What is the Full Disclosure Principle?

Components

Below is the list of components which are as follows:

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#1 – Materiality

A material item is something that is significant and impacts the decision-making process of any person. When an organization prepares its financial statements, it should ensure that every little detail relevant to any party is included in the books of accounts. If you cannot include it in the financial reportsFinancial ReportsFinancial reporting is a systematic process of recording and representing a company’s financial data. The reports reflect a firm’s financial health and performance in a given period. Management, investors, shareholders, financiers, government, and regulatory agencies rely on financial reports for decision-making.read more, it must be shown as a footnote after the reports.

#2 – Accounting Standards

Accounting standardsAccounting StandardsThe top accounting standard books are - UK GAAP 2019: Generally Accepted Accounting Practice under the UK and Irish GAAP, GAAP Handbook of Policies and Procedures (2021), The Vest Pocket Guide to GAAP, IFRS Guidebook: 2021 Edition, IFRS For Dummies. read more in every country are like traffic rules which everyone must abide by. The accounting standards make it compulsory to disclose the standards followed by an organization in the current year and past years. Also, any change in method or accounting policiesAccounting PoliciesAccounting policies refer to the framework or procedure followed by the management for bookkeeping and preparation of the financial statements. It involves accounting methods and practices determined at the corporate level.read more from last year should be disclosed with the reason specified for the change. It will help the other party to understand the rationale behind the change.

#3 – Auditors

Auditors are one of the components of the full disclosure principle, which is also supposed to ensure that the company has disclosed every vital information in the books or footnotes. In case of any doubt, the auditorAuditorAn auditor is a professional appointed by an enterprise for an independent analysis of their accounting records and financial statements. An auditor issues a report about the accuracy and reliability of financial statements based on the country’s local operating laws.read more sends the confirmation query to any third party. Also, in cases where the auditors are not confident about in-house data, they must seek confirmation from higher management and senior leadership to ensure that numbers in the financial reports reflect credibility.

#4 – Related Party Disclosures

Suppose an organization does business with another entity or person defined by law as a related party. In that case, the former has to disclose it to auditors and in the books of accounts. Related party disclosure ensures that two entities don’t get involved in money launderingMoney LaunderingMoney laundering is a criminal act of legitimizing the money acquired through illegal or unethical means by disguising the origin of the crime.read more or reduce a product’s cost/selling price.

#5 – Contingent Assets & Liabilities

Contingent assetsContingent AssetsA contingent asset is a potential and possible asset of the company in the future based on any contingent event beyond the company’s control. It will be recorded in the balance only if it becomes certain that the economic benefit will flow to the company.read more and liabilities are those that expect to materialize shortly and the outcome of which depends on certain conditions. For example – if there is a lawsuit in process and the company expects to win it soon, it should declare this lawsuit and winning amount as contingent assets in the footnote. However, if the company expects to lose this lawsuit, it should declare it and win the amount as a contingent liabilityContingent LiabilityContingent Liabilities are the potential liabilities of the company that may arise at some future date as a result of a contingent event that is beyond the company’s control. read more in the footnote.

#6 – Merger & Acquisitions and Disinvestment

Suppose the company has sold any of its products or business unit or acquired another business or another organization unit of the same business. In that case, it should disclose these transaction details in the books of accounts. Also, the details regarding how this will help the current business, in the long run, should be mentioned.

#7 – Non-Monetary Transaction

It’s not always that only the monetary transaction impacts the organization and other stakeholders. Sometimes change in the lending bank, appointment or release of an independent directorIndependent DirectorThe term “independent director” refers to a member of the board who is not associated with the organization and who provides a neutral opinion because he or she is not tied to the current management.read more, and change in the shareholding pattern is also material to the stakeholders in the organization. So, the organization should ensure that any of these activities are disclosed in the books of accounts.

#8 – Motive

The rationale behind the full disclosure principle is that the accountants and higher management of any organization do not get involved in malpractice, money laundering, or manipulation of books of accounts. Also, it will be easy to form an informed judgment and opinion about the organization when an outsider has full information about loans, creditors, debtors, directors, significant shareholders, etc.

Full Disclosure Principle Example

Let’s consider that X Ltd. has revenue of $5 Million and above in the last three years, and they have been paying late fees and penalties to the tune of $20,000 every year due to delays in filing annual returnAnnual ReturnThe annual return is the income generated on an investment during a year as a percentage of the capital invested and is calculated using the geometric average. This return provides details about the compounded return earned yearly and compares the returns supplied by various investments like stocks, bonds, derivatives, mutual funds, etc.read more. If this $20,000 club has taxation fees, then not many people will know that this is not a tax expense but late fees and penalties. Simultaneously, if shown separately, an investor might question the organization’s intent to file annual returns as there is a delay consistently in all three years. So as per the full disclosure principle, this $20,000 should be shown under late fees and penalties, clearly explaining the nature, which should be easily understandable to any person.

Advantages

  • It makes it easier to understand financial statementsUnderstand Financial StatementsFinancial statements are written reports prepared by a company’s management to present the company’s financial affairs over a given period (quarter, six monthly or yearly). These statements, which include the Balance Sheet, Income Statement, Cash Flows, and Shareholders Equity Statement, must be prepared in accordance with prescribed and standardized accounting standards to ensure uniformity in reporting at all levels.read more and form a decision;It makes the usage and comparison of financial statements easier.Improves the goodwillThe GoodwillIn accounting, goodwill is an intangible asset that is generated when one company purchases another company for a price that is greater than the sum of the company’s net identifiable assets at the time of acquisition. It is determined by subtracting the fair value of the company’s net identifiable assets from the total purchase price.read more and integrity of the organization in the market; Inculcates best practices in the industry and improves public faith in the organization;Essential for audits and applying for loans.

Disadvantages

  • Sometimes inside informationInside InformationInsider Information is a piece of fact, information or an understanding (M&A, New Contracts, R&D breakthrough, new product launch etc.) which could impact the prices of a listed entity or publicly-traded organizations once disclosed in the public domain. Trading based on such information is considered to be illegal.read more disclosed outside might be harmful to the company.Competitors might use the data against the company, which will be bad for business.

Points to Note about Changes in Full Disclosure Principle

Nowadays, with the development of the accounting systemAccounting SystemAccounting systems are used by organizations to record financial information such as income, expenses, and other accounting activities. They serve as a key tool for monitoring and tracking the company’s performance and ensuring the smooth operation of the firm.read more, it is easy and quick to prepare the books of accounts as all the departments are interlinked through ERP – Enterprise Resource Planning systems. It also makes the disclosure easier as most of the information is readily available from computers. Also, the accountants must ensure to implement any change in the tax rate, reporting format, or any other change before disclosure is made.

Conclusion

The disclosure principle is a vital part of the accounting process of any organization. This policy indirectly emphasizes accurately preparing financial statements on time, which leads to timely tax filings and smooth audit facilitation. It also helps creditors, debtors, and other stakeholders have a clear view of the organization’s financial health. The disclosure also makes it easier for the ordinary public to understand the books of accounts and decide whether to invest or not in an organization. We can consider that the full disclosure principle inculcates overall faith in the organization, which is also good for the economy and country in the long run.

This has been a guide to the full disclosure principle and its definition. Here we discuss components and examples of the full disclosure principle in accounting and its advantages and disadvantages. You can learn more about accounting from the following articles –

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