What is the Full Disclosure Principle?

What is the Full Disclosure Principle?

Definition

It is necessary to implement the full disclosure principle when preparing a company’s financial statements. According to this principle, a company must disclose all material facts so that investors, lenders, regulatory authorities, and other users of the financial statements, can gain an accurate understanding of the company’s performance and its prospects.

What does full disclosure principle mean?

A company’s financial statements should provide shareholders and other parties with all the information that they need to form an opinion about the business operations of the company. The full disclosure principle plays a vital role in ensuring that this happens.

Consider a situation where a firm prepares its financial statements on December 31. In January of the next year, one of its key export markets bans its products. The company must report this fact even though its impact will be felt only in the subsequent accounting period. Similarly, any other point that has a material effect on the company needs to be highlighted to shareholders and the other readers of the financial statements.

Example of the full disclosure principle

Here is an illustrative list of issues that should be disclosed by a company to comply with the full disclosure principle:

⇨ A company may provide a loan to one of its directors. This information is of relevance to shareholders and must be disclosed.

⇨ There may be a change in the method by which inventories are valued. This could have an impact on the financial performance for the year. Under the full disclosure principle, the details of the change in the valuation method, as well as the financial impact that it has, should be explained.

⇨ A company may be in the middle of a high-value litigation. If the court rules against it, there could be a significant financial impact. The details of the legal matter will need to be revealed in the financial statements

Summary

The full disclosure principle is one of the basic requirements when preparing financial statements. Its role is to ensure that shareholders and other parties receive all the relevant information that they need to form an opinion about the company’s business operations.