Circular Letter CVM/SNC/SEP No. 01/2004

(Substituted by Circular Letter CVM/SNC/SEP No. 01/2005) CIRCULAR LETTER/CVM/SNC/SEP No. 01/2004 Rio de Janeiro, January 19, 2004

To the Gentlemen
Directors of Investor Relations and
Independent Auditors

SUBJECT: Closing of the Fiscal Year

Dear Sirs,

The Circular Letters issued by the CVM technical area aim to disseminate the main problems and considerations in the application of Accounting Standards applicable to Publicly-Held Companies. These comments have the broader objective of improving accounting information for the market and the consequent convergence with international accounting standards and accounting practices related to the application of corporate legislation. In addition to this purpose, the circular also aims to alert publicly-held companies and their auditors about deviations observed in the information disclosed to the market regarding their standards and accounting principles, and, in some cases, their relationship with international standards issued by the IASB.

This year, aiming to facilitate access to the guidelines issued by these Superintendencies, we decided to consolidate all circular letters regarding the closing of the fiscal year, eliminating provisions that were applicable at the relevant time, updating and reorganizing various items contained in those circulars, and adding new topics that we consider important to disseminate. In this process, and following a commitment of the CVM to IOSCO, we sought, whenever we did not encounter a legal impossibility, to base our work on the guidelines emanating from the International Accounting Standards Board – IASB.

It is important to emphasize that the CVM has been seeking, over the years of its operation, to improve and keep its accounting regulatory framework updated, always with the participation of interested segments of the market or the accounting profession. In this consolidation, we must mention the important collaboration received from the CVM Accounting Standards Advisory Committee, which includes representatives from ABRASCA, APIMEC, CFC, IBRACON, and FIPECAFI/USP.

In this edition, all items were subject to review and alteration, so that for each next edition, the new Circular Letter will replace the previous one. However, it is worth highlighting some items that were added:

a) disclosure of non-accounting measurements (EBITDA), in item 1 - Presentation of Financial Statements; b) example of explanatory note and reformulation of content, in item 8 – Segment Reporting; c) accounting, as an extraordinary item, of the initial adjustment of the actuarial liability for the coming years, in item 12 - Employee Benefits; d) Ibracon communication 03/03 regarding the disclosure of government concession contracts, in item 13 - Accounting for Government Concessions; e) comment on the international pronouncement and the CVM governance booklet, in item 16 - Related Party Disclosures; f) investment acquired from an investee with negative net equity, consolidation of special purpose entities (SPEs) and reverse acquisition (CVM Instruction No. 349/01), in item 17 - Consolidated Financial Statements and Accounting for Investments; g) introduction to the international pronouncement IAS 35 regarding the disclosure of discontinued operations, in item 19 - Discontinued Operations; h) introduction regarding the aspects related to the accounting and disclosure of share-based payment contracts, in item 21 - Share-Based Payment; i) guidance on the rotation of Independent Auditors, conflict of interest, disclosure of non-audit services, and examination of technical qualification, in item 24 – Audit.

This Circular Letter consolidates the Circular Letters issued by the CVM regarding accounting standards and the disclosure of information, and replaces the following circulars:

Circular Letter/CVM/SEP/SNC No. 01/1994
Circular Letter/CVM/SNC/SEP No. 02/1994
Circular Letter/CVM/SEP/SNC No. 01/1995
Circular Letter/CVM/SEP/SNC No. 02/1995
Circular Letter/CVM/SEP/SNC No. 03/1995
Circular Letter/CVM/SEP/SNC No. 04/1995
Circular Letter/CVM/SEP/SNC No. 05/1995
Circular Letter/CVM/SNC/SEP No. 01/1996
Circular Letter/CVM/SNC/SEP No. 02/1996
Circular Letter/CVM/SEP/SNC No. 03/1996
Circular Letter/CVM/SNC/SEP No. 04/1996
Circular Letter/CVM/SEP/SNC No. 01/1999
Circular Letter/CVM/SNC/SEP No. 01/2000
Circular Letter/CVM/SNC/SEP No. 02/2000
Circular Letter/CVM/SEP/SNC No. 01/2002
Circular Letter/CVM/SEP/SNC No. 02/2002
Circular Letter/CVM/SEP/SNC No. 03/2002
Circular Letter/CVM/SEP/SNC No. 01/2003
Circular Letter/CVM/SEP/SNC No. 02/2003

The content of this Circular Letter was distributed in the following items:

1. Presentation of Financial Statements
2. Provision for Doubtful Accounts
3. Social Information
4. Inventories
5. Net Income or Loss for the Period, Fundamental Errors and Changes in Accounting Policies
6. Construction Contracts
7. Income Tax
8. Segment Reporting
9. Information Reflecting the Effects of Price Changes
10. Property, Plant and Equipment
11. Revenue
12. Employee Benefits
13. Accounting for Government Concessions
14. Effects of Changes in Exchange Rates
15. Borrowing Costs
16. Related Party Disclosures
17. Consolidated Financial Statements and Accounting for Investments
18. Financial Instruments: Disclosure, Presentation, Recognition and Measurement
19. Discontinued Operations
20. Provisions, Contingent Liabilities and Contingent Assets
21. Share-Based Payment
22. Corporate Matters
23. Special Topics
24. Audit.

Sincerely,

Signed Original by
OSMAR COSTA JÚNIOR
Superintendent of Corporate Relations
In Exercise

Signed Original by
ANTONIO CARLOS DE SANTANA
Superintendent of Accounting and Auditing Standards

CIRCULAR LETTER/CVM/SNC/SEP No. 01/2004 4

1. Presentation of Financial Statements

1.1 Disclosure and the Objectives of the CVM

One of the objectives of the CVM is to create conditions for the promotion of efficient resource allocation through the capital market, with a view to attracting and retaining the investing public in this market.

The improvement of information available to the investor constitutes one of the most important tasks of the regulatory body to achieve this objective and meet the informational needs of the user. In this way, economic decisions by these investors can be more secure, in addition to providing an additional gain in reducing information collection costs about publicly-held companies.

The purpose of the CVM's regulatory activity is, in this context, the maintenance of efficiency and reliability in the capital market, in view of the public interest, considering these attributes as fundamental conditions to ensure the development of this market. Acting to reduce differences between companies in terms of disclosure, measurement, and methods used in the preparation of financial statements and to promote the change from quantity to quality of this information is a task that comprises the scope of the exercise of regulatory activity.

The attribute of financial statements, internationally considered the most noble by capital markets and the academic community, is that they are capable of allowing analysts and investors to predict the future cash flows of the businesses of publicly-held companies.

In this sense, the CVM's concern is to emphasize to publicly-held companies that the accounting practices to be adopted, among the possible alternatives, must be those that most appropriately reflect the respective companies' financial and economic situation, the results of their operations, their cash flows, and the changes in their net equity. Accounting practices defined for tax and/or sectoral regulatory purposes are limited to such purposes, and do not necessarily lead to adequate and transparent financial statements for capital market purposes. Whenever not explicitly prohibited by legislation or regulation, accounting practices for the purpose of financial statements intended for capital markets must prevail the economic substance of the transactions that give rise to them, even when the substance contradicts their legal form.

The choice of "what" to disclose, "how" to disclose, and "how much" to disclose is an exercise of business common sense, ethics, and subjectivity. There are no objective rules that, once met, fulfill all the requirements of good disclosure; such requirements are built, primarily, by administrators, accountants, and auditors capable of exercising responsible subjectivity in the formulation of accounting policies and in the decision of the disclosure to be made.

Therefore, to achieve the objectives to which it is destined, the set of financial statements made available to the market must disclose all information that is relevant for the assessment of the present and future financial position; it must disclose, especially, future commitments and obligations that may have an impact on the financial and economic situation of the company, even if they do not yet constitute liabilities and, therefore, are not yet recognized in the financial statements.

1.2 The Evolution of Corporate Reporting

The need to support investor decisions, increasingly complex due to innovations in financial and capital markets, has pressured companies to change their information disclosure practices and the accounting procedures involved in these issues.

It is also observed that a large number of companies whose reports do not present adequate information to meet investor needs. Although the same formal structure of reports has been maintained over the years, the evolution of decision-making models of accounting information users and the increase in the complexity of companies' operations demand a new level in the informational quality of corporate reports of companies.

The quality of corporate information disclosure is determined by the content and integration of the entire set of qualitative and quantitative information expressed in the Financial Statements, IAN, ITR, and DFP forms, Management Reports, and Independent Auditors' Reports. This quality determines how far it is possible to achieve success in communication with the investor community and, more broadly, with all agents of the capital market. The general principle for the disclosure of this information establishes the duty of the publicly-held company to make timely and adequate disclosure of relevant information about its business, in exchange for the capital received from investors. This principle is regulated in the obligation to prepare and distribute this information, to allow investors to analyze the factors that affect the risk and return of the business, considered necessary for decision-making.

In this context, some of the fundamental aspects to be observed by companies are:

• the relevance of the information provided;

• the transparency in the disclosure of information;

• the equality in access to information;

• the timeliness and continuity of disclosure.

• the relevance of the information provided

Not just any type of information benefits the functioning of the market. Disclosure must be necessary and sufficient to facilitate the investor's decision, without confusing it with an excess of information, that is, understanding as relevant that which can alter the investor's perception and be capable of allowing the comparison of the performance of the same company over time and of it with other companies. As an example, we can cite the following situations that must be reflected in the set of accounting information (the set of annual and quarterly financial statements) and non-accounting information (the IAN form – annual information): high indebtedness and the need to roll over short-term debts, significant variations, by gains or losses, permanent or temporary, in market share and sales volumes, exposure to exchange rates, relevant loan operations with related parties, risk of obsolescence in product technology, patents, or assets, effects of declining or fierce competition (exit or entry of new protagonists, launches of products widely accepted by customers), volatile operating margins, patents developed or acquired, by the company or by competitors, with the power to influence demand, horizontal diversification of business, verticalization or not of the "supply chain" or of production processes, regulatory or legal changes of representative impact, positive or negative, on the financial and economic position or on the results of operations, and significant changes in corporate governance and/or risk management practices.

• the transparency in the disclosure of information

The information must also be disclosed in a clear and concise manner, and must not vary according to the type of investor. It is assumed that the investor to whom the information is directed is capable of understanding the aspects of returns and risks of the company, and is willing to undertake the necessary efforts in the study of the corporate report.

• the equality in access to information

The disclosure of reports must obey the principles that information must be disseminated in a broad, transparent, and equal manner, and that all market participants must have simultaneous access to them.

• the timeliness and continuity of disclosure

Disclosure must occur in time for the investor's timely decision, avoiding losses due to procrastination in providing the information; this principle is demonstrated by timeliness, that is, the information is due as long as it has the capacity to influence investment decisions. In this sense, the continuity of information disclosure is fundamental for the investor to be able to evaluate the situation of the invested position and decide on buying, selling, or holding securities.

The aspects of equality and timeliness are especially important for companies that have their securities traded in more than one market, such as those that, in addition to shares, are also issuers of ADRs and debentures. These companies must meet the users of their information through the filing of various forms with regulatory authorities – CVM and Stock Exchanges – as well as, through voluntary efforts, make this information available through websites, press releases for news agencies, and interviews, after the broadcasting made public by filing.

The content of press releases is often formatted differently from the information contained in the forms filed and disclosed through the public distribution systems at the CVM and Stock Exchange. A new format is, strictly speaking, new information and, therefore, must be equally registered with the CVM and disclosed for general public access.

1.3 The Company's Information Disclosure Policy

The publicly-held company's information disclosure policy, here understood as the organization of information regularly distributed to the market, is constituted by the choice of various forms that observe the principles of relevance, transparency, equality in access, and timeliness. It must be established with the objective of integrating information and avoiding deviations in the perception of this information. These deviations are characterized as those that may arise from omissions and irrelevant content. The qualitative information expressed in the Management Report, Explanatory Notes, IAN tables, and Performance Comments in the ITR must be, for example, integrated by the most relevant information for the understanding of the company's operations.

When deciding on the matters to be disclosed, administrators establish a structure constituted by the main issues of the operation, that is, a central axis for the information organized in the various statements and forms. The expression – disclosure policy – is, in this context, the set of choices made in the search for the best way to communicate the company's activities and performance, or still, the choice of the most important information so that investors obtain the type of knowledge that supports them in evaluating the company. This vision creates additional value to the investor through the increased understanding of the company's situation and prospects and is reflected, therefore, in the appreciation of its securities.

Although there is no "standard" model to be sought for such a disclosure policy, it is guided by the minimum requirements contained in corporate legislation and accounting pronouncements, industry conditions, facts, and circumstances that are specific to the company, business acumen, and the ethical sense of administrators and accountants. The practical objective of this policy is to explain to the users of the financial statements the performance that is the result of the daily exercise of administering and making business decisions.

1.4 Clear and Objective Language

Financial statements are prepared and disclosed with the objective of bringing to the knowledge of shareholders and other interested parties the financial and economic position of the company, the results of its operations, its cash flows, and the equity changes that occurred during the period.

The investing public needs to understand the information prepared and disclosed by companies, so that it can take rational economic decisions within the analysis of trends and risk propensity of each, in addition to fully enjoying the protection assured by corporate legislation.

In this line, it is the responsibility of administrators in the preparation of financial statements, and of independent auditors in audit reports, to construct texts whose understanding is simple and direct for a reader audience moderately familiar with accounting, business, and finance.

The information produced and disclosed by publicly-held companies, especially those contained in the Financial Statements, the Management Report, and the Independent Audit Reports and Opinions, electronic forms IAN and ITR, must be drafted in a simple and direct manner, allowing an average reader audience to understand the data contained therein and to use them for decision-making.

It is not contemplated to make the drafting of documents disclosed by companies simplistic or banal, but rather the use of common and usual language, prioritizing the clarity of the exposition, in order to communicate, in a simple way, information that is often of a complex nature. The complexities of the transactions and businesses of companies do not necessarily mean complexity of communication.

Expressions and language whose understanding presupposes very specific knowledge belonging only to those people who deal exclusively with accounting and/or financial matters should be avoided. The use of foreignisms or jargon (specific to business, finance, or accounting sectors) should only be tolerated when all simplifying alternatives are inappropriate.

The Administrators of companies must ensure that the set of financial statements constitutes, in this way, a piece that allows the knowledge of the current situation of the company and the facts and events that occurred that led to the determination of results and the changes that occurred during the period.

Financial Statements are communication mechanisms, as effective (or ineffective) as their ability to reach the perception of those to whom such communication is directed. For this purpose, it must be considered that the increase in the volume and complexity of the text does not contribute to the relevance of these reports.

1.5 Explanatory Notes

Disclosure is one of the basic objectives of Accounting in the Capital Market, so as to guarantee all types of users complete and reliable information about the financial situation and results of the company. The explanatory notes that integrate the financial statements must present quantitative and qualitative information in an ordered and clear manner so that the capacity to communicate relevant aspects of the content presented in the statements is exhausted.

The explanatory notes must discriminate, clearly and objectively, the clarifications necessary for the correct understanding of the content of the financial statements, based on the items provided in § 5 of art. 176 of Law No. 6.404/76. This implies that the explanatory notes do not treat the exception of any accounting procedure in the statements but rather clarify a set of integrated information. Explanatory notes must avoid obviousness as well as elaborate writing; their main objective is to disclose to the reader of financial statements: a) which alternative was chosen for an accounting treatment when there is more than one accepted, or b) expand information that is not feasible in the body of the pieces that constitute the set of financial statements. Especially (but not only) all potential or contingent liabilities, possible or probable,

CIRCULAR LETTER/CVM/SNC/SEP NO. 01/2004 9 reflected or not in the accounting statements shall be evidenced in notes or in demonstrative tables. The demonstrative tables should be used to discriminate relevant investments, financial leasing, guarantees, loans and financing, and other information where the quantitative aspect predominates.
Generic notes should be avoided because they provide a disservice to competent information and are detrimental to analysis, such as "... rates permitted by legislation..." or, redundantly, "... prepared in accordance with the law...", or even, "... in accordance with corporate, tax legislation and specific standards of the regulatory bodies of the matter...".
Regarding redundancy, note that the unnecessary reporting that "...were prepared in accordance with the law..." stems from the fact that it is not admissible to confess that it could be different (which would mean disobeying the law).

1.6 The Quality of Accounting Information
The production of accounting information is broadly supported by the Basic Conceptual Framework approved by CVM Resolution No. 29/86, which helps preparers of accounting statements, administrators, accountants, analysts, investors, and auditors in applying and understanding the criteria for evaluating asset items and accounting standards and practices. This basic conceptual framework also helps users in interpreting the set of accounting statements when evaluating and inferring about the numbers and information contained in these statements. With the objective of clarifying and expanding the concepts expressed in that Resolution, we transcribe below the content of the "Qualitative Characteristics of Accounting Information" as presented in the IASB pronouncement on the "Conceptual Framework for the Preparation and Presentation of Financial Statements" (International Accounting Standards, 2001, p.49 - 53.)

"Qualitative Characteristics of Financial Statements
24. Qualitative characteristics are the attributes that make financial statements useful to users. The first four qualitative characteristics are: understandability, relevance, reliability, and comparability.

Understandability
25. An essential quality of the information presented in financial statements is that they be readily understood by users. To this end, it is presumed that users have a reasonable knowledge of business, economic activities, and accounting and the willingness to study the information with reasonable diligence. However, information on complex matters that should be included in financial statements, because of their relevance to users' decision-making needs, should not be excluded merely on the pretext that they would be difficult for certain users to understand.

Relevance
26. To be useful, information must be relevant to users' needs in their decision-making. Information is relevant when it influences users' economic decisions, helping them to assess the impact of past, present, or future events, confirming or correcting their previous assessments.
27. The predictive and confirmatory functions of information are interrelated. For example, information about the current level and structure of assets has value to users in their efforts to predict the entity's ability to seize opportunities and its ability to react to adverse situations. The same information serves to confirm past predictions about, for example, how the entity might be structured or the result of planned operations.
28. Information about financial position and past performance is frequently used as a basis for projecting future financial position and performance, as well as other matters in which users are directly interested, such as dividend and salary payments, changes in bond prices, and the entity's ability to meet its obligations as they become due. To have predictive value, information does not need to be explicitly projected. The ability to make predictions based on financial statements increases, however, depending on how information about previous transactions and events is presented. For example, the value of the income statement as an element of prediction stands out when unusual, abnormal, and sporadic items of revenue or expense are presented separately.

Materiality
29. The relevance of information is affected by its nature and materiality. In some cases, the nature of the information alone is sufficient to determine its relevance. For example, reporting a new segment of the entity may affect the assessment of risks and opportunities faced by the entity, regardless of the value of the results achieved by the new segment in the period covered by the financial statements. In other cases, both nature and materiality are important, such as the values of existing inventories in each of the main classes of inventory, according to the appropriate classification for the business.
30. Information is relevant if its omission or misstatement could influence the economic decisions of users taken based on the financial statements. Materiality depends on the size of the item or error, judged in the specific circumstances of its omission or misstatement. Thus, materiality provides a threshold or "cut-off point," rather than being a primary qualitative characteristic that information needs to have to be useful.

Reliability
31. To be useful, information must be reliable. Information has the quality of reliability when it is free from material error, and when users can place confidence in it as faithfully representing what it says it represents or what could reasonably be expected to represent.
32. Information may be relevant, yet so uncertain in its nature or representation that its recognition could potentially be distorted. For example, if the validity and value of a claim for damages in a legal action are questioned, it may be inappropriate for the entity to recognize the total value of the claim in the balance sheet, although it would be appropriate to disclose the value and circumstances of the claim.

Faithful Representation
33. To be reliable, information must faithfully represent the transactions and other events that it claims to represent or could reasonably be expected to represent. Thus, for example, a balance sheet should faithfully represent the transactions and other events that result in the entity's assets, liabilities, and equity at the balance sheet date, which meet the recognition criteria.
34. Most accounting information is subject to some risk of not fully achieving faithful representation of what it intends to portray. This does not occur due to preconceived ideas; however, it occurs due to inherent difficulties, either in identifying the transactions or other events to be measured or in establishing and applying valuation and presentation techniques that can convey information corresponding to such transactions and events. In certain cases, measuring the financial effects of items could be so uncertain that entities generally do not recognize them in financial statements; for example, although many entities generate internal goodwill over time, it is usually difficult to identify or measure this goodwill with certainty. In other cases, however, it may be important to recognize items and disclose the risk of error involving their recognition and measurement.

Substance Over Form
35. For information to faithfully represent the transactions and other events it intends to represent, it is necessary that these transactions and events be accounted for and presented according to their essence or substance and economic reality, and not merely their legal form. The essence of transactions or other events is not always consistent with what appears based on their legal form or formal documents. For example, an entity could sell an asset to a third party in such a way that the documentation indicated the legal transfer of ownership to that third party; however, there may be agreements ensuring that the entity will continue to enjoy the future economic benefits generated by the asset. Under such circumstances, reporting the sale would not faithfully represent the transaction performed (if indeed there was a transaction).

Neutrality
36. To be reliable, the information contained in financial statements must be neutral, i.e., impartial. Financial statements will not be neutral if, through the choice or presentation of information, they influence decision-making or judgment in order to achieve a predetermined outcome or result.

Prudence
37. Those who prepare financial statements, however, face uncertainties that inevitably involve certain events and circumstances, such as the possibility of collecting doubtful accounts receivable, the probable useful life of the factory and equipment, and the number of complaints covered by warranties that may have been given. Such uncertainties are recognized by disclosing their nature and extent and by exercising prudence in the preparation of financial statements. Prudence consists of including a certain degree of caution in formulating judgments necessary in the preparation of estimates under conditions of uncertainty, so that assets or revenues are not overstated and liabilities or expenses are not understated. However, the exercise of prudence does not allow, for example, the creation of hidden reserves or excessive provisions, deliberate undervaluation of assets or revenues, deliberate overvaluation of liabilities or expenses, as financial statements would cease to be neutral and, therefore, would not have the quality of reliability.

Completeness
38. To be reliable, the information contained in financial statements must be complete, within the limits of relevance and cost. An omission can render information false or misleading and, thus, unreliable and deficient in terms of its relevance.

Comparability
39. Users must be able to compare the financial statements of an entity over time, in order to identify trends in its financial position and performance. Users must also be able to compare the financial statements of different entities, in order to evaluate, in relative terms, their financial position, results, and changes in financial position. Consequently, the evaluation and presentation of the financial effects of similar transactions and other events must be done consistently across all entities and over various periods and in a consistent manner for different entities.
40. An important implication of the qualitative characteristic of comparability is that users must be informed of the accounting policies followed in the preparation of financial statements, any changes in these policies, and the effect of such changes. Users need to be in a position to identify differences between the accounting policies applied to similar transactions and events, used by the same entity from one period to another and by different entities. Compliance with International Accounting Standards, including the disclosure of accounting policies used by the entity, helps achieve comparability.
41. The need for comparability should not be confused with mere uniformity, nor should it be allowed to become an obstacle to the introduction of improved accounting standards. It is not appropriate for an entity to continue accounting for a transaction or event in the same way if the adopted policy is not in conformity with the qualitative characteristics of relevance and reliability. It is also inappropriate to keep its accounting policies untouched when there are more reliable and adequate alternatives.
42. Since users wish to compare financial position, results, and changes in financial position over time, it is important that financial statements show the corresponding information from previous periods.

Limitations on the Relevance and Reliability of Information Timeliness of Information
43. If there is undue delay in reporting information, it may lose relevance. Management may have to establish a balance between reporting information at the opportune time and providing reliable information. To provide information at timely dates, it may be necessary to report information before all aspects of a transaction or other event are known, thereby compromising reliability. On the other hand, if, to report information, there is delay until all aspects become known, the information may be highly reliable, but of little use to users who needed to make decisions in the meantime. To achieve a balance between relevance and reliability, the prevailing principle is to use the best way to meet the needs of users' economic decision-making process.

Balance Between Cost and Benefit
44. The balance between cost and benefit is a pervasive limitation, rather than a qualitative characteristic. The benefits derived from information must exceed the cost of producing it. The evaluation of costs and benefits, however, is essentially an exercise of judgment. Moreover, costs do not necessarily fall on those users who enjoy the benefit. Benefits must be exploited by other users, beyond those for whom the information was prepared; for example, providing more information to lenders may reduce the borrowing costs of an entity. For these reasons, it is difficult to apply the cost-benefit test in a given case. Despite this, standard-setting bodies, especially, as well as preparers and users of financial statements, should be aware of this limitation.

Balance Between Qualitative Characteristics
45. In practice, it is sometimes necessary to make a balancing or accommodation between qualitative characteristics. Generally, the objective is to achieve an appropriate balance between the characteristics, in order to satisfy the objectives of financial statements. The relative value of the characteristics in different cases is a matter of professional judgment.

True and Fair View/Fair Presentation
46. We often say that financial statements reflect true and fairly the financial position, results, and changes in financial position of an entity. Although this Conceptual Framework does not deal directly with such concepts, the application of the main qualitative characteristics and appropriate accounting standards normally results in financial statements that portray what is generally understood as a true and fair presentation of this information.".

1.7 The Statement of Results and Economic Measurements Based and Not Based on Accounting Standards
The use of economic measurements not based on accounting standards, such as earnings before interest, income taxes, depreciation, and amortization – EBITDA, or in comments in the management report and in other informational pieces disclosed by publicly held companies, leads to the need for guidance on the necessary conditions for the understanding of these measurements by users of accounting information. The relevance of disclosing measurements not based on accounting standards is evident, given that it intends to influence users' economic decisions by adding elements not foreseen in the structure of usual reports of accounting-principle-based financial statements. To expand the understanding of this subject, a review of the general concepts associated with these types of measurements was made for better comprehension by those responsible for disclosure to the capital markets.

1.7.1 The Objectives of the Statement of Results
The objective of the Statement of Results expresses the understanding of the economic perspective, according to the pronouncement on the Basic Conceptual Framework. In reading the corporate law, we find the reference regarding this statement: "In determining the result of the fiscal year, the following shall be computed, according to § 1 of article 187 of Law 6.404/76:
a) revenues and earnings earned in the period, regardless of their realization in currency, and b) costs, expenses, charges, and losses, paid or incurred, corresponding to these revenues and earnings".

1.7.2 The accounting principles involved
The Statement of Results intends to present the economic perspective in the accounting view in a way that is useful to the user, who generally uses this statement as a data base for performance measurements and for evaluations of the company and its securities. The principles directly involved in the organization of this statement are the Revenue Recognition Principle and the Matching Principle of Expenses with Revenues and with Accounting Periods. As a general rule, the Revenue Recognition Principle considers revenue realized when the realization process is complete or virtually complete, that is, the effort to obtain the revenue has already been developed, and there has been a transaction. The Matching Principle, also called Accrual, determines that all expenses, representing sacrifices of assets in the pursuit of revenues occurring in a certain period, shall be matched with the respective revenues recognized in that same period, and that gains and losses, comparable or not with Revenues and Expenses, shall be equally recognized when incurred. In the evaluation process based on the profit concept advocated in accounting principles, utility (relevance) and practicability (objectivity) are also important.

1.7.3 The concept of Revenues and Expenses
The concept of Revenues and Expenses is related to the movement of economic benefits present in the financial position, here understood as that which contains assets, liabilities, and equity. The concept of asset is related to resources from which future economic benefits are expected to result for the entity; conceptually, in turn, liabilities are obligations payable with resources containing economic benefits, and equity is the residual right of shareholders over the entity's assets after deducting all liabilities. As a consequence of these concepts, Revenue can be defined as an increase in economic benefits during the accounting period, by increase in assets or decrease in liabilities, which result in increases in Equity. Expenses are decreases in economic benefits during the accounting period, by reduction or consumption of assets or incurrence of liabilities, which result in a decrease in Equity. Revenues present an additional difficulty, insofar as activities with clients involving "multi-services" or "multi-products" have become increasingly frequent. This phenomenon occurs when the relationships between the publicly held company selling products and services and its clients include the seller's commitment to make the product available, update it technologically (upgrades), provide maintenance services, replace components that wear out in regular or normal use, accept it as part payment for new equipment, or alienate it at pre-agreed values. The use of judgment and common sense by administrators and auditors of publicly held companies is required to not succumb to the temptation of precipitous judgment regarding which component of the sold "package" is "revenue", when, and at what value. Mere billing, even if it implies incidence of taxes, does not mean, by itself, that revenue has been earned from the point of view of increasing patrimonial wealth.

1.7.4 The types of revenues and expenses
The types of revenues and expenses were characterized in Ibracon Pronouncement XIV – Revenues, Expenses, and Results, which can be summarized as follows: revenues from the sale of products, provision of services, including those resulting from the use of the entity's assets or resources by third parties, and sale of other items besides those mentioned.
Expenses, in the same pronouncement, were divided into five classes: the cost of assets used and other costs incurred to produce revenue, such as, for example, the cost of goods sold and administrative and sales expenses; extraordinary and accidental transfer expenses; the cost of written-down assets that are not products; costs incurred in unsuccessful activities; and the decline in prices of inventories available for sale.

1.7.5 The presentation of the Statement of Results
To concretize these principles and concepts, the problem must be faced regarding the way in which the elements of Result should be presented to users of financial statements.
The indications of minimum content contained in article 187 of Law 6.404/76 do not prevent the statement of results from being presented in the manner that results in the best possible appreciation by the user. The minimum items provided by the cited article 187 are:
I - gross revenue from sales and services, deductions from sales, discounts, and taxes; II - net revenue from sales and services, the cost of goods and services sold, and gross profit;

CIRCULAR LETTER/CVM/SNC/SEP No. 01/2004 15

III - expenses related to sales, financial expenses, deducted from revenues, general and administrative expenses, and other operating expenses; IV - operating profit or loss, non-operating revenues and expenses:
(item IV with wording given by Law No. 9.249/95).
V - the result for the year before Income Tax and the provision for tax; VI - participations of debentures, employees, administrators, and beneficiaries, and contributions to institutions or funds for employee assistance or pension; and VII - the net profit or loss for the year and its amount per share of social capital.

Resolution CFC No. 686/90, which approves NBC T3, provides for the following elements that must be evidenced in the Statement of Result:
a) revenues resulting from the exploration of core activities; b) taxes levied on operations, discounts, returns, and cancellations; c) costs of products or goods sold and services rendered; d) the gross result for the period; e) operating gains and losses; f) administrative, sales, financial, and other expenses, and financial revenues; g) operating result; h) revenues, expenses, gains, and losses not resulting from core activities; i) result before participations and taxes; j) provisions for taxes and contributions on the result; k) participations in the result, and l) the net result for the year.

The types of presentation of the statement of result have been modified over time, both by the administrators and accountants responsible for disclosing the company's information, and by users who adapt the disclosed financial statements to their analysis model.

1.7.6 Economic Measurements of the Statement of Result
The view of the construction of the company's profit for the period is presented conventionally in the items: (i) gross profit, (ii) operating profit, and (iii) profit before taxes. The first evolution in this framework was the guidance of Circular Letter CVM/PTE No. 578/85 to separately evidence Financial Revenues and Expenses, highlighting interest from monetary updates, both in revenues and expenses. Still from a historical perspective, the indicator of Profit before interest and income tax – Lajir (Ebit – earnings before interest and tax), was constructed with the idea of profit generation by assets and to measure the capacity to service debt (interest payments), given that classic finance theory defines “return on assets” as that obtained independently of how the assets have been financed.

Among these measurements, operating profit is generally an important object in the considerations of administrators and mainly analysts and investors regarding the efficiency in conducting the company's activities. Operating profit is generally defined in accounting standards through its components when dealing with the information brought by the Statement of Result. In its broadest concept, operating profit arises as the result of Operating Revenues and Expenses, defined as those associated with the company's main activity. A Statement of Result based on this approach could be presented as follows:

CIRCULAR LETTER/CVM/SNC/SEP No. 01/2004 16

Operating Revenues
(-) Operating Expenses, including Financial Revenues associated with asset protection (in non-financial institutions) (=) Operating Result (operating profit or loss)

In this approach, operating profit is that produced by the management of its assets, and its most directly related measurement is “return on operating asset” (operating profit / operating asset). This concept allows highlighting, from the ability to manage assets, the skill in capturing resources to finance its activities. The concept of non-operating items in the Statement of Result corresponds, therefore, to items not related to regular activities or linked to its social objectives, such as sporadic sale of permanent asset items and financial charges.

1.7.7 The Lajida economic measurement (profit before interest, income tax, depreciation, and amortization)
More recently, open companies have been disclosing the measurement of profit before interest, income tax, depreciation, and amortization – LAJIDA (EBITDA – earnings before interest, taxes, depreciation and amortization) as a parallel measurement to the conventional ones presented in financial statements. This measurement was also widely used as a type of company cash flow for debt servicing capacity and also as related to a multiple for company valuation, among other applications.

Summary view of economic measurements based and not based on accounting standards, here presented only for the purpose of understanding the text.
Revenues
Cost of Goods Sold
Gross Profit economic measurement based on accounting standards Sales Expenses Administrative Expenses Profit before taxes, interest, depreciation, and amortization (LAJIDA) economic measurement not based on accounting standards, equivalent to EBITDA – earnings before interest, tax, depreciation and amortization Depreciation and Amortization Operating Profit before taxation and interest (I.R. and Financial Expenses) (LAJIR) economic measurement not based on accounting standards, equivalent to EBIT – earnings before interest and tax Financial Expenses (interest) Operating Profit (after financial expenses) economic measurement based on accounting standards Non-operating Revenues and Expenses Profit before income taxes Taxes (on profit: income and social contribution) Net Profit economic measurement based on accounting standards

It has been observed by capital market representative entities that the information on LAJIDA (EBITDA) is being prepared and disclosed in a very particular manner by open companies and in a divergent manner among them. This situation makes it difficult to understand both the formation of the presented number and its integration or reconciliation with other numbers in the Statement of Result, in addition to not being comparable. These measurements, therefore, are not directly extracted from the same structure of the statement of result constructed according to accounting principles and standards, but include and exclude amounts not provided for in these standards.

Non-standard-based measurements are defined as those that include or exclude amounts not provided for in economic measurements associated with the most directly comparable accounting standards. These adjustments intend to reflect the administration's view on the company's resource generation, but must also establish a relationship with the measurements provided for in accounting standards.

As an example, when a company discloses a measurement similar to Lajida (Ebitda), it must establish a reconciliation with the economic measurement based on accounting standards most directly comparable to Operating Profit. In this generic structure, the reconciliation could, for example, have the following format:

Operating Profit
(+) financial expenses
(+) depreciation
(+/-) amortization of goodwill or discount
(+) other amortizations
(=) Profit before taxes, interest, depreciation, and amortization – Lajida (Ebitda)

A reconciliation of this nature gives the reader of the financial statements a clear idea of the calculation performed by the administration and the power of explanation regarding the formation of the economic measurement and comparison with other companies.

1.7.8 Policy for disclosing economic performance measurements based and not based on accounting standards
When seeking to present a new economic performance measurement, company administrators must reflect on the relevance of the information for the user, in addition to the meaning and concepts involved. The mere inclusion of a new measurement, without clarifying what is intended to be communicated, reduces the relevance of this disclosure and may have the opposite effect of what is recommended, confusing instead of informing. Assuming that the company has high indebtedness, including financial leasing contracts, it is reasonable to assume that the administrator intends to demonstrate the resource generation capacity of the operation compared to indebtedness. In this case, it must also present and reference its comments on the amount of financial expenses, which includes leasing contracts treated as loans. This treatment considers the principle of economic substance (leasing treated as a loan) over legal form (leasing treated as a lease).

These considerations refer to the origin of the need for information provision by open companies, its more or less standardized form within a system of information distribution to guarantee equal access to information users. It is understood that, as a fundamental characteristic, the information presented to interested users of the capital market must have certain qualities, among which is the need for them to be comparable over time, within the industry, and between distinct industries, which is why companies observe, fundamentally, all elements of the accounting process that guarantee final quality, that is, the application of the same accounting principles, evaluation criteria, and standards and practices on the set of data.

Furthermore, this set of information has its own logic that allows integration and correlation between its various parts: the balance sheet, the statement of result, the statement of sources and applications of resources and/or cash flow, changes in equity, and explanatory notes. The review by independent auditors is another element that seeks to guarantee the credibility and coherence of the information presented to the set of elements of the accounting process already cited.

Adherence to principles, the formalization, and integration of this information is critical for the purposes of equal access, given that they are intended for general use. These information are primarily intended to meet the needs of users who have access to the company's information only through the required and comparable information in the distribution system, currently administered by the CVM on its website.

Qualitative information provided in other forms such as IAN, ITRs, and foreign forms, such as 20-F for the American capital market, must also maintain internal coherence and with the accounting information provided in Brazil.

All these considerations lead to the need for the adoption of the following set of desirable practices by open companies, when disclosing non-standard-based measurements, such as Lajida (Ebitda):
a) the information must have an explanation of its formation, similar to other conventional measurements such as gross profit, operating profit, and profit before income tax; b) this explanation must include the reconciliation of the non-standard-based economic measurement disclosed by the company with the closest standard-based economic measurement, as in the example already cited: operating profit and Lajida (Ebitda); c) the information must be comparable to the previous same period; d) the information must be audited, or its consistency verified in relation to the information disclosed in the financial statements.

1.8 Generic Designations
The provision of § 2 of article 176 of Law No. 6.404/76 determines that small balances may be aggregated, provided their nature is indicated and they do not exceed 0.1 (one tenth) of the value of the respective account group; but the use of generic designations, such as “various accounts” or “current accounts,” is prohibited.

1.9 Statement of Changes in Equity
CVM Instruction No. 59/86, in its article 10, allows indicating in explanatory notes or analytical tables the subdivisions of the equity groupings provided for in articles 5, 6, and 7, of the same Instruction, for cases where the statement becomes too extensive for publication purposes.

To fully meet user needs, companies must discriminate, account by account, the items comprising their equity.

2. Provision for Doubtful Collection Credits
   Given the growth in indebtedness and default indices, it becomes fundamental that open companies carefully analyze the possibility of realizing their accounts receivable, with a view to constituting or strengthening the provision for doubtful collection credits.

The calculation of the value of this provision must: (i) undergo careful technical evaluation, never limited to criteria of special or tax legislation or any others that do not adjust rights and credits to the probable realization value; (ii) must be based on the experience each company has regarding the level of losses in the past, considering, in addition, the current economic situation, and (iii) priority must be given to the individual situation of clients and the market in which they operate. Special attention must be given to cases of clients with overdue bills or titles, return of goods, as well as cases of clients in bankruptcy proceedings, under bankruptcy regime, or in financial difficulties, or clients who are part of a group of companies presenting this type of situation.

3. Social Nature Information
   3.1 Added Value Statement – DVA
   The wealth generated by the company, measured in the concept of added value, is calculated from the difference between the value of its production and that of goods produced by third parties used in the company's production process. The current and potential applications of added value show the economic and social aspect that its concept involves: (i) as an index for evaluating performance in wealth generation, by measuring the company's efficiency in using production factors, comparing the value of outputs with the value of inputs, and (ii) as an index for evaluating social performance, insofar as it demonstrates, in the distribution of generated wealth, the participation of employees, the Government, Financing Agents, and Shareholders.

The added value also demonstrates the company's effective contribution, within a global performance view, to the generation of wealth in the economy in which it is inserted, being the result of the combined effort of all its production factors..

The Added Value Statement, which may also integrate the Social Balance, thus constitutes an important source of information insofar as it presents this set of elements that allow the analysis of the company's economic performance, evidencing wealth generation, as well as the social effects produced by the distribution of this wealth.

Within this view, the CVM has been encouraging and supporting the voluntary disclosure of social nature information, having, in fact, already in 1992, supported and stimulated the disclosure of the DVA, through CVM Advisory Opinion No. 24/92. In Circular Letter CVM/SNC/SEP/ No. 01/00, the CVM suggested the use of a model prepared by the Institute of Accounting, Actuarial, and Financial Research of USP (FIPECAFI). In addition, it included in the draft reform of Law No. 6.404/76 the mandatory disclosure of the Added Value Statement and social and productivity nature information.

Considering that open companies have increasingly adhered to the disclosure of social nature information, mainly the DVA, and, within this voluntary disclosure character, aiming to guide and encourage those companies that have not yet adhered, we are presenting a simplified model of Added Value Statement (based on a model prepared by FIPECAFI) with instructions for its completion.

It can be verified in the model below the use of the calculation criterion for added value based on sales, which makes the preparation of the DVA simpler and its understanding easier, since, thus, the added value is related to the accounting principles used in traditional financial statements, allowing its reconciliation with the statement of result.

Thus, we start with gross revenues and subtract the value of goods purchased from third parties that was incorporated into the final alienated product or service rendered, so that the value effectively generated by the company is known. It should be highlighted, furthermore, that the depreciation of assets evaluated at acquisition cost must be subtracted from the gross added value to calculate the net added value, and such values should not be classified as retention of the period's profit.

We must emphasize that this model, even because it is not mandatory information, should not inhibit the presentation of a more detailed statement better adapted to the company's business segment. If the company deems it necessary, it may present this information in explanatory notes to the financial statements, instead of including them in the body of the Administration Report.

CIRCULAR LETTER/CVM/SNC/SEP No. 01/2004 20

Added Value Statement in R$ thousand 20X1 20X2 DESCRIPTION 1-REVENUES 1.1) Sales of goods, products, and services 1.2) Provision for doubtful debtors – Reversal/(Constitution) 1.3) Non-operating 2-INPUTS ACQUIRED FROM THIRD PARTIES (includes ICMS and IPI) 2.1) Consumed Raw Materials 2.2) Costs of goods and services sold 2.3) Materials, energy, third-party services, and others 2.4) Loss/Recovery of asset values 3 – GROSS ADDED VALUE (1-2) 4 – RETENTIONS 4.1) Depreciation, amortization, and depletion 5 – NET ADDED VALUE PRODUCED BY THE ENTITY (3-4) 6 – ADDED VALUE RECEIVED IN TRANSFER 6.1) Result of equity method 6.2) Financial revenues 7 – TOTAL ADDED VALUE TO DISTRIBUTE (5+6) 8 – DISTRIBUTION OF ADDED VALUE 8.1) Personnel and charges 8.2) Taxes, fees, and contributions 8.3) Interest and rents 8.4) Interest on equity and dividends 8.5) Retained profits / loss for the year

• The total of item 8 must be exactly equal to item 7.

Instructions for completion:
The information is extracted from accounting and, therefore, must be based on the accounting principle of the accrual basis of exercises.

1 – REVENUES (sum of items 1.1 to 1.3)
1.1 – Sales of goods, products, and services
Includes the values of ICMS and IPI levied on these revenues, that is, it corresponds to gross revenue or gross billing.

1.2 – Provision for doubtful debtors – Reversal/Constitution
Includes values related to the constitution/write-off of provision for doubtful debtors.

1.3 – Non-operating
Includes values considered outside the company's main activities, such as: gains or losses on the disposal of fixed assets, gains or losses on the disposal of investments, etc.

2 – INPUTS ACQUIRED FROM THIRD PARTIES (sum of items 2.1 to 2.4)
2.1 - Consumed Raw Materials (included in the cost of goods sold).
2.2 - Costs of goods and services sold (does not include expenses with own personnel).

CIRCULAR LETTER/CVM/SNC/SEP No. 01/2004 21

2.3 - Materials, energy, third-party services, and others (includes values related to purchases and payments to third parties).
In the values of the costs of products and goods sold, materials, services, energy, etc. consumed, taxes (ICMS and IPI) included at the time of purchases, recoverable or not, must be considered.

2.4 - Loss/Recovery of asset values
Includes values related to market value of inventories and investments, etc. (if in the period the net value is positive, it must be added).

3 – GROSS ADDED VALUE (difference between items 1 and 2).

4 – RETENTIONS
4.1 – Depreciation, amortization, and depletion
Must include the expense accounted for in the period.

5 – NET ADDED VALUE PRODUCED BY THE ENTITY (item 3 minus item 4).

6 – ADDED VALUE RECEIVED IN TRANSFER (sum of items 6.1 and 6.2)
6.1 Result of equity method (includes values received as dividends related to investments evaluated at cost). The equity result may represent revenue or expense; if expense, it must be reported in parentheses.
6.2 - Financial revenues (include all financial revenues regardless of their origin).

7 – TOTAL ADDED VALUE TO DISTRIBUTE (sum of items 5 and 6)

8 – DISTRIBUTION OF ADDED VALUE (sum of items 8.1 to 8.5)
8.1 – Personnel and charges
In this item, charges for vacation, 13th salary, FGTS, food, transport, etc., appropriated to the cost of the product or result of the period must be included (do not include charges with INSS – see treatment to be given in the following item).

8.2 – Taxes, fees, and contributions
In addition to contributions due to INSS, income tax, social contribution, all other taxes, fees, and contributions must be included in this item. The values related to ICMS and IPI must be considered as the values due or already collected in the public treasury, representing the difference between the taxes levied on sales and the values considered within item 2 – Inputs acquired from third parties.

8.3 – Interest and rents
Financial expenses and interest related to any types of loans and financing from financial institutions, group companies, or others, and rents (including expenses with leasing) paid or credited to third parties must be considered.

8.4 – Interest on equity and dividends
Includes values paid or credited to shareholders. Interest on equity accounted for as reserves must appear in the “retained profits” item.

8.5 – Retained profits/loss for the year
Period profits destined for profit reserves and any remaining portions without specific destination must be included.

4. Inventories
   Inventory valuation criteria established in art. 183 of Law No. 6.404/76 must be adopted. Alternative procedures that contradict the rules established in the aforementioned article, especially those created by tax legislation or even special legislation that does not contemplate the Companies Act, will not be accepted.

CIRCULAR LETTER/CVM/SNC/SEP No. 01/2004 22

5. Net Income or Loss for the Period, Fundamental Errors, and Changes in Accounting Policies

As "prior period adjustments" will be considered only those resulting from a change from one accounting criterion to another accepted by accounting standards, or from the correction of an error attributable to a prior period, provided they cannot be attributed to subsequent events (§ 1 of art. 186 of Law No. 6,404/76) – and are not revisions of estimates or determination of values that differ from those provided for. Changes decided by management must aim to improve information or rationalize accounting procedures. The law limits the possibility of management influencing results through changes in accounting practices; therefore, it is treated as an adjustment to the portion that should have been included or excluded from equity in the previous year if the criterion now adopted were already in force. Therefore, modifications in operating conditions that determine the adoption of new criteria, the consequences of which cannot be assessed in comparison with previously adopted criteria, cannot be considered.

Regarding errors attributable to a prior period, they can only be characterized when they involve involuntary accounting different from what would be appropriate, given the documents, information, and circumstances existing at the time. They arise from arithmetic errors in the treatment of correct basic data, for any reason, including misinterpretation. Adjustments to provisions constituted due to inadequate assessment of estimated risks or insufficient information existing at the time of their constitution do not fit this category. Also not included as prior period adjustments are write-offs of non-recoverable assets and adjustments related to provisions for doubtful accounts, income tax provision, and others that, when constituted, must be done within the broadest criteria and exhaustive analysis of possible and available information. Prior period adjustments will be subject to broad and clear disclosure in explanatory notes, specifying their nature and foundations.

6. Construction Contracts

6.1 Accounting Statements of Open Companies in the Real Estate Sector

Companies operating in the real estate sector have the option to record sales of their developments based on accounting guidance fixed in fiscal legislation, which basically presupposes the recognition of revenues as they are received, characterizing the use of the cash basis to the detriment of the accrual basis of periods advocated in article 177 of the corporate law.

Furthermore, when such companies record these sales, they do so using as a counterpart to receivables an account included in the Future Period Results grouping, a practice that the CVM considers inadmissible, as explained in item 13 of CVM Advisory Opinion No. 21, of 12/27/90.

Therefore, in installment or deferred sales of real estate units, for the purpose of complying with articles 177 and 187 § 1 of Law 6,404/76, the accounting recording of results derived from these sales must follow the fundamental principles of accounting. Alternative procedures emanating from tax legislation or specific legislation should be observed in auxiliary records, as provided in § 2 of the aforementioned art. 177.

Thus, in installment or deferred sales of real estate units, the accounting treatment to be adopted comprises the following:

a) Deferred Sale of Completed Unit

The result on the sale must be appropriated at the moment it was finalized, regardless of the term for receiving the contracted value. The amount of installments, when pre-fixed, should be brought to their present value, or, if short-term, when there are relevant effects;

b) Deferred Sale of Unit Not Completed

In this case, the result on the sale should be appropriated over the course of the work, in the same way that contracts for the supply of goods, works, and long-term services are appropriated, that is, based on physical progress or costs incurred.

7. Income Tax

7.1 Disclosure of the Income Tax Provision

In the statement of income for the period, the income tax due must be provisioned by the gross amount to be paid. In explanatory notes to the accounting statements, the portion related to tax incentives embedded in the gross amount provisioned must be evidenced, and reference must be made to the legal provision permitting the use of incentives. In cases of temporary exemption, the tax that would be due will be computed for the determination of the net income for the period and, subsequently, transferred to the respective capital reserve, indicating, in an explanatory note, the start and end dates of the benefit.

7.2 Tax Incentives

CVM Deliberation No. 273/98 established the accounting procedures applicable to the recording of Income Tax and Social Contribution, listing, furthermore, the information that must be evidenced in explanatory notes, when relevant. The CVM Collegiate Body also approved CVM Instruction No. 371/02, which provides for the accounting recording of deferred tax assets and complements CVM Deliberation No. 273/98.

Given that, for many companies, especially those benefiting from tax incentives, one of the most relevant pieces of information concerns this condition, we are requesting that, in addition to the information provided in the aforementioned Deliberation, information be also disclosed, regarding open companies and companies benefiting from tax incentives, their subsidiaries, holding companies, and affiliates, regarding the existence of tax benefits, of any nature, encompassing, at minimum, the type of benefit, the term or maturity, and the amount of tax savings realized in the period and accumulated, when applicable.

For the complete understanding of aspects related to this topic, amounts paid/paid for each tax and/or contribution in the social year must also be disclosed.

7.3 Tax Credits

From CVM Deliberation No. 273/98, the basis for recognizing a deferred tax asset became the evidence/proof of its realization/recovery, based on an assessment of the probability of generating sufficient taxable profit to compensate for the tax loss that gave rise to it.

It is, therefore, the duty of the administrator, through the information provided to the market, to prove that the credit being accounted for has the intrinsic economic condition necessary for its recording as an asset, as well as to disclose the bases of this proof. The supervisory board and the statutory administration bodies must evaluate and approve such proof. The independent auditor is responsible for, in the course of their work, obtaining sufficient and adequate evidence or proofs to support their opinion on the audited accounting statements, especially regarding the premises of realization/recovery of the deferred tax asset accounted for by the company and its correct disclosure, including the evidence that supports its recording. Immediately when changes are identified that imply the alteration of the premises for the recovery of tax credits, in whole or in part, they must be removed from the asset.

7.3.1 Periodic Review

It is also worth remembering that CVM Deliberation No. 273/98 establishes that the book value of a deferred tax asset must be reviewed periodically, and the entity must reduce it or extinguish it as it becomes unlikely to obtain sufficient taxable profit for its realization. We understand that this review must be, at minimum, annual and ideally at a shorter interval, if any relevant event has occurred that could alter the estimates.

The concept that guides this review is the economic substance of the asset, or the asset's ability to transform, directly or indirectly, into net cash inflows, that is, they must represent a future promise of cash.

7.3.2 Recovery Term

It is imperative that this credit can, in fact, be used by the company through future fiscal savings, and this will only occur if and when the company comes to earn taxable profits in sufficient volume. Future profitability must consider the probable capacity to generate taxable profits by the company in the context of the main business variables, such as prices, volumes, market, and competition. This is an example of the cited prevalence of substance over form; it is not enough to have the right to compensation, but it is necessary for the presence of conditions to be achieved, in future operations, business and commercially, the profit whose taxation will enable the recovery of the tax credit on past losses.

Special attention must be given to the fact that long recovery terms for these assets, associated with the distance from result perspectives in comparison with those achieved, greatly increases the degree of uncertainty regarding the recoverability of these assets, consequently increasing the risk of the management of the open company in keeping them on the Balance Sheet, a risk for which Independent Auditors must have heightened attention and which finds no support in the imprescriptibility of the tax credit.

7.3.3 Responsibility

Given the relevance that the issue imposes, the objective is to establish a culture of involvement, proactive participation, and interdependent responsibility among the administration bodies, supervisory board, and independent auditors. It does so when requiring the examination by the supervisory board and approval by the administration bodies (art. 4) of the technical feasibility study.

Independent auditors are required to evaluate the adequacy of procedures for the constitution and maintenance of the deferred tax asset and liability, including with respect to the premises used for the preparation and updating of the aforementioned technical study.

7.3.4 Technical Feasibility Study

It should be emphasized that this study does not constitute an additional requirement to those required by CVM Deliberation No. 273/98:

"004 The deferred tax asset arising from tax losses for income tax and negative bases for social contribution must be recognized, in whole or in part, provided the entity has a history of profitability, accompanied by the justified expectation of this profitability for a term that considers the maximum compensation limit allowed by legislation." (we underline).

The technical study should not be limited to the maximum term of 10 years (this term is established for the purposes of assessing the recovery of the deferred tax asset – impairment). Therefore, it must encompass the generation of results according to management's expectation, considering the continuity of the company and the maintenance of the result for an indefinite time, including its perpetuity.

The examination, approval, and evaluation of this technical study must be, at minimum, annual. However, whenever there is a relevant alteration of the elements comprising the study, it must be subject to new examination, approval, and evaluation, even at a term shorter than the aforementioned one.

It is also worth clarifying that approval by the administration bodies includes the Board of Directors and the Executive Management.

7.3.5 Present Value Adjustment in the Determination of Future Taxable Profits

It should be emphasized that it is the future taxable profits, contemplated in the technical feasibility study, that must be brought to present value. The standard does not determine that the deferred tax asset must necessarily be accounted for at its present value; it establishes, however, the discounting of future taxable profits (which cannot be considered at their nominal value) to verify if the asset is recoverable, and therefore, if it should be recorded and for how much. In this case, for purposes of assessing the recovery of the deferred tax asset, these profits must be brought to present value, based on the estimated term for their realization, even if this exceeds the maximum term of 10 years established in item II, article 2 of CVM Instruction No. 371/02.

Simplified Example:

Deferred Tax Asset (total) .................................. 150.00 Deferred Tax Asset (recoverable portion in 10 years) .................................. 100.00

Tax Effect Considering the Present Value of Future Taxable Profits ("n" years (*)) :
1st hypothesis (260.00 x IR of 0.35) .................................. 91.00 2nd hypothesis (400.00 x IR of 0.35) .................................. 140.00

Deferred Asset accounted for in the 1st hypothesis .................................. 91.00 (amount expected to be recovered) Deferred Asset accounted for in the 2nd hypothesis .................................. 100.00 (nominal value recoverable in 10 years)

(*) for example 15 years + perpetuity.

Therefore, the balances of deferred tax assets should not exceed the values pointed out in the projection of future taxable profits discounted to present value, regardless of the expected term of their recovery.

In this recovery analysis, existing balances prior to the publication of CVM Instruction 371/02 are included, as well as new constitutions of deferred tax credits.

7.3.6 Initial and Additional Recognition of Deferred Tax Asset

It should be clarified that both the company that recognizes a deferred tax asset for the first time, and that which accounts for an additional value to the balance existing prior to the enforcement of CVM Instruction No. 371/02, are subject to the determinations of that normative. Therefore, in these cases, the recognition of a new deferred tax asset has the consequence of the application of CVM Instruction No. 371/02 to the entire amount recognized in the accounting statements.

7.3.7 Mandatory Disclosures in Explanatory Note

It is worth clarifying that, in any situation, including for cases of companies that have recognized a deferred tax asset prior to the enforcement of CVM Instruction No. 371/02 and that do not recognize additional value to that balance, it is mandatory to disclose in the explanatory note the following information (items I, II, and III of article 7):

"I - estimate of the realization portions of the deferred tax asset, discriminated year by year for the first 5 (five) years and, from then on, grouped in maximum periods of 3 (three) years, including for the portion of the deferred tax asset not registered that exceeds the realization term of 10 (ten) years referred to in item II of art. 2; II - effects resulting from eventual alteration in the expectation of realization of the deferred tax asset and respective foundations, as provided in art. 4; III - in the case of newly constituted companies, or in the process of operational restructuring or corporate reorganization, description of administrative actions that will contribute to the future realization of the deferred tax asset."

This also applies to the disclosure, in the explanatory note, of the justified justification of actions implemented by the company, aiming to generate taxable profit in the future. These actions represent fundamental requirements for the company to be able to keep tax credits in the asset in the absence of a profitability history (art. 3, sole paragraph).

8. Segment Reports

Segment information aims to provide users of accounting statements with information on the size, contributions to results, and growth trends of the different operational or geographic areas in which the company operates, allowing for prospective analysis regarding risks and perspectives of a diversified company. Recalling that accounting statements aim to allow the projection of expected future cash flows, it is particularly relevant that the generation of such cash flows can be evaluated by analysts and investors by business area or by geographic region of operation of the open company or the business conglomerate that includes it.

Segmented information provides the user with the opportunity to know the performance of each area or main business managed by the company. Knowledge of this mix is important information insofar as the user can effectively compare these performances, not only within a company, but eventually also in relation to other companies. When analyzing a certain sector, the investor may encounter companies that present a global performance that was not fostered in the basic operating sector, but rather by other activities or non-repetitive businesses. The statements presented in segmented form are also suitable for elucidating this circumstance, as they will allow users to evaluate the performance of each activity.

From this aspect, the CVM encourages the disclosure of this information by open companies, especially for those that publish consolidated statements.

For the presentation of segment information, it is necessary, preliminarily, to define the segments to be evidenced. A segment comprises a component of a company that is involved in the production of goods and services, or group thereof, subject to risks and returns different from other segments. It is important to remember that, as a general principle, the company must use the same logic of analysis for decision-making used in the managerial reports by its administrators in the structure of the information of activities by business segment.

The company, to evidence its segments, must adopt the form of "businesses" or "geographic area", or both. If the form used by administrators does not allow for rapid segmentation, the company may use some rules for its grouping into segments. For example, as defined in international standard IAS 14, the segmentation used for a business segment must observe: (i) the nature of products or services; (ii) nature and technology of production processes; (iii) types of markets in which products and services are sold; (iv) main classes of customers; (v) channels and methods of product distribution and (vi) when applicable, the existence of a specific regulatory environment. In turn, the use of the geographic area segment form comprises an identifiable part of a company focused on operations in a certain country, group of countries, or, as in the Brazilian case, due to continental dimensions, the various regions of the country.

Once the segments are established, whether by "business" and/or "geographic area", the company must also establish which form of disclosure should be considered as primary or secondary, as it will have a direct impact on the content of the information made available.

The segmented information that must be included, considering the primary format of disclosure (business or geographic area) based on international standard 14 (IAS 14), are: (i) revenues, expenses, and results obtained by the segment; (ii) assets and liabilities involved in the segment; (iii) capital expenditures in the segment; (iv) depreciation, amortization, and other significant expenses; (v) reflections in the segment of results with equity method; (vi) nature and value of extraordinary items, provided they are directly attributable to a segment or capable of allocation, on rational bases; (vii) significant contingencies directly attributable to the segment, and (viii) reconciliations between segmented information and accumulated information, as well as any other relevant segmented information used by administrators in the decision-making process.

For the secondary format, the company must disclose, at minimum, the following information: (i) the value of assets of each segment; (ii) sales revenues to external customers (excluding sales between departments/areas of the same company - intersegment) and (iii) capital expenditures of the segment. If the company adopts and exercises its operational activities in a single segment, of business or geographic area, the information must be disclosed.

With the aim of exemplifying segment disclosure, we demonstrate below segment information in compliance with standards issued by the IASB. In this sense, it is convenient to remember that such information is only an example of the minimum information required and that, as a determination of those standards, the model to be used must be consistent with the information used internally during the decision-making process by the manager.

Only for the purpose of illustrating the type of note required, the example of a manufacturing company, with operations in various regions, is presented below:

" NOTE XXX - SEGMENT INFORMATION

Segment information is based on two formats: the primary reflects the managerial structure adopted by the group, while the secondary refers to the division by products. The primary segmentation format, by managerial responsibility and geographic areas, represents the company's managerial structure. The group's main activity is food trade. The other activities, poultry product line and feeds, are managed on a regional basis. The secondary disclosure format, represented by product line, is divided into five categories, or segments. Segment results represent the contribution of the different segments to the formation of the result, encompassing administrative expenses, research and development costs, and the Group's profit. Unallocated items comprise corporate expenses, research and development costs, amortization of possible "goodwills" and, for product segments, restructuring and other small costs. Specific expenses with product research and development are allocated directly to the segments. The assets of each segment comprise the

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properties, equipment, rights to receive, inventories, and prepaid expenses. The unallocated items represent research and development assets, including any goodwill. Liabilities comprise debts to suppliers and other obligations, provisions, and deferred revenues. Eliminations represent transactions between the various companies in the Group, between different segments.

The assets and liabilities segmented by geographic area are stated at year-end values. The assets by product line represent the annual average, which management believes is the best indication of the level of capital investment for decision-making purposes.

By Geographic Area
In millions of Reais 2002 2001 2002 2001
Sales Results
Region 1 6,685 6,571 696 688
Region 2 6,649 6,381 882 876
Region 3 3,864 3,927 650 668
Other Activities 3,976 3,476 537 504
21,174 20,355 2,765 2,736
Unallocated Items (460) (439)
Operating Profit 2,305 2,297

Sales by geographic area are broken down by customer destination. Inter-segment sales are not significant.

In millions of Reais 2002 2001 2002 2001
Assets Liabilities
Region 1 3,127 3,228 1,346 1,320
Region 2 2,748 2,625 919 865
Region 3 1,724 1,724 613 648
Other activities 2,187 1,965 804 724
9,786 9,542 3,682 3,557
Unallocated Items 7,605 2,659 290 97
Eliminations (280) (212) (280) (212)
17,111 11,989 3,692 3,442

In millions of Reais 2002 2001 2002 2001
Capital Expenditure Depreciation of
Property and equipment
Region 1 238 236 201 222
Region 2 187 191 174 192
Region 3 156 138 110 120
Other activities 293 237 139 130
874 802 624 664
Unallocated Items (a) 29 23 21 20
903 825 645 684 a) Corporate, research, and development fixed assets.

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By Product Line
In millions of Reais 2002 2001 2002 2001
Sales Results
Product Line 1 6,005 5,761 1,065 1,080
Product Line 2 5,739 5,493 643 655
Product Line 3 5,331 5,158 506 487
Product Line 4 2,811 2,744 309 291
Product Line 5 1,288 1,199 313 303
21,174 20,355 2,836 2,816
Unallocated Items (a) (531) (519)
Operating Profit 2,305 2,297 a) Corporate, research, and development expenses, and restructuring costs.

In millions of Reais 2002 2001
Assets
Product Line 1 2,772 2,663
Product Line 2 2,782 2,804
Product Line 3 2,155 2,245
Product Line 4 1,587 1,671
Product Line 5 715 647
10,011 10,030

In millions of Reais 2002 2001
Capital Expenditure
Product Line 1 266 234
Product Line 2 143 132
Product Line 3 115 98
Product Line 4 62 62
Product Line 5 25 28
611 554
Administration, distribution, research, and development 292 271 903 825

In the example transcribed above, we can verify that the primary format of disclosure is by geographic area, dividing activities into three large groups: Region 1, Region 2, and Region 3. With the division used, sales, results, assets, and liabilities were presented, as well as information regarding capital expenditures and depreciation. In the example, information by product group was also demonstrated, in respect of IASB standards, which represents the secondary format of disclosure.

9. Information Reflecting the Effects of Price Changes

As highlighted in item 1 of this Circular Letter, the set of financial statements made available to the market must disclose all information that is relevant for the assessment of the open company's net worth.

To be useful to the decision-making processes of their users, accounting information must combine four main qualitative characteristics or attributes: Relevance, Understandability, Reliability, and Comparability.

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Notwithstanding the others, we highlight here the attribute of Comparability. To be comparable, accounting information must be expressed in the same monetary standard, that is, they must be expressed in currency with the same purchasing power on the date of the last accounting information presented.

The voluntary disclosure of accounting information prepared in currency with constant purchasing power constitutes an accounting procedure that aims to eliminate relevant distortions arising from inflationary effects, thereby achieving the objectives of the law to confer the necessary transparency to know the financial and net worth situation of companies. These distortions, evidently, become larger or smaller due to the level of inflation, the company's net worth structure, the return rate of its assets, and its cost of capital (own or third-party).

Therefore, for comparative analysis purposes, its disclosure meets market demands in a more complete manner, thus constituting a more appropriate system to proceed with the analysis of the company's financial position in economic environments where inflation is present, conferring a higher degree of comparability to the information provided to users of the financial statements.

In this sense, it is necessary to alert open companies and their independent auditors regarding the provisions of CVM Opinion No. 29/96, from which, among other guidelines, it can be extracted:

"(...) it is relevant to highlight that open companies must evaluate the importance of this information, including for comparative analysis purposes, and its disclosure, in order to meet, in a more complete manner, the demands of the market.

"(...) Law No. 6.40/76 establishes that financial statements must be completed by explanatory notes and other analytical tables or accounting statements necessary to clarify the net worth situation of the entity and its results."

It should be highlighted that lower annual inflation rates in the Brazilian economy in recent years, compared to our historical experience, do not guarantee the non-existence of relevant inflationary effects. These depend on the combination of the company's net worth structure and the magnitude of inflation, which is not negligible data, considering the evolution of accumulated inflation measured by IPCA (IBGE) and IGP-M (FGV), as can be observed in the table below (in the same period in which the disclosure of inflationary effects in accounting statements ceased to be mandatory):

Accumulated Inflation in the period 1996 – 2003 2003 2002 2001 2000 1999 1998 1997 1996 IPCA () 78.26 63.94 45.68 35.3 27.67 17.2 15.29 9.56 IGP-M 137.7 118.7 74.52 58.12 43.81 19.74 17.64 9.19 () until November

Research conducted by Fipecafi, estimating the recognition of inflation effects in a group of 107 open companies with shares traded on the stock exchange in 2002, indicated the following effects:

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Effects of Inflation on Fixed Assets fixed assets in 2002 historical until 2001 year 2002 total () R$ millions R$ millions % R$ millions % R$ millions % with IPCA 100,793.9 28,128.8 27.9 13,960.2 13.9 42,089.1 41.8 with IGP-M 100,793.9 45,816.3 45.5 33,841.5 33.6 79,657.8 79.0 () The information was obtained from the balance sheet of 1995, the last one that included the recognition of inflation effects, and those of the period 1996 to 2001, all in nominal values. For the year 2002, it was assumed that the nominal variation of increases and decreases in fixed assets was equal to that which occurred in 2001.

These gross increases, compared to the net equity expressed in historical values for the same group of companies, shows the relevance of the lag between historical and corrected values:

Comparison of Fixed Asset Correction with Net Equity Correction of fixed assets until 2002 Net Equity in 2002 (historical) variation percentual R$ millions R$ millions (%) with IPCA 42,089.1 62,796.6 67.0 with IGP-M 79,657.8 62,796.6 126.9

10. Fixed Assets
    10.1 Recoverability of Assets and Spontaneous Revaluations

The Fundamental Accounting Principle for the valuation of fixed assets is based on the concept of acquisition cost as the value basis, and the adoption of market value evaluation criteria is not accepted in many countries. In Brazil, the corporate legislation in force since 1976, complemented by tax legislation, allows this practice with numerous restrictions and cautions.

CVM Deliberation No. 183/95 approved the IBRACON Pronouncement on the subject, making it mandatory, in cases of revaluation, for open companies, to adopt the procedures described therein.

The first of these restrictions is related to the very meaning of revaluing. Revaluation means the abandonment of the original cost principle as the value basis and the adoption of market value or replacement value for the revalued assets.

The second restriction is related to which assets can be subject to revaluation. Only tangible fixed permanent assets can be subject to revaluation, and the revaluation of intangible assets, or assets for which an operational discontinuity is expected, is expressly prohibited.

Furthermore, once the procedure to evaluate a certain set of assets at market value (revaluation) is adopted, such procedure must be periodically redone, meaning that, at least every 4 (four) years (ideally, every year), the open company that has adopted this procedure must re-evaluate these assets, under the terms and procedures described in the cited IBRACON pronouncement.

Another restriction is related to the revaluation of assets individually. It is not acceptable, for the same open company, for assets of the same nature or from the same account to have part evaluated at cost and another part evaluated at market value (revaluation). This restriction also applies to consolidated financial statements, and it is not acceptable that the controlling company and a controlled company maintain assets of the same nature or from the same account evaluated by

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two different criteria (cost and market value), both for equity equivalence purposes and for consolidation purposes.

Another aspect to be observed in revaluation is that concerning the remaining useful life of revalued assets that are subject to physical wear and tear. It is absolutely indispensable that the Valuation Report indicates the remaining useful life aiming to allow the definition of future depreciation rates.

The management of the open company must evaluate, at least, each fiscal year if there is any indication that an asset may have lost value or economic substance. In the existence of external or internal indicators, the company must deepen its analysis in order to verify if the ability to generate future economic benefits, the remaining useful life, the method and term of depreciation or amortization, or the residual value of the assets need to be adjusted, or even if a provision for losses must be constituted.

Attention must also be given to the content of explanatory notes on revaluation, which must contain, at minimum, the information listed in paragraph 67 of the cited IBRACON Pronouncement, especially regarding the company's policy on the treatment given to the effects of revaluation on dividends, with the mandatory citation of the date of the revaluation performed, as well as the expected dates of subsequent and/or complementary revaluations.

10.2 Periodicity of Asset Revaluation

When a company chooses to perform and account for an asset revaluation, the criterion or basis for the valuation of its fixed assets changes radically: it ceases to be cost value and becomes market value or replacement value. More than relying on a legal permission, management is sending a message to the market that it will impact future profits by seeking, in operations, to recover the market value or replacement value of its assets, and no longer just the cost, which has a vital difference in economic interpretation. This means that sales revenues will be compared with a new level of expenses, which affects the result and the subsequent allocations in the calculations of dividends and profit retention. Therefore, revaluations must be performed periodically, with such regularity that the net book value does not present significant differences relative to the market value or replacement value on the date of each balance sheet. It is not appropriate to revalue only once in the history of the company's balance sheets, and to add costs of new assets to the revaluation values accounted for in the past, as thus the fixed asset balance ceases to have any representativeness as information.

In view that CVM Deliberation No. 183/95 entered into force on July 1, 1995, regarding revaluations made from that date, and, by virtue of CVM Deliberation No. 206/96, on December 31, 1996, regarding reserves already existing, we remind that the aforementioned deliberation establishes the following maximum periods for performing new revaluations:

a) annually, for accounts or groups of accounts whose market values vary significantly relative to previously recorded values; b) every four years, for assets whose market price fluctuation is not relevant, including still the assets acquired after the last revaluation; c) observed the concept and periods above, the company may opt for a "rotational system", performing, periodically, partial revaluations, by rotation, with defined schedules, which cover the total of assets to be revalued each period, and d) The open company must disclose in an explanatory note all information related to the option referred to in letter "c" above.

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11. Revenue
    11.1 Results of Future Periods

The group of accounts "results of future periods" is represented by net revenue "not earned or not finalized", due to the accrual basis of periods. It is characterized by the fact that there is no obligation to return money, deliver a good, or provide a service that implies any additional effort, or any burden or significant sacrifice for the assets of the company benefiting from the revenue. The object of the operation – good or service produced – is placed at the disposal of the buyer or user, without any additional effort on the part of the company. The most common examples are: rents received in advance, by virtue of contractual provision, without possibility of return (warehouse, silo leasing), deducted from commissions, taxes, and other charges incident; credit opening commissions in financial institutions. In consolidation, this group must include the discount that is not absorbed in the elimination of the investment.

This group, therefore, does not contemplate installments of customer advances, for products to be delivered, services to be executed, or obligations of another nature, which shall be classified in current liabilities or long-term payable liabilities. Cases fitting this classification are very rare. A special case of technically adequate use of this group is the recording of unrealized profit in transactions between the Controlling Company and its Controlled Companies.

12. Employee Benefits

CVM Deliberation No. 371/2000 approves and makes mandatory, for open companies, the Pronouncement on Accounting for Employee Benefits, issued by IBRACON and prepared jointly with CVM. We also consider applicable to open companies the clarifications contained in IBRACON Technical Interpretation No. 01/01 of NPC 26, attached at the end of the clarifications of this item. There are still some aspects that were not explicit in this technical interpretation and deserve clarification:

12.1 Debt Confession Instruments

As a general rule (in compliance with the accrual basis), obligations arising from employee benefits, both in the existence of a formal debt confession instrument and in its absence, should already have been recognized in the equity of the sponsoring companies. However, given that this is a specific standard that provides a transition rule, we understand that the situation mentioned is included in the effects of CVM Deliberation No. 371/2000.

12.2 Scope and Coverage

Although it is evident, it is worth clarifying that CVM Deliberation No. 371/00 is applicable to open joint-stock companies that are, or will become, sponsors of benefits to their employees. In this sense, the normative establishes as follows:

"The objective of this pronouncement is to establish when and in what form the cost to provide employee benefits must be recognized by the Entity employer/sponsor, as well as the information that must be disclosed in the financial statements of this Entity".

Therefore, the charges assumed by the sponsor regarding the benefits due are in no way modified as a result of the application of this Deliberation. What the normative disciplines is the moment and the form of accounting for these charges by the sponsor (open company). And more, the

CIRCULAR LETTER/CVM/SNC/SEP No. 01/2004 34

obligations assumed by the sponsor do not arise from the accounting registration of the obligation, but rather from contractual clauses or legal and normative impositions assumed by this sponsor.

Although mentioned in the Circular Letter closing the 2001 fiscal year, it is worth emphasizing once again that the pronouncement does not cover only pension and retirement benefits, but rather these and several other categories of benefits, such as life insurance, medical and/or dental assistance, voluntary dismissal plans, indemnities or premiums for retirement, etc.

12.3 Nominal Rates X Real Rates

It was observed that, for the calculation of the actuarial obligation, most companies used nominal interest rates (which include an expected inflation rate). Others, in smaller numbers, used real interest rates. The pronouncement does not determine the rate to be used, whether nominal or real.

For those companies that opt for a real interest rate, it is necessary to disclose, with justification, the inflation expectation.

Notwithstanding, it must be emphasized that, regardless of the option, the model must be consistent, that is, the same model (nominal or real) must be used for all economic rates to be employed (discount, return on investments, salary growth, benefit growth, medical service growth, etc.).

12.4 Discount Rate of the Actuarial Obligation

The discount rate must be compatible with the conditions of the company's obligation. The term and risk compatible with this obligation must therefore be considered.

The pronouncement establishes that the discount rate must be based on first-line papers or government bonds, traded in the market, and in the absence of these, the company must determine and justify the rate used, considering, as mentioned above, term and risk compatible with the obligation assumed.

Although evident, we reiterate that the discount rate is not linked to the return rates of the benefit plan assets.

12.5 Return Rate of Plan Assets

This rate must be compatible with the expected remuneration and, consequently, must be a reflection of the investments of the equity constituted for the payment of benefits. Therefore, and as highlighted above, it should not be tied, without justification, to the discount rate.

12.6 Benefit Growth Rate

It was observed that a significant portion of companies that reported employee benefits did not disclose this rate. It is important to highlight that any relevant premise used must be subject to disclosure, as provided for in item 81.f.iv of the Pronouncement attached to CVM Deliberation No. 371/00.

This rate must be determined based on the plan regulations and its disclosure is relevant given that it can significantly impact results, mainly in cases of readjustments by indices different from inflation indices, benefits corrected by parity with salaries, and readjustments that produce a lag between the inflation rate adopted by the plan and the rate used for benefit readjustment.

12.7 Other Relevant Premises

Although not expressly mentioned in the pronouncement, biometric premises constitute relevant information to be made available to the user of accounting information of a company sponsoring employee benefits. Information related to mortality tables, turnover, and

---

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others, in the same way as the item previously addressed, are relevant, given that they can significantly impact results.

12.8 Exclusions in the Determination of the Fair Value of Plan Assets

Items 17 and 60 of the Pronouncement approved by CVM Resolution No. 371/00 determine that non-transferable financial instruments issued by the sponsor and held by the pension fund are not considered plan assets and should not be included in the determination of the fair value of assets.

In line with IBRACON's Technical Interpretation No. 01/01 attached at the end of this item of the circular letter, the financial instruments referred to above are those issued by the open sponsoring company that cannot be transferred, that is, not subject to negotiation with third parties or relating to unpaid contributions or loans to the sponsor, even if registered as an obligation of the latter. The eventual liability registered in the open sponsoring company, excluded from the plan's net assets, shall be classified as part of the total actuarial obligation.

12.9 Actuarial Valuation Method

As provided in the pronouncement, the method for determining the actuarial obligation is the Projected Credit Unit Method. The Company must declare in the explanatory notes that this was the method adopted. We know that the pension fund sponsored by the Company may have adopted a different method; however, the purpose of the pronouncement is to allow uniformity in the calculation of the actuarial obligation and the eventual actuarial liability/asset of the sponsor.

12.10 Accounting for the Initial Adjustment of the Actuarial Liability

CVM Resolution No. 371/2000 approved and made mandatory, for open companies, the Pronouncement on Accounting for Employee Benefits, issued by IBRACON and prepared jointly with the CVM. This pronouncement determined its mandatory application for the period beginning on or after January 1, 2002. In the transitional provisions (paragraphs 84 and 85), the recognition of this actuarial liability was allowed in two ways; either in the result over a five-year period or by the remaining service or life of the employees if these are shorter, or directly in equity under the title "adjustment of prior periods".

In the first alternative, companies that opted for the debit in the income account, the pronouncement specified that the adjustment would be as an extraordinary item in the result of the first exercise and remained silent regarding subsequent years.

In interpreting this aspect, companies must consider it equally permitted for subsequent years, from the second to the fifth years, that the adjustment of this actuarial liability be equally recognized and disclosed prominently as an extraordinary item, that is, outside operating results.

Annex: IBRACON Technical Interpretation No. 01/01 NPC 26

Question 1

Recently, the federal government issued Provisional Measure No. 2.222, of December 4, 2001, which deals with the taxation, by income tax, of benefit plans of a pension nature. The application of this PM may result in modification of the plan's net assets. How should the resulting effects, if any, be treated within the scope of the application of NPC 26?

Answer

As defined in paragraph 52 of NPC 26, "actuarial gains and losses comprise the differences between actuarial assumptions and what actually occurred, based on experience." Thus, the effects of PM No. 2.222 relate to the yield of the plan's assets and, as such, must be considered as actuarial gain or loss. Consequently, this effect will enter the calculation of the portion of actuarial gains or losses to be recognized in accordance with paragraph 53 of NPC 26 (Actuarial gains and losses).

CIRCULAR LETTER/CVM/SNC/SEP No. 01/2004 36

Question 2

Can the actuarial calculation be made for base dates prior to the end of the fiscal year? What is the maximum acceptable period for this calculation and what are the minimum subsequent mandatory procedures, to ensure that between the calculation date and the end of the fiscal year no significant changes occurred that should be reflected in the actuarial liability to be recorded?

Answer

The calculation can be made for a base date prior to the end of the fiscal year provided that the period does not exceed 60 days and that any relevant changes in assumptions or other components of its calculation, occurring between the base date and the end of the fiscal year, are analyzed, for the purpose of complying with the provisions of paragraphs 49(d) and 49(e), and their effects reflected in the original calculation. The minimum procedure to be performed is the comparison of the assumptions used in the calculation with the actual effects occurred in the period.

Question 3

Assuming that, on December 31, 2001, the company already has an actuarial liability registered, say $1,000, and that, as a result of the application of NPC 26, the new actuarial liability is $1,500, and the company decides to register it over 5 years (or by the remaining service or life of the employees, if these are shorter). In this situation, could the company reverse the $1,000 liability by crediting Equity (PL) and, subsequently, register the $1,500 over time in the result? This would create an increase in PL on 12/31/2001, as a consequence of the decrease in the liability and its constitution over the next 5 years (or less, depending on the other criteria mentioned above).

Answer

This reversal cannot be made. The adjustment that should be registered against PL or the result of the next 5 years refers to the difference between the actuarial liability previously recognized by the company and that determined in accordance with NPC 26.

Question 4

In the event that the company does not register the effect of the initial adjustment directly against equity, but decides to register the initial adjustment in the result in a period shorter than that allowed by NPC 26, is such a position acceptable?

Answer

Adjustments to the actuarial liability, as a result of the adoption of NPC 26, shall be recognized in the result over a period of up to five years or by the remaining service or life of the employees if these are shorter, or alternatively until December 31, 2001, directly in equity under the title "adjustment of prior periods". If the sponsor adopts a period shorter than 5 years, such decision must be disclosed in the explanatory notes and will be irreversible. Thus, if the decision is to amortize, for example, in four years, each exercise, from 2002, will receive a charge of 25% of the adjustment calculated with a base date of December 31, 2001. In any case, the appropriation must follow the linear criterion.

1 Actuarial
2 Actuarial Liability

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Question 5

Adjustments made by subsidiaries and affiliates directly in Equity, as a result of the application of the alternative offered by the Standard, should be reflected directly in the equity of the controlling or investing company, or registered in the result of the exercise, as equity equivalence?

Answer

Exceptionally, the adjustment made by subsidiaries and affiliates, directly in equity, shall be reflected in the same way in the investor, that is, in its equity.

Question 6

In light of NPC 26, is a defined contribution plan, but which at the date of retirement gives the participant the option to receive a lifetime monthly value, characterized as a defined benefit plan? For this plan, must the actuarial calculation be made only for retired beneficiaries?

Answer

This is a very important issue, as some plans have the original characteristic of defined contribution, but give the participant the option to receive a lifetime monthly income having as a parameter, for example, 40% of the official pension ceiling. Thus, the plan or part of it, for the option holder, has become a defined benefit, which will require that the accounting provisions for defined benefit plans be applied. The mass of beneficiaries to be included in the calculation must be actuarially estimated.

Question 7

What consideration should be given to assets accounted for in the private pension entity that represent rights against the sponsor?

Answer

If the right registered in the private pension entity is transferable (i.e., negotiable with third parties) and has a counterpart already registered as an obligation in the sponsor, this right should be included in the amount of the plan's net assets. If the right registered in the private pension entity is non-transferable (i.e., not subject to negotiation with third parties) or relates to unpaid contributions or loans to the sponsor, even if registered as an obligation in the sponsor, this right cannot be considered as net assets of the plan. Additionally, the eventual liability registered in the sponsor, excluded from the plan's net assets, shall be reclassified as an actuarial obligation.

Question 8

In defined benefit plans that aggregate contributions from several sponsoring entities belonging to the same economic group or not (in the latter case, these are multi-sponsor plans), how should the segregation of plan assets/liabilities be made? Can parameters such as the number of employees be used?

Answer

The use of the number of beneficiaries to segregate plan assets is not appropriate. It is necessary that the accumulated actuarial liability of each sponsor be clearly identified and the total assets of the plan must be allocated proportionally to the amounts of accumulated obligations of each sponsor, except when another form is determined in the plan regulation(s). When sponsors assume joint and several liability in a multi-sponsor plan, each sponsor must evaluate the financial capacity of the other sponsors and consider the need to recognize additional liability (contingencies) if it is probable that one or more of them will not be able to fulfill the joint and several obligation.

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Question 9

Is the segregation of the actuarial liability between short and long term appropriate? Under what circumstances would this be appropriate?

Answer

Yes, it is appropriate when there is a provision for the payment of contributions in the 12 months following the closing of the financial statements. If the sponsor opts to recognize the liability over 5 years and the amount of the recognized liability is less than the amount of contributions expected to be paid in the 12 months following the closing date, the entire balance of the actuarial liability shall be presented in current liabilities.

If the sponsor opts to account for the liability in full at once, it shall segregate as current liability the portion to be paid in the 12 months following the closing.

Question 10

Paragraph 84 establishes that adjustments to the actuarial liability, as a result of the adoption of NPC 26, shall be recognized in the result over a period of five years or by the remaining service or life of the employees. Is it possible to recognize the full liability on December 31, 2001 with a corresponding deferred asset account, which would subsequently be amortized over a period of 5 years or by the remaining service or life of the employees?

Answer

If the option is not for full recognition against equity on December 31, 2001, the actuarial liability shall be constituted gradually, over the period established in paragraph 84, and the registration of a deferred asset for future amortization is not allowed. However, the disclosures provided for in paragraph 81 must be made.

Question 11

A company accounted for, before the effectiveness of NPC 26, an actuarial liability of R$ 1,000 with a corresponding deferred asset, which was amortized by the remaining service of the employees. Upon adoption of NPC 26, the calculated actuarial liability is R$ 1,500 and there are still R$ 1,000 and R$ 900 accounted for as liability and deferred asset to be amortized, respectively. How should one proceed?

Answer

The first step is to eliminate the deferred asset against the liability, which will result, in the example, in a net liability of R$100. Subsequently, depending on the option chosen by the sponsor, register R$ 1400 as a complement of the liability, in counterpart of equity, or register this value over 5 years or by the remaining service or life of the employees, if these are shorter.

Question 12

Are the assumptions for actuarial calculations required by NPC 26 the same as those used in the plans, according to the rules of the Secretariat of Complementary Pension?

Answer

The actuarial calculations required by NPC 26 can be significantly different from those required for pension entities. In addition to the actuarial method in the case of NPC 26 being the projected credit unit method, there may be other components of actuarial assumptions different from those detailed in item 49 regarding measurement.

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13. Accounting for Government Concessions

On 14.12.2001, the CVM placed a draft Resolution in public hearing with the objective of collecting the market's opinion on the pronouncement to be issued by IBRACON. This hearing notice highlighted the little accounting literature on this matter, even at the international level, highlighting the existence of two currents of opinion (to capitalize or not the concession right) and especially requesting from interested parties their reasoned understanding regarding the best alternative to be adopted.

In summary, the alternatives considered in the draft to account for government concessions are:
a) capitalize the concession right and the assets received in the concession, and, as a consequence, recognize future obligations (payables); b) do not capitalize and treat the concession as a kind of operating lease (rental), not recognizing future obligations; c) reconciling alternative – due to the lack of recognition of inflationary effects through monetary correction of the balance sheet, capitalize the concession right and defer the effects of monetary variations of future obligations.

The reconciling alternative sought to overcome the limitation of capitalizing the concession right and the assets received, which runs into the problem of the lack of recording of inflationary effects in the financial statements, which is not generally disclosed by companies.

Due to not having been able to reach a consensus on the presented draft given the various positions presented and the lack of an international pronouncement that would contribute to elucidating this problem, Ibracon issued Technical Communication No. 03/03, transcribed below and approved by this Circular Letter, which lists the minimum disclosure requirements of companies that operate with concessions.

In addition to these minimum requirements, administrators must bear in mind that they are legally responsible for the disclosure of the minimum information considered essential for the market. Company administrators must promote the continuous evaluation of additional information needs to the public, given their access and knowledge about the facts and the company's environment and their greater capacity to assess its relevance, using the criterion of the possible reflection of events on the quotation of the securities they issued. Based on this, companies that operate with government concessions must consider whether inflationary effects cause relevant distortions on their equity, assets, and results. The CVM has already manifested itself on the disclosure of inflationary effects through CVM Orientation Opinion No. 29/96 which dealt with: (i) periodicity, (ii) minimum content, (iii) criteria for preparation and (iv) index.

In this regard, PO CVM No. 29 states: "(...) it is recommended that companies, together with their auditors, evaluate the convenience not only of the voluntary presentation of this type of information. They must also consider the convenience of its insertion as explanatory notes to the published financial statements and quarterly information sent to this Commission or even the presentation of these statements and quarterly information complete, in currency of constant purchasing power".

Technical Communication 03/03 - Ibracon

Concessions

After the approval of a draft for public hearing of NPC Accounting for Government Concessions, IBRACON had the opportunity to analyze the responses received in the public hearing process conducted by the Securities and Exchange Commission. During this time, IBRACON learned that the IASB (International Accounting Standards Board) is starting a study of the matter as it is of international interest. Since IBRACON's objective is to issue NPC harmonized with international accounting standards (IFRS/IAS), it was concluded necessary and prudent to wait for the position that will be adopted internationally before issuing a pronouncement by IBRACON.

On the other hand, IBRACON is already contributing to the international debate by passing on the results of studies and discussions already held to the IASB. Therefore, it would not be opportune to require at this time any alteration in the treatment currently adopted by Brazilian companies.

However, IBRACON considers it indispensable that companies provide a minimum of information so that users are provided with minimum elements for decision making. In this context, it is required from companies that operate with concessions the disclosure of the following information:

Concession Assets

1. The following information must be disclosed, at the date of each closing of the fiscal year or period, when applicable:
   a. assets subject to the concession and their total values, concession term, fixed payment commitments, with description also of variable commitments both regarding their calculation and their incidence; b. residual amount of the concession, with indication of the nominal value and the present value of the installments to be paid in the 12 months following the closing of the fiscal year or period and of the installments to be paid after this 12-month period, indicating the interest rate used for the calculation of the present value;
   c. residual value of the concession fixed assets at the date of the financial statements that shall be transferred to the granting authority at the end of the contract (corresponding to assets with residual life greater than the concession and with clause of transfer to the granting authority);
   d. amount paid to the granting authority during the fiscal year or period of the financial statements; e. bases for appropriation to the result of the costs with the remuneration of the granting authority; and f. terms of other financial commitments (maintenance and investments), including variable ones, such as those based on collected tariffs.

Related Parties

2. Considering the peculiar characteristics of a concession, disclosures regarding balances and transactions with related parties must be made, when relevant and applicable, in explanatory notes to the financial statements of the public service concessionaire and/or use of public asset referred to, which are divided into three categories:
   (a) Operating transactions:
   i. amounts accounted for in the financial statements of the concessionaires regarding expenses with services, for example, highway/railway maintenance;
   ii. amounts accounted for regarding purchase and sale, as well as payables or receivables balances resulting from operations;
   iii. provision of administrative services and/or any form of use of the physical structure or personnel of one company by the other, with or without consideration;
   iv. receipts or payments for the lease of real estate or movable assets of any nature;
   v. amounts of real estate or movable assets of any nature received or delivered on loan; and
   vi. other transactions deemed relevant.
   (b) Investment transactions:

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i. amount of contracts already celebrated in execution and accounted for in the entity's financial statements;
ii. amounts of contracts to be executed and indication of the fiscal years in which they will be concluded;
iii. alienation or transfer of assets from the asset; and
iv. acquisition of rights or purchase options or any other type of benefit and its respective exercise.
(c) Transactions with loans/financing:
i. loans and advances, with or without financial charges, and the rates practiced;
ii. revenues or expenses registered in the fiscal year/period regarding the loans or advances referred to in i;
iii. guarantees, sureties, mortgages, deposits, pledges or any other forms of guarantees; and
iv. novation, forgiveness or other forms of cancellation of debts.

14. Effects of Changes in Exchange Rates

14.1 Exchange Rate Variation

The accounting treatment to be dispensed to variations in the exchange rate, occurred during the year 2001, was regulated through Provisional Measure No. 3/01, of 26.09.2001, and CVM Resolution No. 404/01, of 27.09.2001, with new wording given by CVM Resolution No. 409/01, of 01.11.2001. The reading of the provisions contained in the aforementioned acts has generated some doubts and conflicting interpretations by some open companies.

14.2 Amortization

PM No. 03/01, in its article 1st, sole paragraph, determines that the amortization of the negative net result with exchange rate variations, subject to deferral, shall begin from the calendar year of 2001.

With regard to the method of amortization of the deferred exchange asset, CVM Resolution No. 404/01, in its item IX, determines that the deferred exchange asset shall be amortized linearly, over a period not exceeding 4 years. Thus, the period for amortization of the deferred exchange asset can be done in 2, 3 or 4 years (equivalent in quarters).

By way of illustration, an open company that decides to amortize the deferred exchange asset at a rate of 25% for the first year, 25% for the second year and 50% for the third year will not be complying with CVM Resolution No. 404/01. The amortization quotas of the deferred exchange asset must be equal. In the case at hand, the open company shall use, over the three years, an amortization quota equivalent to 33.33% of the deferred exchange asset.

In fixing the amortization period, the company must consider the maturity dates and the installments of the exchange liabilities that originated the deferral. By way of illustration, an open company that possesses solely long-term exchange liability maturing in two years cannot amortize the resulting deferred exchange asset in a period longer than this period.

14.3 Change of the Amortization Period

CVM Resolution No. 404/01, in its item X, provides for the possibility of change in the amortization period of the deferred exchange asset, the effects of this change shall always pass through the result of the current exercise, therefore, its accounting as "adjustment of prior periods" is not accepted.

As the alteration of the amortization period can impact a previously taken investment decision, this alteration is only admitted in the event of a decrease in the period

14.4 Adjustment Resulting from Recovery of Foreign Exchange Losses

CVM Deliberation No. 404/01 determines, in its item III, that the effects of reductions in the exchange rate on foreign exchange liabilities, which are financing fixed assets under construction or long-maturity inventory, occurred during the entire year of 2001, shall be recorded as a reduction in the cost value of these assets.

If the realization of these assets has been initiated, CVM Deliberation No. 404/01, in the same item III, determines that the depreciation expense accounted for in the period's result shall be adjusted.

Likewise, the cost of long-maturity inventory that has been transferred to the period's result must be adjusted.

The same principle must be applied to the deferred foreign exchange asset. CVM Deliberation No. 404/01, in its item XII, with new wording given by CVM Deliberation No. 409/01, determines that the recovery of deferred foreign exchange losses, that is, the occurrence of gains subsequent to the deferral, shall be accounted for as an adjustment of the deferred foreign exchange asset, without prejudice to the recognition of the amortization quota of the exercise.

In addition to normal amortization, the recovery of losses generates an extraordinary amortization.

This is the intelligence of CVM Deliberation No. 404/01, namely, to amortize the deferred foreign exchange asset as quickly as possible. However, any negative foreign exchange variations occurring from 01.01.2002, even if linked to liabilities that gave rise to the deferral, must be recorded in the period's result.

14.5 Partial/Total Settlement of Foreign Exchange Liability

CVM Deliberation No. 404/01 determines in its item XII, with new wording given by CVM Deliberation No. 409/01, that in the event of total or partial settlement of the foreign exchange liability, whether by payment or conversion into capital, the deferred foreign exchange asset shall be amortized totally or partially, in the same proportion in which the settlement of the foreign exchange liability occurred.

14.6 Reserve for Profits to be Realized and Hedge Instruments

CVM Deliberation No. 404/01, in its item V, allows open corporations to allocate the positive net result, with the foreign exchange variations occurring in the year 2001, to the constitution of a reserve for profits to be realized. However, with the advent of Law No. 10.303/2001, as mentioned in item 4 of this Circular Letter, the Reserve for Profits to be Realized can only be constituted by the portion of the mandatory minimum dividend that cannot have its payment supported by realized profits.

This positive net result, as highlighted by CVM Deliberation No. 404/01, in its item VI, refers exclusively to those assets and liabilities, subject to foreign exchange risk, to the extent and in the proportion in which they are not protected by a financial instrument of any kind.

Therefore, for the purposes of constituting the Reserve for Profits to be Realized, only the existence of a positive net result with the foreign exchange variations occurring in the year 2001 should be considered, after the computation of any losses and gains arising from financial instruments, used as Hedge of assets and liabilities subject to foreign exchange risk, occurring in the year 2001.

In the same line, CVM Deliberation No. 404/01 determines, in its item XIII, that the negative net result with the foreign exchange variations occurring in the year 2001, subject to deferral, does not apply to those assets and liabilities, subject to foreign exchange risk, to the extent and in the proportion in which they are protected by a financial instrument of any kind.

Likewise, for deferral purposes, only the existence of a negative net result should be considered after considering the foreign exchange variations with the inclusion of any losses and gains

OFÍCIO-CIRCULAR/CVM/SNC/SEP Nº 01/2004 43

arising from financial instruments used as Hedge of assets and liabilities subject to foreign exchange risk occurring in the year 2001.

With regard to the negative net result with the foreign exchange variations occurring in the year 2001, CVM Deliberation No. 404/01 does not admit the deferral of speculative losses, operations in markets with future settlement for purposes other than the protection of an active or passive position, subject to foreign exchange risk, assumed by the company.

14.7 Effect on Equity Method due to Foreign Exchange Variation

In the computation of the positive or negative net result with the foreign exchange variations occurring in the year 2001, any revenue or expense with equity method must be taken into consideration, specifically the portion attributed to the foreign exchange variation, of equity participation abroad or of any other entity defined by CVM Instruction No. 247/96, articles 2nd and 3rd.

14.8 Temporary Differences

Provisional Measure No. 03/01, in its article 2nd, determines that legal entities that have opted for the deferral of the negative net result with the foreign exchange variations occurring in the year 2001 shall exclude from the net profit of the exercise, for the determination of real profit and the calculation base of the social contribution, the difference between the deferred amount and the value amortized in the period. In the sole paragraph of this same article, Provisional Measure No. 03/01 determines that subsequent amortizations shall be offered for taxation.

The effect of the above-mentioned provisions, together with CVM Deliberation No. 404/01, implies the emergence of a temporary difference. Moreover, according to the taxation regime elected by the company for foreign exchange variations (cash or accrual), other temporary differences may arise. In this sense, the IBRACON Pronouncement approved by CVM Deliberation No. 273/98, of 20.08.98, must be observed.

14.9 Audit Reports/Opinions

With regard to independent auditors, CVM Deliberation No. 404/01, in its item XVI, determines that they must manifest themselves regarding the adoption of the procedures provided for in said Deliberation. Thus, in order to comply with professional standards and CVM standards, independent auditors, when issuing a special review report or independent audit opinion, must observe the Fundamental Accounting Principles – FAP.

It should be emphasized that, in accordance with CVM Instruction No. 308/99, of 14.05.99, article 25, sole paragraph, it is incumbent upon independent auditors to promptly communicate to this CVM about acts practiced by the administrators of open corporations that are not in accordance with legal or regulatory provisions.

In this sense, the non-observance of provisions of CVM Deliberation No. 404/01 by open corporations obliges independent auditors to communicate the fact to the CVM, in writing, within a maximum period of 20 days from its detection. The lack of communication constitutes an infraction of an objective nature, subjecting auditors to a fine and an administrative process in the form of a summary procedure. It should be emphasized, furthermore, that the issuance of an opinion with reservations does not elude the auditor's responsibility regarding this communication.

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15. Loan Costs

15.1 Restrictive Clauses of Financing Contracts

Some companies have liabilities linked to other currencies, whose contracts include clauses that impose certain restrictions, normally linked to the maintenance of certain financial indices (debt ratio, coverage of interest expenses, etc.). It is possible, and in some cases quite likely, the non-compliance with the respective clauses.

To determine the adequate classification of these liabilities, it is necessary to understand in detail at what moment the non-compliance with the restrictive clauses is consummated and the consequences of this non-compliance. In this process, it may be necessary, by the independent auditor, a consultation with the legal representatives of the company. Some loan contracts incorporate clauses that have the effect of making the debt due on demand, including installments of long-term, if certain financial indices are not met.

Under these circumstances, as required by NPC 27 "Financial Statements – Presentation and Disclosure" of IBRACON, the corresponding liability shall be fully classified as current, except when:

• the creditor has formally agreed, before the approval of the corresponding financial statements/quarterly information, not to demand early payment resulting from the breach of a contractual clause; and
• it is unlikely that other breaches will occur within twelve months from the date of the financial statements/quarterly information in question.

15.2 Refis

CVM Instruction No. 346/00 established the conditions for accounting and disclosure of information on the effects resulting from adherence to the Fiscal Recovery Program – REFIS. The aforementioned instruction does not determine the obligation of accounting recording of the debt at its present value, fixing, however, requirements for this recognition to be made.

However, CVM Instruction No. 346/00 determines, when relevant, the disclosure, in explanatory notes to the financial statements, of the present value of debts subject to settlement based on a percentage of gross revenue, as well as the values, deadlines, rates and other premises used to determine this present value. This disclosure must be made regardless of whether the company has accounted for the debt at present value or not.

We must also alert open corporations that the provisions contained in CVM Instruction No. 346/00, due to the concepts contained therein, also apply to other state or municipal programs for refinancing tax debts, which have similar conditions.

In this line, administrators and independent auditors must pay special attention to the disclosure of the fact that the company has adhered to the REFIS program as well as to the amounts paid in each period for the amortization of debts in that program included. It should be remembered, furthermore, that this information must be provided, in an updated manner, throughout the time the company remains adherent to the REFIS Program.

16. Related Party Disclosures

16.1 The motivation for the existence of explanatory notes on "related parties"

Within the scope of the securities market, the disclosure of transactions between related parties is now regulated by CVM Deliberation No. 26/86 and is still the object of the international pronouncement IAS No. 24, revised in 1986, and the recommendations of the CVM "Corporate Governance Guidebook" in its item III.4.

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The nature of transactions between parties that have common interests led the CVM to not recommend the contracting of this type of business, and this prohibition must be contained in the company's bylaws. This recommendation of the CVM governance guidebook is based on the difficulty of establishing exemption in the pricing of these operations, since it is assumed that there is a high probability of existing an interest that may not coincide with the search for the best result for the company and, consequently, for the interests of non-controlling shareholders: shareholders, debenture holders, creditors, etc....

Furthermore, it can be inferred that any transaction of this type, to some extent, large or small, consumes some type of resource of the company in the form of resources available for other types of business, credit limits, in addition to other types of resources that, if applied in some alternative of lower profitability and admitting that the company's resources are by definition limited and scarce, certainly reduce the wealth of non-controlling shareholders.

These are the reasons why, if, still, such types of transactions are carried out, it is necessary to disclose in detail the conditions under which the businesses were contracted so that other interested parties in the company can take full knowledge of the operation.

In the "Discussion of the Problem", the Ibracon pronouncement, approved by CVM Deliberation No. 26/86, highlights this point:

“To allow an adequate interpretation of the financial statements by their users and by those who, based on them, will make economic-financial decisions, it is necessary that transactions between related parties be disclosed in such a way as to provide the reader, and mainly minority shareholders, with sufficient informative elements to understand the magnitude, the characteristics and the effects of this type of transactions on the financial situation and the results of the company.”

It is concluded that the existence and disclosure of transactions between related parties is of a sensitive nature and that the disclosure in a summary and non-detailed manner of this type of business leads to distrust and reduces the appreciation of the company's securities.

16.2 Supervision of transactions between related parties

The CVM corporate governance guidebook in its item III.4 recommends the following:

“The board of directors must ensure that transactions between related parties are clearly reflected in the financial statements and were made in writing and under market conditions. The company's bylaws must prohibit service contracts by related parties with remuneration based on turnover/revenue and, in principle, loan contracts with the controlling party or related parties.

Regardless of the precautions ordinarily adopted so that proof of contracts celebrated is made in the best possible way, it is imperative that due transparency be given to contracts between related parties, in order to enable shareholders to exercise the essential right of supervision and monitoring of the management acts of the company, without prejudice to the duty to promote its wide disclosure to the market, when the contracting constitutes a relevant fact or when of the disclosure of the financial statements.”

16.3 Formalization of business between related parties

The CVM corporate governance guidebook in its item III.4 recommends the following, regarding the need for the form that these types of transactions should take:

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“Contracts between related parties must be formalized in writing, detailing their main characteristics (rights, responsibilities, quality, prices, charges, deadlines, indicators of commutativity, etc.). In the assemblies to discuss such contracts, if minority shareholders deem it necessary, they may ask for an opinion from an independent entity, to be paid by the company.”

Among the operations observed over the last few years, it should be emphasized that loan contracts between companies of the same economic group are included in this explanatory note and must be backed by contracts that discriminate rights, responsibilities, conditions of commutativity and other aspects such as prices, deadlines and charges that allow a reasonable understanding of the economic relationship between the parties.

16.4 Pricing of transactions between related parties

Since the law requires that such contracts be celebrated under market conditions (deadline, rate and guarantees), if the related party seeks credit, for example, it must do so under the same conditions that it would with third parties. Service contracts between the company and the controlling party or related parties must be aligned with the interests of all shareholders of the company. In particular, such contracts shall not be based on turnover/revenue, as part of the remuneration of the controlling party or the related party will be independent of the operational performance of the company.

Special attention must be given to the issue of transfer prices, often used with the objective of maximizing the results of an entity or group of entities. There are several methods used for their definition, based, for example, on the market price, effective or similar, on the cost of the product plus an arbitrated profit margin or on the standard cost plus profit. Thus, it becomes necessary to disclose the calculation criteria used to determine transfer prices in transactions with related parties.

The use of the standard expression in explanatory notes: “Transactions with related parties are carried out at normal market prices and conditions, in a manner similar to those carried out with third parties”, does not fulfill the determination to clarify about prices and/or pricing policies in these types of transactions and is ineffectual. Even if they are made in large numbers and it becomes unfeasible to detail each price in each operation, it is necessary to clarify the method used, the form of calculation and the average prices, for example.

Note that Law No. 9.430/96 established fiscal rules on the transfer prices of goods, services and rights abroad, establishing the methods to be used so that these prices are considered deductible in the calculation of income tax and social contribution. Any relevant consequences of the application of this rule must be considered for disclosure in explanatory notes.

16.5 Content of explanatory notes

The greater or lesser emphasis in the disclosure of transactions shall be given considering the following facts:

• if the transaction was carried out under conditions similar to those that would be applied between unrelated parties (as to prices, deadlines, charges, quality, etc.) that would contract based on their free will and in their best interest; and
• if the transactions by themselves or by their effects affect or may come to affect, significantly, the financial situation and/or the results of the companies intervening in the operation.

Open corporations, when they disclose this type of information, have given greater emphasis to the values resulting from these transactions, which integrate the asset, liability and result, without giving, however, the same emphasis to the conditions under which the transactions were carried out, to the nature of the relationship and to the transfer pricing policy.

The IBRACON pronouncement lists, in a merely exemplary manner, types of transactions between related parties and which must be the object of disclosure in explanatory notes.

Among the transactions between related parties that must be disclosed, we highlight:

• Purchase or sale of products and/or services that constitute the company's social object.
• Alienation or transfer of asset items.
• Alienation or transfer of industrial property rights.
• Balances resulting from operations and any other balances to be received or paid.
• Novation, forgiveness or other unusual forms of cancellation of debts.
• Provision of administrative services and/or any form of use of the physical structure or personnel of one company by the other or others, with or without consideration.
• Guarantees, sureties, mortgages, deposits, pledges or any other forms of guarantees.
• Acquisition of rights or purchase options or any other type of benefit and its respective exercise.
• Any non-remunerated transfers.
• Preemptive rights to subscribe to securities.
• Loans and advances, with or without financial charges, or at favored rates.
• Receipts or payments for the lease or loan of real or movable property of any nature.
• Maintenance of any benefits for employees of related parties, such as: supplementary social pension plans, health assistance plan, cafeteria, recreation centers, etc.
• Market and technological limitations.

17. Consolidated Financial Statements and Accounting of Investments

17.1 Evaluation by Equity Method

This was a subject that also led the CVM to request clarifications from a reasonable number of open corporations due to the discrepancies found between the values described in the balance sheet and the content of the explanatory note on the subject.

What is expected is that the highlights of the note clarify or complement the other financial statements in an objective manner, aiming to provide the reader with a complete understanding of the operation. One way for this to materialize is in which the quantitative data of the notes are consistent with the items of the balance sheet and the income statement, functioning as a calculation memory that will help the user to understand the constitution of the balance of the accounts involved and how this occurred.

17.1.1 Societies Equivalent to Affiliated Companies

Aiming to preserve the basic premises that underpin the application of the equity method, the CVM began to require, from Instruction No. 247/96, that investments in other societies considered equivalent to affiliated companies should also be evaluated by the MEP. The Instruction conceptualized as equivalent to an affiliated company the society that participates in another:

a) indirectly, with 10% (ten percent) or more of the voting capital, without controlling it; b) directly, with 10% (ten percent) or more of the voting capital, without controlling it, regardless of the percentage of participation in the total capital, that is, even if this percentage is less than 10% (ten percent) of the total capital.

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Doubts have arisen regarding how to adjust the MEP (Equity Method) in cases of indirect participation.
In this case, the public company must adjust the balance sheet of the subsidiary/affiliate in which it holds direct participation for the purposes of applying the MEP, or request that it, when applicable, already include such effects in its financial statements.
This same understanding is applicable in cases where individually the investment in affiliates/subsidiaries does not reach the percentage necessary to characterize affiliation, however the sum of participations characterizes the company as equivalent to an affiliate.
It is important to note, furthermore, that in the application of the MEP in equivalent societies, the same conditions of relevance of the investment and influence in the administration defined in articles 4 and 5 of CVM Instruction No. 247/96, and applicable to affiliates, must be observed. An additional care that public companies must have, when applying the MEP in equivalent societies, concerns the percentage of participation to be used. We remind you that the percentage previously mentioned, of 10% or more of the voting capital, serves to measure the equivalence, not necessarily representing the percentage to be used for the application of the MEP.

17.1.2 Loss of Continuity of the Subsidiary/Affiliate's Operations
The question presented is whether a change in the line of activity of the subsidiary/affiliate would characterize loss of continuity, for the purposes of the provisions in article 6 and the sole paragraph of article 8 of CVM Instruction No. 247/96. The Explanatory Note to the aforementioned instruction, in item 4-c, transcribed below, clarifies this issue well:

"Investments in affiliates and subsidiaries that have clear and effective evidence of discontinuity should not be evaluated by the MEP. These are companies that are in the process of liquidation, extinction, or that are operating under severe long-term restrictions, which impair their ability to transfer funds (art. 6)".

Thus, it is clear that the mere change in the line of activity of the subsidiary/affiliate does not characterize loss of continuity, and the investment must continue to be evaluated by the MEP.

17.1.3 Future Sale of the Investment
The Instruction establishes that in the case of investment in subsidiaries/affiliates that are operating normally, where there is evidence of sale in the near future, the criterion of evaluation by the MEP must be maintained until the base date considered for the sale (art. 7). The question that has been raised refers to the term "base date", that is, whether the investment must be evaluated based on the balance sheet of the sale date. It should be mentioned, preliminarily, that article 7 aimed to clarify that the intention to sell the investment, even if formalized by a protocol of intentions or other document, does not characterize the loss of continuity, and the investment must continue to be evaluated by the MEP until the moment the sale is finalized. Regarding the base balance for this evaluation, the ideal is to use that which was adopted for the determination of the sale price, considering the date lags admitted in the sole paragraph of article 10 of the aforementioned instruction. It should also be remembered that tax legislation admits a lag of up to 30 (thirty) days for the application of the MEP, in the case of the write-off of the investment, and this may be the "base date" to be used by the company to comply with CVM standards.

CIRCULAR LETTER/CVM/SNC/SEP No. 01/2004 49

17.1.4 Permanent Losses in Investments Evaluated by the Equity Method
The main change made in this topic concerns the need to constitute a provision for losses, when there is a deficit liability and there is a clear intention of the investor to maintain its financial support to the investee (§ 1 of Art. 12). The provision for losses must be presented in the non-current assets by deduction of the accounting value of the investment (including therein the goodwill and unamortized badwill), with the excess presented in a specific account in the liabilities (§ 2 of Art. 12). It is important to note that the investor must constitute such provision, as already mentioned, only when there is a clear intention to maintain financial support or formal or operational responsibility to cover a deficit liability, this procedure not being applicable in cases where, despite the existence of a deficit liability, the investee does not show signs of paralysis or need for financial support from the investor. Another aspect to be clarified concerns the determination contained in item "a" of item I of article 12 for the investor to constitute a provision for "coverage of effective losses due to events that result in losses not provided for by affiliates and subsidiaries in their financial statements". It has been questioned whether the investor should not adjust the equity of the subsidiary/affiliate beforehand, as prescribed in item I of article 11, in order to eliminate the effects resulting from the diversity of accounting criteria. CVM agrees with such argumentation, however the command of item "a" of item I of article 12 constitutes an additional mechanism in situations where the standardization of accounting criteria is not sufficient to contemplate the provisioning of potential losses. An example to be considered is the case of expectations of losses, resulting from tax contingencies due to judicial demands promoted exclusively by the subsidiary/affiliate, which the administration of the parent/investor considers prudent to constitute a provision for probable losses. Within this theme, due attention is also being requested for the constitution of provisions aimed at covering losses, effective or potential, based on the reasons listed in item II of article 12 of CVM Instruction No. 247/96. We understand that this is an extremely relevant subject and that, consequently, it requires constant monitoring, by the company's administration, of the adequate value of these investments, as well as of its own economic substance. The accounting recording of loss provisions should be promoted:

• when resulting from debts with third parties, in the current liability or long-term payable account, according to the payment term;
• when resulting from losses of credits against invested societies, in the current asset or long-term realizable account;
• in other cases, in an investment correcting account.

17.1.5 Goodwill/Badwill in the Subscription of Capital Increase
The Explanatory Note to CVM Instruction No. 247/96, in its item 7, brought important clarifications regarding the change in the treatment to be given to the goodwill/badwill determined in cases of subscription where there is a variation in the percentage of participation, also presenting a numerical example.
In that example, we arrived at the existence of a goodwill in the investor - Company B in the amount of $200. In view of the doubts that still persist on this subject, we present the same example in another way:

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• The subscription right of Company B was 30% (previous participation) of the capital increase, therefore of $ 360 ($1200 X 30% or 120 shares at $3 each) and on this portion there is no figure of goodwill/badwill or gain/loss.
• The portion effectively "acquired" by Company B (that is, subscribed above its right) was of $840 (70% x $1200 or 280 shares at $3 each) of the capital increase. The calculation of the goodwill can be demonstrated as follows:
  Equity of XYZ after capital increase $3,200
  (:) Number of shares of capital 1,400
  (=) Book Value per share $2.2857
  (x) Number of shares "acquired" 280
  (=) "Acquisition" at Book Value $640
  (-) Acquisition Cost $840
  (=) Goodwill $200

What is sought to be emphasized in this example is that the figure of goodwill/badwill arises in the investor when it "acquires" an additional portion of participation and only on this portion. Therefore, the subscription, even if at a value above/below the book value of the share, does not generate goodwill/badwill if it is carried out in the exact proportion prior to the capital increase. By the same reasoning, it is also concluded that, in cases where the right to subscription is exercised by a percentage lower than the previous participation (or even if this right is not exercised), the investor will be calculating a gain/loss due to variation in the percentage of participation.

17.1.6 Goodwill / Badwill originating from Investments evaluated by equity method
The explanatory notes accompanying the financial statements must contain precise information about affiliates and subsidiaries.
One of the items of extreme importance for inferring future results, provided for in item VIII of article 20 of CVM Instruction No. 247/96, determines that "the basis and foundation adopted for the constitution and amortization of goodwill or badwill and the unamortized amounts, as well as criteria, discount rate and periods used in the projection of results" must be disclosed. Thus, the economic reasons that determined the bases and foundations for the accounting of goodwill and/or badwill and the amounts accounted for as amortization in the period and the amortization bases for subsequent periods must be clearly identified and disclosed. It must be emphasized that the accounting recognition of goodwill (and its maintenance) is intimately associated with its economic foundation, and disclosures that encompass evasive or generic definitions are not accepted. It is worth remembering the provision of article 14, § 2, item "a", of CVM Instruction No. 247/96, including the wording given by CVM Instruction No. 285/98, which recommends the immediate recognition of the loss of economic substance, attested by the mandatory periodic review (at least once a year) of future results projections. The same procedure must be adopted for goodwill whose economic foundation is not justified (§ 5).

17.1.7 Elimination of Unrealized Profits
The Explanatory Note of CVM Instruction No. 247/96, in its item 5, brings clarifications on the concept that involves this new form of elimination of unrealized profits, in addition to presenting the numerical example summarized below:

CIRCULAR LETTER/CVM/SNC/SEP No. 01/2004 51

Example 1
Equity of the Subsidiary R$ 1,200
% Participation 60%
Realized Profits R$ 167
Unrealized Profits R$ 200
Accounting Value of the Investment R$ 500
Calculation of Equity Method calculation by previous standard (revoked) calculation by current standard (in force) Equity R$ 1,200 Equity R$ 1,200 less: unrealized profits (200) percentage of participation 60% Adjusted Equity 1,000 Adjusted Equity R$ 720 percentage of participation 60% less: unrealized profits (200) total Investment R$ 600 total Investment 520 accounting value of investment 500 accounting value of investment 500 result of equity method 100 result of equity method 20

17.1.8 Calculation of Equity Method
As mentioned in the Explanatory Note to CVM Instruction No. 247/96, there is only the figure of unrealized profit in transactions between the parent and the subsidiary; that is, it is as if the transaction had been made between two departments belonging to the same entity, but with distinct legal personalities. In this case, the transaction should not generate profit in the entity. However, since there are third parties (minority shareholders) with participation rights on this profit, this fact must be recognized by the parent, both in its individual statements, as well as in the consolidated statements. Another way to highlight the amount of the parent's profit, in the example above, would be:
Total Profit R$ 367
Unrealized Profit (200)
Minority Profit (40% of $ 367) (147)
Parent's Profit 20

Another aspect, not contemplated in the Explanatory Note, concerns the elimination of unrealized profits in cases where control is exercised indirectly, that is, where there is more than one investor in the subsidiary and which could lead to a multiple and undue elimination of unrealized profits.
Considering the data above, let us see an example where the participation in the subsidiary "C" is presented as follows:

• Parent "A" owns 100% of subsidiary "B" and 15% of indirect subsidiary "C";
• Subsidiary "B" owns 45% of Company "C".

CIRCULAR LETTER/CVM/SNC/SEP No. 01/2004 52

Assuming the occurrence of unrealized profit, in the amount of R$ 200, in an operation of sale of assets from "C" to "B", we would have to:

• "B" when evaluating the investment in "C" must eliminate this unrealized profit; and
• "A" when evaluating the investment in "C" must also eliminate it.
  However, if "A" and "B" proceed thus, the unrealized profit will be eliminated in duplicate.
  To obtain the adequate reflection of the elimination of unrealized profit, in the case of shared controls by companies of the same economic conglomerate, such unrealized profit must be attributed to the controllers in the proportion held by each one on the total participation in the subsidiary. Thus, for the purposes of the MEP we would have:
  Participation of more than one company of the same "economic group" in an investee e elimination of unrealized profit of "C" in "A" e elimination of unrealized profit of "C" in "B" Equity R$ 1,200 Equity R$ 1,200 percentage of participation 15% percentage of participation 45% Equity Method R$ 180 Equity Method R$ 540 less: unrealized profits (1) (50) less: unrealized profits (2) (150) total Investment 130 total Investment 390 accounting value of investment 125 accounting value of investment 375 result of equity method 5 result of equity method 15 calculation of the elimination of unrealized profit of R$ 200 :
  (1) [(0.15 / 0.60)] x R$ 200 = R$ 50
  (2) [(0.45 / 0.60)] x R$ 200 = R$ 150

As observed, the sum of the result of the equity method is the same found in the 1st example.
It is important to note that, in the situations of this example, the unrealized profit must, necessarily, be attributed proportionally to the parent companies/investors, highlighting the hypothesis of only one of the companies eliminating it, in view of the distortions resulting from the values recorded in the individual balance sheets, which may bring effects to third parties, notably minority shareholders of these parent companies. In the example above, for simplification, we assumed that A has 100% of the capital of B, however if there were any minority participation in B, the attribution of the entire unrealized profit to company A or B would lead to a favoring/disadvantaging of these, including with respect to dividends.

17.1.9 Investment acquired from investee with Negative Equity
In the situation where the investee presents a deficit liability, also called negative equity, CVM Instruction 247, in § 2 of article 12, guides towards the constitution of a provision for losses up to the limit of the accounting value of the investment to which it refers, with the excess, when applicable, and in accordance with CVM Instruction No. 247/96, presented in a specific account in the liabilities (see item 17.1.4). If, at the time of acquisition of the investment, the value of the Equity of the investee is already negative, the initial balance of the equity method must be negative, with the goodwill representing the difference between this result and the acquisition cost. The initial total investment, of course, will be positive,

CIRCULAR LETTER/CVM/SNC/SEP No. 01/2004 53

representing the effective value paid. This goodwill must be registered and amortized according to its economic foundation (asset appreciation, expectation of future profitability or recovery of loss and rights of exploration/concession). This practice allows a better recognition of the future results of the investee, through the combination of the result of the equity method opposing the amortization of the goodwill based on its economic foundation, as well as allows a better presentation of the consolidated equity. The recording of the equity method must be normal from then on unless any additional losses surpass the investment, in which case, the result of the equity method progressively decreases the investment until it reaches zero, that is, not registering a negative investment value. The accounting treatment of the goodwill in subsequent operations of incorporation, investee incorporating investor, for example, must also be done taking into account the same principle.

17.2 Consolidated Financial Statements
CVM Instruction No. 247/96 determines that the public company that has investment in controlled societies, including jointly controlled societies, and the command society of a group of societies that includes a public company must, at the end of each fiscal year, prepare consolidated financial statements (art. 21).
It also provides that CVM may, in special cases and upon prior request, authorize the exclusion of one or more controlled societies from the consolidated financial statements (§ 1 of art. 23).
Therefore, the public company that wishes to exclude a controlled society from its Consolidated Financial Statements must request, previously, authorization for the mentioned exclusion, instructing its request with the following information:
a) financial statements of the controlled societies and the parent, relating to the exercise in which the exclusion is being requested, compared with the previous exercise; b) amount of gross revenue of the parent and subsidiaries, from operations with third parties; c) amount of non-operational credits of the parent with the subsidiaries, and d) other information on transactions between the parent and the subsidiaries or among the latter. Alternatively, aiming to speed up the analysis of the request and, consequently, the process of preparing the consolidated financial statements, the company may replace the statements mentioned in "a" with interim statements raised on September 30. The requests for exclusion must be addressed to the Superintendence of Accounting Standards and Auditing of this CVM. It should be noted that, once granted, the authorization will be valid only for the fiscal year in which the exclusion is being requested.

17.2.1 Consolidation of Financial Statements of Jointly Controlled Societies
This topic provides for the procedures that must be adopted for the preparation of consolidated statements, which include jointly controlled societies (art. 32 to 34), here defined as those in which no shareholder exercises, individually, the powers provided for in article 3 of the Instruction.
These provisions reach, mainly, but not exclusively, the so-called joint ventures where, through the existence of a contractual agreement and proportional portions of participation, two or more entities undertake an economic activity subject to joint control.

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Article 32 determines that the components of assets and liabilities, revenues and expenses of jointly controlled societies must be aggregated to the consolidated financial statements of each investor, in proportion to their participation in its share capital.
However, it was verified that there may be situations where the participation in results does not correspond to the participation in capital but to the production and distribution of the result. In these cases, each investor must reflect in the consolidated result statement the effective portion of participation that it has in the result of the investee. Thus, CVM understands that the jointly controlled subsidiary must prepare and provide the financial statements intended for the consolidation of each investor, observing such peculiarities, and it is still up to it to disclose, in an explanatory note, this procedure and the amounts involved. Similarly, there may be balances of active/passive operations with the investors. In this case, it is reiterated that such components must be eliminated from the investor's financial statements proportionally to its participation in the capital, with the remaining balances of such operations, above/below this participation, appearing in said statements as operations with third parties (in this case, with the other partners).

17.2.2 Consolidation of Special Purpose Entities (SPEs)
An SPE is normally constituted to carry out well-defined activities, and may take the form of a company, foundation, society or even not have a corporate form.
Frequently, SPEs are created with legal provisions that impose rigid and sometimes permanent limits on the decision-making powers of their management bodies, trustees or administrators, regarding their operations. These provisions usually specify that the policy guiding the continuous activities of the SPE cannot be modified, unless perhaps by its creator or sponsor, that is, they operate in a mechanism known in international language as "autopilot". The constitution of the SPE seeks, in most cases, the use of financing opportunities, by segregating the specific risks of the assets or activities of the beneficiary company from the global risks of the company by its creation. The participation in the benefits generated by an SPE can, for example, take the form of a debt or equity instrument. In most cases, the creator or sponsor retains a significant participation in the benefits of the SPE's activities, although its participation in the equity of the SPE may be small or none. The consolidation of financial statements, as required by CVM Instruction No. 247/96, has been based on the existence of a corporate link between the parent and its subsidiaries. However, transactions involving SPEs have become increasingly common today and the approach to consolidation, based exclusively on voting capital, has proven insufficient for the full disclosure of economic activities as a whole. Currently, we face several situations where, even without the existence of corporate links, an entity holds, in fact, control over the activities and benefits of another, bearing most of the risks arising from these activities. The lack of consolidation of these entities allows certain businesses "controlled" by public companies to fail to be fully evidenced, affecting, often significantly, the information on the financial and equity situation of the company as a whole. On the other hand, the Companies Law, in its article 249, sole paragraph, item "a", gives powers to CVM to issue norms that determine the inclusion, in the consolidated financial statements of public companies, of entities that, although not controlled, are financially or administratively dependent on the company. In addition, the Basic Conceptual Structure of Accounting, approved by CVM Deliberation No. 29/86, as well as the Fundamental Accounting Principles approved by CFC Resolution 750/93, require that transactions and other events be accounted for according to their essence and economic reality, and not only by their form

CIRCULAR LETTER/CVM/SNC/SEP No. 01/2004 55

legal. In the Conceptual Framework, it is mentioned that an "entity, in its organizational dimension, can be viewed as a group of people or a person exercising control over revenues and expenses, over investments and distributions." This means control over activities and over the benefits arising from these activities, which can be exercised by either an isolated entity or a set of entities, without necessarily having shareholding control or even any participation in the share capital.

Therefore, despite the lack of a specific rule determining the inclusion of SPEs in consolidated statements, we understand that this procedure should be adopted in cases where there is one or more main beneficiaries who, in essence, exercise economic control over the SPE's activities. However, in order to better regulate this procedure and preserve the essence of consolidated information, the CVM placed in public hearing a draft Instruction providing for the inclusion of Special Purpose Entities – SPEs in the consolidated accounting statements of publicly-held companies, with a deadline for submitting suggestions until March 31, 2004. However, while the CVM has not issued a rule making this inclusion mandatory, it becomes necessary that, at a minimum, the following information be disclosed:

1. Name, nature, purpose, and activities developed by the SPE;
2. Participation in the equity and results of the SPE;
3. Nature of its involvement with the SPE and type of exposure to losses, if any, resulting from this involvement;
4. Amount and nature of credits, obligations, revenues, and expenses between the company and the SPE and assets transferred by the company and rights to use assets or services of the SPE;
5. Total assets, liabilities, and equity of each SPE; and
6. Guarantees, sureties, mortgages, or other guarantees granted in favor of the SPE.

17.3 Reverse Merger – CVM Instruction No. 349/01

Most reverse merger operations that the CVM has observed and analyzed so far begin with the holding company constituting a "vehicle" company, to which the value of the investment evaluated by the equity method, plus the value of the corresponding goodwill, is transferred as a capital contribution. Subsequently, this "vehicle" company is merged into the investee that originated that goodwill. This merger model allowed for the tax benefit of the goodwill to be utilized, creating, accountingly, a kind of tax credit based on the future reduction of income tax and social contribution, due to the possibility of amortizing this goodwill. However, this model ended up distorting the figure of the merger in its real economic dimension.

The CVM, with the objective of better disciplining this matter and preserving the quality of accounting statements, issued CVM Instruction No. 349/01, determining that in cases of reverse merger, the goodwill based on profitability perspective or concession right should be recognized by the amount of the expected tax benefit. This recognition is done by the creation of a provision in the merged company, in the amount of the difference between the value of the goodwill and the tax benefit resulting from its amortization. Without this determination, the goodwill would be duplicated without any economic foundation for such.

In this sense, the Explanatory Note to CVM Instruction No. 349/01 clarifies:

"CVM Instruction No. 319/99, by providing that the counterpart of the goodwill could be registered entirely in a special reserve account (art. 6, § 1), ended up making possible, in cases of goodwill based on economic substance based on intangibles or in future profitability perspective, the recognition of an equity increase without effective economic substance. The creation of a company with the sole purpose of serving as a vehicle to transfer, from the original holding to the controlled, the goodwill paid in its acquisition, ended up distorting the figure of the merger in its economic dimension. This distortion occurs because, when the merger process of the vehicle company is concluded, the investment and, consequently, the goodwill remain unchanged in the original holding. (...). Thus, it becomes necessary that, in the evaluation of the investment in the holding, the amounts of the equity method and the remaining goodwill be recomposed."

The holding company, in this case, is the original investor, that is, the one that paid the goodwill upon the acquisition of the investment, and that remains after the merger of the "vehicle" company. Thus, the changes introduced by CVM Instruction No. 349 had a predetermined objective: mergers through the creation of a "vehicle" company in which there could be the recognition of an asset and an equity increase without economic substance.

However, in cases where there is no interposition of a "vehicle" company, the original investor being merged, and where the economic foundations that gave rise to the goodwill remain valid, the same should be maintained in its entirety and amortized under the conditions and period originally established. In this case, the creation of the provision mentioned in CVM Instruction No. 349 may be unnecessary or even undue.

18. Financial Instruments: Disclosure and Presentation Recognition and Measurement

18.1 Current Situation

Since the matter was disciplined by the CVM, a significant lag continues to be observed between the content of the Instruction and Explanatory Note No. 235 and the practice of disclosing financial instruments by Brazilian publicly-held companies. It is the CVM's expectation that publicly-held companies remain attentive to the subject, so that the quality of information produced by Brazilian companies can be equated with international best practices and meet the expectations of the investor community.

When speaking of financial instruments, it is impossible to dissociate the issue of risk. Financial instruments (derivatives in particular) serve, primarily, as risk management strategies of a given publicly-held company; or they leverage (aiming for profits) the exposure of a given publicly-held company to risk factors inherent to it, or reduce it (aiming to mitigate losses).

Sometimes, financial instruments subject the publicly-held company to other risk factors to which it was not originally exposed, a consequence of the type of market in which they are traded (over-the-counter instruments, for example, offer exposure to credit risk, which in turn is eliminated in operations with exchange instruments) or the nature of the instrument itself (leverage clauses in certain contracts entered into, which potentialize gains or losses, or "covenant" clauses that anticipate the liquidation of a debt instrument, for example).

These information, obligatorily, should be present in the explanatory notes prepared by publicly-held companies. The explanatory note for financial instruments must, to be truthful, contain, in an integrated manner, a qualitative description of the market risk factors that affect the business of a given publicly-held company (risk of prices of its merchandise, interest rate risk, exchange rate risk, credit risk, inflationary risk, liquidity risk, etc.), the strategy adopted by the company's management for managing these risks, and in what context the financial instruments are inserted.

The CVM encourages those publicly-held companies that may wish to provide additional quantitative information about market risk factors to which they are subject, in an explanatory note.

The CVM has observed that some publicly-held companies have been improving the quality of disclosure by making available information generated by risk measurement systems such as VAR – Value at Risk.

Another point that must be addressed concerns accounting procedures. Information regarding the accounting policy applied to the financial instrument (measurement criterion, accounting classification received, recording of equity effects, among others) must be disclosed, so that users of the information are not prejudiced in their analyses.

18.2 Disclosure in Explanatory Note

By way of illustration, a possible model of explanatory note is proposed, considering credit, exchange rate, and merchandise price risk factors:

"The company's business comprises the extraction and sale of iron ore, for domestic and foreign markets. The main market risk factors that affect the company's business can be enumerated as follows:

• Credit risk: possibility of the company incurring losses due to financial problems with its customers, which force them not to honor their commitments with the company. To reduce this type of risk, the company enters into ancillary contracts with its customers that oblige them to maintain a certain level of indebtedness and liquidity. Once these levels are exceeded, early liquidation of the debt by the company occurs, and, if applicable, the execution of any guarantees offered.

• Exchange rate risk: possibility of the company incurring losses due to fluctuations in exchange rates, which reduce nominal invoiced values or increase values raised in the market. To reduce this type of risk, the company enters into derivative contracts in exchange markets, as demonstrated in a specific table.

• Iron ore price risk: possibility of the company incurring losses due to fluctuations in iron ore prices, in domestic and foreign markets. To reduce this type of risk, the company enters into derivative contracts in over-the-counter and exchange markets, as demonstrated in a specific table.

Credit Risk
The company's sales policy is intimately associated with the level of credit risk to which it is willing to subject itself in the course of its business. The selectivity of its customers, as well as the diversification of its receivables portfolio, monitoring of sales financing terms by business segment and position limits, are procedures that the company adopts in order to minimize any potential default problems with its commercial partners. The same credit risk management policies are observed in the contracting of over-the-counter derivatives. The table below indicates the evaluation of accounts receivable balances classified by credit risk measurement (rating) of customers:

Customer Credit Rating ()
Contract Term Moody’s Classification Standard & Poor’s Classification Between 1 and 4 years Aa3 AA More than 4 years Aaa AAA Exposure Up to R$ XXX million Aa3 AA Up to R$ XXXX million Aaa AAA Diversification 31.12.20X0 31.12.20X1 XYZ & Co. 6% 6% ABC & Co. 8% 7% Wk & Co. 7% 6% Other Customers () 79% 81% Total Portfolio 100% 100% (*) other customers with participation of at most 5% of the receivables portfolio Observation: The example presented provides information about the risk involved in sales financing in terms of credit quality, concentration by main customers, and sales financing term. The Moody’s and Standard & Poor’s classifications are examples of ratings prepared by independent entities based on qualitative and quantitative criteria. The publicly-held company must disclose the criteria chosen for the preparation of the risk measurement (rating) of its customers, detailing the algorithm used in the classification. It is recommended that objective criteria be selected.

Exchange Rate Risk
The company's indebtedness and the results of its operations are significantly affected by the market risk factor exchange rate (US dollar). Resources were raised in foreign currency (US dollar), on 01.01.20X1, to finance its working capital.
On 01.04.20X1, resources were obtained from the US banking institution (Bank XYZ) to finance the expansion of the company's installed capacity, aiming to meet the company's future objectives of increasing its participation in the international market.
The strategy defined by the company, at the beginning of the 2001 fiscal year, focused predominantly on the international market. With this, it was expected that the company's dollar revenue would act as a natural hedge for its working capital loan (there would be a balancing of its cash flow), which effectively happened during the fiscal year.
The company's net exposure at the moment to the market risk factor exchange rate is demonstrated below:

Book Value Fair Value
31.12.20X2 31.12.20X3 31.12.20X2 31.12.20X3
Loan R$ XXXXX R$ XXXXX R$ XXXXX R$ XXXXX
Financing R$ XXXX R$ XXXX R$ XXXX R$ XXXX
R$ XXXXX R$ XXXXX R$ XXXXX R$ XXXXX
Dollar Assets R$ XXX R$ XXX R$ XXX R$ XXX
Hedge Instruments R$ XXX R$ XXX R$ XXX R$ XXX
Net Exposure R$ XXX R$ XXX R$ XXX R$ XXX
The measurement method used for computing the fair value of all elements, except for hedge instruments, was the discounted cash flow method, considering expectations of settlement or realization of liabilities and assets and market rates in effect on the information cutoff date. For hedge instruments, the market quotation of the contracts on the information cutoff date was used.

Market Risk Factor: Exchange Rate
Amortization Plan/Expectation of Realization
20X4 20X5 20X6 20X7 20X8 Total
Currency US$:

1. Floating Rate Liability
   Working Capital Loan
   Principal R$ XXX R$ XXX R$ XXXXX
   Interest R$ XX R$ XX R$ XXX
   Expected Libor X.X% X.X% X.X%
2. Fixed Rate Liability
   Financing
   Principal R$ XXX R$ XXX R$ XXX R$ XXX R$ XXX R$ XXXXX Interest R$ XX R$ XX R$ XX R$ XX R$ XX R$ XXX Contracted Interest Rate X.X% X.X% X.X% X.X% X.X% X.X%
3. Asset Accounts Receivable R$ XXX R$ XXX R$ XXXXX

Market Risk Factor: Exchange Rate
Hedge Instruments:
Exchange Market Maturity
Purchased Futures Contracts 20X2 20X3 20X4 20X5 20X6 a) Notional Value US$ XXXX mil US$ XXXX mil US$ XX mil US$ XX mil US$ XX mil b) Contracted future rate R$ X,XX R$ X,XX R$ X,XX R$ X,XX R$ X,XX Total (a x b) R$ XXXXX R$ XXXXX R$ XXXXX R$ XXXXX R$ XXXXX Derivative contracts had their notional values registered in clearing accounts and gains and losses, when financially realized, registered in income accounts.

Iron Ore Price Risk
The strategy adopted by the company to minimize its exposure to the iron ore price risk factor is the celebration of future settlement contracts (over-the-counter and exchange), which guarantee the realization of its stocks at a certain level. Its stocks turn over on average three months, which is why every three months a rollover of future settlement contracts is made.

Market Risk Factor: Commodity Price
31.12.20X2 31.12.20X3
Book Value Fair Value Book Value Fair Value
Iron ore stocks $XXX
Hedge Instruments:

1. Over-the-Counter Market Maturity Fair Value
   Sold Forward Contract April/X4 July/X4 October/X4 in 31.12.20X3 a) Notional Value X tons X tons X tons $XXX b) Contracted future price $ X,XX $ X,XX $ X,XX Total (a x b) $ XXXXX $ XXXXX $ XXXXX
2. Exchange Market Maturity Fair Value
   Sold Futures Contract April/X4 July/X4 October/X4 in 31.12.20X3 a) Notional Value X tons X tons X tons $XXX b) Contracted future price $ X,XX $ X,XX $ X,XX Total (a x b) $ XXXXX $ XXXXX $ XXXXX The measurement method used for computing the fair value of stocks and exchange instruments was the market value of these on the information cutoff date. For over-the-counter instruments, the method used for computing the fair value was the discounted cash flow method, considering expectations of settlement or realization and market rates in effect on the information cutoff date. Derivative contracts had their notional values registered in clearing accounts and gains and losses, when financially realized, registered in income accounts."

18.3 The Issue of the Substance Over Form Principle in the Disclosure of Financial Instruments

It is not uncommon for situations in which the legal-formal aspects involving an operation related to financial instruments do not reflect their true economic aspect and, consequently, their real effects on the equity of companies.

In this sense, the Basic Conceptual Structure of Accounting, approved and endorsed by CVM Deliberation No. 29/1986, preaches: "Accounting has a great relationship with the legal aspects surrounding equity, but, often, the legal form may fail to reflect the economic essence. In these situations, Accounting must be guided by its objectives of well informing, following, if necessary for that, the essence instead of the form."

For example, an operation based solely on its contractual aspects, not considering its economic aspects, may be accounted for as generating immediate or deferred gains, when, in reality, these gains, when existing, should be recognized over the period of the contract.

Item IV of the Explanatory Note to CVM Instruction No. 235/95, although referring to so-called linked operations, alerted to the prevalence of substance over form in the accounting of financial instruments. Therefore, administrators and independent auditors must dedicate special attention to these operations, in order to report in their accounting reports the true economic effects resulting from these operations.

Within this philosophy, it is important to consider that, although the accounting of hedge operations has not yet been the object of a specific CVM rule, its use, provided it does not conflict with corporate law, should be aligned with international accounting best practices.

Following this posture, a hedge operation, to be accounted for as such, in line with international best practices, must observe a series of restrictive, non-exhaustive conditions, namely: (i) the company must previously document its risk management policy (internal manual of rules and instructions); (ii) the company must previously document the hedge operation to be carried out, identifying (a) the balance sheet item or cash flow (of a given operation) to be the object of the hedge, (b) the risk factor or risk factors of this balance sheet item or cash flow that will be hedged, (c) the financial instrument that will be used as a hedge, it being imperative that this instrument does not subject the company to other risk factors (e.g., a derivative contract with a maturity different from the item to be hedged cannot be considered a hedge instrument, as it offers basis risk to the entity), (d) the delimitation of the effectiveness of the hedge operation and the manner in which the effectiveness of the hedge operation will be monitored, (e) the accounting procedures to be applied to the effective part of the hedge operation and to the ineffective part of the hedge operation.

The general rule for hedge accounting is: without documentation, there is no hedge operation.
This is sought to eliminate possible abuses in the accounting treatment to be applied, such as "hedge is the operation that results in a loss, subject to deferral. What results in profit is not a hedge." It is inadmissible, for this reason, to consider exchange losses arising from pre-payment contracts for exports as a currency hedge. Otherwise, information being taken to the market would be manipulated, treating as "hedge" a non-accepted accounting practice (of deferring exchange losses).

18.4 Effects resulting from the application of Bacen Circulars No. 3,068/01 and 3,082/02 and Susep Circular No. 192/02

The Central Bank of Brazil issued at the end of 2001 Circular No. 3,068, establishing categories for classification and respective criteria for evaluation and registration of securities acquired by financial institutions and other entities authorized to operate by the Central Bank of Brazil, producing effects from June 30, 2002. The Private Insurance Superintendence – SUSEP also adopted new criteria for evaluation and accounting classification of securities acquired by insurance companies, capitalization societies, and open complementary pension entities, with effects produced from June 30, 2002.

Previously, this CVM had pronounced itself in the sense that it considers the procedures contained in the Central Bank's normative harmonized with international best practices. Given this understanding and also aiming to give consistent treatment to the move, publicly-held investor or controlling companies of entities subject to those normative, with respect to the effects on the equity method and consolidated accounting statements must, exclusively, apply reflective treatment, that is, the adjustments resulting from the initial adoption of those normative must be equally registered in the investor directly to equity.

In the same way, reflective registration must be adopted for the counterpart resulting from the marking to market of the portfolio of securities classified as available for sale, recognizing the effects in the result or, while not realized, in a separate account of equity that evidences its nature.

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ANNEX: Risk Measurement Criteria (Rating) of Each Agency

Standard & Poor’s Agency

AAA
An issuer rated "AAA" has an EXTREMELY STRONG capacity to meet its financial commitments. "AAA" is the highest rating in Standard & Poor’s classification.

AA
An issuer rated "AA" has a VERY STRONG capacity to meet its financial commitments. It differs from an issuer with a higher rating only to a small degree.

A
An issuer rated "A" has a STRONG capacity to meet its financial commitments, but is somewhat more susceptible to the adverse effects of changes in circumstances and economic conditions than issuers with higher rating categories.

BBB
An issuer rated "BBB" has an ADEQUATE capacity to meet its financial commitments. However, adverse economic conditions or changing circumstances are very likely to lead it to a weakened capacity to meet its financial commitments.

Issuers rated "BB", "B", "CCC", and "CC" are considered to have significant speculative characteristics. "BB" indicates the lowest degree of speculation and "CC" the highest. Although such issuers may sometimes have some quality and protective characteristics, such aspects may be offset by great uncertainties or great exposure to adverse conditions.

BB
An issuer rated "BB" has lower SHORT-TERM VULNERABILITY than other issuers with lower ratings. However, it faces continuous great uncertainties and exposure to adversity in its business, financial or economic conditions, which may lead it to an inadequate capacity to meet its financial commitments.

B
An issuer rated "B" is MORE VULNERABLE than issuers rated "BB", but the issuer has the capacity to meet its financial commitments currently. Adversity in its business, financial or economic conditions will likely impair its capacity or willingness to meet its financial commitments.

CCC
An issuer rated "CCC" is CURRENTLY VULNERABLE and is dependent on favorable conditions in its business, and on favorable financial and economic conditions, to meet its financial commitments.

CC
An issuer rated "CC" is CURRENTLY HIGHLY VULNERABLE.

Plus (+) or minus (-):
Ratings from "AA" to "CCC" may be modified by the addition of a plus or minus sign to show a relative standing within the main rating categories.

R
An issuer rated "R" is under regulatory supervision due to its financial condition. During the regulatory supervision process, regulators may have the power to favor one class of obligations over others, or to pay some obligations and not pay others.

N.R.
An issuer classified as "N.R." is not rated.

Moody’s Agency

Aaa

CIRCULAR LETTER/CVM/SNC/SEP No. 01/2004 63

Issuers rated "Aaa" offer exceptional financial security. Although the credit capacity of these entities is likely to change, such a change will very unlikely impair their consolidated strong position.

Aa
Issuers rated "Aa" offer excellent financial security. Along with the "Aaa" group, they constitute what is generally known as high-rating entities. They are rated below Aaa entities because their long-term risks are somewhat greater.

A
Issuers rated "A" offer good financial security. However, certain elements may be present, indicating susceptibility to credit deterioration at some point in the future.

Baa
Issuers rated "Baa" offer adequate financial security. However, certain protective elements may be absent or may not be reliable over a long period of time.

Ba
Issuers rated "Ba" offer questionable financial security. Frequently, the ability of these entities to meet their obligations may be moderate and may not be guaranteed in the future.

B
Issuers rated "B" offer poor financial security. Guarantee of payment of obligations over any long period of time is small.

Caa
Issuers rated "Caa" offer very poor financial security. They may be in default on their obligations or there may be elements present that indicate uncertainty in the timely payment of their obligations.

Ca
Issuers rated "Ca" offer extremely poor financial security. Such entities are frequently in default on their obligations or have other background that tarnishes their image.

C
Issuers rated "C" represent the lowest rating class, are normally in default on their obligations, and potential recovery values are low.

19. Discontinued Operations

In situations where a company, based on its strategic planning and formal business plan, decides to jointly discontinue a group of assets, possibly associated with liabilities, in a single transaction, special disclosure is required. This disclosure aims generally to highlight the ability to generate results and cash flows between current operations and operations to be discontinued. This group of assets can be characterized in various ways: (i) as a business segment characterized as a group of cash and income generating units, (ii) as a single cash and income generating unit, or (iii) as part of a cash and income generating unit. What characterizes these assets as "non-current and held for sale" is the expectation of recovering their value through a sale transaction and not through their consumption on a continuous basis.

In this sense and in order to provide higher quality information, listed companies must, whenever relevant, disclose in explanatory notes information relating to discontinued operations, which are currently considered in the international pronouncement IAS 35 "Discontinued Operations". This pronouncement considers discontinuation based on the magnitude of the operation, such as the abandonment or transfer of a business segment, establishing a basis to segregate this information from operations that will continue. It should be noted that the IASB placed for public discussion in 2003 a draft pronouncement titled ED 4 Disposal of Non-current Assets and Presentation of Discontinued Operations, dealing with matters associated with reducing the differences between international and American SFAS 144 Accounting for the Impairment or Disposal of Long-Lived Assets standards, regarding the identification of operations to be discontinued, valuation, and disclosure.

With the objective of advancing the disclosure of this type of information, the information required for discontinued operations can be presented in explanatory notes, without modifying the form of the currently used financial statements. For general guidance, the main points to be observed in the preparation of this explanatory note are summarized and adapted below, based on a free translation and reading of the current wording of pronouncement IAS 35.

19.1 Definition

For the purpose of disclosure in financial statements, a discontinued operation is a relatively large component of an entity:
(a) that, in accordance with a determined plan, the entity is: (i) substantially disposing of the component in its entirety, such as selling in a single transaction, by spin-off or capital reduction; (ii) disposing of in parts, such as selling the assets and settling the liabilities of the component individually; or (iii) closing by abandonment.
(b) that, on its own, represents an important business segment or geographic area of operations; and (c) that can be differentiated operationally and for financial reporting purposes.

19.2 Initial Disclosure Event

The initial disclosure event is the occurrence of one of the following events: (a) the entity has signed a contract to sell all assets attributable to the discontinued operation; or (b) the entity's board of directors or management board has (i) both approved a detailed formal plan for discontinuation (ii) and made the announcement of the plan.

19.3 Impairment Losses on Recoverable Amount of Assets

The approval and announcement of a plan for discontinuation are an indication that the assets attributable to the discontinued operation may have suffered impairment of their recoverable amount or that a loss, previously recognized for these assets, must be increased or reversed. Therefore, the explanatory note disclosure of discontinued operations must also consider the policies for recognizing and measuring these events.

19.4 Initial Disclosure

An entity must include the following information in explanatory notes regarding a discontinued operation in its financial statements for the period in which the initial disclosure event occurs, as cited above.
(a) a description of the discontinued operation; (b) the business segment or geographic segment to which it belongs; (c) the date and nature of the initially disclosed event;

CIRCULAR LETTER/CVM/SNC/SEP No. 01/2004 65

(d) the date or period in which discontinuation is expected to be completed, if known or determinable; (e) the accumulated values, at the balance sheet date, of total assets and liabilities to be alienated or settled; (f) the values of revenues, expenses, and profit or loss before taxes, from ordinary activities attributable to the discontinued operation in the current fiscal year disclosed and the related income tax expense; (g) the values of cash flows (statement of sources and applications of funds) attributable to the operating, investing, and financing activities of the discontinued operation during the disclosed fiscal year period.

19.5 Other Disclosures

When an entity alienates assets or settles liabilities attributable to a discontinued operation or enters into agreements to sell these assets or settle these liabilities, it must include in explanatory notes, in the period in which the event occurs, the following information:
(a) for any gain or loss that is recognized in the alienation of assets or settlement of liabilities attributable to the discontinued operation (i) the value of the profit or loss and (ii) the income tax expenses related to this profit or loss; (b) the net selling price or price range (after reducing expected decommissioning costs) of those net assets for which the entity has signed one or more firm sale agreements, the expected time of receipt of these cash flows, and the book value of these net assets.

19.6 Update of Disclosures

In periods subsequent to that in which the initial disclosure event occurred, in the explanatory note on discontinued operations, a description of any significant change in the value or periods of cash flows related to the assets and liabilities to be alienated or settled and the events that caused these changes must be disclosed.

These disclosures must continue in the financial statements of periods until discontinuation is completed. Discontinuation is completed when the plan is substantially fulfilled or abandoned, even if payments by the buyer(s) to the seller have not yet been concluded.

If an entity abandons or withdraws a plan that was previously reported as a discontinued operation, this fact and its effect must be disclosed.

19.7 Separate Disclosure for Each Discontinued Operation

All disclosures must be presented separately for each discontinued operation.

19.8 Presentation of Disclosures

Disclosures of discontinued operations shall be presented in explanatory notes to the financial statements, except for the disclosure of the value of profit or loss before taxes, recognized in the alienation of assets or settlement of liabilities attributable to the discontinued operation, which must be included in the income statement.

19.9 Disclosure in Interim Financial Reports

The explanatory notes of an interim financial report must describe any significant activities or events that have occurred since the completion of the most recent annual report, regarding a discontinued operation, and any significant changes in the values or timing of cash flows related to the assets and liabilities to be alienated or settled.

20. Provisions, Contingent Liabilities and Contingent Assets

20.1 Contingencies

A contingency is a condition or situation whose final result, favorable or unfavorable, depends on uncertain future events. In accounting, this definition is restricted to situations existing at the date of the financial statements and accounting information, whose financial effect will be determined by future events that may or may not occur.

Estimates regarding the outcome and financial effects of contingencies are determined by the judgment of the company's management, supported by studies and technical opinions that reflect an impartial position, and reviewed by the independent auditor. Both estimates and the review must include the examination of events occurring after the balance sheet date, supplemented by experience obtained in similar transactions.

In complement to the understanding of this CVM technical area, we are attaching to this item the Ibracon Technical Interpretation 03/2002 regarding the resolution of doubts about contingent gains.

20.2 Contingent Assets

Contingent assets that, in compliance with accounting principles, should not be recognized in accounting, must be disclosed in a note with the description of their nature, the potential value, and the company's expectation regarding their eventual realization.

We reaffirm the understanding contained in CVM Orientation Opinion No. 15/87 regarding contingent gains. In compliance with the Principle of Conservatism (Prudence), these gains should not be accounted for until their obtaining is effectively assured in a final decision for which no further appeals are possible.

20.3 Contingent Liabilities

CVM has observed that certain information disclosed in issuance prospectuses does not correspond to the financial statements or Quarterly Information made available to the public. This is the case of contingent liabilities.

Over the years, through the process of monitoring information made available to the public by listed companies, CVM has verified many incongruities. In a specific case, for example, up to 4 pages were dedicated in the issuance prospectus to the description of events associated with contingent liabilities involving the listed company, whereas in its Quarterly Information or financial statements not even a paragraph on the matter was found. The rewriting and republication of the same were inevitable.

Using subsidiarily the IBRACON Pronouncement on uncertainties, NPA No. 09, of June 1995, to better elucidate the matter, it is understood that, technically, an uncertainty, from an accounting point of view, can be classified, probabilistically, according to its chance of occurrence, into three groups: (i) probable chance of incurring a liability or not realizing an asset; (ii) possible chance of incurring a liability or not realizing an asset; (iii) remote chance of incurring a liability or not realizing an asset.

A contingent loss must be provided for whenever: (i) it is probable that future events and/or past experience will confirm the decrease in the realization or recovery value of an asset or the existence of a liability; and (ii) the loss can be reasonably estimated.

However, if the amount involved cannot be reasonably estimated, all relevant information must be disclosed, at least, in an explanatory note, so that users

CIRCULAR LETTER/CVM/SNC/SEP No. 01/2004 67

of the financial statements can become aware of the contingent risks to which a given company is subject.

When the chance of occurrence of contingent liabilities is possible or remote, CVM understands, in light of NPA No. 09, that all relevant information must be disclosed in an explanatory note, even if the uncertainties are great. CVM understands that the benefits of providing relevant information about contingent liabilities, even with a possible or remote chance of occurrence, far outweigh the probable costs to be incurred in their production. The costs are incurred only at first; the benefits extend over several fiscal years.

CVM recommends that in the preparation of explanatory notes on contingent liabilities, the following information be provided, at minimum: (i) nature of the contingency (labor, social security, tax, civil, environmental, etc.), (ii) detailed description of the contingent event involving the company, (iii) chance of occurrence of the contingency (probable, possible, or remote), (iv) instances in which contingent liabilities are under discussion (administrative or judicial, lower or higher courts), (v) jurisprudence on contingent liabilities, (vi) assessment of the consequences of contingent liabilities on the company's business.

Annex: Ibracon Technical Interpretation 03/2002

Accounting treatment of contingent gains

Due to the difficulties being found by professionals in the treatment of judicial, tax, and other claims made by companies in lawsuits, Ibracon deemed it appropriate to reaffirm its understanding regarding the accounting treatment of so-called contingent gains.

In this context, this Technical Interpretation aims to guide the application of paragraph 7 of Pronouncement XXII - Contingencies, in the accounting treatment of contingent gains, specifically directed at judicial processes for the recovery of taxes or the extinction of registered tax obligations.

Question 1
What characterizes a contingent gain?
Answer
Based on Pronouncement XXII - Contingencies, from Ibracon, potential gains that have conditions or situations of undefined solution at the date of the end of the fiscal year or period to which the financial statements refer, and as such, depend on events that may or may not occur.

In this context, a contingent gain corresponds to the potential right to recover a paid tax or the potential extinction of a registered tax obligation.

Question 2
Under what circumstances can a company record a contingent gain according to Brazilian accounting practices?
Answer
Paragraph 7 of Pronouncement XXII – Contingencies, from Ibracon, defines when a contingent gain must be recognized, as reproduced below:

"As a general rule, contingent gains should not be subject to accounting in obedience to the conservatism accounting convention, by which revenue should only be recognized when realized".

On the same subject, CVM issued Orientation Opinion No. 15/87 which addresses the subject as follows:
"The Conservatism convention (also called Prudence) stipulates that among alternative sets of valuation equally valid according to fundamental principles, the

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CIRCULAR LETTER/CVM/SNC/SEP No. 01/2004 68
Accounting shall choose to present the lowest current value for the asset and the highest for the obligations.
This understanding should not be confused or distorted with the effects of accounting earnings manipulation, but viewed in light of the protective, careful, and neutral vocation that Accounting must have, especially regarding excess enthusiasm and valuations by the administration and owners of the entity (see item 6.3 of the pronouncement attached to CVM Deliberation No. 29/86). By this convention, contingent assets or contingent gains should not be recorded; only when their obtaining or recovery is effectively assured should they be recognized accounting-wise. Thus, a possible gain in administrative or judicial proceedings should only be recognized when, after exhausting all necessary instances, the company obtains a favorable decision. If the company has already recognized revenue involving an asset in dispute (accounts receivable, for example), it must then create a provision for losses in proportion to the contingent value.

Question 3
In situations where the Company has obtained a final favorable decision regarding a contingent gain, what is the moment of its accounting recognition? Upon the judicial decision or upon its financial realization?

Answer
If there are no longer any possibilities of appeal by the opposing party, the risk of non-realization of the contingent gain is considered "remote," and therefore, the Company must recognize the gain accounting-wise when the final judicial decision produces its effects, which normally occurs after publication in the Official Gazette. This means it will no longer be a contingent gain but rather a right of the Company, for which the Company's administration, before its registration, must take into account the mentioned in the following paragraph. Before the registration of the contingent gain and periodically after its registration, the Company's administration must evaluate the recovery capacity of the asset, as the opposing party may become unable to honor this commitment or its future use may be uncertain. In subsequent evaluations after its registration, the need for a provision for asset impairment must be considered.

Question 4
In situations where the Company has not yet obtained a final favorable decision for the recovery of a tax or the extinction of a registered tax obligation, but there is favorable jurisprudence for other Companies in identical cases and the lawyers' assessment is that the chances of a favorable outcome are probable, may that Company recognize the contingent gain based on jurisprudence and the lawyers' opinion?

Answer
Even in situations where there is favorable jurisprudence, this is not sufficient to provide a basis for recognizing the contingent gain, as this does not ensure a final favorable decision for the Company, since many other factors may influence this decision, for example, the line of business, the formalization of the process, etc.
Even if it is considered that the Company has an injunction and there is favorable jurisprudence, the concept described above (non-recognition of gain) equally applies. The Company must make disclosure in an explanatory note regarding the subject.

Question 5
In cases of processes not yet finally judged where the Company discusses the recovery of taxes allegedly overpaid and obtains an injunction allowing those values to be offset against other taxes, should it register the contingent gain supported by this injunction?

Answer
As the injunction is a provisional instrument, the registration of a contingent gain is still not possible, as the realization of the gain is not definitive.

CIRCULAR LETTER/CVM/SNC/SEP No. 01/2004 69
The Company will proceed with the offset from a financial point of view; however, the offset tax must still appear as a liability until the final outcome of the case, as its settlement is also provisional, and if the outcome is unfavorable to the Company, it must pay the tax previously offset with the legal additions.

Question 6
Is the practice adopted in Brazil harmonized with international best practices?

Answer
Yes, the accounting practices adopted in Brazil are harmonized with the international standards prescribed in IAS No. 37, which deals with the subject, issued by the International Accounting Standards Committee. These standards, in summary, conclude that "An entity should not recognize a contingent asset."
In the same vein is the American accounting treatment prescribed in FASB 5, issued by the Financial Accounting Standards Board (now IASB - International Accounting Standards Board).

21. Share-Based Compensation
    21.1 Introduction
    The increasing use by Brazilian companies of programs for remuneration through the grant of stock purchase options to employees and the revision of international pronouncements on the subject due to public debates in the form of accounting, makes the subject relevant for the considerations of this circular letter.
    The issuance of a new international standard (ED 2 Share-Based Payments) dealing with the recognition of transactions made with share-based payment, as well as American standards that improve the transition to more suitable regimes for accounting for share-based compensation plans (Transition and Disclosure an amendment of FASB Statement No. 123, of 4/10/2002), was put to public hearing.

21.2 Overview
The listed employer company may adopt various types of plans to remunerate executives and employees by granting stock purchase options issued by the company. In conventional stock grant plans, for example, the employer company grants options to purchase a fixed number of the company's shares, at a set price, during a specific period, in exchange for current or future services of executives and employees. This type of remuneration is usual in the American market and, to a lesser extent, in the European community markets, as a way to align investor objectives with the objectives of administrators and employees. In Brazil, there are few disclosed cases of companies with this type of remuneration plan, possibly motivated by the low delegation of powers by controlling investors to administrators, given the identification of controlling shareholders with administrators, forming a single group of interest. In any case, Brazilian companies with shares traded in foreign markets must follow international recommendations that provide for the accounting of these programs in their income statement, i.e., the effect of the option plan on the statement of results.

21.3 The concept of stock options as employee remuneration
In the most common configuration, the stock option gives the employee the right to purchase a certain number of the company's shares at a fixed price for a certain number of years. The price at which the option is granted is usually the market price on the date the options are granted. The logic of this benefit is the expectation that the share price will rise and employees can buy it

CIRCULAR LETTER/CVM/SNC/SEP No. 01/2004 70 by exercising (purchasing) at a lower price than was referenced at the time of grant and sell it at the current market price, for example.
The grant of shares to employees is considered a flexible form of remuneration that aims to attract and motivate employees by granting a portion of the company's future growth. This form also makes sense for listed companies that intend to maintain a continuous form of remuneration and employee participation in the company's administration. The general idea is the benefit of increased productivity and talent retention added to the relatively small dilution of capital through the grant of stock options. The positive effect of remuneration to employees through the grant of options depends, to a large extent, on the creation of a real and significant commitment to the company's destiny. In the design of an option program, it is necessary to consider the number of shares that will be available to be exercised and how many employees will receive the right to receive these options each year so that there is regularity in the grant of this type of remuneration and in the expected beneficial effects. This consideration is important so that there is the possibility of including future employees in this type of remuneration. Another important consideration is the intention to grant the benefit to all employees or only to some key employees. The answer to these and other questions will determine the type of plan, the time frame for its duration, eligibility characteristics, allocation, valuation, time of grant, vesting periods, and exercise price of the options. In the practice of companies in more developed markets, options are typically subject to a three to five-year service period (vesting period), which means that if an employee has only 20% of this period, they can only exercise 20% of the options, or an employee can typically exercise options to which they are entitled at any time, proportionally to the eligibility period. Some companies may offer an alternative exercise of options without outlay, in which the employee exercises the option and the company pays an amount equal to the difference between the market price and the exercise price. In other cases, it is necessary for employees to pay the amount necessary to pay for the shares at the exercise price agreed in the share-based compensation plan.

21.4 Situation of accounting in American standards
SFAS 123, Accounting for Stock-Based Compensation, encourages the recognition of the "fair value" of share-based compensation plans as an expense at the date of grant of these benefits, but allows companies to continue accounting for these plans according to the rules of APB No. 25, Accounting for Stock Issued to Employees. In APB No. 25, remuneration expenses are estimated according to the "intrinsic value," that is, the difference between the quotation value and the exercise price of the option, on the date when the exercise price and the number of options are known. Most American companies grant a fixed number of options with an exercise price equal to the share price on the date of grant of the benefit, which, under APB 25 rules, is the same date of measurement, and therefore results in the recognition of a value equal to zero in expense. Firms applying the estimation method of APB No. 25 must disclose in an explanatory note the estimated value of the grant of this benefit through the concept of fair value, that is, using an adequate pricing method to estimate the expense with the advantage granted, i.e., the effect on results and earnings per share. In summary, in the general current practice of American companies, APB No. 25 is adopted, in which the fair value is disclosed in explanatory notes to the financial statements with the recognition of a zero value in remuneration expenses (income statement).

CIRCULAR LETTER/CVM/SNC/SEP No. 01/2004 71
21.5 Situation of the proposed accounting in international standards
The main difference between the current American standards and the proposed international standards lies in the definition of the object to be regulated. Exposure Draft No. 2 – Share-Based Payment (ED 2) addresses the issue from the point of view of all transactions involving the issuance of equity instruments (shares, options, and others). In this view, the logic of recognizing all types of share-based remuneration lies in the similarity between the provision of services by employees and the suppliers of goods and services through any equity instrument. In transactions where options are granted to employees, there is a fundamental similarity in the recognition methods both in SFAS 123 and in the IFRS draft, which recognize accounting values through the measurement of the fair value of the equity instruments granted. The draft of the international standard ED 2 considered the following aspects: (i) convergence with the American standard SFAS 123 of US GAAP, (ii) the issue of disclosure versus recognition as expense, and (iii) confidence in the measurement of stock options granted to employees. This draft - ED 2 - considered these aspects: (i) determine accounting or recognition as expense without allowing the choice of methods currently allowed by SFAS 123 through the use of APB 25 standard, (ii) information on the grant of share-based compensation plans must be accounted for because the exclusion of a special item in the statement of results is not acceptable, and moreover, there is evidence that information merely disclosed in explanatory notes may not fully reflect in share prices, and (iii) the premise that it is possible to make a reliable estimate of the fair value of options granted to employees. The disclosure of information in the proposed international standard intended to give users the ability to understand the following aspects of this type of transaction: (i) the nature and extent (quantitative aspects) of share-based compensation agreements that were in effect during the period, (ii) the fair value of services rendered, or the fair value of equity instruments granted, during the period were determined (calculated), and (iii) the effect of share-based compensation transaction expenses on the company's results.

21.6 The controversy over the estimation and pricing methods of options
In estimating the expenses corresponding to the grant of stock options to employees, companies must choose a pricing method capable of measuring the present effect of this type of instrument. The Black-Scholes model and the binomial model are the most popular for the valuation of stock options. Each of these models is based on subjective premises such as volatility, that is, its historical tendency to increase or decrease over a certain period of time. Although the valuation of these financial instruments is imperfect since, for example, it considers options as freely tradable while options granted to employees are subject to a set of restrictions, it is considered that: (i) some type of estimate is preferable to no estimate, and (ii) it is possible to make some adjustments in the inputs of option pricing models to consider these differences, such as expected volatility, expected life, and probability of acquiring the right (vesting).

21.7 Corporate aspects of the approval of the option plan
Approval by shareholders is a relevant aspect for the existence of the option plan. This type of remuneration plan implies a modification of the company's share capital structure and, furthermore, that it does not substantially modify the participation relationships, must be approved by the General Assembly of shareholders or by the Board of Directors. This topic must also be considered in the corporate governance rules established so that investors have full understanding of the amounts involved both in the company's results and in the general shareholding position. Even though share-based compensation intends to incentivize in employees and

CIRCULAR LETTER/CVM/SNC/SEP No. 01/2004 72 administrators the behavior that shareholders desire, there are ethical aspects that must be present in the behavior of these employees when proposing and changing accounting rules in general and, especially, in the disclosure of information that are capable of inflating expectations of future profits.

21.8 Glossary of some of the main terms used in option plans

• vesting: delivery by the company of a benefit corresponding to the right of an employee acquired gradually by the time of service rendered;
• date of approval of Option Plans: the plan must be approved by the Board of Directors or General Assembly;
• disclosure date: The Option Plan is disclosed in accordance with CVM Instruction No. 358/02;
• grant date: the date on which an option is granted to an individual, or the date on which a company and the employee agree (as provided in a share-based compensation agreement) on the date of grant of the right over equity instruments, under certain conditions (vesting conditions), by which this right will be exercised;
• vest date: date from which an option can be exercised and sold;
• exercise date: the option is generally exercised between two dates: the date from which the plan conditions make exercise possible (vesting date), fixed after the grant date, and the expiration date, which is generally fixed a few years later;
• expiration date: is the last day on which an option can be exercised, or sold; on this date the employee's rights are extinguished, i.e., they lose value;
• vested right – vested or meeting contractual conditions
• exercise: decision to buy the share through the option;
• equity instrument: contract identified with the residual result of the company's assets minus all liabilities;
• stock option as remuneration: a right issued by a listed company to an individual to purchase an amount of shares of the company at a set price, within a specified period of time;
• vesting period: period between the grant date and the date on which all eligibility conditions (vesting conditions) of an option plan have been met;
• Option Plan: contract that gives its holder the right, but not the obligation, to subscribe to shares of a company at a fixed or determinable price over a certain period of time. (contract containing a set of rules defined in a document that gives the employee the right to buy a share of the company on a future date).
• exercise price: price at which a share can be purchased through the exercise of an option (strike price);
• expected life: the period of time between the grant date and the date when it is estimated that the option will be exercised;
• grant value: represents the face value of the option. This value is calculated based on the application of the pricing method used.
• expected value: represents the value of the remuneration offered to the participant and not necessarily the realized gain; it is the present value of future gains; the quantification can be done with several methodologies, the most common being the Black-Scholes and Binomial models.
• fair value: the amount by which an asset can be traded in an active market, where the buyer and seller possess knowledge of the subject and independence from each other, without corresponding to a compulsory transaction or resulting from a liquidation process, or - in the absence of an active market for a given financial instrument: a) the value that can be obtained with the negotiation of another financial instrument of similar nature, term, and risk, in an

CIRCULAR LETTER/CVM/SNC/SEP No. 01/2004 73 active market; or b) the net present value of future cash flows to be obtained, adjusted based on the interest rate prevailing in the market, for instruments of similar nature, term, and risk.

21.9 Accounting of share-based compensation plans
The management and information problems arising in international companies have led an increasing number of companies to voluntarily recognize the costs with the grant of stock options as expenses recognized in the statement of results. This trend supports and backs the understanding of international bodies in the sense of recognizing the effect on results of this type of remuneration plans estimated by fair value, that is, through adequate pricing methods. It is the understanding of the technical area of this CVM that companies must account for the expenses related to the grant of shares as a way to remunerate employees using an adequate pricing method. However, while there is no express determination in this sense, listed companies must disclose in an explanatory note what would be the amount of the period's results and Equity, if this accounting had been done.

21.10 Disclosure in Financial Statements and Periodic Information of option plans
The objective of initiating the process of knowledge of this issue within the Brazilian capital market led to the provisions of the Ibracon Pronouncement on Accounting for Employee Benefits approved by CVM Deliberation No. 371, which determines the disclosure, at a minimum, of the following information: (i) the nature and conditions of the stock purchase option plans; (ii) the accounting policy adopted; and (iii) the quantity and value by which the shares were issued. To fulfill the disclosure objectives, the company must disclose in the Explanatory Notes to the financial statements and in the Quarterly Information Form – ITR the following information related to Option Plans, always comparatively to the respective previous periods:
I - the existence of Option Plans, with a description of their nature and conditions (including eligibility conditions for beneficiaries).
II - the quantity, description of the nature and conditions (including, where applicable, rights to dividends, vote, conversion, exercise and expiration dates) and amount of options granted, exercised, and expired, if applicable, held by each group of beneficiaries, including their exercise price or, if applicable, the method of calculation to obtain it. The measure of beneficiaries' eligibility to exercise the right must be indicated (for example, the time elapsed since the date of grant of the option in relation to the total time until the beneficiary can exercise the option); III - the percentage of participation dilution to which current shareholders will eventually be subjected in case of exercise of all options to be granted; IV - regarding exercised options, description of the shares delivered, in quantity, class, and species, and the total and unit exercise price relative to each of the classes and species and the respective market value on the respective dates; V - the dates or periods in which options may be exercised by beneficiaries and any expiration dates; VI - description of any negotiations involving treasury shares to redeem the options, indicating the quantity of shares, by class and species, as well as the value received by the company; and VII – the effect on the Statement of Results of the Period and on Equity, if this accounting had been done

CIRCULAR LETTER/CVM/SNC/SEP No. 01/2004 74
22. Corporate Matters
22.1 Law No. 10,303/2001 – Changes to the Corporation Law
Law No. 10,303, of October 31, 2001, brought some changes to provisions of Law No. 6,404/76. The first change is that contained in item II, of §1º, of the new wording of art. 124. By this provision, the notice period for the first call for a general meeting, in an open company, becomes 15 (fifteen) days, and for the second call, 8 (eight) days.

The second change refers to the documents that must be made available to shareholders up to one month before the date set for the Ordinary General Meeting. Law No. 10,303/2001 added the opinion of the fiscal council, including dissenting votes, and other documents pertinent to the matters included in the agenda, to the list of documents available to shareholders.

Another very significant change is that made in articles 197 and 202, which deal with the constitution of the Reserve for Unrealized Profits. The change brought by the new Law is that the Reserve for Unrealized Profits is no longer constituted by the amount of unrealized profits, as defined by Art. 197, but rather by the portion of the mandatory dividend exceeding the amount of realized profit.

No less important is the modification of art. 196, which determines the annual review of a capital budget that encompasses a period longer than one fiscal year, a budget used to support the constitution of the Reserve for Profits – Retention of Profits. This budget must include the main items of investment in working capital and fixed capital with the main sources of financing – equity and third-party capital – projected, as well as the premises that support it. The content of the capital budget must receive adequate disclosure in the IAN form, and it is recommended that it be considered in the preparation of the Management Report and in the performance comments in the ITR form.

Reinforcing the understanding that CVM has maintained over time, § 6º of the new article 202 establishes that profits that are not destined for profit reserves, in accordance with articles 193 to 197, must be distributed as dividends.

22.2 Participation in Results Not Referenced in Profit
Employee participation in profits or results is provided for in article 7, item XI, of the Constitution, and regulated by Law No. 10,101/00.

Although it is a complex subject, our objective is merely to issue an understanding regarding the accounting treatment of participations in profits or results, given the different accounting treatments adopted by some open companies.

It is the understanding of this CVM that the classification provided for in item VI, of article 187, of Law No. 6,404/76, applies only to statutory participations provided for in corporate law and that have profit as a base and are determined in accordance with the provisions of said Law.

Therefore, any gratification to employees, even those denominated as participation in profits or results, that does not fully observe the conditions provided for in the Corporation Law, must be classified as cost or operational expense, regardless of its denomination or calculation base.

22.3 Reserve for Unrealized Profits – Law No. 10,303/01
From the effective date of Law No. 10,303/01, the Reserve for Unrealized Profits began to be constituted by the amount of the mandatory dividend, calculated in accordance with the bylaws or art. 202, that exceeds the realized portion of the net profit of the fiscal year.

Thus, the amounts constituted from the effective date of Law No. 10,303/01 come to represent the deferred dividend itself and no longer its base in realization.

However, the previous balance constituted under the previous rule still has that characteristic, i.e., upon its realization, it will constitute the calculation base for dividends.

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Given this differentiated characteristic in the constitution of the reserve, it is necessary to alert that there must be adequate segregation of the amounts that make up the balances of the Reserve for Unrealized Profits constituted before and after the effective date of Law No. 10,303/01.

Alternatively, the open company in this situation may uniformize those amounts, transforming the previous balance to adapt it to the new form of realization of the reserve.

Only the portion that will be paid as a dividend should be maintained in the Reserve for Unrealized Profits account, with the remaining balance reversed and destined in the manner of article 19 of CVM Instruction No. 247/96 (capital increase, distribution of dividend and/or constitution of other profit reserves or absorption of fiscal year loss, meeting legal requirements).

22.4 Retention of Profits
Legally, shareholders have the right to receive, as mandatory dividend, at least the portion of profits established in the bylaws. This dividend, stipulated in the bylaws, must be the minimum remuneration due to the shareholder. All the remaining undistributed profit must be mandatorily destined, in the manner of corporate law, with no indiscriminate retentions either as a reserve or in the accumulated profits account.

The destinations made under the title of retention of profits must be justified by a capital budget approved by the general meeting and their classification must be made, preferably, in a specific reserve account. However, their classification in an accumulated profits account is admitted, provided that their nature is evidenced and the provisions of art. 196 of the corporate law are observed.

We must also emphasize that CVM Instruction No. 323/00 defines as an abusive exercise of controlling power the approval by the controlling shareholder of the constitution of a profit reserve that does not meet the prerequisites for its constitution, as well as the retention of profits without a budget, approved in a General Meeting, that justifies this retention.

22.5 Effect on the Calculation of Mandatory Dividends Resulting from the Accounting Treatment of Exchange Gains
Given the doubts raised by some open companies regarding the accounting treatment to be given to exchange gains with liabilities indexed in foreign currency and regarding their computation in the calculation base of the mandatory dividend, we present the clarifications below.

1. Item 4 of CVM Advisory Opinion No. 13, of July 6, 1987, provides regarding exchange variations:
   "4. Guided by the fundamental principles of accounting, the Securities and Exchange Commission clarifies that the open company shall observe the following procedures regarding exchange variations resulting from changes in the exchange rate:
   a) variations resulting from the adjustment of credits and obligations in foreign currency, due to changes in the exchange rate, constitute revenue or expense and integrate the determination of the result in the fiscal year in which the exchange changes occur; b) when they refer to obligations linked to the financing of assets..."

2. However, a problem arises regarding the payment of dividends, relative to the portion of such gains included in the result of the fiscal year: in the case of exchange gains originating from the existence of a long-term liability, their recognition may imply an immediate impact on cash flow, to meet that payment, generating financial problems for the company.

3. The understanding of CVM, in such cases, is that, although realized from an accounting point of view, this gain constitutes an unrealized result from a financial perspective. Thus, in the same way that "profit on sale on terms realizable after the end of the following fiscal year" is treated (art. 197, sole paragraph, letter "c", of Law No. 6,404/76), the company may consider this gain as unrealized when constituting a reserve for unrealized profit, within the limitations established in the caput of said article.

4. This understanding is supported by the statement of reasons that forwarded the Bill of the Corporation Law, when dealing with reserves and retention of profits:
   "The reserve for unrealized profits is regulated in the Bill so that the mandatory dividend can be fixed as a percentage of the profit of the fiscal year without risk of creating financial problems for the company."

5. The reversal of the reserve, and its consequent computation in the calculation base of the mandatory dividend, will occur when there is a reversal of the expectations of exchange gains or at the maturity of each long-term contract, whichever occurs first, which gave rise to the aforementioned exchange gains.

6. Special Topics
   23.1 Consultations on Accounting Matters
   As part of its duties, CVM maintains a service to exercise elucidatory or orientation activities towards agents of the securities market or any investor.

Constituting an important communication channel, this service is widely used by those agents and especially by open companies regarding accounting matters.

CVM, through norms and standards, guides companies to disclose minimum information, considered essential for the market, establishing qualitative and quantitative indicators.

To the administrators of companies, as responsible for their disclosure, it falls to promote the continuous evaluation of additional information needs to the public, given their access and knowledge about the facts and their greater capacity to assess their relevance.

To the independent auditor, it falls to apply a set of technical procedures that aim to issue an opinion on the adequacy with which the accounting statements represent the net worth and financial position, the result of operations, the changes in equity, and the sources and applications of resources of the audited entity.

It is always important to remember that Accounting is a social science, and as such, it is characterized as the language of business and markets and is embodied in concepts, definitions, methodologies, techniques, and practices that arise from the interaction and conflicts between groups.

In this sense, there has been an increasing incidence of consultations regarding the change of a certain practice or accounting procedure. These consultations often bring to the knowledge of CVM the aspirations and demands of the market.

This communication channel is considered of great importance in the process for the establishment of accounting norms and standards. However, it is equally important that all agents involved in this process participate in it. In this sense, the participation of the independent auditor is an essential condition for the broad debate of the matters under examination.

Therefore, the guidance is that consultations regarding the change or adoption of new practices or accounting procedures should be accompanied by the prior manifestation of the independent auditor regarding their position on the matter consulted.

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24. Audit
24.1 – Rotation of Independent Auditors
Article 31 of CVM Instruction No. 308 establishes that the independent auditor, whether an individual or a legal entity, cannot provide services to the same client for a period longer than five consecutive years, counted from the date of this Instruction, requiring a minimum interval of three years for their re-hiring.

In this sense, it is worth noting that the five-year period established is counted from the date of publication of the Instruction, which occurred on 05/19/1999, not reaching the past time. Thus, open companies and other entities registered with this CVM, whose accounting information has been audited by the same independent auditor(s) since that date, must arrange for the hiring of another independent auditor(s).

Thus, for cases of application of the rotation of the independent auditor due to the five-year limit established in the aforementioned article 31 of CVM Instruction No. 308/99, it is worth clarifying that the work performed by the auditor who will be replaced may be performed until the 1st ITR/2004, base date 03/31/2004, emphasizing that the deadline for issuing the review report of the ITR prepared by the said auditor will be 05/19/2004.

Nothing prevents the audited entity from replacing its independent auditor(s) in a period shorter than five years; however, in case of re-hiring, the minimum interval of three years must be observed.

For the full compliance with the principle contained in the rule of rotation of independent auditors, under certain circumstances, a simple change of audit firm is not sufficient. Considering that such a rule was established to prevent that the prolonged relationship between the auditor and the audited entity may diminish independence and objectivity in the execution of the work, when changing independent auditors, at least the professionals who worked at the previous audit firm and who participated in the work at the audited entity for 5 (five) or more years, in the event of being hired by the substitute audit firm, must, to preserve the essence of the norm, observe a waiting period of 3 (three) years to return to audit work at the said audited entity.

24.2 Conflict of Interest
For the perfect exercise of the independent audit activity, the professional must, essentially, be exempt from interests linked to the audited entity, not allowing such interests to condition their performance in the execution of the work and, consequently, in the issuance of audit reports and opinions.

In harmony with this premise, CVM considers that there are 3 essential prerequisites for the performance of independent auditors in the securities market:

• the market must have highly qualified auditors;
• at the same time, these auditors must enjoy a high degree of independence, and
• the need for the auditor to become aware that their primary responsibility is with the external public, users of the audited accounting statements.

Independence is a fundamental issue, and the most relevant aspect is not the fact that the auditor is independent or maintains their attitude of independence in relation to their client, but rather, and this is the crucial point, if they, in addition, appear to have independence. To the extent that the auditor's independence is put on trial by society, the information they audit tends to undergo the same process. For this reason, CVM understands that the provision of other services

CIRCULAR LETTER/CVM/SNC/SEP No. 01/2004 78 for the audited entity may configure a decrease in the degree of independence of the auditor and generate situations of conflict of interest.

Articles 22 and 23 of CVM Instruction No. 308/99 define the hypotheses of impediment and incompatibility for the independent auditor to provide other services, in addition to external audit services, to the audited entity.

Article 22 provides that "Independent Auditors – Individuals, partners, and other members of the technical staff of Independent Auditors – Legal Entities shall not perform independent audit when it is configured, in their performance at the audited entity, its subsidiaries, holding companies, or members of the same economic group, the infringement of the norms of the Federal Council of Accounting – CFC regarding independence." Article 23 lists the services whose provision together with external audit services is prohibited to the independent auditor and to the individuals and legal entities linked to him.

On the other hand, articles 19 and 20 establish that the independent auditor must comply with the specific norms of CVM and observe, furthermore, the norms emanating from the Federal Council of Accounting - CFC and the technical pronouncements of the Brazilian Institute of Independent Auditors – IBRACON, considering that there is no conflict with specific CVM norm, regarding professional conduct, the exercise of the activity, and the issuance of opinions and audit reports.

In this sense, CFC Resolution No. 961/03, a professional norm dealing with the independence of the independent auditor regarding the relationship with the audited entity, expanded the list of situations and provision of services listed in the aforementioned article 23 of CVM Instruction No. 308/99 that potentially generate conflict of interest, namely:
(I) employment or similar links by administrators, executives, or employees of the audited entity previously maintained with the audit entity; (II) members of the audit entity who, previously, were administrators, executives, or employees of the audited entity; (III) bookkeeping services; (IV) internal audit services to the audited entity; (V) information system consulting services; (VI) litigation support, judicial or extrajudicial expertise services; (VII) corporate finance and similar services; and (VIII) senior executive selection services.

However, said CFC Resolution No. 961/03 establishes that in situations regarding the provision of other services to the audited entity, the independent auditor must observe certain parameters that, according to the nature of these services, may or may not be provided in addition to external audit services. For example, the aforementioned professional norm allows the independent auditor to provide tax planning services to the audited entity, provided that the independent auditor elaborates it on strictly scientific bases, that the planning is legally supported, supported by suitable documentation, and that the fees do not include a variable portion proportional to the benefit obtained by the audited entity. However, the sole paragraph of article 23 of CVM Instruction No. 308/99 prohibits the provision of consulting services regarding tax planning to the audited entity.

Furthermore, according to item VII of the aforementioned sole paragraph of article 23 of CVM Instruction 308/99, the provision of any other product or service that influences or may come to influence decisions taken by the administration of the audited institution is prohibited.

In view of the above, within the scope of the securities market, independent auditors, regarding situations related to conflict of interest, and administrators of audited entities must primarily observe the norms emanating from CVM, complemented by the norms of CFC in points where these are more comprehensive.

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24.3 Disclosure of Non-Audit Services
Open companies and other issuers of securities must disclose in the accounting statements closed on 12/31/2003, information regarding the provision, by their independent auditor or persons linked to him, of any other service that is not external audit, as determined by CVM Instruction No. 381/03.

According to the Instruction, companies must disclose in the Management Report the following information about these other services:
a. the date of hiring, the duration period, if longer than one year, and the indication of the nature of each service provided; b. total value of contracted fees and its percentage in relation to fees related to external audit services;
c. the policy or procedures adopted by the company to avoid the existence of conflict of interest, loss of independence or objectivity of its independent auditors.

In case of alteration, in the fiscal year, due to new hiring, cancellation or modification of contracts, this information must be updated in the Quarterly Information – ITRs).

The audited entity may refrain from disclosing this information, if the remuneration paid for other services is not relevant (less than 5% of the remuneration for external audit services); however, it is recommended that there be only information if the independent auditors provided or did not provide other services, in addition to external audit services, to the audited entity.

It is also emphasized that the independent auditor must declare to the audited entity the reasons why, in their understanding, the provision of another service, which is not external audit, does not affect their independence and objectivity. A summary of this exposition must also be disclosed by the audited entity in its annual reports.

Finally, according to CVM Instruction No. 386/03, administrators of financial investment funds, funds for application in quotas of financial investment funds, and funds for investment abroad must disclose in a note to the accounting statements of the said funds, the information required by CVM Instruction No. 381/03.

24.4 Relationship with the Independent Auditor – Responsibilities of Administrators
CVM Instruction No. 308/99, in its articles 26 to 29, establishes duties and responsibilities of administrators and fiscal council members in their relationship with independent auditors.

Consequently, it must be emphasized that the care for independence is not the exclusive task of the auditor. In this aspect, article 27 of CVM Instruction No. 308/99 establishes that administrators of audited entities will be held responsible for hiring independent auditors who do not meet the conditions provided for in the cited norm, especially regarding their independence (existence of conflict of interest) and the regularity of their registration with this Securities and Exchange Commission.

Among these responsibilities, article 28 determines that the administration of the audited entity must communicate to CVM, within 20 days of the occurrence, the change of auditor, in which the consent of the replaced auditor must necessarily appear. Said article also disciplines the hypotheses of lack of communication by the audited entity and by the auditor, as well as the disagreement of the latter regarding the justifications presented by the audited entity.

It is worth noting that the automatic update of registration data by the open company or even the change of independent auditors due to compliance with the rotation rule does not eliminate the need to send the communication required in article 28 of Instruction No. 308/99,

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resulting, in case of non-compliance, in the application of a daily coercive fine, without prejudice to other applicable sanctions.

24.5 Technical Qualification Examination

CVM Deliberation No. 466, of December 26, 2003, endorsed CFC Resolution No. 989/03, regarding the approval of NBC P 5 – Standard on Technical Qualification Examination, establishing that from January 1, 2004, for purposes of registration as an Independent Auditor - Individual and registration as Technical Responsible for Independent Auditor - Legal Entity, interested parties, provided that the other provisions of CVM Instruction No. 308/99 are met, will obtain provisional registration, with the granting of definitive registration remaining conditional upon the subsequent presentation of the certificate of approval in the Technical Qualification Examination.

We emphasize that registrations of Independent Auditor - Individual and registration as Technical Responsible for Independent Auditor - Legal Entity granted until December 31, 2003, are exempt from presenting the certificate of approval in the Technical Qualification Examination.

According to CFC Resolution No. 989/03, the 1st Technical Qualification Examination will be applied in the first semester of 2004.

24.6 Annual Information

In compliance with article 16 of CVM Instruction No. 308/99, independent auditors registered with this CVM (individuals or legal entities) must send the annual information (Annex VI), competence 2003, to the CVM by the deadline of April 30, 2004, noting that late submission will result in the application of a daily coercive fine, according to article 18 of the aforementioned Instruction.

It is worth remembering that independent auditors have the option to send their annual information via the internet, considering two alternatives: a) presentation by filling out the "web" form (for auditors whose information is reduced) and b) presentation in standard XML file (for auditors with a large volume of information).

For sending annual information electronically, independent auditors, on the CVM page (www.cvm.gov.br), must proceed as follows: "Document Submission", enter CPF and password, "Document Submission via Form" or "Document Upload (XML file)" and follow the instructions on the screen.

24.7 External Quality Control – Peer Review

Article 33 of CVM Instruction No. 308/99 determined that independent auditors should have their internal quality controls reviewed by their peers, according to the guidelines issued by the Federal Council of Accounting – CFC and the Brazilian Institute of Independent Auditors – IBRACON.

Thus, CFC Resolution No. 964/03, which revoked CFC Resolutions Nos. 910 and 923, respectively, determines that at least every 4 (four) years, independent auditors registered with the CVM must undergo the peer review process. However, the Administrative Committee of the External Quality Review Program – CRE, the body responsible for organizing and coordinating the program, has been determining that independent auditors whose reports prepared by the reviewing auditor contain reservations, adverse opinion, or abstention from opinion, must prepare an action plan to solve the identified flaws and undergo a new review process to verify if the appropriate corrections were implemented.

It is worth noting that notwithstanding the educational and preventive nature of the 1st external quality review, non-compliance with the provisions contained in CFC Resolution No. 964/03 constitutes a disciplinary offense subject to the penalties provided for in letters "c", "d", and "e" of article 27 of Decree-Law 9295/46 and, when applicable, the Professional Ethics Code for Accountants (CEPC), in addition to resulting

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non-compliance with article 20 of CVM Instruction No. 308/99, being subject to the application of the penalties provided for in article 35 of the aforementioned Instruction.

24.8 Audit of Subsidiaries

The main aspect to be highlighted is the obligation to be audited, by an independent auditor registered with the CVM, all subsidiaries included in the consolidation. In this sense, it would be ideal for this examination to be carried out by the same auditor of the holding company; when this is not possible, whether by management decision or by compliance with the rotation rule, it is essential that the subsidiary's auditor makes their working papers available to the holding company's auditor (sole paragraph, article 35 of CVM Instruction No. 247/96).

The problems pointed out by the market refer to subsidiaries located abroad and the difficulty of meeting the requirement for examination by an auditor registered with the CVM, as well as the issue of difficulty in accessing working papers if it is not the same audit in Brazil when abroad.

In these cases, the holding company's auditor, in Brazil, must guide their analysis and verification to the extent necessary and sufficient to be able to certify and issue the opinion on the holding company's financial statements and on the consolidated financial statements without any restriction to any group of accounts (in particular, to the "Investments" asset). The publicly held company obliged to prepare and disclose consolidated financial statements must provide its independent auditor with all conditions so that there are no limitations in the scope of their work.

24.9 Audit in Merger, Consolidation, and Spin-off Operations

Article 12 of CVM Instruction No. 319 establishes the obligation of independent audit of the financial statements that serve as the basis for merger, consolidation, or spin-off operations involving a publicly held company. This instruction does not require the audit of the set of financial statements normally required by corporate law and CVM standards. Given some doubts that have arisen in the market, we must clarify that, as the text itself mentions, only the statements prepared to effectuate this type of operation (basically the balance sheet and income statement for the period) must be subject to audit.

24.10 Audit of Transactions with Related Parties

An important item that has been worrying the CVM concerns the disclosure of information regarding transactions carried out with related parties, as required by CVM Deliberation No. 26/86. This is fundamental information, especially for non-controlling shareholders, insofar as the effects of these transactions can significantly impact current and future results, coming to influence decision-making by those shareholders and investors in general.

The Federal Council of Accounting, which approved NBC-T-11, determines that the auditor must examine relevant transactions with related parties, applying the necessary procedures to obtain information about the purpose, nature, and extent of the transactions, with special attention to those that seem abnormal. Therefore, the auditor must verify if these transactions are duly disclosed and, if not, mention it in their audit report.

Notwithstanding the aspects related to disclosure, given the provisions of articles 115, 116, 117, 145, 153 to 165 of Law No. 6.404/76 and CVM Instruction 323/2000, the independent auditor must observe whether the formalization, implementation, and adequate description of the circumstances established in those documents meet the concept of equal or market conditions and, if necessary, communicate the fact to the CVM, in accordance with the provisions of article 25 of CVM Instruction No. 308/1999.

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At this point, the action of the independent auditor is important in the sense of verifying the existence, and consequently, taking care of its adequate disclosure, of contractual instruments or other document signed that disciplines operations with related parties.

24.11 Distribution of Results

Art. 25, of CVM Instruction No. 308/99, determines that the independent auditor must verify if the allocation of results of the audited company is in accordance with the provisions of corporate law, the norms issued by the CVM, and with the company's bylaws. If any irregularity is found, the auditor must communicate the fact to the CVM, within 20 (twenty) days, from its occurrence. The failure to communicate the fact to the CVM constitutes an offense of an objective nature, subject to the initiation of an Administrative Process of Summary Procedure, according to the provisions of art. 38 of the same Instruction.