The Evolution of the Accounting Quality Model Essay

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The Evolution of the Accounting Quality Model
Sam Ferguson
Regis University

Executive Summary

Charlie Hoffman is credited with inventing XBR, is a computer readable language for financial reporting similar to HTML language except for it allows users to define the tags. Each tag element of the financial data provides the user a linkbases to a set of taxonomies comprised of the Accounting Standard Codification reassuring users the information can be compared to other XBRL reports.

The SEC adapted the XBRL language into its EDGAR system and compliance standards for disclosure in a three-stage process to allow time for registrants to incorporate the technology into their reporting supply chain. Required reports include the 6-K, 8-K, 10-Q, and 10-K as well as supporting detailed footnotes and management discussion & analysis.

The new technology led to the innovation of the Accounting Quality Model (AQM) or “RoboCop.” The “RoboCop” applies various analytical models and tools to each section registrant’s filing as well as comparing it to peer industry groups and the market as a whole to identify outlier information indicative of earnings management. A score is assigned to a based on the level of risk resulting in a comment letter to formal inquiry or worse, a full audit.

In determining the level of earnings quality, the “RoboCop” analyzes discretionary accruals and financial benchmarks of a disclosure. As some of these anomalies easily justifiable, skeptics point out the potential costly disruptions and damaging effects any SEC interaction could have on a business. In response to skepticism, the SEC offers that false positives are kept to a minimum as the AQM’s analysis goes far beyond traditional earnings quality models a well as the final review of the analysis by SEC Examiners.

The flexibility of the Accounting Quality Model is paramount in the SEC’s continued commitment to the proactive detection of fraud in accounting and financial disclosures with the creation of two new initiatives by the current SEC Chairman, Mary Jo White. The SEC announced in July 2013 the creation of two new task forces, the Financial Reporting and Audit Task Force (FRAT) and the Mircocap Fraud Task Force (MFT).

Recommendations for compliance include the following: file accurate XBRL reports; implement conservative accounting practices in accordance with peer industry groups; ensure adequate documentation; stay informed of SEC regulatory matters; and, be prepared for an SEC inquiry.

Introduction

The turn of the millennium ushered in a rash of major accounting scandals and a new high-tech era of big data that offered the policing of fraudulent accounting and report disclosure. The bankruptcy of Enron Corporation in 200l was the largest in U.S. history at that point, resulting in thousands of employees losing their jobs and retirement savings. However, Enron was not alone. Arthur Andersen, Enron’s accounting firm, as well as the largest service firm in the world at the time, ceased to exist after 2002 as a result of being charged with obstruction of justice in the Enron financial fraud case. What led to Enron and Arthur Andersen’s demise was the liberal interpretation of accounting techniques to portray the company’s business activities and financial position in a favorable light motivated by the expectation of stakeholders. Although there are times when a company’s accounting practices are legitimate, it was difficult for regulatory agencies to differentiate between allowable GAAP measures and earnings manipulation without the quantitative analysis of registrants filing. Adding to the challenges was the fact that financial reports varied in format preventing the comparison of one company’s financial benchmarks to their peers. However, while Enron was still a market favorite, a few potential investors were able to painstakingly compile and analyze Enron’s financial data, peered through their veil, and predicted the company…