What is Full Disclosure Principle?
Full Disclosure Principle is an accounting policy backed by GAAP (Generally Accepted Accounting Principles) and IFRS7 (International Financial Reporting Standards), which requires the management of an organization to disclose each and every relevant and material financial information whether monetary or non-monetary to creditors, investors and any other stakeholder who depends on the financial reports published by the organization in their decision-making process related to the organization.
Components of Full Disclosure Principle
Various components of the full disclosure principle are as follows:
#1 – Materiality
A material item is something which 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 which could be important to any party is included in the books of accounts. If it cannot be included in the financial reports, it must be shown as a footnote after the reports.
#2 – Accounting Standards
Accounting standards 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, if there is any change in method or accounting policies from last years, it should be disclosed with reason specified for change. This 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 are also supposed to ensure that the company has disclosed every important information in the books or footnote. In case of any doubt, the auditors have the authority to send the confirmation query to any third party. Also, in cases where the auditors are not confident about inhouse 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
If the organization is doing business with another entity or person who falls under the definition of a related part as defined by law, then the organization 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 laundering or reducing the cost/selling price of a product.
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#5 – Contingent Assets & Liabilities
Contingent assets and liabilities are those assets and liabilities which are expected to materialize in the near future and the outcome of which depends on certain conditions. For example – if there is a lawsuit is in process and the company expects to win it in the near future, 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 this lawsuit and winning amount as a contingent liability in the footnote.
#6 – Merger & Acquisitions and Disinvestment
If the company has sold any of its product or business unit or acquired any other business or a unit of another organization of same business, the organization should disclose the details of these transactions in the books of accounts. Also, the detail 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 another stakeholder. Sometimes change in the lending bank, appointment or release of an independent director, change in the shareholding pattern are also material to the stakeholders in the organization. So, the organization should ensure that any these types of activity 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, when an outsider has full information about loans, creditors, debtors, directors, major shareholders, etc., it will be easy to form an informed judgment and opinion about the organization.
Example of Full Disclosure Principle
Let’s take an example of full disclosure principle in accounting.
Let’s consider that X Ltd. which has revenue of $5 Million and above in last three years and they have been paying late fees and penalty to the tune of $20,000 every year due to delay in filing of annual return. Now if this $20,000 is clubbed with taxation fees then not many people will know that this is not a tax expense but late fees and penalties. At the same times, if this is shown separately, an investor might question the intent of the organization in the filing of annual return as there is a delay consistently in all the three years. So as per 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 of Full Disclosure Principle
Some of the advantages of Full Disclosure Principle are as follows:
- Makes it easier to understand financial statements and form a decision.
- Makes usage and comparison of financial statements easier.
- Improves the goodwill and integrity of the organization in the market.
- Inculcates best practices in the industry and improved public faith in the organization.
- Important for audits and applying for loans.
Disadvantages of Full Disclosure Principle
Some of the disadvantages of Full Disclosure Principle are as follows:
- Sometimes inside information disclosed outside might be harmful to the company.
- Competitors might use the data and use it against the company which will be bad for business.
Points to Note about Changes in Full Disclosure Principle
Disclosure principle is a very important part of the accounting process of any organization. This policy indirectly puts emphasis on accurately preparing financial statements on time, which leads to timely tax filings and smooth audit facilitation. It also helps creditors, debtors, and other stakeholders to have a clear view of the financial health of the organization. The disclosure also makes it easier for normal public to understand the books of accounts and take an informed judgment to invest or not in an organization. We can consider that 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 what is the full disclosure principle and its definition. Here we discuss components and example of the full disclosure principle in accounting along with advantages and disadvantages. You can learn more about accounting from the following articles –