CVM Orienting Opinion 37

ORIENTING OPINION NO. 37, OF SEPTEMBER 22, 2011.

Reception of the concepts of true and fair view and of the primacy of substance over form in the Brazilian accounting framework.

The accounting framework introduced with the enactment of Law No. 11,638, of December 28, 2007, incorporated several innovations into Brazilian accounting with the aim of producing financial statements more useful to investors and other external users in their resource allocation processes. This new framework, resulting from the adoption of International Financial Reporting Standards (IFRS), aims to improve the information infrastructure of the national capital market, thereby reducing asymmetries.

Many concepts brought by IFRS are not necessarily new to Brazilian accounting doctrine, but they certainly bring novelty to the professional practice of many accountants and to the accounting environment of companies. In this context, a cultural paradigm long present in our economic-financial environment is being broken, according to which economic events were interpreted and, consequently, recorded and measured predominantly according to their legal form.

Two interrelated concepts are essential for understanding this new accounting reality: (i) true and fair view; and (ii) the primacy of substance over form. Accounting will only fulfill its essential function of providing useful information to the decision-making process of its users if it truly reflects the underlying economic reality. For this appropriate representation (true and fair view) to be achieved, it is important to observe the primacy of economic substance over the legal form of economic events.

Thus, with the change initiated with the issuance of Law 11,638, of 2007, the fundamental characteristic of accounting statements is rescued: they must faithfully represent the reality of the economic effects of transactions, regardless of their legal treatment.

In this sense, the Basic Conceptual Pronouncement of the Accounting Pronouncements Committee (CPC), approved by CVM Resolution No. 539, of March 14, 2008, establishes:

“33. For information to be reliable, it must represent adequately the transactions and other events that it purports to represent. Thus, for example, the balance sheet at a given date must represent adequately the transactions and other events that result in assets, liabilities, and equity of the entity and that meet the recognition criteria.
(...)
35. For information to represent adequately the transactions and other events that it purports to represent, it is necessary that these transactions and events be accounted for and presented in accordance with their substance and economic reality, and not merely their legal form. The essence of transactions or other events is not always consistent with what appears to be based on their legal form or artificially produced. For example, an entity may sell an asset to a third party in such a way that the documentation indicates the legal transfer of ownership to that third party; however, there may be agreements that ensure that the entity

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will continue to enjoy the future economic benefits generated by the asset and will repurchase it after a certain period for an amount that approximates the original sale value plus market interest during that period. Under such circumstances, reporting the sale would not adequately represent the formalized transaction.”

The reform of the basic conceptual structure of accounting recently carried out by the International Accounting Standards Board (IASB), which resulted in the Pronouncement on the Conceptual Framework for Financial Reporting, in the process of introduction to the Brazilian framework by the CPC and CVM, does not alter this scenario in any way, despite the apparent omission of the expression “substance over form,” as clarified in the Basis for Conclusions Section BC3.26:

“BC3.26 Substance over form is not considered a separate component of faithful representation because it would be redundant. Faithful representation means that financial information represents the substance of an economic phenomenon rather than merely representing its legal form. Representing a legal form that differs from the economic substance of the underlying economic phenomenon could not result in a faithful representation.”1

As can be seen, although there is no express citation of the principle of substance over form, its foundations are elevated to a higher level; that is, the principle permeates the entire process of recognition, measurement, and disclosure of accounting information.

Thus, accounting rules should not serve as a “shield” that prevents the true and fair representation of economic transactions. In the rare cases where the application of some standard (in whole or in part) conflicts with the adequate representation of economic reality, the latter must prevail, as provided in Technical Pronouncement CPC 26 Presentation of Financial Statements – approved by CVM Resolution No. 595, of September 15, 2009:

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

20. When the entity does not apply a requirement of a Pronouncement, Interpretation, or Guideline, in accordance with item 19, it must disclose:
    (a) that management has concluded that the financial statements present fairly the financial position, financial performance, and cash flows of the entity; 1 In free translation:
    “Substance over form is not considered a separate component of faithful representation because it would be redundant. Faithful representation means that financial information represents the substance of an economic phenomenon instead of merely representing its legal form. Representing a legal form that differs from the economic substance of the underlying phenomenon cannot result in faithful representation.”

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(b) that it has applied the applicable Pronouncements, Interpretations, and Guidelines, except for the non-application of a specific requirement for the purpose of obtaining adequate representation; (c) the title of the Pronouncement, Interpretation, or Guideline that the entity did not apply, the nature of this exception, including the treatment that the Pronouncement, Interpretation, or Guideline would require, the reason why this treatment would be inadequate and would conflict with the objective of financial statements established in the Conceptual Framework for the Preparation and Presentation of Financial Statements, and the treatment actually adopted; and (d) for each period presented, the financial impact of the non-application of the Pronouncement, Interpretation, or Guideline in effect in each item in the financial statements that would have been reported if the unapplied requirement had been complied with.”

It is observed that, in the cited items, the accounting regulator expressly recognizes that accounting standards must be subordinate to the principles of true and fair view and the primacy of substance over form. That is, not only must economic effects prevail over form, regardless of legal treatment, but it is imperative in the new accounting framework that the representation of economic reality be true and appropriate. So imperative that, even in the case of conflict with issued standards, the predominance must be of adequate representation. These are the central pillars of this new framework.

This command is fully consistent with the provisions of Law No. 6,404, of December 15, 1976, which establishes in its article 176:

“Art. 176. At the end of each fiscal year, the board of directors shall prepare, based on the company’s commercial bookkeeping, the following financial statements, which must clearly express the company’s equity situation and the changes that occurred during the year:” (emphasis added)

The primacy of substance over form as a central element in the process of preparing financial statements that truly and appropriately represent economic reality applies to the entire accounting process, in the entirety of the subjects covered by the standards. In the context of the capital market, the issue of classifying financial instruments as liabilities or equity instruments in the representation of the economic reality of publicly held companies stands out, among others.

In this topic, special attention must be given to the essence of these instruments vis-à-vis the extremely undesirable consequences that inadequate accounting can generate for investors, creditors, and other interested parties in the performance of companies.

Thus, for example, the contractual obligation to deliver cash or another financial asset or to exchange financial assets or financial liabilities with another entity under potentially unfavorable conditions, essential for classifying a financial instrument as a liability, must be analyzed taking into account the essence of the instrument and the type of obligation it effectively creates for the issuing entity. Similarly, the unconditional right to avoid delivering cash or another financial asset to settle a contractual obligation must be analyzed under the primacy of substance over form. This is because, if such right does not exist, the obligation will meet the definition of a financial liability.

For the reasons stated above, those involved in the preparation and audit of financial statements must base their interpretations of economic events on full adherence to the primacy of substance over form so that accounting statements truly and appropriately represent the economic reality of the transactions accounted for.

Approved by the Collegiate Board in a meeting on September 20, 2011.

Original signed by
MARIA HELENA DOS SANTOS FERNANDES DE SANTANA
President