To understand the full import of what Huh is saying, it helps to understand something about accounting. It is something that you have probably suspected all along: Accounting is not about THE TRUTH. (See? You knew that …)
I am not suggesting that anybody is being dishonest. Further, for a great many things that are reported under Generally Accepted Accounting Principles (GAAP), what you see is pretty close to what anyone would judge to be the real state of affairs.
But there are a couple of areas where GAAP is in a state of flux, and
where–for historical reasons–accountants have decided that it is OK for
companies to report numbers that are substantially smaller than the actual liabilities that a company might really have.
One of these areas has to do with reporting on pension liabilities. It wasn’t long ago that companies did not report on these liabilities at all — they simply recognized pension-related expense as they incurred it. But, as future problems in dealing with pensions became more obviously important, it became clear that it was important to reflect SOME of this pension liability on a company’s balance sheet.
But is was also clear that if companies suddenly reflected ALL of this liability, all at once, a great many companies would suddenly go from looking like they were healthy to looking really burdened with liabilities. So, the accounting standard setters decided to create a kind of compromise, where companies must recognize some of this pension liability, but not all of it, all at once. The rules for pension accounting are, frankly, a kludge. They are an attempt to balance a number of concerns by using some arbitrary cut off points and special boundary conditions. The result is that the relationship between pension liability reported on the balance sheet and real liability is slippery, at best.
A second area where the rules of financial reporting can result in some strange distortions is with regard to accounting for operating leases. If you work the numbers right, you can effectively buy something expensive, like an airplane, but not have it show up on your balance sheet. To which a good CFO says, “Cool.” All the advantages of productive assets and none of the unpleasant downside of having to report increased debt.
Elmer Huh focused in on these two areas of potential distortion in his analysis. He showed graphs of debt to asset ratios using the reported numbers for companies — and then showed the ratios figuring in operating lease obligations and pension obligations. The differences were dramatic and had powerful explanatory value when applied to a number of companies that “look” healthy but which are actually having trouble. It was a great, entertaining presentation.
But it was also a good presentation because it said something true and important about XBRL. The reason that Huh could do what he did is that most of the information you need to see the real picture is, by law, disclosed in the notes to the financial statements rather than in the actual balance sheet or income statement. The information that Huh was using was, for the most part, already there in the financial report, but presented in a way that makes it hard to find and use.
In this case, the power of XBRL is in its ability to break free of the standard accounting constraints to recast facts and relationships to see things in new ways. To that, I say “Cool.”
By the way, this same power to free content from presentation, and to rearrange it and present it in new ways, is the flip side of the headache that I described in an earlier posting this evening, about assurance.