Accounting is an information system that identifies, records, and communicates the economic events of an organization to interested users” (Kieso, Weygandt, and Warfield, 2007). Information that is relevant and important to users should be disclosed; unfortunately, some information cannot be quantified through financial data. Certain data cannot be included in the organization’s financial statements. The full disclosure principle explains how companies handle situations that cannot be explained in numerical terms but should be disclosed to the investing public. This paper will explain what is the full disclosure principle in accounting and why has disclosure increased substantially in the last 10 years.
This paper will also address why full disclosure is needed and what possible consequences may occur if companies do not follow these principles.
What is Full Disclosure?”The full disclosure principle calls for financial reporting of any financial facts significant enough to influence the judgment of an informed reader” (Kieso, Weygandt, and Warfield, 2007, p. 1282). For example, certain financial information does not directly influence specific journal accounts.
However, these financial events may influence the future of the company’s or may influence how investors view the financial stability of the company. For example, a high-profile ongoing lawsuit may cause dramatic constraints on the company’s liabilities and assets if the company must pay high litigation fees and settlements.
This type of information has a huge impact on how stable the company seems. Unfortunately, it will not be stated in the financial statements since the case has not been settled. According to the full disclosure principle, the company should disclose this type of information in the notes of the financial statements.
This kind of information influences how investors rate the company’s financial stability and strategic future even though the company has not settled the case yet. Full disclosure also curbs fraudulent accounting acts that can be hidden or omitted from financial statements.
Why Full Disclosure Increased Substantially in the Last 10 Years?The full disclosure principle has substantially increased within the last 10 years due to several reasons. One of the reasons is due to the wake of off-balance sheet financing made public by the Enron scandal (Kieso, Weygandt, and Warfield, 2007). Fraudulent accounting acts made famous by the Enron scandal has prompted the industry to reinforce this principle. Consequently, the SEC called for an expanded disclosure in order to ensure that companies are disclosing all necessary information.
By disclosing information that may affect users, companies comply with the increased reporting requirements recently made by the accounting profession. It also forces companies to disclose information that has the potential of having huge financial consequences to the business. Moreover, the complexity of the business environment, and the need for timely information has increased the need for full disclosure as well. As a result, the SEC enforced the full disclosure principle more fully to help monitor and control business organizations (Kieso, Weygandt, and Warfield, 2007).
Why is Full Disclosure Needed?The Securities Exchange Commission (SEC) and the public have both called for the need to disclose accurate financial information that states all contractual obligations and liabilities must be reported. In other words, full disclosure is needed to ensure that organizations are disclosing all of the necessary information to help investors, creditors, and the public make better and wiser decisions regarding their companies. Full disclosure is also needed to ensure that companies do not commit fraudulent activities like the activities that were committed within the Enron organization. Full disclosure also helps investors determine if a company is as stable as the financial statements appear to be.
Possible ConsequencesFailing to disclose items in financial statements can have several possible consequences. The Enron scandal shows how company executives can be held liable for fraudulent activity. Criminal and civil liabilities may occur if executives fail to disclose financial information that may mislead investors. Another consequence is losing public trust if an organization is caught not disclosing pertinent information. A company may lose high public opinion if shareholders are led to believe that the company was more profitable than what was actually occurring. Moreover, a company may not be able to recover from bad press, litigation costs, and government fines if caught not fully disclosing financial information.
The Sarbanes Oxley Act reinforces the consequences and punishments of not fully disclosing financial information. The main goal of this act focuses on deterring fraudulent acts and cutting down on poor reporting practices. CEOs and CFOs are held personally liable for the accuracy of financial statements; a forfeit of the CEO’s bonuses or company profits may be withheld if accounting restatements are made as well (Kieso, Weygandt, and Warfield, 2007). Independent auditors must be employed to ensure that accurate information is disclosed as well.
The full disclosure principle ensures that relevant and useful financial information is reported accurately to the public. Fraudulent accounting activity has called for stricter interpretations of this principle since criminal, civil, and SEC violations may occur if full disclosure is not followed. The Sarbanes Oxley Act highlights the consequences of not fully disclosing information. These strict guidelines show how the government has responded to accounting activities that attempt to hide certain financial activities. Accounting managers must be aware of the heightened need for fully disclosing all types of financial events or information that may affect the investor’s view of the financial stability of a company.
Weygandt J., Kieso D., & Kimmel, P. (2007) Financial Accounting and Accounting Standards. Intermediate Accounting (12th edition).
Kieso D., Weygandt J., & Warfield T. (2007). Full Disclosure. Intermediate Accounting (12th edition).