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XBRL Audit Issues

XBRL Audit Issues. eXtensible Audits Presenter John Ryan Available at http://www.ryannetworks.com. Topic Outline. XBRL Overview Easing Financial Reporting Red Flags for Accountants and Investors Auditor’s New Roles Sarbanes-Oxley 404 issues. XBRL Overview. History Goals Outlook

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XBRL Audit Issues

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  1. XBRL Audit Issues eXtensible Audits Presenter John Ryan Available at http://www.ryannetworks.com

  2. Topic Outline • XBRL Overview • Easing Financial Reporting • Red Flags for Accountants and Investors • Auditor’s New Roles • Sarbanes-Oxley 404 issues

  3. XBRL Overview • History • Goals • Outlook • Looking Deeper • Examples

  4. History • Started as AICPA project • Adopted by w3c • Creation of XBRL.org • Accepted by Microsoft, SEC

  5. Goals • Common Language • To reduce filing burdens • Napster for accountants • Lower the cost of finance depts.

  6. The XBRL GL was created to meet these goals: • Multi-GAAP, drill-up to multi-XBRL reporting taxonomies. • Standard format for 3rd-party software to create journal entries to pull into client GL system. • Standard format to move unposted and posted GL information back and forth from branch offices to consolidating systems, budgeting and forecasting tools, reporting tools.

  7. Goals Cont. • Standard format to upload general ledger information as well as payables and receivables master files and open balances in migrating from one system to another or moving information to or from an Internet Application Service Provider (ASP). • Standard format to move information from client systems to CPA/CA. • Standard format to move information from one CPA/CA system (e.g., write-up) to another (e.g., tax) in an international context.

  8. Goals Cont… • Standard format to represent open receivables, open payables, inventory balances, and other asset-based measures for sharing with banks. • Tool for representing detail drill-down for performance measurement reporting items. • Extensible for any type of mandatory audit trail. • Extensible for meeting any "sub-ledger" need. • Designed as XBRL spec-compliant but for easy translation to other uses; cannot assume that XBRL period, entity, unit and other context (numeric, nonnumeric) will automatically be there.

  9. Outlook • Adoption by Microsoft, and the SEC (Edgar Online) • Adoption by 100% of major accounting packages, Oracle, Peoplesoft, SAS… • Still Immature (SEC XBRL filings are hidden inside .gif files to avoid rejection) • Thousands of Dollars problem

  10. Instance Document Creation • Blast Radius (XMetal) • CaseWare International • Creative Solutions • Fujitsu • Hitachi Systems and Services • Microsoft Business Solutions • Semansys Technologies • Ubmatrix

  11. Taxonomy Creation • Fujitsu • Hitachi Systems and Services • Semansys • Ubmatrix

  12. XBRL Validation • DecisionSoft • J2R • Fujitsu • Semansys Technologies • UBmatrix

  13. Easing Financial Reporting • Agreement on Terms • Create One Data Set • Distribute multiple forms

  14. Agreeing On Terms – Context

  15. XBRL is XML – The Absolute Beginners Guide to XML <!-- The original html recipe --> <HTML> <HEAD> <TITLE>Lime Jello Marshmallow Cottage Cheese Surprise</TITLE> </HEAD> <BODY> <H3>Lime Jello Marshmallow Cottage Cheese Surprise</H3> My grandma's favorite (may she rest in peace). <H4>Ingredients</H4> <TABLE BORDER="1"> <TR BGCOLOR="#308030"><TH>Qty</TH><TH>Units</TH><TH>Item</TH></TR> <TR><TD>1</TD><TD>box</TD><TD>lime gelatin</TD></TR> <TR><TD>500</TD><TD>g</TD><TD>multicolored tiny marshmallows</TD></TR> <TR><TD>500</TD><TD>ml</TD><TD>cottage cheese</TD></TR> <TR><TD></TD><TD>dash</TD><TD>Tabasco sauce (optional)</TD></TR> </TABLE> <P> <H4>Instructions</H4> <OL> <LI>Prepare lime gelatin according to package instructions...</LI> <!-- and so on --> </BODY> </HTML>

  16. Now in XML <Ingredient> <Qty unit="ml">500</Qty> <Item>Cottage cheese</Item> </Ingredient> <Ingredient> <Qty unit="dash"/> <Item optional="1">Tabasco sauce</Item> </Ingredient> </Ingredients> <Instructions> <Step> Prepare lime gelatin according to package instructions </Step> <!-- And so on... --> </Instructions> </Recipe> <?xml version="1.0"?> <Recipe> <Name>Lime Jello Marshmallow Cottage Cheese Surprise</Name> <Description> My grandma's favorite (may she rest in peace). </Description> <Ingredients> <Ingredient> <Qty unit="box">1</Qty> <Item>lime gelatin</Item> </Ingredient> <Ingredient> <Qty unit="g">500</Qty> <Item>multicolored tiny marshmallows</Item> </Ingredient>

  17. A Markup <!ELEMENT Ingredients (Ingredient)*> <!ELEMENT Ingredient (Qty, Item)> <!ELEMENT Qty (#PCDATA)> <!ATTLIST Qty unit CDATA #REQUIRED> <!ELEMENT Item (#PCDATA)> <!ATTLIST Item optional CDATA "0" isVegetarian CDATA "true"> <!ELEMENT Instructions (Step)+> <!-- This is the example DTD for the example XML --> <!ELEMENT Recipe (Name, Description?, Ingredients?, Instructions?)> <!ELEMENT Name (#PCDATA)> <!ELEMENT Description (#PCDATA)>

  18. <BODY> <H3> <xsl:value-of select="Name"/> </H3> <STRONG> <xsl:value-of select="Description"/> </STRONG> <xsl:apply-templates/> </BODY> </HTML> </xsl:template> XSL <?xml version="1.0"?> <xsl:stylesheet xmlns:xsl="http://www.w3.org/TR/WD-xsl"> <xsl:template match="/Recipe"> <HTML> <HEAD> <TITLE> <xsl:value-of select="Name"/> </TITLE> </HEAD>

  19. XBRL Concept There are two components that we can consider: an XBRL instance and its associated taxonomy set. While the XBRL instance contains the concrete facts (e.g., the value of the business concept "sales_per_share") being reported, the taxonomy contains descriptions of the business concepts (e.g., the description of the business concept "sales_per_ share", what its syntax is, how it is calculated, etc.) that are being reported.

  20. Example XBRL <ifrs-gp:AssetsHeldSale contextRef=“Current_AsOf” unitRef=“U-Euros” Decimals=“0”> 100000 </ifrs-gp:AssetsHeldSale>

  21. Taxonomies • Approved Taxonomies comply with official guidelines for the taxonomy and with the XBRL Specification • Acknowledged Taxonomies meet the XBRL Specification only • Private Taxonomies have no requirements

  22. Link Base – Five Links in Three Categories • Label links (labelLink) • Reference links (referenceLink) • Relation links (calculationLink, definitionLink, presentationLink)

  23. Label And Ref Links Label and reference links relate business concepts to metadata. For instance, label links can associate concepts with text strings that can be used to label (or otherwise document) the concept in a report (e.g., the label "Revenues in most recent quarter" for the item revenueMRQ defined in the taxonomy). Multiple labels can be defined for a single business concept in different languages. The XBRL instance author can decide which labels to use for that particular instance.

  24. Labels used for Authority Similarly, reference links can associate references to authoritative literature in the business domain. The mechanism used is similar to the label links in that you define a reference link with a locator for the business concept, one or more references to documentation, and a referenceArc defining the association between the locator and the reference(s).

  25. Links For Calculations In contrast to label and reference links that relate business concepts to metadata, relation links relate business concepts to other business concepts. For example, calculation links define how a given concept figures in the calculation of another business concept. For example, the concept "profitAfterTax" is calculated from the concepts "profitBeforeTax" and "taxPaid" by subtracting one from the other. profitAfterTax = weight(1) * profitBeforeTax + weight(-1)*taxPaid

  26. More About Links The relationship between these three business concepts is captured in the calculationLink in Figure 3. Definition links describe several types of relationships among business concepts, such as generalization-specialization relationships (e.g., "postalCode" is a generalization of "zipCode") among others. Presentation links, as the name implies, define the relationships between concepts from a presentation perspective (e.g., in the presentation of the report, a parent/child relationship should be shown between "sales" and "printerSales").

  27. Sample XBRL Application

  28. Index of Taxonomies

  29. Red Flags • Easy shifting of data between accounting models • Quick and Dirty Ratio Testing • Non-Audit Fees and Bond Rating

  30. Effects of Financial Leverage on ROE • Assume cost of debt is 8% and total assets = $100 • EBIT = earnings before interest and taxes • EBT = earnings before taxesROE = return on equity • Tax Rate = 50%. Assume losses result in tax credit

  31. Rates of return on assets 0% 4% 8% 12% 16% EBIT $0.00 $4.00 $8.00 $12.00 $16.00 Interest Expense 0 0 0 0 0 EBT $0.00 $4.00 $8.00 $12.00 $16.00 Taxes 0 2 4 6 8 Earnings avail com eq $0.00 $2.00 $4.00 $6.00 $8.00 ROE 0.00% 2.00% 4.00% 6.00% 8.00% Panel A 0% Leverage

  32. ROA 0% 4% 8% 12% 16% EBIT $0.00 $4.00 $8.00 $12.00 $16.00 Interest Expense -2 -2 -2 -2 -2 EBT ($2.00) $2.00 $6.00 $10.00 $14.00 Taxes -1 1 3 5 7 Earnings avail com eq ($1.00) $1.00 $3.00 $5.00 $7.00 ROE -1.30% 1.30% 4.00% 6.70% 9.30% Panel B 25% Leverage

  33. ROA 0% 4% 8% 12% 16% EBIT $0.00 $4.00 $8.00 $12.00 $16.00 Interest Expense -4 -4 4 4 4 EBT ($4.00) $0.00 $12.00 $16.00 $20.00 Taxes -2 0 6 8 10 Earnings avail com eq ($2.00) $0.00 $6.00 $8.00 $10.00 ROE -2.00% 0.00% 4.00% 8.00% 12.00% Panel C 50% Leverage

  34. ROA 0% 4% 8% 12% 16% EBIT $0.00 $4.00 $8.00 $12.00 $16.00 Interest Expense -6 -6 -6 -6 -6 EBT ($6.00) ($2.00) $2.00 $6.00 $10.00 Taxes -3 -1 1 3 5 Earnings avail com eq ($3.00) ($1.00) $1.00 $3.00 $5.00 ROE -12.00% -4.00% 4.00% 12.00% 20.00% Panel D 75% Leverage

  35. Capital Markets Expected Returns E(Risk) Ris(free) Sigma Risk Security Markets Expected Returns E(Risk) Ris(free) Beta

  36. Horrigan Bond Rating Model • Z=(1.197 x X0) + (.034 x X1) + (.272 x X2) – (.501 x X3) + (4.519 x X4) – (.203 x X5) • X0 1 or (0) if the bond is un-subordinated (subordinated) • X1 = Total Assets • X2 = Common equities / total debt • X3 = Working capital /sales • X4 = Operating profit / sales • X5 = Sales / stockholders’ equity

  37. Ratings • AAA 2.855 < Z • AA 2.094 < Z < 2.855 • A 1.062 < Z < 2.094 • BBB 0.838 < Z < 1.062 • BB 0.360 < Z < 0.838 • B or Lower Z < 0.360

  38. Non-Audit Fees and Bond Rating –AaronCrabtreePresentation at www.bus.lsu.edu Recent accounting scandals and perceived audit failures have resulted in excessive criticism of the accounting and auditing professions. […] Our research investigates one aspect of this situation by exploring the effects that non-audit services performed by a firm s external auditors have on perceived auditor independence in the bond market. Specifically, we analyze the effects that the magnitude and relative degree of non-audit services have on the bond rating process. Regression results indicate that the amount of non-audit services provided by a firm s external auditors is negatively associated with that client s bond rating. […] provide empirical evidence regarding the role that audit and non-audit service fees play in establishing a firm s bond rating.

  39. Trouncing the DOW Pension Fund (by Kenneth Lee) • Uses Ratios do determine Buy and Sell Points • Good Track Record based on ROE vs price movements (28% avg annual return from 1973-1996.) • In 2001 Buys Coca-Cola because ROE is up 50% but price is not

  40. Coke Misbehaves Stephen Taub, CFO.com - January 16, 2004 The Coca-Cola Co. announced that the Securities and Exchange Commission has launched a formal investigation of the soft-drink giant. The probe stems from allegations made by former finance manager and whistle-blower Matthew Whitley, who sought a $44.4 million settlement from the company on the grounds that he had been fired in retaliation for raising concerns about accounting fraud….

  41. Coke Admits Misbehavior Atlanta Journal 6/18/03 Coca-Cola admitted Tuesday that a high-level employee faked […] a written apology from Coke's president and chief operating officer. The extraordinary exchange highlighted a day in which Coke admitted to some -- but not all -- of the allegations raised by a former employee, Matthew Whitley. […] wasn't told about the deception when Coke discovered it in 2001. Fisher was fined, but he kept his job and even was promoted. He no longer works for Coke.

  42. The Cause ? Coke's largest shareholder, Warren Buffett, has argued that the existence of stock options has induced many executives to doctor financial reports in order to inflate the price of company shares. Enron executives, for example, received tens of millions of dollars by cashing in stock options while their company's financial statements showed false information. "I think accounting generally, in recent years, has deteriorated and it's done so with the help of management," said Mr. Buffett, who is a member of the boards of directors of Coca-Cola and The Washington Post.

  43. My Investment went Ouch! – The Cure • Sarbanes-Oxley • Continuous, timely auditing • Transparency • Separation of Auditors & Consultants • XBRL • Could XBRL help predict this?

  44. MINI – Minority Interest Net Income MINI is computed as the shareholders interest in the subsidiary’s income. All other Items are simply added. Note that the Parent Income and the consolidated income are equal. Note that while Coke (parent) is bigger CCE’s interest expense is greater. Suggesting Coke is parking liabilities.

  45. Financial Ratios of CocaCola Equity Method vs Consolidation 2001 2000 Financial Ratios Equity Consolidated Equity Consolidated Current Ration 0.85 0.77 0.71 0.74 Debt to Equity 0.97 2.39 1.24 2.80 Debt to Tangible Equity 1.26 (8.21) 1.56 (7.29) Debt to Assets 0.49 0.70 0.55 0.74 Debt to Tangible Assets 0.56 1.14 0.61 1.16 Gross Profit 0.70 0.64 0.69 0.63 Return On Sales 0.20 0.13 0.11 0.07 Return On Assets 0.18 0.09 0.10 0.05 Return on Tangb Assets 0.20 0.14 0.12 0.08 Return on Equity 0.35 0.30 0.23 0.20 Return on Tangb Equity 0.45 (1.04) 0.29 (0.52) Times Interest Earned 20.62 6.61 8.60 3.82 Inventory Turnover 5.73 6.45 5.82 6.55 Receivables Turnover 10.90 9.06 11.32 9.73 LTD to Equity 0.11 0.88 0.09 1.02 LTD to Assets 0.05 0.26 0.04 0.27 Consolidated Ratios Financial ratios show the discrepancy between the equity method and the consolidated method. All ratios are negatively impacted. Financial leverage is the hardest hit. Debt to equity Doubles, while debt to tangible equity goes negative. Return metrics are also negatively impacted

  46. Other Bad Actors using Equity Method • Enron • Boston Chicken • Elan • WorldCom/Embratel • …

  47. Other Methods of Debt Hiding • Lease Accounting • Lease Trouble at Delta and others • Banks get preferred Airplane lease rates • Recalculate Airline Debt using lease payments and work backwards • Pension Accounting • Pension troubles at AMR, Delta, Avaya, Goodyear, GM, Delphi, Navistar, and Ford • Restate the Pension debt at realistic interest rates • Debt matters including Pension Debt

  48. University of Illinois – XBRL Kirkwood Credit Analyzer Ratio Cmpq Dell HP IBM AssetTurnover 1.53 2.75 1.26 1.01 CurrentRatio 1.17 1.48 1.51 1.09 DaysCOGSInventory 24.24 5.96 57.91 32.58 […] Earnings Manipulation Probablity: 0.38% 0.36% 0.17% 0.80%

  49. Issues for XBRL • Taxonomy Selection Issues • Select One or More Taxonomies • Implementation Issues • Must Map Data Elements to Labels • Poor Flexibility • XBRL is Flat • No Security

  50. Auditor’s New Roles • XBRL Validation • Round Tripping • Source verification • Instance verification • Completeness verification

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