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.
Below is the list of components which are as follows:
#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 which could be relevant to any party is included in the books of accounts. If it cannot be included in the financial reportsFinancial ReportsFinancial Reporting is the process of disclosing all the relevant financial information of a business for a particular accounting period. These reports are used by the stakeholders (investors, creditors/ bankers, public, regulatory agencies, and government) to make investing and other relevant decisions. , 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. 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 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. from last year, 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 vital information in the books or footnote. 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. 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 an organization does business with another entity or person who is defined by law as of a related part, then the former has to disclose 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.
#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. and liabilities are those assets and liabilities which expect to materialize shortly 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 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 this lawsuit and winning 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. in the footnote.
#6 – Merger & Acquisitions and Disinvestment
If the company has sold any of its products or business unit or acquired another business or another organization unit of the same business, it should disclose these transaction details 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 is also material to the stakeholders in the organization. So, the organization should ensure that any of these types of 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, when an outsider has full information about loans, creditors, debtors, directors, significant shareholders, etc., it will be easy to form an informed judgment and opinion about the organization.
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 penalty to the tune of $20,000 every year due to delay in filing of annual return. Now, if this $20,000 club with 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 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.
- 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. and form a decision;
- Makes 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. and integrity of the organization in the market;
- Inculcates best practices in the industry and improved public faith in the organization;
- Essential for audits and applying for loans.
- 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. 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 vital 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 the ordinary public to understand the books of accounts and take an informed judgment 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 what is the full disclosure principle and its definition. Here we discuss components and examples of the full disclosure principle in accounting along with advantages and disadvantages. You can learn more about accounting from the following articles –