Disclosure Principle in Accounting Is the Standard

¶ … disclosure principle in accounting is the standard adopted by the accounting profession, which "calls for financial reporting of any financial facts significant enough to influence the judgment of an informed reader" (Kieso, Weygandt, & Warfield, 2007). Obviously, this definition is a very subjective one, because the reporting entity makes the determination of what facts are significant enough to influence an informed reader. "To reduce the amount of disclosure, it is customary to only disclose information about events that are likely to have a material impact on the entity's financial position or financial results" (Accounting Tools, 2011). However, the principle is not meant to be narrowly interpreted, and may require a company to report things that cannot be reduced to numbers on a balance sheet. For example, "this disclosure may include items that cannot yet be precisely quantified, such as the presence of a dispute with a government entity over a tax position, or the outcome of an existing lawsuit" (Accounting Tools, 2011). Moreover, full disclosure involves explaining "existing accounting policies, as well as any changes to those policies (such as changing an asset valuation method)" (Accounting Tools, 2011).

Full disclosure has not always been the norm in the accounting industry. In fact, only a relatively short time ago, full disclosure was not a goal or a principle. However, disclosure has increased substantially in the last ten years. Many people think that this increase has been a response to the financial scandals that have plagued the corporate world in recent times, however some of those scandals actually occurred after full disclosure reporting became the norm. There is even some suggestion that full disclosure may constitute the type of information overload that allows unscrupulous companies to bury unfavorable information. Despite that concern, there are several valid reasons that full disclosure has increased in the last ten years. First, the increasing complexity of the business environment has made it more difficult to summarize a company's economic status in a simply financial statement. "As a result, companies extensively use notes to the financial statements to explain these transactions and their future effects" (Kieso, Weygandt, & Warfield, 2007). Second, users are demanding timely information that is both current and predictive, including published financial forecasts (Kieso, Weygandt, & Warfield, 2007). Moreover, the government views accounting as a potential control and monitoring device, with the hopes of avoiding another Enron-type scandal (Kieso, Weygandt, & Warfield, 2007).

Full disclosure in financial reporting is necessary for a number of reasons. Perhaps the best reason to support full disclosure is that it is good for the market. Countries with the best disclosure have the biggest stock markets (Kieso, Weygandt, & Warfield, 2007). Warren Buffet has stated his belief that higher reporting standards drive excellence (Kieso, Weygandt, & Warfield, 2007). Furthermore, companies face unprecedented pressure to provide overly optimistic financial reports, because stock price is tied to the financial reports, and stock price is oftentimes viewed as the most critical indicator of success for a company (Kieso, Weygandt, & Warfield, 2007). Investors require full disclosure in order to make good decisions about their stock purchases (Kieso, Weygandt, & Warfield, 2007). Moreover, while there can be penalties for improper reporting, including criminal sanctions, the fact is that those penalties are never sufficient to overcome the damage to investors from inadequate or fraudulent reporting. Preventing that type of reporting in the first place protects investors and protects the overall market. In fact, full disclosure should help prevent accounting irregularities, which are mistakes that are intentional. These irregularities often involve underlying illegal acts. Accountants are still required to disclose those acts if a company "derives revenue from an illegal act that it's considered material in relation to the financial statements" (Kieso, Weygandt, & Warfield, 2007). Therefore, at least in theory, full disclosure can help with crime detection, and, because people know these acts must be reported, should also result in some degree of crime prevention.