CVM Orienting Opinion 18

SUMMARY: Procedures to be observed by publicly held companies and independent auditors in the preparation and publication of the financial statements, management report, and audit opinion relating to fiscal years ending from December 1989 onwards.

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 report, and audit opinion.

The work of monitoring the financial statements of previous fiscal years has revealed an improvement in the quality and quantity of information provided, attesting to the effectiveness of previous guidelines: CVM/PTE Circular Letters 578/85 and 309/86 and Orienting Opinions No. 15/87 and 17/89.

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
   It must be based on the values of the supplementary financial statements in currency of constant purchasing power and observe the breadth of information recommended in Orienting Opinions 15/87 and 17/89.

3. EXPLANATORY NOTES
   In previous guidelines, various situations that should be subject to explanatory notes were mentioned, and, where applicable, they must continue to be observed. Some items, however, must receive more careful treatment in the current fiscal year, namely:

a) Transactions between related parties (CVM Resolution No. 26/86).

• The explanatory note on transactions between related parties must characterize the transactions that occurred, the conditions under which these transactions took place (especially prices, terms, charges, quality, etc., and whether the transaction was carried out under conditions similar to those that would apply between unrelated parties) and the present and future effects on the financial situation and/or results of the company;

b) Allocation of the fiscal year's result:

• An explanatory note must be presented regarding the proposal of the management bodies for the allocation of the fiscal year's result. In this regard, four points stand out:

I - Retention of profits - The justifications and the main lines of the respective capital budget must be made explicit. Profits not allocated, even if kept in Accumulated Profits, are characterized as Retention of Profits (Article 196 of LAW No. 6.404/76).

II - Reserves of profits to be realized - This reserve was introduced into corporate law so that the mandatory dividend can be fixed as a percentage of the fiscal year's profit without risk of creating financial problems for the company, according to section II of chapter XVI of the Statement of Reasons No. 196, of 24.06.76, from the Minister of Finance, forwarding the Bill of S.A. Therefore, if there is no such risk, the reserve should not be constituted.

The calculation of the constituted reserve must be demonstrated, it being worth remembering that the Reserve of Profits to be Realized that may be constituted is the excess of profits to be realized over the reserves (Legal, Statutory, for Contingencies, and for Retention of Profits) constituted;

Reserves constituted in previous fiscal years and already realized must be reversed and included in the base for calculating the mandatory minimum dividend. The reversals must be made in proportion to the realization of the balance of monetary correction, dividends or profits received from affiliates and controlled companies, and profits from long-term sales realized in the period. For the purpose of the mandatory dividend on values realized in the period, the portion that should have been paid as a dividend at the time of the formation of the reserve, if it had not been constituted, plus the respective monetary correction, must be considered.

III - Dividend - The demonstration of the calculation of the proposed dividend must be presented, with its payment with monetary correction being recommended, according to CVM INSTRUCTION No. 72, of 30.11.87.

IV - Full allocation - It is the understanding of CVM that corporate law determines the full allocation of the fiscal year's result (Art. 192 of LAW No. 6.404/76). See CVM INSTRUCTION No. 59, of 22.12.86.

Deferred Assets - Inform their composition and amortization criteria.

Companies in the market for fiscal incentives and those in the pre-operational phase must provide information on this account to the greatest degree of detail possible and with general information about the progress of the project, the phase in which it is, and what is left to enter operation.

Such companies must make every effort to frame their accounting according to the standards applicable to publicly held companies.

4. GOLD INVESTMENTS
   Classifiable, among companies that do not have the commercialization or industrialization of gold as their corporate object, as Current Assets or Long-Term Receivables. This type of investment must be evaluated by the current acquisition cost updated monetarily by the Fiscal Treasury Bond (BTN) of the end of the period or by the market value, the lesser of the two, and, when applicable, a provision for adjustment to market value must be constituted.

Understood as:

• Acquisition cost: the price paid for the purchase of gold and stated in the document representing the transaction on the exchange or issued by a company authorized to trade the metal, plus brokerage, fees, and taxes actually due by the buyer;
• Market value: the weighted arithmetic average of the daily quotes, occurring during the exchange session of the country where the largest volume of trades occurred, on the day of the closing of the fiscal year or, if there is no session on that day, on the day of the last previous session.

5. PRESENTATION OF NUMBERS IN FS
   The financial statements of the fiscal year ending on 12/31/89 may be published in thousands or millions of new cruzados, depending on the magnitude of the numbers presented. Comparative financial statements may be presented only in full monetary correction, obeying the same form of presentation of corporate law.

6. DEFERRED ASSETS
   Regarding enterprises in the implementation phase, the provisions of item 06 of CVM Orienting Opinion No. 17, of 15.02.89, continue to prevail.

Regarding the amortization of deferred assets derived from expenses originating from product development, it must bear a relationship with the cycle of realization of these expenses.

Companies belonging to sectors whose products present a high degree of obsolescence, such as electronics and information technology, must adopt amortization rates consistent with the expected useful life, or the period for obtaining revenue from the developed products, and must therefore refrain from using, in linear terms, the maximum amortization periods legally admissible.

7. MONETARY UPDATE OF ASSETS (RIGHTS) AND LIABILITIES (OBLIGATIONS)

All rights and obligations, legally or contractually subject to monetary updates, must be recorded by their updated values on the balance sheet date, observing the "pro rata die" criterion.

In this update, the principle of fiscal year competence must be adequately considered for the recognition of revenues and corresponding costs and expenses, in order to enable the correct balancing of active and passive monetary updates.

Special consideration must be given to the symmetry that must exist in the update of indexed rights and obligations, taking into account the effects on the financial statements resulting from the adoption of the Fiscal Treasury Bond (BTN) for the monetary correction of the balance sheet (fixed assets, gold investments, real estate inventory, advances to suppliers of goods, and shareholders' equity).

The following indexed rights and obligations require special attention:

a) Indexed obligations based on the Treasury Bond corrected monthly.
These obligations, regardless of their monthly update, must be recorded with monetary correction "pro rata" between the date of their monthly maturity and the balance sheet date, based on the variation of the Fiscal BTN, in order to counterbalance their updates with the updates of assets (goods and rights), mainly in cases of fixed asset financing.

b) Obligations indexed based on the Capital Standard Unit.
Despite these obligations being updated quarterly, for the same reasons stated above, they must be recorded with monetary correction "pro rata".

c) Financial applications with monthly correction.
Certain financial applications have their earnings credited or paid monthly (post-fixed). In observance of the principles that guide the preparation of financial statements (fiscal year competence regime and the going concern assumption of the company's operations), the earnings of these applications, pre- or post-fixed, short or long term, must be recognized proportionally (pro rata temporis) on the balance sheet date.

d) Values used.
The values applicable to the balance sheet date are: the Fiscal BTN in force on 01/02/90 and the exchange rate in force on the last business day of the fiscal year.

8. PROVISIONS FOR LIABILITIES AND FORESEEN LOSSES WITH ASSETS
   All obligations known on the balance sheet date must be recorded under the competence regime. Those whose values cannot yet be determined with precision must be recorded by their estimated values based on the objective information then available. Examples of provisioned obligations include: labor charges, financial charges, federal and state income tax, and contingencies.

Similarly, foreseeable losses with assets must be estimated on the balance sheet date based on the objective information then available and provisioned under the competence regime. Examples of provisioned asset losses include: uncollectible accounts, market value of temporary investments and financial applications lower than book value, loss of a permanent nature in permanent corporate participations, obsolete inventory, and amortization of deferred items.

Regarding loans to Brazilian Electric Power Companies S.A. and the shares of its capital, resulting from the conversion of the loans, the provisions of CVM RESOLUTION No. 70/89, of January 10, 1989, must be observed.

9. RETIREMENT AND PENSION PLANS
   Many companies maintain retirement and pension plans for their employees and dependents.

In the implementation of these plans, the sponsoring companies generally assume the obligation to contribute to the plan and, in the event of insufficient resources for its funding, guarantee the complementation of these resources.

The explanatory notes must contain information on the existence of the plan, the actuarial regime for determining the cost and contributions of the plan, the annual cost, the defined obligations accounted for, and the potential obligations, accounted for or not, and, when applicable, the reasons for non-accounting must be duly disclosed.

10. ADJUSTMENTS OF PREVIOUS FISCAL YEARS
    Adjustments of previous fiscal years are considered only those resulting from changes in accounting criteria or rectification of errors attributable to previous fiscal years, provided they cannot be attributed to subsequent events.

Adjustments relating to provisions that were subsequently altered after the balance sheet date due to a new assessment of involved risks or new facts or information that modify the original assessment do not qualify as adjustments of previous fiscal years. Thus, adjustments relating to the provision for uncollectible accounts, income tax provision, and others that, when constituted, were based on adequate criteria at the time, are integral parts of the result of the fiscal year in which they were identified.

Adjustments of previous fiscal years must be itemized in the statement of changes in shareholders' equity, with their nature and foundations presented in an explanatory note.

11. DEFERRAL OF RESULT FROM CONTRACTS WITH PUBLIC LAW LEGAL ENTITIES
    Current tax legislation allows the deferral of income tax and social contribution, until their realization, in the case of construction contracts or the supply, at a determined price, of goods and services, entered into with a public law entity, or companies under its control, public company, mixed-economy society, or its subsidiary.

Since corporate law requires the recognition of the result of transactions under the competence regime, regardless of their financial realization, the deferral of the result of the aforementioned contracts, in publicly held companies, must be observed in auxiliary records (§ 2 of art. 177 of Law 6.404/76). Furthermore, deferred income tax, including state tax, and social contribution must be duly provided for in the financial statements of publicly held companies.

12. WITHHOLDING INCOME TAX ON NET PROFIT
    Law 7.713, of December 22, 1988, partially amended by LAW No. 7.959, of December 21, 1989, and regulated by the Normative Instructions of the Federal Revenue Secretariat, No. 49 and 139, of 05/10/89 and 12/22/89, respectively, establishes in its articles No. 35 to 39, the withholding income tax of 8% (eight percent), calculated based on the net profit determined by legal entities on the date of closing of the base period and having as taxpayers: the partner-shareholder, the shareholder, or the holder of the individual company.

In the specific case of publicly held companies, the taxpayer will be the shareholder, beneficiary of the net profit of the fiscal year, determined in the manner of articles 187, 189, 190, and 191 of LAW 6.404, of December 15, 1976.

Given that the new system of withholding income tax generated some doubts regarding the best way to account for it, especially regarding the distribution of dividends, it becomes necessary to disclose, in an explanatory note, the criteria used by the company. If the publication of the financial statements occurs before the established time for identifying immune and exempt taxpayers, the disclosure of the respective information may be made subsequently in the first of the subsequent quarterly financial statements forwarded to CVM and stock exchanges, according to current regulations.

13. FULL MONETARY CORRECTION
    JANUARY AND JUNE/1989

January:
For the month of January, it is recommended that revenues and expenses be converted by the OTN of NCz$ 6.92 and then converted into BTN. It should be remembered that for statements with full correction, the tablita does not apply, and consequently, its effects will be within the gains or losses on monetary items. The other adjustments of the Summer Plan will be in their normal accounts of financial expenses, equity method, etc.

However, it is accepted that the revenues and expenses of the first part of the month are divided by NCz$ 6.17 and multiplied by 6.92, thus finding the respective quantity of BTNs. In this case, the month of January will correspond, for the purposes of full correction, to two distinct periods.

It should be noted that all movement of Fixed Assets and Shareholders' Equity carried out by the OTN of NCz$ 6.17 will be adjusted (gains or losses on monetary items) in companies that have opted to consider the movement of revenues and expenses by the OTN of NCz$ 6.92.

Exemplifying:
Assume that the company acquired fixed assets for cash for NCz$ 20,000.00 and recorded it by the quantity of OTNs at the base of NCz$ 6.17. In the calculation of losses on the monetary item, an adjustment relative to this acquisition must be made. The adjustment will be 351.3177 BTNs, that is, 20,000: 6.17 minus 20,000: 6.92, to be considered as a reduction of losses with the monetary item "cash".

June:
For the month of June, companies may use, for the conversion of revenues and expenses, the BTN of NCz$ 1.2966 or the Fiscal BTN of 06/30/89: NCz$ 1.5992.

Those companies that use the Fiscal BTN of 06/30/89 and have movement of Fixed Assets and Shareholders' Equity during this month must proceed with the adjustment in "Gains and Losses on Monetary Items" in the same way as in the previous example for the month of January, using here the BTNs in Gains of NCz$ 1.2966 and NCz$ 1.5992. The normal gains and losses will be calculated taking as a base the variation between the BTN of May and the Fiscal BTN of 06/30/89.

For companies that in the month of June used the conversion of revenues and expenses by the BTN of NCz$ 1.2966, even if they had movement in Fixed Assets and Shareholders' Equity, no special adjustment due to this movement will be necessary to be made in "Gains and Losses on Monetary Items". But the normal gains and losses of this month will be calculated as in the mixed criterion, as seen below, with the BTN of NCz$ 1.2966 functioning as if it were the average BTN of this month.

14. MIXED CRITERION:
    According to Instruction 101/89 and SEP Circular Letter No. 018/89, both from CVM, the supplementary statements could be prepared using the Fiscal BTN or the monthly average BTN.

Many companies expressed themselves regarding the use of the daily Fiscal BTN as being a complex way to prepare the supplementary statements.

Also, the control in average BTN of the movement of the Fixed Assets and Shareholders' Equity accounts would entail parallel controls to those already existing in Fiscal BTN.

In view of this, it was concluded that a mixed criterion, that is, the use of daily controls for the movement of Fixed Assets and Shareholders' Equity and the conversion of revenues and expenses by the monthly average BTN would be quite adequate and would certainly achieve the objectives of the supplementary statements.

On 12/04/89, CVM issued CVM Instruction No. 108, which added in item III of article 2, the option for this alternative.

With the adoption of this mixed criterion, the calculation of gains and losses on monetary items will be prepared in two stages, namely: the balance in new cruzados of the active monetary account at the end of the month of July, for example, will be converted into BTN of the last day of July and compared with the balance in new cruzados of the end of July transformed by the average BTN of August. The difference found will be a loss.

Subsequently, transform the balance in new cruzados of the end of August by the average BTN and by the final BTN of August, finding another loss. The sum of the two losses considered in the example is what will compose the total loss of the monetary asset in the month of August. The same procedure will be necessary for the computation of the cost of goods/products sold and other non-monetary items written off, provided that the assets to which they relate are not corrected in the supplementary accounting statements.

15. PRESENT VALUE ADJUSTMENT
    CVM INSTRUCTION No. 64/87 made such adjustment mandatory only for values that will mature in periods longer than 90 days. CVM Orienting Opinion No. 14, of 12/14/87, in its item 3, already observed that this 90-day period is very extended and therefore inadequate for the preparation of supplementary statements. Considering that P.O. 14 admitted that this was a matter of simplification and given the persistence of high inflation rates, the use of "pro rata" day discount is recommended, considering the number of effective days for the respective maturities, regardless of whether they are less than 90 days.

CVM Instruction No. 64 defined that the discount rate to be used would be equal to the arithmetic mean of the last three variations of the OTN before the closing of the fiscal year. Now, with CVM Instruction No. 108, this is no longer possible, giving two alternatives: either the rates effectively practiced by the company in its credit sales/purchases, or the rate relative to the variation between the Fiscal BTN of the last day of the previous month and the Fiscal BTN of the balance sheet day. The alternative adopted will be disclosed. There is no need for adjustment for the statements of the previous fiscal year due to this change in rate.

The third issue related to the Present Value Adjustment is treated in item No. 13.4 of this P.O. regarding the distribution of "Gains and Losses on Monetary Items".

16. ALLOCATION OF GAINS AND LOSSES ON MONETARY ITEMS AND PRESENT VALUE ADJUSTMENT
    Item No. 15 of CVM Orienting Opinion No. 14/87 addressed the issue of the distribution of gains and losses on monetary items.

At that time, for reasons of simplification, the gains and losses account was not distributed to specific items because few companies were adjusting payables and receivables to present value.

As today the practice of adjusting to present value is more used and imperative, it is now necessary that all these adjustments and the gains and losses on monetary items be distributed among the various components of the income accounts to which they refer. See examples in the Explanatory Note of CVM Instruction No. 108/89 itself.

The values presented in the 1989 income statement will be presented comparatively to the 1988 values. For the latter, when relevant, companies must perform the distribution and explain the modifications relative to the previous publication, through an explanatory note, mentioning the criteria for the distribution of these gains, losses, and adjustments.

17. ABNORMAL END-OF-MONTH BALANCES
    Many accounts may have at the end of the month values that are not representative of the average of the values that remained in the said account during the month.

For example: a company receives its revenues at sight and pays its suppliers at the end of the month. All values received during the month are applied in the financial market generating a nominal revenue and at the end of the month they are redeemed for payment to suppliers. This causes distortions in financial revenues that do not compensate the respective losses and in the gain on suppliers whose values are undervalued. In the explanatory notes, the criteria used must be informed. Adjustments would also be necessary in financial revenues relating to gains with suppliers.

There are cases of relevant revenues and expenses, concentrated on certain days of the month, whose treatment should be similar to that adopted for abnormal end-of-month balances.

18. ADJUSTMENT IN GAINS AND LOSSES ON MONETARY ITEMS
    Companies that opt for the mixed criterion, that is, the movement of Shareholders' Equity, Fixed Assets, and other non-monetary items by the Fiscal BTN and the other operations by the average BTN

monthly, entities must adjust gains and losses on monetary items. These adjustments will always be based on the effect on monetary items by comparing the movement on a specific date with the average monthly BTN.

Exemplifying:
If the acquisition of fixed assets for cash is converted by a fiscal BTN lower than the average monthly BTN, an adjustment must be made to the loss calculated on the initial monetary asset/liability, as this loss was calculated as if the initial balance remained without movement until the moment of the average monthly BTN. The difference in quantities in Fiscal BTN between the date of acquisition and the quantity in average BTN will indicate the difference to be adjusted in the loss of the specific monetary item. It is worth highlighting that if the acquisition is made on a date where the value of the Fiscal BTN is higher than that of the average monthly BTN, the adjustment must also be made, but with the opposite effect.

19. ACQUISITION OF LONG-TERM ASSETS
    For the most appropriate recording of long-term asset acquisitions, it is necessary to initially perform the present value adjustment and, subsequently, convert the adjusted value to the respective quantity of BTN.
    As the adjustment value (discount) is calculated based on inflation expectations, this value will rarely be exactly equal to the actually realized value. This difference (estimated versus actual) must be considered in the statement of the year's result as "Other Operating Revenues or Expenses", and must be highlighted in an explanatory note if it involves relevant values.

20. PRESENTATION OF NUMBERS IN FINANCIAL STATEMENTS
    The supplementary financial statements, by virtue of the provisions of CVM Instruction 64/87, must be presented in new cruzados as of the date of the end of the fiscal year, and the option provided for in item 5 of this Orientation Opinion may be used.
    For comparability purposes, the values of the financial statements of the previous year must also be presented in new cruzados as of the date of the end of the current fiscal year, after their conversion from OTN to BTN at a rate of NCz$ 6.92 OTN/BTN.

Signed Original by
ANTÔNIO LÚCIO DA SILVA
Acting Superintendent of Accounting Standards

Signed Original by
SULI DA GAMA FONTAINE
Superintendent of Corporate Relations

Approved by the Board on 18/01/90.
Signed Original by
MARTIN WIMMER
President