What is the Full Disclosure Principle?
The Full Disclosure Principle states that all relevant and necessary information for the understanding of a company’s financial statements must be included in public company filings. For example, financial analysts who read financial statements need to know what inventory valuation method has been used, if there have been any significant write-downs, how depreciation is being calculated, and other critical information for the understanding of the financial statements.
The full disclosure principle is crucial to ensuring that there is limited information asymmetry between the company’s management and its current shareholders, debtors, or other third parties.
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Explaining the Full Disclosure Principle
The full disclosure principle does not require the release of every piece of available information to the public. On the contrary, the rule would be impractical then, as it would dump a huge volume of information on analysts and investors. The principle urges the disclosure of information that can have a material impact on the company’s financial results or financial position.
The principle helps foster transparency in financial markets and limits the opportunities for potentially fraudulent activities. The importance of the full disclosure principle continues to grow amid the high-profile scandals that involved the manipulation of accounting results and other deceptive practices. The most notable examples are the Enron scandal in 2001 and Madoff’s Ponzi scheme discovered in 2008.
In addition, the full disclosure principle can be used in contractual law. In such a case, the parties in a business transaction must disclose to each other all material information that is related to the execution of a transaction.
Full Disclosure Requirements
Generally, public companies are required to disclose only information that can have a material impact on the financial results of the company. The most common items that the companies must report include the following:
- Audited financial statements
- Employed accounting policies and changes in the accounting policies
- Non-monetary transactions
- Material losses
- Asset retirement obligations
- Details and reasons for goodwill impairment
- Existing litigation
Note that not all of the examples above can be quantified with certainty. However, despite that fact, all items could have a material impact on the company’s financials and must be disclosed.
In addition, a company’s management generally provides forward-looking statements anticipating the future direction of the company and events that can influence its financial performance.
Where is the Information Disclosed?
The information is disclosed in the regulatory filings (e.g., SEC filings) that a public company must submit. The most important filings include the company’s quarterly and annual reports, which contain audited financial statements, various notes and schedules to the statements, as well as descriptive guidance from the management.
In the filings, management also discusses the risks associated with the company’s operations and provides forward-looking statements concerning future decisions and activities.
Conference calls with the company’s management may be used to clarify the information provided in the reports.
Some other filings include the disclosure of the beneficial owners of securities and notification of the withdrawal of a class of securities.
Video Explanation of the Full Disclosure Principle
Watch a quick video below that explains the concept of the Full Disclosure Principle. The video is a small excerpt from our Reading Financial Statements Course.
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