What is Full Disclosure Principle?

//What is Full Disclosure Principle?
What is Full Disclosure Principle? 2017-10-04T21:43:38+00:00

Definition: The full disclosure concept is an accounting principle that requires management to report all relevant information about the company’s operations to creditors and investors in the financial statements and footnotes. In other words, GAAP requires that management tell external users material information about the company that they can use to base their decisions on.

What Does Full Disclosure Principle Mean?

The purpose of the full disclosure principle is to share relevant and material financial information with the outside world. Since outsiders don’t know the details of a company’s business deals, contracts, and loans, it’s difficult to form an opinion of the entity. Relevant information to outsiders is anything that could change an external user’s decision about the company. This can include transactions that have already occurred as well as future events contingent on third parties. Any type of information that could sway the judgment of an outsider should be included in the financial statements in an effort to be transparent.

Example

Take loan agreements for example. According to the full disclosure principle, management should list the loans along with terms, maturity dates, current portions, and collateral obligations attached to the loans in the notes of the financial statements. With this holistic view of the company’s debt picture, investors and creditors can make their decisions much more easily.

Another example disclosure is contingent liabilities. Companies often face lawsuits from customers, vendors, and competitors. Some of these suits will be settled out of court while others will take years of battling to conclude. External users can’t possibly know what suits and what possible negative judgments the company faces if management chooses not to disclose them. This is why both the full disclosure principle and the conservatism concept require management to disclose in the notes any material negative settlements that could exist in the near future.

Investors and creditors should know if the company is facing a $2M lawsuit that it will probably lose in the next year. The purpose of this principle is to make companies more transparent.