Circular Letter CVM/SNC/SEP No. 001/2011

Circular Letter CVM/SNC/SEP No. 001/2011
Rio de Janeiro, February 24, 2011
SUBJECT: Guidance on relevant aspects to be observed in the preparation of financial statements for the fiscal year starting on or after January 1, 2010

To: Investor Relations Directors and Independent Auditors,

This Circular Letter aims to inform publicly held companies and their independent auditors about the most frequent deviations identified by the CVM, in its supervision activity during the 2010 exercise, in the financial statements of publicly held companies.

As highlighted in the Risk-Based Supervision Plan, the CVM established, among its priorities, for the Biennium of 2009 and 2010, the monitoring of the process of adaptation of companies to the changes introduced by Law No. 11,638/07 in Brazilian accounting standards and practices, emphasizing, above all, an action with an educational character.

This supervision work resulted in the sending of letters to publicly held companies whose financial statements were analyzed, containing recommendations for improvement in the disclosed information. However, considering the rate of deviations identified in the analyzed samples, it is deemed appropriate to call attention, preventively, to the need for company administrators to diligence in order to avoid incurring these same failures.

General Aspects

Broadly speaking, it was found that the main deficiency of the examined accounting statements concerns the disclosure of information in explanatory notes. It is known that one of the most relevant aspects of the new Brazilian accounting scenario concerns the increase in the quantity and quality of information in explanatory notes to financial statements. It is important to emphasize that explanatory notes are fundamental so that users of financial statements are able to identify the accounting practices selected by the company for its preparation, as well as methodological details that allow these users to understand the premises and judgments assumed by management in the recognition and measurement of economic-financial events incurred by the company.

Below, the most frequent deviations identified in the financial statements disclosed in 2010 will be addressed, as well as some specific rules to be observed in the preparation of statements for the fiscal year ending 12/31/2010.

I. CPC Pronouncement 01 “Impairment of Assets”

In accordance with item 132 of Pronouncement CPC_01(R1), the entity is encouraged to disclose the premises used to determine the recoverable amount of assets (cash-generating units) during the period.

However, item 134 requires the entity to disclose information regarding the estimates used to measure the recoverable amount of a cash-generating unit when future profitability goodwill (goodwill) or intangible assets with indefinite useful life are included in the carrying amount of the unit.

In these cases, the entity must disclose the information required in items (a) to (f) of item 132 of Pronouncement CPC_01(R1), for each cash-generating unit (group of units) whose carrying amount of goodwill or intangible assets with indefinite useful life, allocated to the unit (group of units), is significant compared to the total carrying amount of goodwill or intangible assets with indefinite useful life recognized by the entity.

If a portion of goodwill arising from business combinations occurring during the period has not been allocated to a cash-generating unit (group of units) by the end of the reporting period in accordance with item 84 of that same pronouncement, the unallocated value of goodwill must be disclosed along with the reasons why the value remains unallocated.

II. CPC Pronouncement 05 “Disclosure of Related Parties”

Entities must disclose, in the explanatory notes, a broad set of information listed in items 13 to 27 of Pronouncement CPC 05(R1), regarding their relationship and possible transactions with related parties.

It is recommended that all this information be contained in the specific explanatory note on related parties or, alternatively, that a precise reference to another note containing the required information be included in this note.

Among the information required in the aforementioned pronouncement, the entity must disclose the remuneration of key management personnel in total and for each of the following categories: (a) short-term employee and administrator benefits; (b) post-employment benefits; (c) other long-term benefits; (d) termination of employment contract benefits; and (e) share-based remuneration.

In item 13 of the Reference Form, the issuer must disclose, among other information, in table form, by body, quantitative data on the annual remuneration attributed to the board of directors, statutory executive board, and audit committee, segregated between their different fixed and variable components. It is important that the issuer verifies the consistency of the information disclosed in the explanatory notes with this information contained in the Reference Form.

Similarly, attention must be paid to the consistency of the information contained in the explanatory note regarding related parties with the information contained in item 16 of the Reference Form.

It is emphasized that the guidance contained in item 23 of Pronouncement CPC 05(R1) states that disclosures that transactions with related parties were carried out on terms equivalent to those prevailing in transactions with independent parties are made only if these terms can be effectively proven.

Cases were identified where the issuer, in item 16.1 of the Reference Form, declares that its transactions with related parties follow market practices and values, when this information was not contained in the explanatory notes to its financial statements.

We call the attention of those responsible for preparing the financial statements of publicly held companies to include in the respective explanatory note, regarding each transaction or set of relevant transactions, the disclosure of the aforementioned information. In cases where transactions between related parties have been carried out under verifiable market conditions, the issuer must present this information, in accordance with § 23 of the aforementioned Pronouncement. In the case of contracts where it is impossible for these terms to be effectively proven, conditions of the transaction and procedures for its contracting must also be disclosed, in line with the information required in item 16.3 of Annex 24 of CVM Instruction No. 480/09, including measures taken to address conflicts of interest and ensure the commutative nature of the agreed conditions.

III. CPC Pronouncement 12 “Present Value Adjustments”.

As required by Pronouncement CPC 12, the issuer must disclose, in the respective explanatory notes, the premises used by management in the accounting measurement at present value of assets and liabilities.

In item 33 of the aforementioned pronouncement, it is highlighted that, “regarding disclosure in explanatory notes, minimum information must be provided that allows users of accounting statements to obtain an unequivocal understanding of the present value measurements carried out for assets and liabilities, comprising the following non-exhaustive list”:

(a) detailed description of the item subject to present value measurement, nature of its cash flows (contractual or non-contractual) and, if applicable, its quoted market entry value; (b) premises used by management, interest rates decomposed by premiums incorporated and by risk factors (risk-free, credit risk, etc.), amounts of estimated cash flows or series of amounts of estimated cash flows, estimated or expected time horizon, expectations in terms of amount and timing of flows (associated probabilities); (c) models used for risk calculation and model inputs; (d) brief description of the discount allocation method and the procedure adopted to accommodate changes in management premises; (e) purpose of the present value measurement, whether for initial recognition or (f) new measurement and management’s motivation to carry out such procedure.

We emphasize that the above list, although it is a non-exhaustive list of information to be disclosed, must be considered as a minimum set of information that, insofar as applicable, enables the understanding of the criteria used in the present value measurement of the issuer’s assets and liabilities.

IV. CPC Pronouncement 25 – Provisions, Contingent Liabilities and Contingent Assets

Contingent assets normally arise from past events that give rise to the possibility of economic benefits entering the entity and their effective realization may be confirmed or not by the eventual occurrence of one or more uncertain future events not entirely under the control of the entity.

For this reason, it should be highlighted that, as stated in item 57 of the conceptual framework, the concept of asset is linked to the entity’s ability to control the economic benefits arising from that asset or right.

In this sense, contingent assets are not recognized in accounting statements, as their realization is independent of the entity’s control, potentially being a result that may never be realized.

When the entry of economic benefits is probable, the entity must disclose a brief description of the nature of contingent assets at the balance sheet date and, when practicable, an estimate of their financial effects measured, using the principles established for provisions.

When the realization of the gain is virtually certain, the corresponding asset is not a contingent asset and its recognition is required.

In light of all the above, the gain can only be considered as virtually certain in cases where the entity begins to control the economic benefits arising. In other words, the realization of the asset is virtually certain when it is independent of any action or omission by third parties.

In the case of legal actions, even if there is a tendency towards gain, and even if management judges the final victory to be probable, if the other party still has the right to appeal, the situation is not yet considered virtually certain, and therefore, the gain should not be recorded.

In this evaluation, those responsible for preparing the financial statements must consider the principles listed in items 36 to 52 of Pronouncement CPC 25, especially the principles of prudence and true and fair view.

It should also be noted that, in item 4 of the Reference Form, all relevant contingencies must be described, in particular, judicial, administrative, or arbitral proceedings that, individually or collectively, are relevant, in which the issuer or its subsidiaries are parties.

When preparing the explanatory note regarding provisions and contingencies, the entity must ensure that the information contained in this note, in addition to complying with items 84 to 91 of Pronouncement CPC 25, is consistent with the information disclosed in item 4 of its Reference Form.

V. CPC Pronouncement 40 and Guidance OCPC 03 - Financial Instruments: Disclosure

Regarding the topic of financial instruments, it is worth remembering that the set of accounting standards issued by the Accounting Pronouncements Committee (CPC), and approved by the CVM, converges entirely with international accounting standards IFRS issued by the International Accounting Standards Board (IASB), whose guidance is based on principles and not on rules.

In this sense, according to Technical Pronouncement CPC 40, with the aim of providing useful information that allows users to adequately evaluate financial instruments, the publicly held company must disclose in an explanatory note the information that best indicates (i) the significance of the financial instrument for the entity’s net assets and financial position and performance, and (ii) the nature and extent of risks resulting from financial instruments to which the entity is exposed during the period and at the end of the accounting period, and how the entity manages these risks.

Throughout 2010, in the course of the analysis of accounting statements contained in DFP/ITR Forms, in some cases, insufficiencies and omissions of information in explanatory notes regarding financial instruments contracted by publicly held companies were identified, especially regarding derivative financial instruments.

Below, we exemplify some types of insufficiencies and omissions identified, regarding derivative financial instruments:

a) incomplete disclosure regarding evaluation criteria, measurement, methods, and significant premises applied in determining fair value (§79 (d) of OCPC 03 and § 27 of CPC 40); b) unsorted or even insufficient information regarding values recorded in asset and liability accounts and which were not properly segregated, by category, risk, and market strategy (§79 (e) of OCPC 03 and § 31 of CPC 40); c) unsorted information regarding amounts and maturity dates of operations, as well as reference values, cost, fair value, and portfolio risk and counterparties of transactions (§79 (f) of OCPC 03); d) in the case of adoption of hedge accounting methodology, insufficient information regarding amounts transferred from equity due to the accounting recognition of losses and gains in the item subject to hedge (§ 79 (h) of OCPC 3 and § 23 (d) of CPC 40); e) incomplete information regarding the characteristics of embedded derivatives in composite financial instruments (§ 31 of CPC 40).

Additionally, it is important to highlight that companies must present information regarding derivative financial instruments contracted duly reconciled with positions registered in entities authorized to register such operations, especially in the case of contracting over-the-counter (non-standardized) derivatives.

It should also be noted that, in the event of application of resources in exclusive investment funds, in which there are operations with derivative financial instruments, the company must detail the objectives and strategies for the use of these vehicles, as well as proceed to complete disclosure of contracted positions, in light of the parameters established by the Technical Pronouncement CPC 40 itself, notably in cases where, by force of the fund’s regulations, the company is exposed to the risk of covering eventual negative net assets.

It is worth remembering the obligation to disclose the sensitivity analysis table, for each type of market risk considered relevant by management, originating from financial instruments, to which the entity is exposed at the end of each period, required by CVM Instruction No. 475/08 and Technical Pronouncement CPC 40, §§ 40 and 41.

Finally, attention must be paid to the consistency of the information contained in the explanatory note regarding financial instruments with the information contained in item 5 of the Reference Form.

VI. CPC Pronouncement 27 - Fixed Assets

Article 73 of Pronouncement CPC 27 provides that accounting statements must disclose, for each class of fixed assets, among other information, (i) the depreciation methods used; (ii) the useful lives or depreciation rates used; and (iii) the gross carrying amount and accumulated depreciation (plus accumulated impairment losses) at the beginning and end of the period.

The indication, for a set of assets of the same classification, of a very extensive useful life range, such as, for example, 2 to 30 years, does not allow the user of the information to understand the depreciation rate effectively used for those assets. In these cases, the Company must evaluate whether these assets and their respective components should, in fact, have the same classification, and, if so, inform for each set of assets, the expected (weighted) average useful life.

It should be highlighted that the residual value and useful life of an asset are reviewed at least at the end of each fiscal year, and if expectations differ from previous estimates, the change must be accounted for as a change in accounting estimate.

VII. Deemed Cost - Technical Interpretation ICPC 10

CVM Deliberation 619/09 approved ICPC 10, which allows and encourages the application of deemed cost to fixed assets and investment properties, in substitution to the previously recorded carrying amount. This option is applicable only and solely upon initial adoption, and revision of the option in subsequent periods to the initial adoption is not admitted.

It should be emphasized, however, that, as an optional procedure, its non-adoption does not indicate exemption from disclosure. Item II of CVM Deliberation 619/09, which approved the aforementioned Interpretation, must be observed, which determines:

“II – publicly held companies that do not adopt, in the initial evaluation of fixed assets and investment property, the deemed cost provided for in items 20 to 29 of Technical Interpretation ICPC 10 must disclose the fact, in explanatory notes to their financial statements, indicating the reasons that justified the non-adoption, especially in the occurrence of the provision in item 21 of the aforementioned Technical Interpretation”;

Therefore, we alert to the need for broad disclosure of the facts and reasons that led companies, which opted for the non-adoption of deemed cost, to conclude that the carrying value of Fixed Assets and Investment Properties adequately represents the potential for generation of future economic benefits of these assets.

VIII. Reliability of Financial Statements

In social years ending from 12/31/2010, publicly held companies are applying, for the first time, the complete set of new accounting standards in their individual financial statements according to the Technical Pronouncements, Interpretations, and Guidelines issued by the CPC - Accounting Pronouncements Committee, as well as are applying, for the first time, the complete set of IFRS in their consolidated statements according to the specific CPC Pronouncements, documents from the CPC approved by this Autarchy.

In the application of these aforementioned standards, special attention must be given to the interpretation and judgment necessary to achieve the objectives set in the Basic Conceptual Pronouncement - Conceptual Framework and in Technical Pronouncement CPC 26 (R1) – Presentation of Financial Statements.

The CVM reminds that the responsibility for the preparation of the aforementioned statements lies with the company’s management; thus, in cases requiring the exercise of judgment, always keeping in mind the aforementioned objectives, it is necessary for management to analyze, judge, and deliberate on the most appropriate procedure, formally documenting the reasons that lead to the chosen effective procedure.

On the other hand, independent auditors must also exercise their own judgment after analyzing the arguments presented by the company, and must also formalize the reasons why they agree or disagree, totally or partially, with the company’s management position.

In eventual cases of qualification, adverse opinion, or disclaimer of opinion by the auditor due to divergence regarding judgment, the CVM reminds that it will request the documentation supporting the positions of the company and the auditor.

The analysis of the facts and circumstances that underpinned the understandings of the company’s management and its auditors may lead to the determination of republication of these statements, without prejudice to other measures applicable to the specific case.

It should be remembered, furthermore, that, according to Technical Pronouncement CPC 26 (R1) cited:

“9. Financial statements are a structured representation of the entity’s net assets and financial position and its performance. The objective of financial statements is to provide information about the entity’s net assets and financial position, performance, and cash flows that is useful to a large number of users in their assessments and economic decision-making. Financial statements also aim to present the results of management’s performance in managing the entity and its accountability regarding the resources entrusted to it.”

Consequently, the standards are the instrument for meeting these objectives, and not the objective itself of Accounting.

For this reason, it is worth remembering, finally, that, also according to the cited Pronouncement,

19. In extremely rare circumstances, in which management concludes that compliance with a requirement of a Pronouncement, Interpretation, or Guidance would lead to such a misleading presentation that it would conflict with the objective of financial statements established in the Conceptual Framework for the Preparation and Presentation of Financial Statements, the entity shall not apply that requirement and shall follow the provisions of item 20, unless such procedure is strictly prohibited from a legal and regulatory standpoint.”

IX. Independent auditor’s report

On 07/13/2007, CVM issued Instruction 457, subsequently amended by Instruction 485/10, determining that the consolidated financial statements for the year ended 12/31/2010 should be presented adopting the international accounting standard as issued by the IASB. The aforementioned Instruction further determines that in the preparation of consolidated statements, publicly-held companies must use documents issued by the CPC and endorsed by CVM, as they are fully convergent with the aforementioned international standards. However, as described in CVM Deliberation 651/10, which approved CPC 43(R1), a caveat must be made when referring to individual financial statements; that is, in our legal-corporate environment, two exceptions to full convergence with international standards may occur. The first is the application of the equity method in these individual statements, a practice required by our corporate legislation and divergent from international accounting standards when dealing with separate statements, according to CVM Deliberation 607/09 which approved Technical Pronouncement CPC 35/09. The other divergence, permitted by Law 11.941/09, is the maintenance of the Deferred Asset balance existing on 12/31/2007.

Therefore, publicly-held companies that have one or both of the situations presented cannot have their financial statements declared as convergent with international accounting standards.

In this context, special attention must be given to the independent auditor’s report when declaring the set of accounting practices used in the preparation of the financial statements for the year ending from 2010. IBRACON issued Technical Communication 04/2010, approved by CFC Resolution 1320/11, regarding the Issuance of the Independent Auditor’s Report on Individual and Consolidated Financial Statements for the years ended on or from December 31, 2010. In this document, specific audit report models are presented for cases of divergences between the accounting practices adopted in Brazil and international accounting standards.

CVM makes public that it ratifies the guidelines contained in the aforementioned document, as it understands that the content of the auditor’s report models adequately expresses the possible hypotheses of divergences between the accounting practices adopted in Brazil and international accounting standards.

X. Recognition of financial asset in public concessions (bifurcated model)

OCPC 05 deals with the initial recognition of this financial asset in item 22:

“Classification of the financial asset in the balance sheet
22. Item 24 of ICPC 01 allows the classification of the financial asset into three categories, as defined in Technical Pronouncement CPC 38 – Financial Instruments: Recognition and Measurement. Analyzing the Brazilian regulatory environment, and the definitions of CPC 38, it is understood that the financial asset of indemnification, in principle, would be better classified as receivable”. (emphasis added)

CVM alerts that the understanding highlighted above is a result of the analysis of the nature of this asset and its classification within the definitions of financial asset contained in CPC 38. Thus, the initial recognition of the financial asset must be based on its economic essence and not on the effects of subsequent valuations. It should also be noted the need for broad disclosure of the reasons that led the company to decide on a registration different from that provided in OCPC 05.

XI. Regulatory assets and liabilities

The recognition of financial assets and liabilities has been debated by the IASB since 2005, culminating in the issuance in July 2009 of Exposure Draft ED/2009/8 – Rate-Regulated Activities. After the public hearing period ended, the IASB began discussions on the project in meetings in February, June, and September 2010, culminating in the finding of a lack of consensus regarding the definition of whether the recording of regulatory assets and liabilities would be in accordance with the IFRS conceptual framework.

Therefore, we have that the normative framework of the IASB, and consequently of the CPC, does not contain a specific norm on the subject, which leads us to observe items 10, 11, and 12 of CVM Deliberation 592/09, which approved CPC 23 - accounting policies, changes in estimates, and errors:

“10. In the absence of a Pronouncement, Interpretation, or Guidance that specifically applies to a transaction, other event, or condition, management shall exercise its judgment in the development and application of an accounting policy that results in information that is:

(a) relevant to the economic decision-making by users; and (b) reliable, such that the financial statements:
(i) adequately represent the net assets and financial position, financial performance, and cash flows of the entity; (ii) reflect the economic essence of transactions, other events, and conditions, and not merely the legal form; (iii) are neutral, that is, free from bias; (iv) are prudent; and (v) are complete in all material aspects.
11. In exercising the judgments described in item 10, Management must consult and consider the applicability of the following sources in descending order:
(a) the requirements and guidance of Pronouncements, Interpretations, and Guidelines that deal with similar and related subjects; and (b) the definitions, recognition criteria, and measurement concepts for assets, liabilities, revenues, and expenses contained in the Conceptual Framework.
12. In exercising the judgments described in item 10, management may also consider the most recent technical positions assumed by other accounting standard-setting bodies that use a conceptual framework similar to that of the CPC to develop accounting pronouncements, or other accounting literature and generally accepted practices of the sector, to the extent that these do not conflict with the sources stated in item 11”.

XII. Guidance on filling out Form DFP/10 – information from previous years for comparative purposes

Items 38 to 43 of Pronouncement CPC 26, in line with what was already provided by Law No. 6.404/76, in § 1 of its article 176, provide that, in general (except in cases where the entity applies an accounting policy retrospectively or makes retrospective disclosure), financial statements must contain the indication of values from the current and previous years. In the same line, Pronouncement CPC 37, which deals with the initial adoption of international accounting standards.

For this reason, it should be observed that, notwithstanding the already existing legal provision (art. 176 mentioned) for the disclosure of two years, the Form DFP model already provided for the submission of information from the year before last (“three columns”).

This model with the provision for submission of information from the last, penultimate, and antepenultimate years (three columns), considering the relevance of the comparative information presented, continues to be adopted in the new EmpresasNet system. For this reason, the third column is present in the aforementioned form.

Notwithstanding, in the cases of companies that are adopting international accounting standards for the first time, the columns relating to the 2008 year, of the Statement of Profit or Loss, Statement of Comprehensive Income, Statement of Cash Flows, Statement of Changes in Equity, and Statement of Value Added are optional. In these cases, the column of 12/31/08 of the Balance Sheet must be filled with the data from the opening balance of 01/01/09.

We recommend, finally, the reading of Circular-Office CVM/SNC/SEP No. 002/2010, which contains “Highlights of documents issued by the CPC - Financial Statements of 2010”, observing that, as already highlighted in the aforementioned document of the CPC, this work does not replace the full reading of the pronouncements, interpretations, and guidelines, nor should it be considered as a list of the main items of that set of documents for all circumstances and for all companies.

Sincerely,

FERNANDO SOARES VIEIRA
Superintendent of Corporate Relations
Interim

ANTÔNIO CARLOS DE SANTANA
Superintendent of Accounting Standards and Auditing