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 which 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 the 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 their investors and fabricated some parts of their 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 which 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, 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 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 asset and liabilities
These are those items which are expected to materialize in the near future based on certain circumstances. For instance, if a company is involved in a lawsuit and it expects that it will win this 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.
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 query 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 the 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, recorded to be used to provide more clarity on the annual reports.