Question

Sethi & Sons. is in the process of preparing its year-end financial statements. The management decides not to disclose a contingent liability related to a pending lawsuit, as they believe the outcome will be favourable.

1. Discuss the accounting principle that is at risk of being violated.
2. What are the potential consequences of this non-disclosure for the company?

Answer 1

1. The management’s decision not to disclose the contingent obligation violates the Principle of Full Disclosure. This concept states that all material information relevant to the company’s financial situation and performance must be included in the financial statements or supporting notes. This includes contingent liabilities, or possible obligations that may develop as a result of a future event, such as pending litigation.
2. By not deciding to disclose this possible liability, the corporation risks misleading stakeholders about its actual financial situation. If the litigation does not yield a favourable result, the company may be forced to pay a considerable sum, which could affect its financial viability. Nondisclosure of such information can destroy shareholder trust, result in legal consequences, and harm the company’s brand. Financial statement users who make decisions based on insufficient or misleading information may face substantial financial consequences for the company and its stakeholders.