04 January 2011

The XBRL Mandate: Opportunities, And Threats, For Non-Big 4 Auditors

I love Francine McKenna's blog "re:TheAuditors". One of the best parts frequently is the comments. When she offered me the chance to guest post, I jumped at the opportunity. So my thanks to Francine, and for your reading (and commenting) pleasure:

Or you can keep reading exactly the same content  here:
For years now, every time someone complains about “auditor concentration” the stock response from the big firms seems to be “the smaller firms aren’t stepping up”, all the while the largest four firms are auditing approximately 98% of the market capitalization of the largest companies on the major exchanges in the US and the UK. While there is, of course, no single reason for this dominance, the ability to invest in technology and quickly adapt to new standards does contribute to smaller firms’ subordination.

Mandates such as XBRL provide an example of how the largest audit firms exploit new regulation to further market concentration for their advantage.

The SEC mandated that companies provide XBRL versions of public company 10-K and 10-Q filings.  This year, 2011, is the “third year” of a three-year phase in. If we’re in the third year, why isn’t XBRL “old news”? Because this year – 2011 – the vast majority of public companies, those with market caps under $75 million, are required to file in XBRL for the first time. The SEC’s estimate is that 8700 companies are required to provide XBRL versions of their filings for the first time in 2011.

How does this “new” reporting standard further encourage audit firm concentration?
Until now, only the largest companies had XBRL on their radar. As a result, XBRL was also on the radar of the largest, global accounting firms. In fact, the Big 4 (and a couple of the next-tier firms) have been active in the development of XBRL for years. So the Big 4 have had more than two years to train a cadre of individuals who understand this new technology and can talk to current and potential clients about it. The smaller firms have been playing the eternal game of “Standards Overload” and catch-up. None of their clients needed to create XBRL (until this year) and, therefore, those firms did not invest in their own knowledge.

If I were a Big 4 business development executive, I’d be taking a very good look at the list of high quality companies – the ones with growth prospects and great audit fee potential – that are not currently Big 4 firm audit clients. New, complex, expensive and time consuming technologies are perfect for FUD: “Fear, Uncertainty and Doubt”. How can I use FUD to poach plum clients from smaller audit firms? I’d make a list of a couple hundred targets for the partners and  give them a script. This is what they should say:
“Mr CFO, did you know that you are required to provide your 10-K and 10-Qs in XBRL? You have to create versions of your reports in this complex, expensive and time consuming standard. Are your current auditors briefing you on this requirement?”
And then they should reinforce the fright formula:
It is very complex, with things like ‘arcroles’ and ‘linkbases’ – things that I don’t understand, but that we have experts that have been working on this for years. Oh, and did I mention ‘detailed tagging’? And, our experts are some of the only people in the world that have actually provided any assurance over XBRL.”
As a Big 4 business development executive, I don’t want the minnows, only the whales. Then the partners go in for the kill…
“We’ve already helped a number of companies just like yours. Maybe a bit bigger, and more complex, but that ensures that our experts will be able to help you through this difficult transition.”
Now the rest of the FUD:
“Of course, your current auditor is a great firm, we know them well. I don’t remember though if they have been involved with this XBRL thing. Maybe you should ask them.”
At this point, it really doesn’t matter if the client does talk to their auditors, the Big 4 partner has already undercut them.  He or she has sown FUD and given the prospective client a great additional reason why the Big 4 just might be the firm for them now.
In summary, here’s how it works:

1. XBRL supported by the Big-4 for years
2. Limited participation by other firms
3. Assurance not well defined
4. SEC mandate not well communicated
5. Smaller audit firms might not be ready
6. Big 4 cherry pick the clients they want to poach, using XBRL readiness / advice as a way in
7. Big 4 cement concentration

And that is how something ‘new’, and, in reality, not that complex – and that does not need to be expensive – becomes another tool to expand Big 4 control. At a minimum, the largest audit firms ensure there is no erosion of Big 4 concentration.
But lets take a look at that FUD.

1. XBRL is not complex. Okay, it is a little complex. But we’re not building an airplane here. We’re producing reporting in a different format. There are lots of tools and processes to make it relatively easy. In addition, the SEC has a comprehensive site to help filers.
2. No human in the CFOs office (or anywhere other than a development shop somewhere) should be worrying about ‘arcroles’, and linkbases. They will be built automatically by any decent XBRL software.
3. Implementation of XBRL does not need to be expensive. The SEC’s estimate was $40,000 – $80,000 for the first year. It is very possible to outsource the production of good quality, SEC-ready XBRL for between $6000 – $9000. So shop around. With the right software, companies (smaller audit firm clients) can produce their own SEC ready XBRL for around $4000 – $5000 plus internal labor costs.
4. ‘Detailed tagging’ will be difficult, but is not required until a company’s second year of filing. By that time they will have more experience, and the software will be even better.
5. The smaller accounting firms have not been involved in the development of the XBRL taxonomies, but haven’t needed to be involved. However, there are people in those firms who do understand XBRL.
6. Finally, even the Big 4 have no real idea how to provide assurance that is cost effective, and today there is no requirement for assurance or an audit of the XBRL.

So while the SEC’s mandate for XBRL is real, and yes, all remaining SEC registrants really must provide XBRL this year, it is not a nightmare. Accounting firms other than the Big 4 have every opportunity to help their clients select the best options. Clients – SEC registrants – have a wide range of options, some very expensive and some very reasonable. The software has had a few years to mature and now is really very good.

But here is a real warning: The SEC estimated that 8700 companies will provide XBRL for the first time in 2011. If companies do not book the resources early, and if their accountants and auditors are not ready to give them options soon, this mandate will turn into a SOX-type cost. Companies – and their auditors – should be talking about, and planning for this, now.

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