Full Disclosure Principle

The full disclosure principle states that any information that is useful or can make a difference in decision making should be disclosed in the financial statements. In this way, the users of the financial statements including investors, creditors, etc. will have the whole picture regarding the financial position of the company before they make a decision.

The amount of information that can be provided is potentially massive and therefore only information that has a material impact on the financial position of the company should be included. The disclosure can also include items that cannot be quantifiable yet. For instance, an ongoing tax dispute with the government or the outcome of an existing lawsuit.

Full disclosure will also mean that the company must disclose the current accounting policies that it is using, as well as any changes to those policies compared to the financial statements of the prior period.

Financial analysts who are reading the financial statements would like to know what inventory valuation method has been used, significant write-downs that might have occurred, or which depreciation methodology is being followed by the company. Information related to all these questions will be found in the disclosures on the financial statements.

Importance of the Full Disclosure Principle

The full disclosure principle exists so that the users of the financial statements including the investors and creditors have complete information regarding the financial position of the company. Without this principle, it would be highly likely that companies would withhold information that could possibly put the company’s financial position in a negative light.

The most well-known example of a company that went against the full disclosure principle was Enron. It is said that the company withheld a lot of key information from its investors and fabricated some parts of its financial statements. If the investors had known about this beforehand, they would have not invested in the company in the first place.

Advantages of Full Disclosure

There are many benefits to be had by using the full disclosure principle in accounting. For example:

• Financial statements become easier to understand and make decisions on.
• Comparison of financial statements is made a lot easier.
• It improves the reputation and goodwill of a company as it shows the investors that the company is willing to disclose material things and does not intend to hide anything.
• Indoctrinates best practices in the industry.
• It is important from an audit standpoint.

Disadvantages of Full Disclosure

There are a couple of “disadvantages” to the full disclosure principle, but I would argue that these allow a level playing field for all companies to play by the same rules.

• Sometimes a company might disclose information that is harmful to itself.
• Competitors might use the data against the company to gain a competitive advantage.

Full Disclosure Requirements

Public companies, in general, are required to disclose only that information that could have a material impact on the company’s financials. Some of the most common types of disclosures include:

• Non-monetary transactions

Sometimes non-monetary transactions might also impact a company and its stakeholders. For instance, the release of an independent director, change in the lending bank, appointment of a new director, and change in shareholding patterns are items that have a material impact but cannot be quantified.

• Material losses

Materiality can be defined as something which affects the decision-making process of a person. A company should ensure that even the smallest detail which can be described as the material is shown in the financial statements. If they cannot be shown in the financial reports, they must be included in the footnotes after the reports.

• Contingent assets and liabilities

These are those items that are expected to materialize in the near future based on certain circumstances. For instance, if a company is involved in a lawsuit and expects that it will win in the future, the company should disclose the winning amount in its footnotes as contingent assets. However, if the company expects to lose, it should disclose the losing amount in its footnotes as a contingent liability.

• Goodwill impairment

The disclosure relating to goodwill impairment and the methodology used will be included in the footnotes.

• Auditors

This is one of the most important components of the full disclosure principle as they are supposed to ensure that all-important information has been correctly disclosed. In case there is any doubt auditors have the authority to send confirmation queries to any third party.

• Mergers and Divestments

If the company has sold one of its business units or acquired another one, it must disclose this transaction and its complete details in its books including how this transaction will help the company in the long run.

• Existing and changes in accounting policies

The accounting standards make it compulsory for businesses to disclose the accounting policies they have used throughout the accounting period. Additionally, if there has been a change in accounting policy used as compared to prior periods, this must be disclosed as well along with the reason for the change.

Some of the items mentioned above might not be quantifiable with certainty, but they still get disclosed as they may have a material impact on the company’s financial statements. Additionally, some items might be included in the management discussion & analysis (MD&A) section of the annual report as forward-looking statements.

Where is the Information Disclosed?

The material information needs to be disclosed in the regulatory filings (SEC filings) that a company submits. These filings include the company’s quarterly and annual statements, audited financial statements, footnotes, and schedules, as well as management discussion and analysis in which they provide descriptive guidance.

The management discussion and analysis (MD&A) also discusses the risks that the company might be facing or is expected to face on an operational or a strategic level.

Company conference calls can, and often are, be recorded to be used to provide more clarity on the annual reports.

FAQs

1. What is a full disclosure principle?

A full disclosure principle is a concept in which a company must disclose all material information related to finance to its shareholders. This means that no matter how big or small the item might be, it must be included in the financial statements of the company.
The primary aim of this principle is to ensure transparency and accuracy as well as assist investors in making informed decisions.

2. What is the information to be disclosed when referring to the full disclosure principle?

Information to be disclosed includes details about mergers and acquisitions, contingent assets and liabilities, material or non-material losses, goodwill impairment or impairment of assets recorded using the revaluation model, etc.

3. In a full disclosure principle, where is the information disclosed?

The information is disclosed in the regulatory filings such as annual reports and quarterly reports, management discussion and analysis (MD&A), footnotes accompanying annual and quarterly reports, etc. It can also be included in press releases or conference calls with third-party analysts.

4. How does the full disclosure principle work?

The full disclosure principle ensures that all-important and relevant information is disclosed to the shareholders and no material item remains undisclosed. This must be done in a proper manner as per the applicable accounting standards and regulations. This is done through the press releases, and the quarterly and annual reports which get audited by qualified auditors.

Additionally, it is possible to get information clarified using conference calls with third-party analysts or through other disclosures that are made.

5. Why is the full disclosure principle important?

The full disclosure principle is the key to building trust and credibility among shareholders and stakeholders.

Shareholders, lenders, and other stakeholders need material information to make informed decisions that will benefit them in the long run such as whether or not they should sell their stocks or if a company deserves loans.