Full Disclosure Principle When the full disclosure principle is mentioned some questions may immediately come to mind. Such as, what is the full disclosure principle in accounting? Why is there a need for the full disclosure principle? Why has disclosure increased substantially in the last 10 years? What are some consequences of improper disclosure? The full disclosure principle and these questions are the main focus of this paper. Through the course reading we will break down the full disclosure principle and take on one question at a time. Let’s begin with the first question. What is the Full Disclosure Principle?
The full disclosure principle in accounting is the practice of reporting financial facts significant enough to influence the judgment of an informed user of the financial statements. Information that falls under the full disclosure principle can be found in the main part of the financial statements, the notes to financial statements, or in the supplemental information section. According to former SEC Commissioner, Cynthia Glassman (2006) financial accounting standards and disclosure rules are in place because the SEC wants “companies to present their business and financial condition based on current knowledge and expectations for the future. The full disclosure principle allows investors to make educated investment decisions based upon accurate and timely information presented in financial statements. The full disclosure principle ensures that all relevant information be included in those statements. After analyzing companies financial statements potential investors should be able to determine whether or not to invest in that company and also at what price they should invest. Why is there a need for the Full Disclosure Principle? The SEC is focused on deterring accounting fraud and the full disclosure principle is an integral part of that fight.
Ultimately the full disclosure principle is a vital part in nourishing investor confidence, making companies more transparent, and deterring financial accounting fraud. Disclosure has increased because the business environment has become more complicated and because users demand more information for the purpose of monitoring businesses. The financial scandals at companies such as Enron and WorldCom have caused the SEC and FASB to enact even tighter controls to try to prevent corruption such as this from happening again. It was corruption like this that prompted Congress to pass the Sarbanes-Oxley Act of 2002.
This leads us to the next question. Why has disclosure increased in the last ten years? New regulations within the Sarbanes-Oxley Act of 2002 directly addressed corporate disclosure. According to Commissioner Glassman (2006) “regulatory focus expanded to include corporate governance and the processes and procedures necessary to further induce public companies to provide reliable financial statements and other disclosures. ” The financial fraud committed by the companies mentioned above and others like them have lead to demands for increased disclosure as well as clarification of the disclosure rules.
There are other factors involved in the demand for increased disclosure as well. The evolution or meltdown of economic conditions has played a role as well. The housing market crash as witnessed between 2008 and the present is a great example. It was unfortunate that it took the market crash to bring to light the financial fraud going on within the banking industry. It was revealed that banks were making high risk loans, setting up home buyers with loans that they knew the customer could not afford, and even adjusting information for customers who wouldn’t qualify for certain loans to make them eligible.
This was a stepping stone, years in the making that lead to a meltdown in the economy and downfall of the stock market. An increase in the revelation and discovery of questionable financial practices have lead to the increased demand of disclosure from not only the government and financial analysts but also from the general public over the last ten years. Many people have begun to educate themselves more on the use of financial statements and reporting practices due to these circumstances. People are tired of loosing their investments due to lack of material financial information.
What are some consequences of improper disclosure? There are various consequences for failing to follow proper disclosure practices. Some failures can be chalked up as unintentional. Those failures can lead to financial report user to make bad decisions based upon inaccurate information. If unintentional mistakes are made frequently companies can be fined by the SEC or other government agencies. Intentional failures can lead to extensive fines and even prison sentences. Whether intentional or unintentional these failures will have an impact on a company’s or accounting agency’s reputation—sometimes the damage is irreparable.
Conclusion Full disclosure is crucial! Investors and analysts rely on financial statements to make informed financial decisions. The consequences for failing to follow proper disclosure rules can be phenomenal. References Glassman, C. A. (2006). Speech by SEC Commissioner: “Complexity in financial reporting and disclosure regulation” remarks before the 25th Annual USC Leventhal School of Accounting SEC and financial reporting institute conference. Retrieved from http://www. sec. gov/news/speech/2006/spch060806cag. htm