discussion on "an empirical test of bentham's theory of the

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Towards a New Paradigm for Business Reporting

Miklos A. VasarhelyiMichael AllesRutgers University

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Outline

1. The problem in an evolving environment 2. The solution

2.1 A model 2.2 Objectives of the measurement effort 2.3 The technology 2.4 The information 2.5 Measurement rules

3. Illustration 4. Conclusions

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Rethinking the rationale of current system of financial reporting a) Users are assumed to be unsophisticated (the

“widows and orphans” mentioned at the time the ’33 acts were passed) and incapable of processing more disaggregate information for themselves, and

b) it is costly to prepare and report information on a more timely basis.

Hence: Firms preprocess information to issue highly aggregated, condensations of financial performance, which are often misleading and allow for substantial manipulation.

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The problems

A real-time economy cannot be measured with static measurements. Information age businesses need new metrics and methodologies of performance.

The disclosure model is very broken We cannot measure an information economy set of entities

and processes with an industrial age measurement model And we are internationally converging towards it

Audit opinions on irrelevant measures are irrelevant by itself-auditability is not an integral part of the process.

The malfeasance crisis is not the problem is the inevitable consequence of the above

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The intractable problems of accounting Consolidation Intangibles Materiality Stale, erroneous, and opaque

information Definition of ownership The specification of contractual terms in

the measurement model Valuation

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Intractable (cont)

Deterministic representation of stochastic phenomena

Semantic vs quantitative description of accounting phenomena

The disclosure of predictive information

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Underlying Axioms of a Reengineerd Business Reporting Model A1: This Business Reporting Model is intended to

drive discussion, NOT to impose a particular solution. It is only one input into ranges of potential solutions

A2: When in doubt of valuation, disclose the facts A3: Support estimates A4: Raw, not processed data, panoramic view of

details A5: Standardization of form and substance of

transactions

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Axioms (2)

A6:Multiple-model disclosure A7:Digital standards – not principle-based A8: Data level assurance A9: Information provisioning is a continuum

from internal to external information

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Some new economic facts The technology of conducting business became virtual,

distributed and progressively automated while the reporting technology has remained somewhat stagnant

What is expensive is system setup not the creation of repeated reports (that are not massaged) Eventually most of new proposed reports will be

impounded into ERPSs For the purpose of valuation and reporting many

variables that were important in the industrial economy have limited value on the real-time information economy e.g. inventory and plant

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Outline




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2.1 The Model

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•Investment•Regions•Clients•Dynamics

•Product detail•Regions•Clients•Dynamics

•Inventory•Distribution•Ownership•Dynamics

•Collection•Aging of receivables•Clients•Dynamics

• Drill Down• History• Distribution

Data level

Sales change = Incremental Marketing cost * 2.7 +- 12%E-Care queries = number of sales * 4.1Delay relationships

Relationship level

Structural level

SalesMarketingA/R

Cash

Bad Debts Provisioning

Inventory

E-Care

Analytic monitoring levelKPIs: Marketing/Sales Ratio Inventory turnover Intra-company transfers



Continuous Reporting Continuous Assurance

Transaction assurance, Estimate assurance, Compliance assurance,Judgment evaluation

Monitoring and Control: 5 levels of activity

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The Proposed Extreme “Solution”: GALILEO

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A solution for some of the ailments Creation of a multivariate measurement

model that does not focus exclusively on earnings per share and allow for users to predict and evaluate business on a multivariate basis even if these measurements are in different dimensions (apples and oranges)

Creation of a measurement model that is oriented not only to investors but to the other stakeholders of business

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2.2 Objectives

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Objectives

Create a business measurement and communication methodology that is Competent measurement of business Highly resilient to manipulation Appropriate to the different constituencies

(stakeholders) More objectives

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System Reliability

Financial and Non-Financial Measures

Information Dissemination

Understandable Disclosures

Corporate Accountability

ELEMENTS OF ENHANCED BUSINESS REPORTING

CONVERGENCE TO “NEAR

REAL-TIME”

Technology

Measurement

Information

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2.3 Technology

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Medium/Technology Not on paper Web display Database background A la a OLAP (Online Analytical Processing) cube

display Rich in visuals Enriched footnote as a web page taxonomy Web enriched video and audio explanation of key

issues Web commenting on risks by management and

auditors XBRL – XML – XBRL/GL enabled

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ERPS / RDB

Basic OLAP Cubeand data warehouse

StakeholderStyle Sheets





XML derivative transactions/XBRLGL

ActiveWeb

Pages

Intelligent Agents

Aggregation Layer

M&C layer

Authorization and Authentication Layer

Cross-sectio

nal

Benchmarks/ data

Stakeholders

Basic Stakeholder Driven Disclosure Technology

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With technology

The report is user-driven living thing, with automatic updating, based on the life-cycle of the process Relationships update automatically Partners / Outsourcers work together Users are a part of the reporting process

User’s reactions are part of the reporting process

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2.4 Information

Non-financial / financialExogenous /Endogenous

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Dimensions of Disclosure Publicity

Granularity

Frequency

Dimensions

Division

Geography

Product

Fields / variables

Nature of Use

User sophistication

Articulation with Others

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Continuous reporting

It is paradigmatically different from traditional reporting Different reporting structures are to emerge Mainly internal reporting not external Processes have different life rhythms Part of the real time economy monitoring and control

management Closely linked to continuous assurance level process by

process

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Stochastic reporting alternatives that are context dependent Report on the number (best estimate) Report on the number and reliability Report on number and range of

estimate Report on a range Do not report on aggregates just

intermediates that add up

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Access control matrix and level of public availability

Public availability is defined for each stakeholder based on: Need for data/decision Account/performance measure Frequency of data Drill down permission

Stakeholder Account/access allowed /frequency/Drill-down

Creditors Cash/yes/daily/no

Customers Cash/yes/monthly/no

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2.5 Rules of Measurement (Accounting)

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Accounting Methodology (G-GAAP) Raw not processed data ..e.g. inventory layers

not FIFO or LIFO Digital standards – not principle-based Multiple-model disclosure Panoramic views in detail

E.g. when options expire and their terms Form of estimate (uncertainty, ordinal, yes/no) Data level assurance (due to the balkanization of

data) When in doubt disclose

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The new accounting 2.5.1 The business reporting portal 2.5.2 Virtual Entities (consolidation) 2.5.3 Non-financial information 2.5.4 Relationships 2.5.5 Dynamic Valuation 2.5.6 Disclosure of KPIs and Analytic Monitoring 2.5.7 Points of comparison 2.5.8 Future Oriented Information 2.5.9 Formalization of Business Artifacts 2.5.10 Real time support of estimates

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2.3.1 Business reporting portal

Meet our management

Meet our People

Meet our owners

Meet our customers

Meet our stakeholders

Introducing

Contracts ContingenciesNoteworthy

eventsFootnotes relationships Measuring

EvaluatingFinancial

benchmarksPoints of

ConparisonComparing

relationshipsConsolidating

Drilling down and modeling

DisclosingMeet our Physical assets

Meet our Intangible

assets

Financialreports

Otherreports

BS IS FF 10K HR IP MktgOSHA

Access and Aggregation Control Matrix

OLAP Cube Access Level

Insurancereport

NaïveInvestorreport

Bankersreport

AdvancedInvestorreport

Unionsreport

Value chainpartnerreports

Outsourcingpartnerreports

Paid buildYour own

reports

Transaction levelaccess

Comparison agents

Krons and self-activatingagents

Cookie crumbs andControl tags

Automatic confirmationProtocols

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Many non-business reporting disclosures

OSHA

FCC

EPA

DOT

FERC

IRS

CENSUS

Financial

Statements

Internal forecasts Exogenous data

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3.5.2 Virtual Entities

Risk based reporting for each stakeholder “Pure play” segments

Full set of information Consolidation by user

Based on disclosed parameters Ownership, dependence, inter-company transactions Different models available (cost, equity, pooling)

Cross-sectional for segments Along the value chain

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Virtual Entities

Manufacturer

Consolidation Parameters

Dot.ComFinance

CompanyService

CompanyLease

Company Ownership

Inter-company transactions

Relationships

Contingencies

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Virtual Entities

Supplier A

Supplier B

Supplier CSupplier D

Client A

Client B

Client CClient D




Partial consolidation along relevant variables

Lease

Company

Service

Company

Finance

Company

Dot.Com

Manufacturer


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2.5.3 non-financials

(focus on redundant multi-source disclosures) HR Markets / marketing / sales and budgeted sale IP Sustainability Resources used Channels and their contribution Supplier managed inventory Contractual and non-contractual contingencies Reserves Forecasts

disclose the model and data used broken down by edl /rdl/ fdl discussion of forecast assumptions

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Types of Measures in Use

Typical Measures: Quality of Output Customer Satisfaction/Retention Employee Turnover Employee Training R&D Productivity Environmental Competitiveness, and Company-specific measures.

Source: New Corporate Performance Measures

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2.5.4 Relationships

Structural relationships (# of shipments)[t+] = *(# of P.O.’s)[t] + .

Simultaneous continuity equations (# of shipments)[t+1] = 1*(# of P.O.’s)[t] + 1,

(# of vouchers)[t+2] = 2*(# of shipments)[t+1] + 2.

Empirical relationships (PGC # of employees) =3*(labor costs)[t+1] + 2.

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2.5.5 Dynamic Valuation

The value of an item is not an invariant You cannot reasonably value all things in

common bases (AFR 190, SFAS 33) The real-time economy and technology

allows for ongoing valuation Different categories of assets cannot be

valued the same way therefore their addition is non-sensical

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Valuing assets

Tangible assets Property Inventory

Non-tangible assets The HR asset chart The IP chart The marketing chart The supply chain chart

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Valuation factors

Hyperlinks New benchmarks

Use –ebay factors (new business for them) Real estate comparables (new business) Aggregate value chain comparables B2B / B2C price lists

Why depreciation? Very misleading –must be abandoned as new measurements can be made

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3.5.6 KPI’s and Analytical Monitoring Plane seat occupancy

By route By day With partners

PREDICTS MONTHLY INCOME Sales of PCs

PREDICT TECH SUPPORT CALLS Hospital Bed Occupancy

PREDICT HOSPITAL RESULTS

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3.5.7 Points of comparison (POCs) To achieve comparability in a world of widely

diverging reporting and process aggregation key POC metrics are to be defined

These will be compared time-series and cross-sectionally at the virtual entity level

POCs will be single metrics, ratios, KPIs and a wide set of relationships

POCs will be the key elements for analytic monitoring

XBRL/GL will have to be granular enough to satisfy industry-based mandated POCs

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Points of comparison – POCs (as statutes) POCS

For each major process For some basic assets For the basic liabilities For relationships

As numbers, ratios, relationships and KPIs

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Points of Comparison (POCs)

Process or variable Metric / point of comparison

Human resources Pension retirement matrixSummary of training and investment on HR

Brand Brand value assessment and method

Intellectual capital Number of patents granted and appliedExpenses in R&DExternal valuation of IPMethod of valuation and estimates

Marketing Market shareIndustry ranking

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3.5.8 Future Oriented Information

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3.5.9 Formalization of Business Artifacts Fuzzy organizational structures actions and

outcomes Taxonomy of business financial instruments Taxonomy and structures of footnotes

Definition of real-time structures Structuring and Formalizing MD&A Digital standards are basic to the above

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3.5.10 Structured support of estimates Usage of POCs that require that certain common

estimates be disclosed together with key variables Hyperlinks to spreadsheets with the exact method of

calculation of the estimate Parameter estimate reconciliation sheet Bottom line effect sheet showing the effect on one of

the forms-of-income of the above estimate changes Provide a simulator spreadsheet for user sensitivity

analysis with some guidance to user

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Outline




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Illustration outline

1. The business reporting portal

2. The security / access sheet

3. Virtual entities OLAP

4. Points of comparison /benchmarks

5. Dynamic valuation

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Basic Stakeholder Driven Disclosure Technology

ERPS / RDB

Basic OLAP Cubeand data warehouse






XML derivative transactions/XBRLGL

ActiveWeb

Pages

Intelligent Agents

Aggregation Layer

M&C layer

Authorization and Authentication Layer

Cross-sectio

nal

Benchmarks/ data

Stakeholders

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Publicity is defined for each stakeholder based on: Need for data/ decision/ Is set for each account/ KPI Determines the access rights by the frequency of the data Drill down (level of detail) permission

Access control matrix and level of “publicity” analogy

Stakeholder Account/Access allowed /Frequency/Drill-down

Creditors Cash/yes/daily/no

Investors Cash/yes/monthly/no

Suppliers Inventory/Yes/Real Time/Yes** for their products only

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Authorization and Authentication

User Name

Password

ENTER

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2.3.1 Business reporting portal

Meet our management

Meet our People

Meet our owners

Meet our customers

Meet our stakeholders

Introducing

Contracts ContingenciesNoteworthy

eventsFootnotes relationships Measuring

EvaluatingFinancial

benchmarksPoints of

ConparisonComparing

relationshipsConsolidating

Drilling down and modeling

DisclosingMeet our Physical assets

Meet our Intangible

assets

Financialreports

Otherreports

BS IS FF 10K HR IP MktgOSHA

Access and Aggregation Control Matrix

OLAP Cube Access Level

Insurancereport

NaïveInvestorreport

Bankersreport

AdvancedInvestorreport

Unionsreport

Value chainpartnerreports

Outsourcingpartnerreports

Paid buildYour own

reports

Transaction levelaccess

Comparison agents

Krons and self-activatingagents

Cookie crumbs andControl tags

Automatic confirmationProtocols

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Open Financials

Welcome to Galileo’s Reporting

Operations

Supply chain Information

HR Reporting

Compliance Reporting

Benchmarking

OLAP

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Galileo’s Financials

Generate Reports by frequency

Detailed account report

Choose your virtual entity

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The Virtual Entity

Choose Subsidiaries

Choose Outsourcing

Partners

Choose Upstream Supply Chain

Choose Downstream Supply Chain

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Calculate

Galileo’s Financials- Detailed Account Report

Choose your AccountChoose your Account

FrequencyFrequency

Choose the Level of detailChoose the Level of detail

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Calculate

Point of Comparison/Benchmarking

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Valuation

Independent third party valuation Based on publicly available databases

Objective No human intervention in the process

Reliable Assurance on the algorithms that are used

Range of valuation assessments Max, Min, Likely calculate as

Value=(4*Likely+1*Max+1*Min)/6 Report all values

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Catalyst 6500 Cisco Switch

Independent trusted third party assessor Use automated algorithms Use eBay to check recent sales Use MySimon, PriceGrabber and other

comparison shopping agents to assess the fair market value.

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Outline




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Conclusions

New and improved accounting and reporting requirements and mechanisms are needed to meet our commitment to the user/public marketplace of the 21st century.

The accounting profession cannot create a new business reporting model by itself

Continuous reporting is emerging Already exists internally in certain forms It is paradigmatically different from traditional

reporting

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Takeaways

User driven reports/ appropriate to different constituencies

More data/ higher frequency/drill down capability Less potential manipulation Dashboard of all external reports Virtual entities/segment reporting/ subsidiaries

breakdown/consolidation of commitments to suppliers.

Technology is the facilitator XBRL/OLAP/Web

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ATTACHMENTS

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Real time economy

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XML derivative transactions

Traditional data item

Explanatory labels (tags)

•Identity, units, source, etc.

Control labels

•E-signatures, sequence numbers, invisible markers,

•Control signals

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Financial-related Web Services in the future (the universal data bus)

Audit Servic

e

Accounting bots and services

SelectiveLayered

Reporting

Fraud detection Service

FinancialAnalyticServices

ERP

Other Assurance

Services

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ERPS / databases

reports

Decision

Xbrl/gl

standards

alarm

Management actionThe digital data life-cycle: reporting layer

Continuous reporting: balances

Continuous reporting: transactions

Serv. purchase

Inv. purchase

Labor purchase

XBRL

Auditor alarm

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Inv. purchase

Labor purchase

Serv. purchase

ERPS / databases

reports

Continuous reporting

Decision

Xbrl/gl

standards

alarm

ContinuousAssurance

The digital data life-cycle:the umbrellaof assurances

•Transaction assurance

•Estimate assurance

•Rule assurance

•Judgment assurance

Management action

Data level assurance

Othertertiary

assurance

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Miscellaneous Issues

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3.5.4 Relationship: logical, other disclosures, OSHA

disclosuresP.P &E

Pension

Guarantee

Corporation

Pension

Costs

IRS

disclosures

Multiple

Financial

Items

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Do we add them together?

Business reporting item Precision

Cash 99%

Receivables 95%

Inventory & PP&E 75%

Intangibles Not specifiable

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Enhanced Business R eportingO rganization of R eporting C ategories

Prism R eport Form at

B /S

I/S

R a tios

S tm t. o f C /F

C a p tl' M kt

F o o t N o tes

T a ng ib leA sse ts

(XBRL Driven )

In d u s tryT re n ds

M a c ro

K P I

M a rke tS h a re

M ic ro

E xe cu tiveS u m m a ry

O ve rv iew

P a te n ts

C o p y R ig h ts

C o n tra c ts

L icen ses

D e s ig ns

T ra d e m a rks

In tan g ib leA sse ts

S o c ia lR e co rds

E n v.R e co rds

L eg a lR e co rds

S a fe tyR e co rds

T a xR e co rds

G o ve rn m e nt(P e rfo rm a n ce)

L e ad e rsh ip

W o rk fo rceC a lib re

O rg an iza tionD e s ign

In no va tio n /R & D

R isk &O p po rtu n it ies

G o a ls &O b jec tives

G o ve rna n ce

S tra te gy

D is tin c t

C o re

R o utine

In tan g ib leC o m p e ten c ies

E B R

Frequent Disaggregated Reliable

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Real-Time analytics

Company Competitor BCompetitor A

Product line

Growth

Geographical Location

Product line

Growth

Geographical Location

Expected Sales

Supplier A Supplier B

Extract XBRL tagged data and perform real-time analytics and performance evaluation.

Economic

Indicators

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Problems

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The real time economy requires models Models to compare with actuals both at the variance

level as well as the extent of variance evaluation level

Models that are adaptive and responsive to conditions such as Spikes, cyclicality and process relationships

Models that can be kept updated constantly and are executed automatically

Models that are applied at a non- “cookable” level (say validated transactions)

Models that can be analytic, can be empirical benchmarks, that can be structural logical, etc.

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Risk Management and Contingency Disclosure Disclosure of key risk factors Quantification of some of these factors Disclosure of management risk contingency

plans

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Consolidation

Unresolved at the FASB for 20 years Deconstruction (and outsourcing) of business is

breaking the idea of consolidation SPEs are legitimate, their accounting is un-

accountable Adding parts creates a very false sense of reality

and security Comparisons should be at the virtual entity

levels A new type of aggregate entity should be

invented

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Intangibles

Should not be added to total assets May be measured in not financial terms and

linked to business reports through the relationship level as well as through POCs

Intangibles will have different measurement and valuation bases

Should not be added together or with financial numbers

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Materiality

Concept will be replaced by “accuracy of measurement”

Basic audit, precise audit, and super audit Audit will be justified on the basis of

improving data quality not agent certification Auditors will place an imprimatur on data at

the tag level Wider audits, intervening audits, ubiquitous

audits, control rating audits, casuistic audits

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Stale, erroneous, and opaque information Ultimate drill down to the transaction levels of

all related parties !!!! Business report a living thing dependent on

intrinsic business process rhythms In case of doubt give data not models or

aggregates Disclose the time-series bases of aggregates

and estimates

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Definition of ownership

Create rigid structures of ownership Allow for user choice re: aggregation Further disclose the nature and structure of

owners Link more control and percentage of

ownership Tough laws on obfuscation!!!!!!!!!!

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The specification of contractual terms in the measurement model Where clear obligations are not available a

deeper standard of disclosure applies E.g. legal, operational, and contractual

contingencies Management compensation contracts at a

much deeper level… a fully descriptive taxonomy is needed

Hyperlinks to fuzzy contracts or non-standard financially engineered contracts

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Valuation

High fluctuation transaction-based values following real-time indices

Valuation change do not flow thru income, they have their own valuation income account

Present value of any future income flow with allowance for best-estimators (and their variance)

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Deterministic representation of stochastic phenomena Processes, nature of account, inter-process

controls and other lesser items determine reliability of numbers at the transaction, reporting aggregate, and general ledger levels among many.

Assurance / audit processes change these values on a continuous basis (real time seal, alarms, control tickers, points of comparison)

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Probabilistic reporting

BS, IS,

FF etc

Reported as estimates at the account level

Control

points

Reported as an index at all times with variances and

history drill downs, specially affected by alarms as well

as the environment

Database

Quality

measures

Risk

scorecards

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Semantic vs quantitative description of accounting phenomena Heavy use of hyperlinks joining semantic

descriptions with simplified qualitative extractions

Key items required POCs in most common footnotes and textual

description materials (e.g. marketing, pensions, accounting policies, etc.)

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The disclosure of predictive information

Past focused reporting

Current continuous reporting

Leading indicators and relationships

Forecasting and models

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Objectives

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Additional Objectives

Drawn directly from operational and cross-sectional information

Provides measures of all subunits, and links to related ones

“Consolidatable” across any structure of entities

Measurements as estimates (stochastic) Data supportable at the atomic level

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Additional Objectives (2)

Real time information feeding real time agents

Reportable events detected and automatically reported

Competitive intelligence protected Data level assurance Management accountability improved

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Slice and Dice

Reg

ion

Frequency

Monthly

Product

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The power of the drill-down

Reg

ion

Frequency

Monthly

Product

BS – IS -- FF

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The power of the Hyper-links

Service XML

Inventory XML

Labor XML

Web site

taxonomies

agent

Cookie crumbs

Automatic confirmations

discussion on "an empirical test of bentham's theory of the

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