CVM Orienting Opinion 15

SUMMARY: Procedures to be observed by publicly held companies and independent auditors in the preparation and publication of financial statements, management reports, and audit reports relating to fiscal years ending from December 1987.

1. INTRODUCTION
   This opinion aims to guide all publicly held companies and their respective independent auditors regarding the preparation and publication of financial statements, explanatory notes, management reports, and audit reports.
   The monitoring work on the 1986 financial statements revealed an improvement in the quality and quantity of information provided; however, in addition to some new deviations observed, others persist that have already been the subject of previous guidance (CVM Letters nºs 578/85 and 309/86). With the objective of further improving the quality of information brought to the market and continuing to reduce restatements, this guidance is issued.

2. MANAGEMENT REPORT
   According to Law 6.404/76, the management report must be published together with the financial statements of the end of the fiscal year, precisely containing information on:
   a) acquisition of debentures of its own issuance (art. 55, § 2º); b) policy of reinvestment of profits and distribution of dividends contained in shareholder agreements (art. 118, § 5º); c) corporate business and main administrative events occurring during the year (art. 133, item I); d) list of investments in affiliated and/or controlled companies, evidencing modifications that occurred during the year (art. 243). Since the advent of LAW Nº 6.404/76, the CVM has been examining the content of the reports presented annually by publicly held companies, with an expressive number of companies presenting them in a succinct manner using the most varied justifications, among which we highlight the one that the necessary reports for analysis of the aspects in question are already contained in the explanatory notes. Such a procedure, in addition to infringing the law, is not compatible with the posture expected of a publicly held company, resulting in the loss of a valuable opportunity for the company to be better known and evaluated by the investing public, its customers, suppliers, and creditors. Another point that must be observed in the preparation of the reports concerns the content; the simple presentation of percentages that can be obtained by any reader of the accounting statements is not valid, since the relevant information concerns the commentary or appreciation of the endogenous and exogenous factors that influenced the variations that occurred. Only in this exercise was the restatement of 66 reports determined for not meeting the minimum required by the above provisions. In most of these reports, the administrators limited themselves solely to presenting the financial statements thanking the collaboration of employees, creditors, etc., and placing themselves at the disposal of shareholders for further clarification. Other reports presented incomplete or inconsistent information with the published statements. The disclosure of useful, reliable, and detailed information, which enables the knowledge of the company and its objectives and policies, is an essential right of the shareholder. The management report cannot be excluded from this premise; thus, both the lack of information and the inclusion of studies and generic facts that do not concern the particular situation of the company constitute a disregard for the interest and right of the investor. The report, as an integral part of the financial statements, must therefore complement the accounting pieces and explanatory notes, observing the due coherence with the situation reflected in them, forming a complete picture of the postures and performance of the administration in the management and allocation of resources that are entrusted to it. It must be drafted with simple language to be accessible to as many readers as possible; adjectives and phrases such as "excellent result", "great performance", "low indebtedness", "excellent prospects" should be avoided, unless corroborated by
   comparative data or facts. The growing complexity of business and the instability of the economic environment and its inevitable reflection in the life of companies requires an increasingly professional posture from administrations, and the report can and must become a powerful element of communication between the company, its shareholders, and the community in which it is inserted. LAW Nº 6.385, of 12/07/76, grants the CVM competence to establish norms regarding the management report. Based on this competence, a specific orienting opinion contemplating the minimum information to be disclosed in the report is being studied and should be issued. However, at a minimum, the presentation of the information determined in LAW Nº 6.404/76 is required.

As a recommendation and example, we present below a list of items that constitute information that meets the general lines previously commented on, already presented by many companies in Brazil (and commonly in some other countries):
a) Description of business, products, and services: history of physical sales for the last two years and sales in currency of purchasing power at the date of the end of the fiscal year. Some companies present description and analysis by segment or product line, when relevant for their understanding and evaluation. b) Comments on the general economic situation: competition in markets, government acts, and other relevant exogenous factors on the company's performance. c) Human resources: number of employees at the end of the last two fiscal years and "turnover" in the last two years, segmentation of the workforce according to geographic location; educational level or product; investment in training; social security funds and other social plans. d) Investments: description of the main investments made, objective, amounts, and sources of allocated resources. e) Research and development: brief description of projects, allocated resources, amounts applied, and status of projects. f) New products and services: description of new products, services, and expectations related to them. g) Environmental protection: description and objective of investments made and amount applied. h) Administrative reforms: description of administrative changes, corporate reorganizations, and rationalization programs. i) Investments in controlled and affiliated companies: indication of investments made and objectives intended with the investments. j) Shareholder rights and market data: policies regarding the distribution of rights, splits, and groupings; book value per share, trading, and quotation of shares on the Stock Exchange. k) Perspectives and plans for the current and future fiscal year: the administration's expectation regarding the current year may be disclosed, based on premises and foundations explicitly stated, with this information not being confused with projections as it is not quantified.

l) In the case of a holding company, the report must contemplate the above-mentioned information, even if in a more synthetic form, relating to the invested companies.
It is worth noting that these suggestions should not inhibit the creativity of the administration in preparing its report.

3. EXPLANATORY NOTES
LAW Nº 6.404/76 determines that financial statements must be accompanied by explanatory notes and other analytical tables or accounting statements necessary to clarify the financial situation and the results of the year (art. 176, § 4º). It also presents a list of minimum information that must obligatorily appear in a note (§ 5º). Furthermore, the CVM, using the faculty conferred in LAWS 6.404 and 6.385, determines the presentation in a note of several other information necessary for the clarification, knowledge, and analysis of the company's situation and results. Despite this, many publicly held companies still do not make adequate use of the explanatory notes, failing to comply with the above determinations, both by omission of information and by the disclosure of unnecessary information. Such is the case that during the current fiscal year, deficiencies in the explanatory notes of a significant number of publicly held companies were still observed (more than 300 cases were recorded). These deficiencies range from the lack of presentation of the minimum information required by LAW Nº 6.404, for more than 10 years, to the non-compliance with the most recent CVM instructions and deliberations. The highest incidence, in the latter case, is due, mainly, to the lack of disclosure of transactions between related parties required by CVM DELIBERATION Nº 26, of 02/05/86, and the information relating to asset revaluations required by CVM Deliberation nº 27, of 02/05/86. Below, we list the main items that must be subject to disclosure in an explanatory note and respective normative provisions. In addition to these, other information is required in this orienting opinion. We alert, however, that this is a minimum list and should not restrict the presentation of other information by the company:

1. Treasury Shares
CVM Inst. nº 10/80 (art. 21)
2. Adjustments of
Prior Years
CVM Inst. nº 59/86 (art. 11, § 3º).

3. Financial Leasing
CVM Inst. nº 58/86 (art. 4º)
4. Authorized Capital CVM Inst. nº 59/86 (item I of the Explanatory Note)
5. Share Capital LAW Nº 6.404 (art. 176, § 5º, "f") and CVM Orienting Opinion
CVM nº 04/79 (item 8.6)
6. Valuation Criteria
LAW Nº 6.404 (art. 176, § 5º, "a")
7. Complementary Statements
CVM Inst. nº 64/87 (various articles) and CVM Orienting Opinion CVM nº 14/87 (various items)
8. Consolidated Statements
LAW Nº 6.404 (arts. 249 and 275, § 3º), CVM INST. Nº 15/80 (arts. 21 and 24) and CVM DELIBERATION Nº 26/86 (item 12)
9. Dividend per
Share
LAW Nº 6.404 (art. 186, § 2º) CVM Inst. nº 59/86 (art. 12)
10. Equity Method
LAW Nº 6.404 (art. 176, § 5º "b" and 247, I to V), CVM Inst. nº 01/78 (item XXXIV) and CVM Orienting Opinion CVM nº 04/79 (items
8.1 and 8.2)
11. Subsequent Events
LAW Nº 6.404 (art. 176, § 5º, "i") and CVM Orienting Opinion CVM nº 04/79 (item 8.8)
12. Tax on
Foreign Exchange Operations
CVM Orienting Opinion CVM nº 07/81 (items 4.2 and 5.1)
13. Corporate Investments
Abroad
CVM DELIBERATION Nº 28/86, (items 17, 51 and 52)

14. Change of
Accounting Criterion
LAW Nº 6.404 (art. 177, § 1º)
15. Long-Term Obligations
LAW Nº 6.404 (art. 176, § 5º, "e") and CVM Orienting Opinion CVM nº 04/79 (item 8.5)
16. Liens, Guarantees and
Liabilities
LAW Nº 6.404 (art. 176, § 5º, "d"), CVM Inst. nº 59/86 (item 4 of the Explanatory Note)
17. Share Purchase Operations
LAW Nº 6.404 (art. 176, § 5º, "g")
18. Revaluation LAW Nº 6.404 (art. 176, § 5º, "c") and CVM Deliberation nº
27/86 (various items)
19. Remuneration of
Administrators
CVM Orienting Opinion CVM nº 04/79 (item 9)
20. Reserves -
Detailing
CVM Inst. nº 59/86 (art. 10)
21. Reserve for
Profits to be Realized
CVM Inst. nº 59/86 (item 4 of the Explanatory Note)
22. Retention of
Profit
CVM Inst. nº 59/86 (item 4 of the Explanatory Note)
23. Transactions between
Related Parties
CVM DELIBERATION Nº 26/86 (various items).

In addition to this information, aiming at the full knowledge by shareholders and investors regarding the form and amount of remuneration of their investment in the company and the protection and preservation of this investment, it is required that the following information be evidenced in a note, auxiliary table, or report:
a) Note on Dividends:
A demonstration of the calculation of the dividend proposed by the administration must be presented. Thus, for example, if the bylaws establish the payment of a mandatory minimum dividend of 25% of the adjusted net profit, the company must present this demonstration starting from the net profit of the year, evidencing the deductions allowed for reserves, reversals of reserves, adjustments of prior years (if considered), the profit base for the calculation of the dividend, the percentage applied, the value of the proposed dividend, and the deductions and deductions of advanced dividends and their monetary correction if applicable. b) Note on Insurance:
The company must inform if and which assets, liabilities, or interests are covered by insurance and the respective amounts, specified by modality.

4. FINANCIAL LEASING
It has already been said, in the work on the Basic Conceptual Structure of Accounting, approved and endorsed by CVM DELIBERATION Nº 29/86, that to achieve the main objective of Accounting, especially in the context of publicly held company/external user, it becomes necessary to observe two very important points:
1st - Companies must emphasize the DISCLOSURE of all information that allows the evaluation of their financial situation and the mutations of this patrimony, and in addition, enable inferences regarding the future.
2nd - Accounting has a great relationship with the legal aspects surrounding the patrimony but, not infrequently, the legal form may fail to reflect the economic essence. In this situation, Accounting must be guided by its objectives of well informing, following, if necessary, for that purpose, the ESSENCE instead of the FORM. As is known, leasing operations in Brazil, although covered by all legal formalities, in essence are characterized as financing operations. It is also known as financial leasing. The recognition of these transactions has caused, in the lessee, enormous distortions in its financial statements. On the one hand, the values of assets applied in the company's activities and the corresponding liabilities are omitted, in addition to anticipating (and not evidencing) depreciation expenses in the form of leasing expense. (It should be noted that distortions so violent were created in the lessors that they completely invalidated their financial statements in the past. With the changes introduced by CVM INSTRUCTION Nº 58/86, and Circular nº 1.101/86 of BACEN, an important step was taken towards the improvement of the quality of these statements; this improvement, based on methodology presented by ABEL - Brazilian Association of Leasing Companies, evidenced, already in the fiscal years of 1986, how much more faithful and reliable the lessors' statements became.)

1. LESSEE COMPANY
In the case of the lessee company, even while there is no change in the process of accounting for leasing operations carried out in Brazil, it becomes necessary that the two points mentioned above - Disclosure and Essence over Form - be attended to in some way. For this, the information and effects of these operations must be evidenced in an explanatory note. The company must disclose the existence of leasing contracts, informing the value of the asset and liability that would exist if such contracts had been recorded as financed purchases.

2. LESSOR COMPANY
As required by CVM INSTRUCTION Nº 58/86, publicly held companies that explore the activity of financial leasing must, to better meet the fundamental principles of accounting, adjust their financial statements, eliminating the effects of revenue anticipations and deferrals, so that net profit and net equity correctly evidence their values. It is also required that the effect of income tax paid in advance due to fiscal criteria for the appropriation of revenues be considered in the determination of adjustments, but only and solely if the company has assured the effective possibility of its recovery. Given that in several cases the tax paid in advance is not effectively compensable with results of subsequent years, a careful analysis of each situation must be carried out, determining its recovery or not, before computing its effect in the adjustments of assets.

5. RESERVE FOR PROFITS TO BE REALIZED
1. CONSTITUTION
The Reserve for Profits to be Realized is constituted based on the amount of profits to be realized that exceeds the total retained in the year in the accounts of legal reserve, statutory reserve, for contingencies, and retention of profits (including in the account of accumulated interest). For this effect, profits to be realized are considered (art. 197, Sole Paragraph of LAW Nº 6.404/76):
a) the credit balance of the account for recording the counterparties of monetary correction adjustments (art. 185, para. 3º, LAW Nº 6.404/76); b) the increase in the value of investments in affiliated and controlled companies (art. 248, III, LAW Nº 6.404/76);

c) profit in installment sales realizable after the end of the following fiscal year.
Note that only the value of profits to be realized exceeding the values already retained, including in the own account of Accumulated Profits, can originate the creation of the Reserve for Profits to be Realized.
In the case of item "b" above, the Law refers to the increase resulting from the application of the equity method that arises from profit or loss ascertained in the affiliated or controlled company or that corresponds, demonstrably, to actual gains or losses. Thus, for the determination of the portion of profit to be realized, the net result of the equity method must be considered, encompassing positive and negative results, operational or non-operational, with profits to be realized existing only when this net result is positive. The constitution of the Reserve for Profits to be Realized aims to postpone the payment of the mandatory dividend, fixed as a percentage of the year's profit, until the moment when the profits to be realized that gave rise to the reserve are financially realized, thereby compatible the company's financial availability with the proposal for dividend payment. According to the Statement of Reasons on the Bill of Corporations, the "Reserve for Profits to be Realized was regulated so that the mandatory dividend can be fixed as a percentage of the year's profit without risk of creating financial problems for the company. The values listed as profits to be realized are modalities of profits that although computed in the year's result, have not yet been realized in conditions that allow their distribution with dividend." It is important to emphasize that the constitution of the Reserve for Profits to be Realized is optional. If the company has the necessary resources for the payment of the mandatory dividend, it may do so, in which case it is not appropriate to constitute the aforementioned reserve. It should also be commented that, in the case of the credit balance of monetary correction, there was a lapse in LAW Nº 6.404/76. The majority of situations of this credit balance present, in counterpart, monetary variation expenses, increases in the costs of products sold, or other items that invalidate the idea that the part of the profit formed by this balance is not financially realized. The complete correction of the financial statements evidences this very well. But, as stated in CVM INSTRUCTION Nº 64/87, there is no corporate effect that derives from it. Thus, the provision of LAW Nº 6.404/76 remains in force, even if technically incorrect.

2. DISCLOSURE
Given the importance that the constitution and reversal of the Reserve for Profits to be Realized has for the purpose of determining the dividends to be distributed, and consequently, for decision-making by shareholders and investors, it becomes necessary for the company to disclose in an explanatory note complementary information about this Reserve, discriminating the origin and value of each portion destined for its constitution, amount realized in the year and respective parameter and foundation, and effect on the calculation of the mandatory dividend.

6. CONTINGENT ASSET
The convention of Conservatism (also called Prudence) stipulates that among alternative sets of valuation for patrimony equally valid, according to fundamental principles, Accounting will choose the one that presents the lowest current value for the asset and the highest for obligations. This understanding should not be confused or distorted with the effects of accounting result manipulation, but viewed in light of the vocation for safeguard, care, and neutrality that Accounting must have, especially regarding the excesses of 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, active contingencies or contingent gains should not be recorded; only when their obtaining or recovery is effectively assured should they be recognized accountingly. Thus, a possible gain in administrative or judicial actions should only be recognized when, having gone through 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 constitute a provision for losses in proportion to the contingent value. In the case of the supply of goods or services that is being contested by the acquirer, there is also a need for non-recognition of revenue or provisioning of the value in dispute. If there is any form of contestation by the debtor, and the company considers that it has objective conditions to evidence its right, leaving no doubt on its part regarding its right and the chance of receipt, it may not effect the provisioning provided that it evidences, in an explanatory note to the financial statements, the existence of the contestation. The auditor must surround himself with all proofs and evidence that convince him of the non-necessity of provisioning, requiring, even, an opinion or the opinion of third-party specialists (lawyers, normally).

7. STATEMENT OF SOURCES AND APPLICATIONS OF RESOURCES
The objective of this statement is to present the modifications that occurred in the company's financial position between two dates, normally, those of the beginning and end of the fiscal year.
Many statements have, over the several years of validity of LAW Nº 6.404/76, accumulated errors in their preparation, thereby prejudicing their correct understanding.
Thus, for the adequate understanding of the SOAR, it is necessary to know its content. For this reason, the CVM recommends that the following basic requirements be considered in the preparation of the SOAR:
1. SOURCES OF RESOURCES

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1. Sources of Resources from Company Operations - represented by the net result of the fiscal year adjusted by values that do not affect net working capital (depreciation, amortization, and depletion quotas, computed in the year's result; equity method income, etc.), and by the variation of the result of future fiscal years. If, after adjustments, the result is positive, it constitutes the financial resources generated by the company's operations. If negative, it is understood that the company's operations absorbed resources, due to insufficient revenues to cover incurred costs. In this case, the financial "deficit" of operations will be shown as an item of resource applications.

2. Shareholders' Resources - are resources contributed to the company by its shareholders or for their benefit, which did not result from operations. They are represented by contributions for capital increases and contributions to capital reserves.

3. Resources from the Realization of Long-Term and Permanent Assets - are derived from receipts, sales, write-offs, or transfers to current assets of items classified in long-term and permanent assets.

4. Resources from Long-Term Third-Party Capital - are obtained by the company through loans, financing, and other obligations, causing an increase in long-term liabilities.

2. APPLICATIONS OF RESOURCES

1. Resources Applied in Operations - when the net result of the fiscal year, after the adjustments referred to in item 1.1, presents a negative situation, indicating that revenues were insufficient to cover incurred expenses.

2. Resources Applied in the Payment or Remuneration of Shareholders - record the portions destined for the payment of dividends, return of capital, etc., constituting a reduction in the company's net equity.

3. Resources Applied in the Acquisition (or Increase) of Long-Term and Permanent Assets - records values resulting from credits granted by the company, long-term; acquisitions of goods, investments, and fixed assets; applications in deferred assets, etc.

4. Resources Applied in the Reduction of Long-Term Liabilities - represented by decreases in long-term liabilities, due to transfers to current liabilities or early payments of debts.

3. Variation of Net Working Capital - calculation of the difference between the totals of sources and applications of resources.

4. Demonstration of the Variation of Net Working Capital - demonstrates the increase or decrease in net working capital, by indicating the initial and final balances of current assets and liabilities, and their respective net variations, in the period.

It is important to emphasize that the demonstration of sources and applications of resources will only be informative if presented in constant currency (full correction); otherwise, due to including values from different dates, it will present distortions resulting from inflationary effects.

8. ADVANCES

Advance accounts (assets and liabilities) present some peculiarities that deserve highlight in this orientation opinion. A distinction must be made, preliminarily, between advances without specific linkage (monetary items) and those linked to the provision of services or delivery/receipt of goods (non-monetary items). Although they are of quite differentiated nature, in most cases, the same treatment has been given to both types of advances; however, while the first has the characteristic of a loan, the other is an integral part of the value of the good or service to be provided. Thus, it becomes inadmissible under fundamental accounting principles that, for example, disbursements made for the future and effective delivery of goods (fixed assets or inventory) have the same accounting treatment and classification as an advance that essentially constitutes a loan operation.

Thus, aiming to unify the various treatments found, the following procedures should be adopted:

a) advances granted to suppliers of fixed assets goods should be classified in a specific account within the Fixed Assets group, undergoing monetary correction;

b) advances granted to suppliers of merchandise or raw materials should be classified in a specific account within the Inventory group, undergoing the same treatment given to other accounts in the group;

c) advances, even to suppliers of goods or services, that essentially characterize loan operations, should receive adequate titling and the income contracted should be accrued according to the nature of the operation;

d) when the received or disbursed advance is linked to the contractual clause of monetary correction, its update should be classified as monetary variation;

e) advances related to foreign exchange contracts (ACC) should be updated by changes occurring in the exchange rate, with these changes also accounted for as monetary variations; and

f) customer advances, for products to be delivered, services to be performed, or obligations of another nature, should be classified in current liabilities or long-term liabilities in an account that evidences their nature.

9. AGENCIES ABROAD - CONSOLIDATION

Branches, agencies, subsidiaries, or dependencies whose consolidation was exceptionally waived in the 1986 fiscal year must be included in consolidated statements, as required by CVM RESOLUTION NO. 28/86, items 7 and 8.

10. AMORTIZATION OF GOODWILL/BARGAIN PURCHASE - EQUITY METHOD

Goodwill/bargain purchase must be determined and accounted for upon each acquisition, and for it to be so conceptualized, it is essential that it has economic foundation. This foundation may result from:

a) difference, higher or lower, between the market value of asset goods and the book value of these same goods in the affiliated or controlled company;

b) difference, higher or lower, of profitability expectation based on projection of results of future fiscal years;

c) goodwill, intangibles, or other economic reasons (these duly specified).

The economic reason justifying the goodwill/bargain purchase must be disclosed in explanatory notes, in addition to the criteria established for amortization; the generic designation "other economic reasons" is not admissible as the basis for goodwill.

CVM INSTRUCTION NO. 01/78 establishes the criteria for amortization of goodwill/bargain purchase resulting from the foundations referred to in letters "a" and "b" above, and the criteria for amortization of goodwill registered based on the foundations contemplated in letter "c", with no manifestation regarding bargain purchase.

Thus, the understanding of this Commission is that the amortization of bargain purchase, in the latter case, should only be made in the event of the alienation or loss of the investment to which it refers.

11. FINANCIAL STATEMENTS OF THE PREVIOUS FISCAL YEAR (1986)

The financial statements of the 1986 fiscal year were prepared based on the models suggested in CVM Orientation Opinion No. 11, of 15.09.86. These models contemplated the segregation of events and transactions occurring up to and after 28.02.86, the disclosure of special accounts in the Statement of Changes in Equity, and the detailed presentation of adjustments resulting from the economic stabilization program, DECREE-LAW NO. 2,284.

For the current fiscal year, the publication of financial statements of the previous year (1986) is permitted without contemplating the segregation and details required in said Orientation Opinion, provided that the company, in an explanatory note, separately discloses (up to and after 28.02.86) the main items comprising the statement of the year's result, such as: net revenue from sales and/or services, gross profit, operating expenses, operating result, and result of each period or, in the case of financial institutions, income from financial applications, funding expenses, other revenues, and other operating expenses, operating result, and result of each period.

It is worth noting, furthermore, that CVM Orientation Opinion No. 14/87 regarding CVM INSTRUCTION NO. 64/87 suggests models of financial statements relating to the 1986 fiscal year and respective explanatory notes.

Signed originally by
HUGO ROCHA BRAGA
Superintendent of Accounting Standards

Signed originally by
MILTON FERREIRA DARAÚJO
Superintendent of Corporate Relations

APPROVED BY THE COLLEGIATE BODY IN A MEETING ON 28.12.87