What is the Full Disclosure Principle in Accounting? - Definition & Application

Instructor: Tammy Galloway

Tammy teaches business courses at the post-secondary and secondary level and has a master's of business administration in finance.

In this lesson, we'll define the full disclosure principle. You'll also learn when it's applied and who benefits from disclosing material events and financial line items.

What Is GAAP?

Do you know the meaning of the acronym GAAP? GAAP represents Generally Accepted Accounting Principles. In sum, GAAP outlines financial reporting standards for publicly traded companies. Juan, a certified public accountant, is facilitating a seminar to hopeful accountants and explains that GAAP is formed by several guiding principles. Today he'll focus on the full disclosure principle which states that an organization must disclose all the information that would affect a reader's understanding of the financial statements. Let's explore more of their discussion.

Full Disclosure Principle

Financial Statements
disclosure

Juan explains that the full disclosure principle applies to all financial statements: the balance sheet, income statement, statement of cash flows, and statement of owner's equity. To minimize the number of disclosures, the principle requires an event to have a material impact on the financials. An accountant asks Juan to further define 'material'. Juan shares that one of the problems with the full disclosure principle is the subjectivity of the word 'material'. However, the Financial Accounting Standards Board (FASB), the entity who manages GAAP, has offered a few examples referencing material elements. Let's take a closer look.

Full Disclosure Applications

Juan explains that there are many examples where full disclosure applies, and here are a few of those examples:

  • Non-quantifiable items - This includes events or line items that have an estimated dollar amount rather than an exact amount, such as a pending lawsuit.
  • Change in accounting principle - GAAP incorporates the cost principle which requires organizations to record assets at their acquisition cost. If another dollar amount such as fair market value is used instead, a solid explanation in the financials is required.
  • Substantial inventory losses - This includes inventory losses due to reduced demand, obsoleteness or spoilage. Under full disclosure, companies must note how and why they accounted for the loss.
  • Goodwill impairment - This occurs when a company purchases another organization for more than its current market value. Disclosure as to the rationale most be stated.

Full disclosures are written in the notes section of financial statements, quarterly reports, or the management discussion and analysis section in a company's annual report.

Now, Juan asks the accountants if they have any questions. One accountant asks why these disclosures are so important. Juan then reviews the purpose of the full disclosure principle.

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