CVM Orienting Opinion 12

SUMMARY: Monetary correction of interim results. Circumstances under which it is admitted - Compatibility with tax legislation - Practical examples.

1. INTRODUCTION
   Instruction CVM No. 57, of 12/17/86, determines in its Article 4 that values represented by interim results calculated within the same fiscal year shall not be subject to updating. The Explanatory Note of that Instruction mentions that "updating interim results is only a technically correct procedure when it does not produce an effect on the net income of the year" (emphasis added) and that this complex subject would require a specific pronouncement. Circular Letter/CVM/PTE No. 309, of the same date in its item 11, also alerts about the prohibition of this correction of results calculated during the fiscal year, but goes a bit further, by mentioning that, in the case of correction carried out for tax purposes, the result must be adjusted in such a way that there is no effect on the net result of the year.

Thus, in view of the doubts raised by publicly-held companies and independent auditors, regarding an apparent conflict of legislation (corporate/tax), it is necessary to disclose, in a broader and more elaborate manner, the orientation of the Securities and Exchange Commission (CVM) on the subject.

2. PROFIT AS THE EXCESS OF CAPITAL EVALUATED MONETARILY
   The traditional concept of result considers profit or loss as the variation in a company's net equity that occurred during a certain period, after excluding from this variation the effects of capital increases and those related to the distribution of profits. Therefore, in the absence of capital increases, contributions to capital reserves, spontaneous revaluations of assets, trading in shares issued by the company itself, adjustments of prior periods, and distribution of profits, the result is the increment (or reduction) of the company's own capital (net equity), where this net equity is evaluated monetarily within the fundamental principles of accounting.

In an inflationary situation, however, it is necessary to exclude from this variation in net equity the effect merely derived from the variation in the purchasing power of the currency to arrive at the real increment (or reduction) that corresponds, then, to the actual profit (or loss) of the period.

Thus, abstaining from the effects cited above (of capital increase and others), it is found that the result is the difference between the final and initial net equity of a certain period, discounting from this difference the effect of inflation.

3. THE PROBLEM OF PERIODS TO CONSIDER

Based on this quite universal concept of profit, adopted even by our corporate legislation, we conclude that the period defined for the calculation of the result and the inflation rate observed in it are essential for the adequate measurement of the result.

In an extremely simple example, if a company possesses exclusively an asset represented by a financial investment originating from exclusively own capital, it will have, as a measure of its result, what this net equity grows during a period above what is necessary to compensate for the inflationary effect. For example, if the following values are obtained for the asset and net equity:

• On 01.01.19X6: Cz$ 1,000,000.00
• On 12.31.19X6: Cz$ 1,800,000.00
  and if there has been an inflation of 56% during 19X6, it is evident that the profit, at this final value, will only be the excess over the initial capital corrected monetarily, that is, Cz$ 240,000.00, and it will be formed by the following parts:
  Nominal Financial Revenues: Cz$ 800,000.00
  (-) Monetary Correction (560,000.00)

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Result Cz$ 240,000.00

4. THE EFFECT OF INTERIM PERIODS
   Suppose, however, that this nominal revenue was obtained in the following way: Cz$ 300,000.00 in the first semester and Cz$ 500,000.00 in the second. And that the inflation of the first period is 20% and that of the second, 30%.

The result of the first semester will be recorded:
Nominal Financial Revenues: Cz$ 300,000.00
(-) Monetary Correction (200,000.00)

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Result Cz$ 100,000.00
This value corresponds to the difference between the net equity on 06.30.X6 (Cz$ 1,300,000.00) and that of 01.01.X6 corrected by the inflation of the first semester.

But what is the correct value of the result isolated in the second semester? Within this reasoning, it corresponds to the difference between the net equity at the end of the year (Cz$ 1,800,000.00) and the net equity of 06.30.X6 updated monetarily by the 30% inflation of the second semester. Since the net equity at the beginning of the second period is Cz$ 1,300,000.00, we will have as the result the value of Cz$ 110,000.00 (Cz$ 1,800,000.00 - Cz$ 1,300,000.00 X 1.30), accounted for as follows:
Nominal Financial Revenues: Cz$ 500,000.00
(-) Monetary Correction (390,000.00)

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Result Cz$ 110,000.00

Note that this is the correct result of the second semester, but it was reached after having corrected the entire net equity of the first, including the interim result obtained in it. Therefore, it is technically correct to make, in the second semester, the correction of all the net equity existing at the beginning of this second period, including the result obtained in the first.

However, by adding the result calculated at the end of the first semester, of Cz$ 100,000.00, with that of the second semester, of Cz$ 110,000.00, one does not arrive at the correct result for the whole year, which, as seen above, is Cz$ 240,000.00.

If the result of the second semester had been accounted for without the correction of the part of the net equity corresponding to the profit of the first semester, one would have:
Nominal Financial Revenues: Cz$ 500,000.00
(-) Monetary Correction (30% of N.E. of Cz$ 1,200,000.00 and not of Cz$ 1,300,000.00) (360,000.00)

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Result Cz$ 140,000.00
The result of the second semester would be wrong, but the sum of the two profits, Cz$ 100,000.00 from the first and these Cz$ 140,000.00 from the second, would be correct to represent the actual profit for the whole year.
This version is the one that prevailed until recently in Brazil. Even financial institutions, obliged to present semi-annual results in addition to annual ones, were calculating the correct result for the first semester, incorrect for the second, but correct for the whole year. The same was occurring with the quarterly information of publicly-held companies: that of the first quarter presented the correct profit, but those of the following quarters were incorrect; however, the nominal sum of the four periods ended up generating the correct result for the whole year.

5. RECONCILIATION
   Starting in 1986, with the implementation of the semi-annual exercise for tax purposes, legislation of this nature came to accept, justly, the correction, in the second semester, of the result obtained and already taxed in the first. How to perform the reconciliation?

In the Brazilian monetary correction system, when one corrects the initial net equity by the period's inflation and compares this value with the final net equity, one obtains a profit measured in the currency of the final date of the period. Even if the items comprising the result are formed by the sum of the nominal values of the whole year, the final result, after monetary correction, is in the currency of the end of that year.

As commented previously, we can deduce that:
a) when preparing semi-annual statements, the result calculated in the 1st semester is in currency with the purchasing power of the end of that period, and b) that when correcting, for the purpose of calculating the result of the 2nd semester, the initial net equity of the 2nd semester, including the interim result (that is, the net equity at the end of the 1st semester), one has a result in the currency of the end of this 2nd period.

Therefore, the sum of the nominal values of these results, in currencies with purchasing power of different dates, cannot provide the correct result for the year. It is necessary, therefore, before carrying out this sum, to update the result of the 1st semester, bringing it, then, to the currency of the end of the 2nd semester. Thus, for the examples given, the correct result for the year of 19X6, after the calculation of the adequate semi-annual results of Cz$ 100,000.00 and Cz$ 110,000.00, is obtained after updating the value of the first by the inflation occurring in the second semester:

• Result of the 1st semester, corrected to the currency at the end of the 2nd semester:

Cz$ 100,000.00 X 1.30 = Cz$ 130,000.00

• Result of the 2nd semester, already updated to the currency at the end of the year: Cz$ 110,000.00

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Result of the year Cz$ 240,000.00

Therefore, as we have already seen, it is perfectly correct and valid to correct, in the second semester, the result obtained in the first, provided that this correction does not affect the annual result.

Since the CVM is responsible for safeguarding the corporate information of publicly-held companies and since the corporate result is, for all joint-stock companies, necessarily for one year, hence its insistent pronouncements in the sense of prohibiting the correction of interim results, if with this procedure the annual result that would be obtained without this updating of partial results is altered.

However, provided that the due reconciliation is carried out, not only is the correction of interim results acceptable, but even desirable and necessary. Provided, that is, that the correct value of the result of the fiscal year is not altered, which is, as a general rule, 12 months (exception to the first of the company's life or in cases of change of its closing date).

6. PRACTICAL WAYS OF RECONCILIATION
   In the previous item, a correction of the first semester's profit was made before its addition to that of the second.

Note that the updating, in each period, of the result of the previous period corresponds to an updating of each revenue and each expense of that preceding period. It is concluded from this that the best and most complete technique is the use of Integral Correction, with the updating of all revenues and all expenses, and with the substitution of the monetary correction account by the gains or losses that monetary assets and liabilities suffer as a result of inflation.

But since this methodology, although it has already originated publications by publicly-held companies in Brazil, is not yet fully disseminated, it is necessary to use, at least for now, simple forms of value reconciliation.

1st Alternative:
A. creation of a special result account, named "Monetary Correction of the 1st Semester Result" (or similar), to be evidenced in the calculation of the result of the 2nd semester.

B. disregard of the balance of this account in the calculation of the annual result.
With this, the balance of the Patrimonial Monetary Correction account, relative to the fiscal year, will not be the nominal sum of the two values of the first and second semesters; the portion related to the accounting, in the second period, of the correction of the result of the first, registered in this special account, will be excluded.

For example, considering the hypothetical situation that had been shown, one would have:

	Result of 1st Semester	Result of 2nd Semester	Result of Year 19X6
Nominal Financial Revenues	Cz$ 300,000.00	Cz$ 500,000.00	Cz$ 800,000.00
Monetary Correction	(200,000.00)	(360,000.00)	(560,000.00)
Monetary Correction of the 1st Semester Result	(30,000.00)
Result	Cz$ 100,000.00	Cz$ 110,000.00	Cz$ 240,000.00

2nd Alternative:
Another hypothesis would be the evidence of the updating of the first semester's result to the currency at the end of the second:

	Result of 1st Semester	Result of 2nd Semester	Result of Year 19X6
Nominal Financial Revenues	Cz$ 300,000.00	Cz$ 500,000.00	Cz$ 800,000.00
Monetary Correction	(200,000.00)	(360,000.00)	(590,000.00)
Results of the Semesters	100,000.00	110,000.00
Updating of the 1st Semester Result	30,000.00	30,000.00
Results in Currency at End of 2nd Semester	Cz$ 130,000.00	Cz$ 110,000.00	Cz$ 240,000.00

3rd Alternative:
An additional alternative would be the conjugation of these two previous ones:

	Result of 1st Semester	Result of 2nd Semester	Result of Year 19X6
Nominal Financial Revenues	Cz$ 300,000.00	Cz$ 500,000.00	Cz$ 800,000.00
Monetary Correction	(200,000.00)	(360,000.00)	(560,000.00)
Monetary Correction of the 1st Semester Result	30,000.00	(30,000.00)
Result in Currency at End of 2nd Semester	Cz$ 130,000.00	Cz$ 110,000.00	Cz$ 240,000.00

4th Alternative:
The company could also prepare the corporate balance sheet before the correction of the interim result, when then the annual result would consist of the simple sum of all revenues and expenses of the periods covered. Immediately after, it would make the correction of the interim result and prepare the balance sheet and the result statement of the second semester for tax purposes.

5th Alternative:
Another acceptable hypothesis for the CVM would be the accounting of the reversal of the monetary correction of the first semester's result, after the calculation of the second, eliminating the effects of this updating. For tax purposes, there would be the monetary correction of the second semester with a value, after the updating of the first result, but before the reversal, and for corporate purposes there would be another value, after this reversal.

Other Alternatives:
Other forms may be adopted, but the fundamental point is that the result of the fiscal year is evidenced and used for all corporate purposes (participations, constitution of reserves and dividends) and analysis by its correct value, without the eventual distortion, possibly resulting from bad accounting of the correction of interim results.

The CVM also accepts other alternatives provided this objective is met and the procedure used is evidenced in the financial statements.

7. CONSIDERATIONS ON INTERIM RESULT
   The interim result, as its very expression defines it, is not relative to the fiscal year and, consequently, cannot have a definitive destination in the interim balance sheet, except regarding dividends, if legal and statutory requirements are met. Thus, the Legal Reserve is not constituted nor is any other destination given to it, except provisionally. Any use of this nature of the interim result balance must be reversed if an adverse result in the complementary period invalidates such destination.

In the case of payment of dividends from interim results, it should not be accounted directly to the Retained Earnings account, but rather in a special rectifying account, such as "Interim Dividends". This account, or at most sub-account, must rectify Retained Earnings and must also undergo monetary correction from its constitution.

In the case of a negative interim result, it must also remain in a special account or sub-account of Accumulated Profits or Losses, awaiting the calculation of the corporate result of the fiscal year.

8. BALANCE SHEET OF 06.30.86 CORRECTED BY OTN OF Cz$ 106.40
   Publicly-held companies that need to disclose the result relative to the second semester of 1986 are not obliged to adjust their financial statements of 06.30.86 because they carried out correction based on OTN of Cz$ 106.40 on that date.

The CVM alerts users of financial statements that the difference between the OTN of Cz$ 106.40 and the pro-rata OTN at the end of the year does not represent, in a totally adequate manner, the inflation of that period.

In the case where this effect is relevant, the publicly-held company must disclose it in an explanatory note.

9. EQUITY METHOD
   The equity method result, being obtained by the difference between the proportional value of the investee's net equity at the end of the year and the previous value of the investment corrected, up to that same date, has the characteristic of being one of the rare revenues or expenses recorded in currency with the purchasing power of the end of the year.

With the correction of interim results, this may cease to occur, as this result becomes the sum of values in currencies of different dates (June and December, for example).

Attention is also drawn to this fact and to the need for possible adjustments in the consolidation of results.

Furthermore, the expense with the provision for income tax also loses the characteristic of being in currency at the end of the year, the same possibly happening with other items.

For now, it is up to the company to carry out adjustments regarding these effects, without prejudice to the value of the result of the fiscal year, as set out in this Opinion.

10. CONCLUSION
    The monetary correction of interim result is, in essence, credit and debit in accounts of the result of the fiscal year itself. It must be made for an adequate calculation of the result of each period taken in isolation, but it cannot affect the measurement of the result of the year. This must be calculated corporately as if there had been no updating of the partial results.

Therefore, it is possible, it is correct, and it is even necessary to make this interim result correction, provided that the result of the fiscal year is calculated as if these corrections of interim results had not occurred. And this is quite simple to do. Several suggestions have been shown here and can be used, provided that the publicly-held company clearly evidences that the result of the fiscal year measures the growth of the company's net equity in real terms, considering the inflationary effect of the period.

However, small problems arise with this correction, relating to equity method, profit participations, and others.

It should be remembered that the only way, within the concept of result in force, that can most completely and perfectly evidence the composition of the period's result, is the Integral Correction of the components of the accounting statements, with the elimination, in the result statement, of the balance of the monetary correction account, as already widely evidenced in publications by several publicly-held companies (TELEPAR - Telecomunicações do Paraná S/A, VASP - Viação Aérea São Paulo S/A and CVRD - Companhia Vale do Rio Doce, for example).

Signed originally by
HUGO ROCHA BRAGA
Superintendent of Accounting Standards