Full Disclosure Principle
Full Disclosure Principle is an accounting convention requiring that a firm’s financial statement provide users with all relevant information about the various transactions a firm has been involved in.
The full disclosure principle is a very important concept in business ethics and governance because it can prevent fraud or deception from happening.
When applied correctly, this principle will help maintain trust with your shareholders and investors.
Why Does the Full Disclosure Principle Matter?
When you disclose all relevant information in your financial statements, it demonstrates good faith and trustworthiness to the people you are doing business with.
If you are concealing important information, it can lead to legal problems and cause your investors to lose trust in the accuracy of your financial statements.
You also do not want your business to lose the trust of its customers.
Suppose you conceal important information from your investors. In that case, they may lose trust in your financial statements’ accuracy and integrity, which could result in a lower stock price or even legal action against you for fraudulently misrepresenting yourself as being more profitable than you really are.
Another reason is, if you do not disclose all the relevant information, your investors cannot make good investment decisions.
Lastly, if you do not disclose all the relevant information, your financial statements will be of no value to investors.
How Can This Principle Apply to My Own Business?
From there, writing down everything, so no detail falls between the cracks will ensure you have not forgotten anything.
Be honest about whether or not a transaction has occurred and disclose any relevant information, even if it is embarrassing or unpleasant for either party involved.
The next step is determining what information about these transactions is relevant to your investors or lenders.
You could do this by asking yourself questions like: “What would my investors want to know?” and “Is there anything that might cause them concern if they knew it before investing in our company?”.
Finally, prioritize what is most relevant and provide it first in your financial statements so that everything else can be understood with context by looking at it afterward.
Benefits of Full Disclosure Principle
There are many benefits associated with following the Full Disclosure Principle correctly. This includes:
- By demonstrating trustworthiness through complete honesty regarding your finances, people may become more likely to do business with you because they feel confident their investment will remain safe in your hands.
- This also encourages people to invest in your company because they know that their investment is secure and likely successful if you are honest with them.
- Your stock will most likely rise due to investors having more confidence in the company’s ability to do well financially, leading to more money and resources for the company.
- It is also a safer way to do business because full disclosure of information can prevent legal problems.
- If you are transparent about all your finances, then there is no way to be accused of fraud or misrepresenting yourself in any way.
- Finally, it can save time and money because legal battles cost lots of both, whereas full disclosure will prevent those from happening as often.
Disadvantages of Not Disclosing All Relevant Information in Financial Statements
There are several disadvantages to not disclosing all relevant information in financial statements. These are:
- It can cause legal problems if investors feel they have been defrauded by your company and take you to court over the matter, which could lead to fines or even imprisonment for those responsible.
- When undisclosed transactions are on your financial statements, it is difficult for investors to make sound investment decisions because they do not have all the necessary information.
- Investors can feel like their resources are being wasted if there is money unaccounted for and no one knows where it has gone.
- Suppose you do not disclose everything relevant to your investors and lenders. In that case, they cannot make informed decisions that can cause future problems when certain transactions are expected but never occur.
- Lack of full disclosure could lead to a false sense of security among both employees and investors, which can cause them to make poor decisions that could be avoided with full disclosure and transparency.
- Finally, it is more difficult to correct any mistakes or errors in your financial statements if they are not fully disclosed on the front end because you will need to redo everything without the help of context from other transactions.
Examples of Information That Should Be Disclosed
There are several examples of information that should be disclosed in financial statements.
These include all transactions between you and anyone else (including employees) such as:
- loans with interest rates
- professional services like accounting or lawyers
- salaries for any employee
- all assets and liabilities need to be disclosed on your balance sheet
- all income and expenses need to be disclosed on your profit and loss statement
- disclosure of any tax rebates
- any information that could affect your company’s ability to do business in the future
The Full Disclosure Principle is meant to encourage full honesty in all matters related to financial statements and transactions so that investors and lenders can feel confident about their decisions.
It is important to disclose every relevant transaction on your financial statements because investors and lenders cannot make informed decisions if they don’t have all the information necessary.
This also encourages full transparency so that everyone can see exactly what is going on with their money, which leads to fewer problems when both employees and investors are aware of everything that is going on.
The Full Disclosure Principle can be a hard one to follow because it requires complete honesty and transparency. Still, the benefits far outweigh the disadvantages if you are open with your investors about all relevant transactions and information.
About the Author
True Tamplin, BSc, CEPF®
True Tamplin is a published author, public speaker, CEO of UpDigital, and founder of Finance Strategists.
True is a Certified Educator in Personal Finance (CEPF®), contributes to his financial education site, Finance Strategists, and has spoken to various financial communities such as the CFA Institute, as well as university students like his Alma mater, Biola University, where he received a bachelor of science in business and data analytics.