Ten Keys to Creating a Universal Digital Financial Reporting Framework
As explained in the book The Great Upheaval, the world is in the midst of a “great upheaval” where the world is transitioning from an analog, industrial economy to a digital, knowledge economy. My take on this great upheaval as it relates to financial accounting, reporting, auditing, and analysis is summarized in The Great Transmutation.
The article, An Economic Case for Transparency in Private Equity,
which is an abridged version of the academic paper, An Economic Case forTransparency in Private Equity: Data Science, Interest Alignment and Organic Finance, points out that XBRL offers the opportunity
to create a Universal Digital Financial Reporting Framework.
Key 1: Accounting and Reporting Rules Served by Immutable Standards based
Machine Readable Declarative Rules
The coming transformation of financial reporting requires some
of the rules and regulations related to financial accounting and financial
reporting to be represented in an immutable standards-based machine-readable
declarative form.
Rules and regulations, some of them not all of them, can be
represented in machine-readable form using a global standard, such as XBRL,
placed on the Inter-Planetary File System (IPFS) so they will always be available, be instantiated as an NFT, or
non-fungible token, and then reliably used by software applications. This article, What Are NTFs and How Do They Work, points
out these characteristics of NFTs which help you understand what they are:
- Non-interoperable: NFTs
are unique and unlike fungible tokens which are all the same basically and
any one is just as good as any other; NFTs are not interchangeable.
- Indivisible: NFTs cannot be
divided into smaller denominations.
- Indestructible: NFTs are stored on
the blockchain and can never be destroyed.
- Verifiable:
Because NFTs exist on a blockchain they can be traced back to the original
creator.
Here is a list of NFT use cases that might help you get your head around what they are and what they can be used for.
However, this does not subordinate accountants, reporting entities, auditors, financial analysts, investors, standards setters or regulators and the rules and regulations to the constraints of computer science.
The information communicated by a financial
report and the rules and regulations that govern such reports is, and always
will be, the legal agreement, not the computer code. The code can only refer
to, or facilitate the transmission of, those professional work products that
bring a financial report into being. It does not seem productive to attempt to
translate legal and regulatory technical complexity into code when adjudication,
in the case of default, will revert not to code but to the judiciary.
As pointed out by the Business Rules Manifesto,
Article 4;
- Rules should be expressed declaratively in natural-language sentences for the business audience.
- If something cannot be expressed, then it is not a rule.
- A set of statements is declarative only if the set has no implicit sequencing.
- Any statements of rules that require constructs other than terms and facts imply assumptions about a system implementation.
- A rule is distinct from any enforcement defined for it. A rule and its enforcement are separate concerns.
- Rules should be defined independently of responsibility for the who, where, when, or how of their enforcement. Rulemaking is a separate responsibility from rule enforcement.
- Exceptions to rules are expressed by other rules.
Key 2: Ease of Use is Required
Digital financial reporting will only emerge if the
technology developers allow those market participants that create, read, or
otherwise make use of such digital financial reports like accountants, business
professionals, investors, auditors, financial analysts, regulators, data
aggregators, attorneys, and commercial loan officers, who are not computer
scientists or coders, and never want to be computer scientists or coders. Software in support of digital financial
reporting must be built around the needs of its users.
Notwithstanding the digitization of the “paper” process or
“e-paper” such as PDF, HTML, word processing documents, creating digital
financial reports requires that existing workflows, business processes, audits,
and financial analysis be maintained in a way that users can accept,
understand, and integrate into existing processes.
Ease of use is required by taking the complexities of digital
financial reporting and burying those complexities within software applications
or within platforms that serve those software applications and their users.
Creative and clever use of explainable rules-based artificial intelligence by
software engineers can simplify software use.
Simplistic software will not do. Attempting to remove what might be considered
a complex or sophisticated task or process from software to make developing
such software easier will never be acceptable.
The law of irreducible complexity mandates that all necessary parts of
the system exist.
Key 3: Clear, Understandable Accounting and Reporting Logic
The terminology, rules, and other logic used in accounting
and financial reporting must be clear and understandable because computers
simply cannot work effectively with ambiguity.
Remember, computers are machines. Computers have no
intelligence until they are instructed by humans. Computers only appear smart when humans
create standards and agree to do things in a similar manner in order to achieve
some higher purpose. A machine such as a
computer can only mimic what humans tell the machine to do via machine-readable
information.
A logical system enables a community of stakeholders trying
to achieve a specific goal or objective or a range of goals/objectives to agree
on important common models, structures, and statements for capturing meaning or
representing a shared understanding of and knowledge in some area of knowledge. Such logical systems can be explained using a
logical theory. Logical theories can be
tested to prove if the theory described is true of false.
A financial report is a logical system. Financial reports
represent economic events, activities, and other circumstances in words and
numbers. A financial report is a true
and fair representation of a set of claims made by an economic entity about the
financial position and financial performance of that economic entity. Financial reports are not arbitrary, not
random, and not illogical.
A logical theory is made up of a set of logical models, logical
structures, logical terms, logical associations, logical rules, and logical facts. Such logic must be clear and understandable.
A financial reporting scheme represented using an XBRL taxonomy which is then used to represent a report model for a report created by an economic entity in machine readable form serves multiple purposes:
- Description: It is a clear and should be complete description of a report model (specification of what is permitted); created by standards setters or regulators or anyone else specifying a report. And obviously the clear and complete description should represent accounting and reporting rules precisely and accurately.
- Construction: It is a guide to the creation of a report based on that permitted report model description whereby a human can be assisted by software applications utilizing that machine readable description of permitted report models.
- Verification: The actual report constructed can be verified against the clear, complete description assisted by software applications utilizing that machine readable description.
- Extraction: Information can be effectively extracted from machine readable reports and report models assisted by software utilizing that machine readable clear and complete description.
Key 4: Good Practices and Best Practices
An area of knowledge is a highly organized socially
constructed aggregation of shared knowledge for a distinct subject matter. An area of knowledge has a specialized
insider vocabulary, jargon, underlying assumptions (axioms, theorems,
constraints), and persistent open questions that have not necessarily been
resolved (i.e. flexibility is necessary).
Accounting is an area of knowledge. You can explain aspects of the accounting
area of knowledge, such as the nature of a financial report, using a logical
theory which explains a logical model. A
logical theory can be tested and proven by providing a proof.
Knowledge can be represented in human-readable form, in
machine-readable form, or in a machine-readable form that can be effectively
converted into human-readable form.
The knowledge within an area of knowledge can be explained
using tools such as the Cynefin Framework which is a sensemaking process.
Some accounting knowledge related to the repetitive, mechanical,
mathematical, and logical aspects of accounting, reporting, auditing, and
analysis are obvious and can be explained in terms of “best practices” or are
complicated and can be analyzed by those with accounting expertise and
explained as a set of “good practices”.
There are other frameworks similar to Cynefin that help one make sense
of things such as ISO-9000 quality frameworks.
Key 5: Clear, Understandable Terms, Associations, Rules, Facts
Double entry bookkeeping is an ancient best practices
technique that is in global use today and commerce and global multinational
organizations could not exist without that ancient best practice. Double entry bookkeeping is a mathematical model. That double entry bookkeeping mathematical
model is the foundation for robust financial reporting schemes such as U.S.Generally Accepted Accounting Principles (US GAAP) and International Financial Reporting Standards (IFRS) among others. Both US GAAP and IFRS are grounded in a
version of the accounting equation. Both US GAAP and IFRS define a core set of interrelated elements of financial statements that form a
conceptual framework for financial reporting using that financial reporting framework. The semantics of US GAAP has been maturing
for almost 100 years and IFRS for almost 50 years.
These interrelated elements of financial statements are the
building blocks with which financial statements are constructed. Both US GAAP
and IFRS discuss the notions of “articulation” which relates to the intentional
interconnectedness of each of the primary financial statements and
“intermediate components” which relates to the notion that different reporting
entities are permitted to use different subtotals and totals and report line items to
represent the financial position and financial performance of that economic
entity. This flexibility is intentional,
by design, encouraged for specific reasons; and must be considered when
creating software applications.
Triple-entry accounting takes double-entry accounting to an entirely new level. Double-entry accounting
and triple-entry accounting work together to create an even stronger
system. Combined, double- and
triple-entry accounting creates bullet proof accounting systems for aggressive
uses and users.
It is worth mentioning that some point out that “triple-entry
accounting” is something different than how blockchain enthusiasts use the term. What we mean is that there are considerable
benefits in writing transaction information into an immutable ledger on a
blockchain.
Key 6: Control of Report Model Modifications to Maintain High Report
Quality
Financial reporting using both/either US GAAP and IFRS encourages comparability with consistency. What this means is that financial statements are not, should not, and need not be forms. Rather, within the boundaries of these, and other similar, financial reporting schemes; flexibility is provided to economic entities to create their financial reports to effectively describe their economic entities including important unique aspects of the economic entities.
As such, reporting economic
entities are permitted to modify their report models within permitted boundaries. As such, software applications that enable
the creation of such financial reports must control the software users to help
keep those software users within these permitted boundaries. Saying this another way, financial reports are not "standardized"; rather they can be "customized" and customizations made by report creators must be controlled and kept within permitted boundaries.
Control is provided using the machine-readable accounting and
reporting rules described previously in Key 1.
Rules are used to articulate allowed variability and
"channel" creators of financial reports in the right direction and
therefore control variability, keeping the variability within standard
limits. That keeps quality where it
needs to be. Rules enable things like
preventing a user from using a concept meant to represent one thing from
unintentionally being used to represent something different.
Further, the discipline of describing something in a form a
computer algorithm can understand also assists you in understanding the world
better; weeding out flaws in your understanding, myths, and misconceptions
about accounting and reporting standards.
This helps accountants be better accountants.
Key 7: Tamper Proof Audit Trail
Digital financial reporting will involve thousands of
machine-readable rules, machine-readable report models and reports, provided by
tens of thousands of economic entities, thousands of auditors, tens of
thousands of analysts and investors; you get the point.
How can you be sure rules, reports, and other technical
artifacts have not been tampered with?
How do you know an inadvertent mistake, or an intentional manipulation
has not been induced into the system?
How can you be sure that software is working correctly and giving you
the right answers such that you can rely on automated processes provided by the
software?
All of these issues can be effectively handled using
immutable digital distributed ledger technologies such as blockchain. Writing information into an immutable digital
public ledger offers significant advantages.
Financial reports can be created at different levels, a spectrum of quality and reliability and machine readability, these levels are explained in the blog post Financial Report Levels. Each level builds on the preceding level:
- Level 0 – Provided physically, such as on printed paper, not machine readable
- Level 1 – Provided digitally, but are really “e-paper”; PDF, HTML, Word, etc.
- Level 2 – Structured for meaning, as contrast to structure for presentation
- Level 3 – Structured for meaning using global standard
- Level 4 – Provide a common dictionary
- Level 5 – Provide a complete set of rules
- Level 6 – Provide report level trust related to where complete set of rules came from and assurances that the rules have not been tampered with
- Level 7 – Provide transaction level trust related to rules and transaction information
Key 8: Standards Convertible into Multiple Technology Stacks
Standards are necessary for effective digital financial
reporting at a global scale. The
Extensible Business Reporting Language, XBRL,
is the de facto standard for digital financial reporting and business reporting
with over 180 XBRL projects in 60 different countries.
Standard methods for implementing XBRL have also emerged
including the ISO Data Point Model (DPM), Standard Business Reporting (SBR), OMG’s Standard Business Report Model (SBRM), European Single Electronic Format (ESEF), and the Seattle Method. There are other approaches to representing
XBRL-based digital financial reports.
But enterprises have different preferences for technology
stacks that they use to implement technologies within their individual organizations. The industry standards group RuleML points out that there tends to be three primary problem solving logic
implementation approaches:
Key 9: Nothing is a “Black Box”
Accounting
is about, well, about accounting for things. Accounting is a Universal Technology for Accountability. As such, any accounting or reporting system must be able to explain and
justify everything, every detail.
Transparency into how conclusions are reached, what rules where used,
lines of reasoning, origin of facts and rules used to reach conclusions, and
information about the problem-solving method used for any logical deduction or
derivation are non-negotiable; they must be provided to creators of
information, consumers of information, and all intermediaries involved in the
process.
This universal technology of accountability is grounded, even ingrained, in medieval traditions. Yet this universal technology of accountability is going to be impacted by structured information, artificial intelligence, digital distributed ledgers, and other such technologies. And they should be. Those same technologies that are causing the ever increasing volume and complexity of information that is overwhelming us is also the solution to the information overload that is being experienced.
Explainable artificial intelligence (XAI) that is rules base is the tool of choice for modernizing this universal technology of accountability.
Key 10: High Level Logical Meta
Model
In order to achieve several of the other keys, a high-level meta model of a business report is necessary, such as the OMG Standard Business Report Model (SBRM) or the Logical Theory Describing Financial Report. The high level logical meta model serves as the consistent model (meta model) that any report model will fit into. The high level meta model also enables the creation of an abstraction that enables the technical syntax, which is hard to understand, can disappear into the background; business users making use of software would deal at the logic level only, never exposed to technical details.
Leveraging the same report model enables, say, the report created by Microsoft to be compared to, say, Google, Apple, and Amazon. But what enables a report submitted to the SEC to be compared to a report submitted to the ESMA? The SEC and ESMA must use the same report meta-meta model. One universal logical meta model will enable an effective standard Universal Digital Financial Reporting Framework. The same software can be used for any financial reporting scheme, which reduces the cost of software for everyone. Competition to differentiate software will be by providing higher level functionality that adds value, rather than support for the proper support for fundamental functionality.
Other resources:
Comments
Post a Comment