Definition and explanation:
The full disclosure principle of accounting is related to materiality concept of accounting and talks about the information disclosure requirements for the users of financial statements of an entity. According to this principal, the management of an entity is required to disclose all the relevant and appropriate information (both financial and non-financial) in their financial statements that could impact the decision making behavior of the users of those statements. Such information is made available to stockholders and other users either on the face of financial statements or in the notes to the financial statements.
The financial statements of a company are primarily prepared for the use of shareholders of that company. This allows them to look after the activities of management and to make sure that their company is running profitably. But it is also a fact that shareholders are not the only party of interest that relies on these financial statements. Stakeholders like suppliers, customers, lenders, potential investors etc. also use these financial statements to feed their individual information needs. These external stakeholders analyze and interpret these financial statements to make informed and detailed decisions. Thus, full disclosure principle of accounting emphasizes that any piece of data that could materially alter the opinion or decision of these users must be included in entity’s financial statements. Due to lack of insight about the company’s internal affairs, these statements are vital piece of information for outsiders and full disclosure principle serves as a savior for them.
- If we talk about a loan to a director provided by the company. The full disclosure principle will require the managers of the company to disclose all the information related to that loan arrangement like loan deed itself, the duration of loan, any collateral liability attached and the rate of interest the company is charging to that director etc. So in the light of this data any new possible investors can make their decision about investing in the company with more ease.
- Another example could be the knowledge about the assets and liabilities of a company. Along with the values, the rate of depreciation, the policy of charging depreciation or amortization, the policies about revaluations of assets, any liabilities or provisions that are contingent, any assets that fall under fixed or floating charge, any assets leased, physical condition of the building and machinery etc. could help external users to make more informed decision. Like, for instance, if a bank has related covenants to meet certain liquidity ratios (e.g. current ratio) that depict the company’s capacity to pay its liabilities as they fall due, all the information mentioned above will help the bank decide whether the company meets the requirements of the covenants and based on that information the bank can decide whether it should renew the loan or not.
- If a company expects a change in tax rate in near future, it must disclose this information in some appropriate manner.
- Every company uses certain accounting policies and methods for preparing its financial statements. These policies and methods must be disclosed to the users of financial statements.