What Is Adequate Disclosure?
Adequate disclosure is an accounting concept confirming that all essential information is included in financial statements for an investor or creditor to rely on when analyzing a company. Adequate disclosure refers to the ability for financial statements, footnotes, and supplemental schedules to provide a comprehensive and clear description of a company's financial position.
- Adequate disclosure is an accounting guideline for companies to report all essential information, including financial statements to investors.
- Adequate disclosure mandates that companies provide a comprehensive outlook of a company's financial position.
- A company's disclosure can include the annual financial results via a 10-K as well as ongoing quarterly results via a 10-Q.
Understanding Adequate Disclosure
Adequate disclosure in accounting practices mandates that all readers of a financial statement have access to pertinent data that would be deemed essential to understanding an entity's financial position.
The accounting standards are set by organizations such as the Financial Accounting Standards Board (FASB), International Accounting Standards Board (IASB), and Government Accounting Standards Board (GASB), which all have rules for corporate disclosures.
Regulatory bodies such as the Securities and Exchange Commission (SEC) have disclosure policies. The SEC regulates the securities markets to protect investors and ensure corporations comply with the rules. Financial Industry Regulatory Authority (FINRA), which regulates brokers and broker-dealers also has disclosure guidelines.
Below are a few of the disclosures required by companies on an ongoing basis as mandated by the SEC. The reports include earnings and financial information for publicly-traded companies on stock exchanges in the U.S.
Annual Report via 10-K
The annual report via the Form 10-K should provide a comprehensive overview of a company's financial condition along with audited financial statements. Companies have 60 days after their fiscal-year close to file their 10-K if they have more than $700 million worth of outstanding shares. Companies with $75 to $700 million worth of outstanding shares have 75 days to report their 10-K.
Besides the financial statements, the 10-K includes a description of the business, listing of subsidiaries, how revenue was generated, and information about the executive management team.
Quarterly Reports via a 10-Q
The 10-Q often has unaudited financial statements and is designed to provide investors with an ongoing financial outlook for the company throughout the year. The 10-Q is to be filed 40 days after the close of the quarter for any company with $75 million or more in outstanding float or shares. The 10-Q contains the financial results for the prior three months as well as the year-to-date numbers.
Along with the annual 10-K and the 10-Q reports each quarter, companies must report via an 8-K any major events that shareholders should know about. The events might include the sale or disposition of assets, bankruptcy, changes in management, mergers, and acquisitions.
Internal and External Audits
Internal and external parties work to ensure that a reporting entity, whether a private-sector company, nonprofit organization, or government agency, provides adequate disclosure for investors, creditors, donors, taxpayers, or other constituents depending on how the information is used.
Internally at a company, for instance, accountants and record keepers would gather transactional details throughout a period and work with an in-house financial auditor to organize the reports.
If there is no in-house auditor for this function, the company would hire an external auditor to organize the books. An internal audit group (not to be confused with a financial auditor) would double-check the integrity of the financial statement compilation process. If it is discovered there is inadequate disclosure in any area, the deficiency would be rectified.
Disclosure of Accounting Policies
Key to any set of financial statements with respect to adequate disclosure is a description typically entitled "Summary of Significant Accounting Policies." In this summary section, located at the beginning of the notes to financial statements, a company outlines its accounting policies as required by GAAP, or generally accepted accounting principles. The section is important to investors since it explains how the accounting policies might impact the financial results being reported by the company.
The summary of accounting policies can contain the accounting practices for a wide range of areas, including the following:
- Principles of consolidation or the companies and subsidiaries under the parent company's control
- Inventory valuation method, including how their cost is calculated
- Liabilities such as how debts and loans are valued and recorded
- Cash and cash equivalents, including the definition of what's considered cash and the length and term of convertible deposits such as CDs that are counted as cash
- Accounts receivable and trade such as how long receivables are expected to be collected from the customers
- Accounts payable or short-term debts to suppliers and the payment terms for when they need to be paid
- Revenue recognition policy such as when revenue is recorded after a sale
- Property, plant, and equipment (PP&E) valuation methods such as whether it's valued at cost as well as the depreciation methods
- Intangible asset valuation tests, such as an asset that was acquired and whether it's valued at fair value at the time of acquisition
- Income tax treatment and any deferred or due taxes
- Investment valuation methods such as securities or joint ventures
The goal of the standardized disclosures is to help investors understand and analyze a company's financial statements. In other words, the revenue received for one company needs to be recognized in the same manner as the revenue for another company in order to compare the financial results accurately. By having a standardized process for disclosure and reporting, investors can make more-informed investment decisions.