The full disclosure principle states that information that would “make a difference” to financial statement users or would be useful in decision-making should be disclosed in the financial statements. This way investors or creditors can see a total picture of the company before they choose to take any action.
Companies use the full disclosure principle as a guide to understand what financial and non-financial information should be included in their financial statements. The full disclosure principle states that disclosed information should make a difference as well as be understandable to the financial statement users.
This information is either disclosed in the footnotes of the financial statements or the supplemental information. The financial statement footnotes usually explain the information presented in the body of the financial statements. If an item on the balance sheet is unclear, the notes can be used to explain it. For instance explanations of lawsuits and contingencies might be mentioned in the notes as well as accounting methods used for inventory.
Supplemental information, on the other hand, is extra information that companies may want to show potential investors. This information is usually relevant but is often not very reliable. For instance, management might include its own analysis of the financial statements and the company’s financial position in the supplemental information.
As you can see, these disclosures would be essential for investors, creditors, and other readers of the financial statements to properly view a company’s overall financial position; although, no amount of disclosures can make up for bad accounting. Companies cannot be negligent with their records and disclose everything.
– Guitar Emporium is a nationwide guitar retailer. It reports $10.5M in guitar inventory last year. In the notes of its financial statements, GE should disclose its significant accounting policies. This would include its inventory evaluation methods. GE should disclose whether its financial statements are prepared uses FIFO or LIFO inventory cost methods.
– Lake Real Estate, LLC purchased a piece of property from a foreclosure. A few months after the purchase, someone slipped and fell on the property and became seriously injured. The injured party is currently suing Lake Real Estate for negligence. It is probably that LRE will lose the lawsuit. In this case, LRE should disclose the lawsuit in the footnotes.
– Some other examples of transactions and events that need to be disclosed in the financial statement footnotes include encumbered or pledged assets, related party transactions, going concerns, and goodwill impairments.