-year timeline is surprisingly aggressive, especially the goal of pushing large companies to file XBRL-tagged reports next spring. But with appropriate planning, they say, even that tight schedule is possible.

Purnhagen

“It’s aggressive, but it’s absolutely doable,” says Gary Purnhagen, an independent consultant and former executive at Merrill Corp. “I’d expect to see half of those 500 companies file voluntarily this year and not wait until their 10-K. I also think many companies that aren’t mandated to file in the first year will say, ‘Why are we waiting?’”

XBRL technology works by converting financial reports—typically crammed with text and difficult to read—into simpler, more dynamic pages akin to what people see on Websites. Companies would “tag” individual pieces of financial data according to an XBRL taxonomy of financial reporting terms, so computers could recognize which numbers are revenue, earnings, liabilities, and so forth. Investors and the public would then use XBRL “reader” programs on their computers to interpret those tags and could read financial reports much more quickly and simply.

With the proper taxonomy of accounting terms, XBRL enthusiasts say, the language could encompass all manner of financial data, from inventories to contingency accounts to payroll. And with the right software on users’ computers, XBRL could give rise to powerful new data analysis tools, allowing investors to pore over financial reports and quickly compare them with other companies.

The challenge for companies will be to get all that financial data tagged properly. The XBRL taxonomy of U.S. Generally Accepted Accounting Principles has more than 15,000 terms, and few software tools exist right now to automate all that tagging. Skeptics say tagging documents in XBRL could add another 100 to 200 man hours to the time necessary to prepare financial reports, although that could fall significantly once companies get used to the technology.

Nashman

“If they get started fairly quickly … companies at all levels should be able to comply with the timelines [the SEC] has defined,” says Mark Nashman, chief technology officer of Clarity Systems, a maker of financial reporting software.

Simon Hecht, a senior financial reporting analyst at United Technologies Corp., says much the same. “It requires a lot of time up front, but if companies spend the time now, by the time they’re required to submit tagged filings, they should be able to reduce the amount of time it takes,” he says. UTC is a participant in the SEC’s voluntary pilot XBRL program, which has been running since 2005. Currently, just 76 companies provide XBRL-tagged results under the pilot program.

Details of the Proposal

Under last week’s proposal, domestic and foreign large accelerated filers that use U.S. GAAP and have worldwide public float above $5 billion—that is, roughly the 500 largest public companies in U.S. markets—would be required to tag their financial reports for fiscal periods beginning on or after Dec. 15, 2008. All other domestic and foreign large accelerated filers using U.S. GAAP would follow a year later. Smaller reporting companies and foreign private issuers filing statements in International Financial Reporting Standards would come last, one year after that.

In the first year, large companies would be able to tag footnotes and schedules as single blocks of text. In subsequent years, however, they would need to tag the details within footnotes and schedules individually. The disclosure would be provided as additional exhibits to annual and quarterly reports and registration statements.

Companies would also need to file XBRL-tagged reports to the SEC and publish them on company Websites following the same deadlines they currently have for regular financial reports, with two exceptions: a 30-day grace period for filing their first XBRL report, and another 30-day grace period for the first exhibit with footnotes and schedules tagged in detail.

XBRL UPDATE

The following excerpt from an SEC press release highlights some XBRL commentary made at the May 14 open meeting.

This is all about bringing investors better, faster, more meaningful information about the companies they own," said SEC Chairman Christopher Cox. “It would transform financial disclosure from a 1930s form-based system to a truly 21st century model that taps the power of technology for the benefit of investors.”

John White, Director of the SEC’s Division of Corporation Finance, said, “These steps will represent real progress, both for SEC filers and investors. All of the technology is coming together to make electronic filing a true analytical tool. The staff has gathered valuable experience during the almost three years that public companies have been submitting interactive data in our voluntary filer program. This helps give us a strong foundation for moving forward.”

Conrad Hewitt, the SEC’s Chief Accountant, said, “Accounting is the business language of the world, and interactive data will become an easy and reliable technology to improve that language worldwide, just like many other tools available on the Internet. The SEC’s Advisory Committee on Improvements to Financial Reporting has been studying the benefits of interactive data and has proposed that the Commission proceed with a mandatory adoption schedule. Over the long term, preparers are expected to benefit through better internal management information and applications, and investors will benefit with improved analytical methods to analyze financial information.”

Corey Booth, SEC Chief Information Officer, said, “Interactive data represents the logical next step in the evolution of company disclosure, just as HTML and Internet access were the next logical step a decade ago. And like a decade ago, this move will usher in a quantum leap in helping companies explain their business to investors."

David M. Blaszkowsky, Director of the SEC’s Office of Interactive Disclosure, said, “Information — meaningful, accurate, timely, easy-to-use financial reporting — always has been the driver of commerce and markets. This proposal provides the critical regulatory framework by which interactive data will make financial reporting more easily and quickly available, and help transform the relationship between filer and investor.”

Source

Securities and Exchange Commission (May 14, 2008).

Companies that miss their filing deadlines would lose eligibility to use short-form registration, and would be deemed not to have current public information for purposes of the resale exemption safe harbor provided under Rule 144 of the Securities Exchange Act. As soon as companies do file and come into compliance, however, they would be deemed to be timely and the punitive restrictions would end. The proposal also provides for modified versions of the hardship exemptions provided for EDGAR filings.

Like XBRL-tagged reports filed under the voluntary pilot program, tagged data would be subject to limited legal liability.

One pressing question, upon which the SEC was silent last week, is whether external auditors will need to provide some sort of attestation that financial data is tagged correctly. Skeptics fear that auditors ultimately will claim some need to audit XBRL-tagged reports, racking up the billable hours and audit fees as they did after SOX was passed.

White

A text of the proposal was not available as of May 19. Once published in the Federal Register, it will be out for comment for 60 days. Cox has always said he wants to have a final rule approved by this fall (just before his tenure as chairman ends), but John White, director of the SEC’s Division of Corporation Finance, said the SEC would monitor implementation of XBRL closely and could revisit the deadlines “as appropriate.”

Starting Down the XBRL Road

The XBRL mandate, regardless of when it passes and what it ultimately looks like, should catch nobody by surprise. Chairman Cox has touted the benefits of XBRL for years to just about any audience he could find, and the voluntary pilot program is now in its third year. The SEC has also released a family of XBRL reader programs on its Website, free to all, to prod development of other XBRL applications.

Hecht says the most important thing companies can do now is to download the correct XBRL taxonomy for their industry and figure out which specific elements fit their financial statements. “Once you’ve identified the pieces of the taxonomy that are important for your company, the tagging is a simple exercise,” he says.

UTC has been making voluntary XBRL filings for three years, and Hecht says the first such filing took 80 hours. But, he says, that effort used an older, more rudimentary XBRL taxonomy that required more “editing.” With the new, vastly more comprehensive taxonomy adopted earlier this year, his team has whittled the XBRL filing process down to a four-hour exercise, he says. UTC has submitted 14 filings, including one complete 10-K and 10-Q, and spent about $40,000 in all, Hecht adds.

Purnhagen now expects a rush on services and software as companies try their hand at a test filing before the real thing is due. And while the immediate challenge will be implementing XBRL for external reporting, Purnhagen says the real advances for XBRL will come later, as companies figure out how to use it for internal reporting and operations management.

While companies currently use a “bolt on” approach to tag financial data at the end of the reporting process, eventually they will tag information from their financial management systems at origin, he says. That could allow companies to monitor sales in real-time, spot accounting discrepancies more quickly, or even notice quirks like spikes in product returns that might indicate manufacturing or sales problems.

Nashman agrees. “The real pain companies are currently having is that, as a whole, the external reporting process is a manual process,” he says. “Adding XBRL tagging will give the investor community more accurate information, but it’s a new activity for companies.”