Subtitled: A cautionary tale
Since the early days of 1999, and in the eleven years since, the accounting profession has invested hugely in XBRL, and as we all know, accounting firms are a public good, so this investment has had the purest goals of enabling greater transparency and internal company process improvements. And in that spirit, I have no doubt that they will be doing everything in their power to reduce the marginal incremental cost of assurance over XBRL to a net increase of $0 over current audit costs.
It is merely a byproduct of that altruistic concern that will result in potentially (again subject to some very questionable assumptions - see below) anywhere up to an annual $100 million in additional revenue to each of the Big-4 (although possibly "only" up to $30 million from the first wave of filers).
The cautionary message is this: unless the assurance profession finds a way to ensure that the marginal incremental cost of assurance over XBRL is $0, XBRL will be seen as simply another cost burden being placed on American business. Continuing to pile cost onto the producers of the XBRL while delivering the benefits to the users, will increase resistance and endanger businesses acceptance of this new filing requirement.
Lets be absolutely clear - a cost-benefit analysis requires that both the costs and the benefits be defined and measured, and then balanced to confirm a net benefit (and thus support for the proposition) or a net cost (which will only increase resistance). If we do a societal cost benefit, then we can balance individual company costs against societal gains, but it still needs to be quantified.
The SEC, in the XBRL mandate, provided litigation relief for the first two years of production and provision of XBRL with 10Q and 10K filings. At the end of that two year window, filers will no longer have that protection. Does this mean that there is a requirement for the XBRL to be audited? No. Does this mean that companies may be held liable for investment decisions or adverse changes in share values due to erroneous information making its way to the investing community via the XBRL? The answer to that is "the jury is out". Well, actually, since no case has been taken yet, there is still no jury, so maybe that's no the right answer.
In my most recent post, I provided a set of assumptions, and from those assumptions developed a range of potential cost to American businesses to provide XBRL to the SEC. I did not include the cost of audit in that calculation. I'm attempting to do so here.
A reminder, as in my previous post, what follows are assumptions, and reader should accept or change them to fit their own views and expectations. I welcome a different set of assumptions and a different set of expected costs.
- Virtually all of the top 1500 largest filers are audited by the Big-4, and that that those 1500 are 'evenly' distributed across the 4. (I know they are not, but for the sake of basic assumptions...)
- Today the only assurance that can be provided over XBRL is through Agreed Upon Procedures - not an audit and not external assurance.
- The cost of assurance over block-tagged XBRL ranges from $25,000 - $50,000, a range that reliable sources have told me is 'conservative'.
- Assurance professionals, as part of their assurance process, need to look at each extension and confirm that there was not an equally valid existing taxonomy element that could have been used.
- Extension elements (in first year "block tagged" XBRL) are running in the 10s, not the 100s in block tagged XBRL.
- The second year of XBRL production brings in the requirement for block tagging, which is increasing the number of reported elements by up to a factor of 10.
- Extensions in block tagged XBRL are running in the 100s. In one (outlier) case I counted over 700, in another (randomly selected) the number of extensions went from around 10 to over 200.
- External assurance, for the same subject matter, generally required more work and quality assurance than AUP internal assurance.
- Auditor risk will be significantly higher for external assurance over XBRL than for AUP assurance.
- Auditors will have identified process improvements that will reduce a "cost per element", so to speak, or assurance.
- The total effort to audit will be at least 10x the first year (when assurance was voluntary), due to more complex XBRL and a massive increase in extensions.
- Total effort (big assumption, please feel free to modify) will therefore be 8x the AUP (10x the XBRL, more QA, improved processes).
- In all cases, I'm rounding down for additional conservatism.
So, with that behind me, what costs $25,000 today will only cost $200,000 when assurance is required, or should I say, when filers and auditors no longer have litigation relief. And by the same logic, the higher end could easily reach $400,000. But if we settle on an average of $300,000 to provide external assurance over the XBRL, we then have something to extrapolate.
So lets take an average of 360 year-1 and year-2 filers per Big-4. Lets look at $300,000 each. Pretty soon we have over $100 million in additional audit revenue per in 2013. The firms themselves are gathering the information that will validate (or otherwise) these estimates right now, as the first wave of filers leaves the safety of the SEC's two year umbrella.
So some counter arguments
These are pretty wild guesses. What are some of the arguments against these figures? Again, I'll simply list these as if they were assumptions.
- If XBRL really is built into the consolidation process, then there will be less need to actually audit the XBRL. The good news is that this may well be the case, and as such, consolidation software companies could well be selling systems implementations or upgrades purely on the cost saving of reducing the (coming) audit costs. "Spend more money with us or you will spend even more money with them".
- The SEC might extend the litigation relief period - but I wouldn't plan on that. In fact, while the CCR did ask for that, with the re-nomination of Commissioner Aguilar, I'm pretty confident they won't get an extension.
- My numbers could be completely wrong. Well, as with all assumptions, that's a given. The issue is not are the right or wrong, the question is "what are your estimates of the cost based on your assumptions?"
- The assurance profession will identify mechanisms by which the cost of assurance over XBRL can be slashed.
What is happening?
For almost six years various working groups of XBRL International and the AICPA have focused on defining how assurance can be provided over XBRL. Some progress has been made. Yes some sticking points remain. In April 2009 the AICPA released Statement of Position 09-01, "Performing Agreed-Upon Procedures Engagements that Address the Completeness, Accuracy, or Consistency of XBRL-Tagged Data". To date that remains the primary guidance for assurance over XBRL.
The IAASB continues to put XBRL in the "later" basket, although I'm hearing that increased interest in being shown. The PCAOB, official auditing standards setter these days, released a set of Q and A on XBRL in 2005, and to the best of my knowledge they have not updated it since.
Credit should be given to the AICPA, which has been taking the lead, and with the major firms all involved with their task force on assurance over XBRL. Amy Pawlicki at the AICPA has taken on the difficult task of chairing the XBRL International Assurance Working Group, and has not been shy about pushing participants to advance the goals of the Working Group.
I also have no doubt that the major auditing firms have developed, or are developing, software that will automate the vast majority of the checks that auditors are required to perform. Robust automation can radically reduce the overall workload required to assure XBRL. The residual concern is that the firm might not see any benefit in reducing the cost.
In summary, much is happening, and hopefully guidance will be made available that will reduce the marginal cost of assurance over XBRL to a $0 incremental additional cost to filers.
Which leads me to a little disappointment that I have. After my previous post on putting a cost on XBRL, instead of anyone providing an alternative range of cost, the majority of responses (public) were to say that my assumptions were wrong and that I do not factor in the benefits. Or as one person put it: "An analysis that considers the costs without the benefits does not seem like it is very balanced." My response was, and remains "An analysis that considers the benefits without the costs does not seem like it is very balanced." So while advocates of XBRL continue to say just how wonderful XBRL will be (especially if you are a very big company with a lot of money to spend), none of them seem willing to admit that there is a cost to implementation of XBRL.
1. The audit profession must demonstrate how it is driving down the cost of providing assurance over XBRL.
2. I have a difficult time quantifying the benefits of assurance over XBRL, but I am confident that some in the assurance community, and certainly those who have been advocates form XBRL for a decade should by now have quantified the benefits. Please share that information. But it should be quantified.
3. Those who disagree with my analysis should provide a counter analysis that documents their assumptions and the resulting calculated costs to balance against the benefits that they quantified in number 2 above.
4. If you are a filer, ask your auditor how much assurance over XBRL will cost. Demand at least a range and estimate (if you are a 2nd or 3rd year filer).
5. Send me any information you can on what it is costing you or what you have been quoted - I will not post or in any other way allow identification of you, your company or your auditor.