To ensure consistency in financial reporting, businesses must follow a collection of common accounting rules known as the Generally Accepted Accounting Principles or GAAP. The full disclosure principle is one of the central tenets of GAAP and implies that a business should prepare accounts honestly and fully disclose all material information.
Full disclosure is the act of including all relevant information in a company's financial statements so that anyone reading those statements gets a full understanding of the company's financial situation.
GAAP Definition of Full Disclosure
Full disclosure is a core principle of the GAAP, the rules which provide the basis of all financial reporting in the United States. It requires full and complete disclosure of all situations and events that are relevant to financial statement users and that might influence an investing decision. Simply stated, full disclosure means that a company must disclose all material information – good and bad – about the company's financial position so everyone knows where the company stands.
Full Disclosure Principle
Full disclosure exists so that all stakeholders, from potential investors to executives, can understand the financial situation in which a business exists. Without the full disclosure principle, there's a risk that insiders could use non-public information for their own gain or that companies would hide information that portrayed their financial standing in a negative light. A well-known example is the Enron scandal where the company was accused of withholding and fabricating information to investors. The lack of disclosure caused investors to make decisions they otherwise would not have made.
Meaning of Disclosure in Accounting
To have full disclosure you must first have "disclosure," which has a specific meaning in accounting. Essentially, it's the supplemental information attached to a company's financial statements that help to explain what's going on with the numbers. Since a business potentially could release a massive amount of information, it's customary to disclose information that has significantly influenced the company's financial results. For example, a company might include a memorandum explaining the nature of related-party transactions or the effect of foreign currencies.
Why Full Disclosure Is Essential for a Business
Besides the moral imperative of protecting investors and stakeholders, public companies can expect to face serious consequences if they fail to adhere to the full disclosure rules. The Securities and Exchange Commission has the power to police financial reporting behavior and can fine companies millions of dollars for misconduct involving their financial statements. For small, private companies, full disclosure becomes especially relevant whenever there's an external audit, such as when the business applies for financing. External auditors look at how well the company's accounts conform to GAAP guidelines, including the full disclosure principle.