Explanatory Note to CVM Instruction 191

Ref.: CVM Instruction No. 191, of July 15, 1992, which amends and consolidates CVM Instructions No. 64, of May 19, 1987, No. 138, of January 16, 1991, and No. 146, of June 13, 1991, establishes the Accounting Monetary Unit, provides procedures for the preparation and disclosure of financial statements in constant purchasing power currency, for full compliance with Fundamental Accounting Principles, and takes other measures.

INTRODUCTION

Although considerable advances resulted from CVM Instruction No. 64, of May 19, 1987, and its subsequent amendments (especially CVM Instructions No. 138, of January 16, 1991, and No. 146, of June 13, 1991), the disclosure of information with higher quality and clarity by open companies, through the preparation of supplementary financial statements in constant purchasing power currency, had not yet achieved full compliance with Fundamental Accounting Principles, according to the definitions contained in the Technical Pronouncement of IBRACON, approved by CVM Deliberation No. 29, of February 5, 1986.

For this purpose, the Instruction currently being commented on sought to eliminate the main limitations presented by the aforementioned instructions, derived from the operational difficulties of implementing and understanding a system, initially quite complex.

As time passed, those difficulties dissipated, and today we find a more favorable environment to implement the changes being introduced.

THE CREATION OF THE ACCOUNTING MONETARY UNIT

The fixation of the indexer to be used in the preparation of financial statements in constant purchasing power currency has been a matter of great concern, both for this Commission and for the entities representing the agents of the Brazilian capital market.

Historically, this indexer has been identical to that established by fiscal legislation and used in the monetary updating of financial statements prepared in the corporate form. The determination of these indices, however, met, on several occasions, solely and exclusively the needs and requirements of fiscal and monetary policy.

As a consequence, it was perceived that it was essential to create a monetary standard exclusive for the preparation of financial statements of open companies, given their peculiar characteristics of transparency and publicity.

Thus, this Commission is establishing, through the Instruction currently being commented on, the Accounting Monetary Unit - U.M.C. - as the reference unit to be used by open companies for the preparation of financial statements in constant purchasing power currency, which will represent a guarantee of the quality of information offered to investors.

Aware of the substantial costs that would be involved in the immediate implementation of duplicate records—one for the preparation of financial statements in the corporate form, and another for financial statements in constant purchasing power currency—this Commission determined the identification of the monetary expression of the UMC with the monetary expression of the Daily Fiscal Reference Unit - Daily UFIR -, after concluding on its representativeness regarding the loss of purchasing power of the national currency.

THE NEW DESIGNATION: FINANCIAL STATEMENTS IN CONSTANT PURCHASING POWER CURRENCY

The old designation: “supplementary financial statements, in constant purchasing power currency” was changed to “financial statements in constant purchasing power currency.”

This Agency sought, with this, to emphasize the fact that these statements, being prepared in total conformity with Fundamental Accounting Principles, and being presented in a single monetary standard, provide a more adequate presentation of the company's financial and equity situation, greatly facilitating the evaluation of results and equities.

Accordingly, these statements must be taken by capital market analysts as the primary financial statements of an open company.

It is worth noting that the same determinations and recommendations apply to consolidated financial statements in constant purchasing power currency.

POSSIBILITIES OF USING THE UMC

In view of the high inflation rates verified in the country and its identification with the monetary expression of UFIR - Daily, the monetary expression of the UMC must be modified daily. Thus, this Commission understands that recording all transactions at the value of the UMC on the day of its occurrence is the accounting procedure that provides the most adequate presentation of the economic-financial flow in the financial statements in constant purchasing power currency of open companies.

However, serious operational problems, mainly derived from the currently available computer systems, could arise from the use of the daily UMC for all transactions, which would be extremely detrimental to open companies. Thus, they may also use a mixed criterion of daily UMC with monthly average UMC.

It should be noted that open companies opting for the use of this mixed criterion must make the necessary adjustments so that gains and losses generated by monetary items of relevant value are appropriately appropriated, especially when these originate from acquisitions made on a date distant from the 15 (fifteenth) of each month, in order not to prejudice the quality of the information.

If the variation periodicity of the UMC value changes, becoming monthly, due to a consistent decrease in inflation indices, it might be possible for this Commission to accept that all transactions begin to be recorded at the monthly average value of that index. The use of the monthly variation of the UMC value would only be recommended in cases of extremely low inflation indices.

THE PRESENT VALUE ADJUSTMENT OF CREDITS AND OBLIGATIONS

DEFINITION OF PRESENT VALUE ADJUSTMENT

The most correct methodology to know the value of a certain amount of resources over time is its capitalization at a certain interest rate, so that it refers to a future date, or its discount, at the same rate, to place it at present value. Thus, for pre-fixed values, represented by payments or receipts to be made on future dates, their respective present values, on the dates of origin of the transactions, must be calculated by applying an interest rate.

The “pre-fixed operations” carried out by open companies, i.e., transactions generating rights and obligations payable or receivable in currency, on a future date and in previously determined amounts, must be translated to present value, from the origin of the transaction.

The present value adjustment is determined by the average pre-fixed interest rate of the ANBID in effect at the time of the transaction, in order to give reliability to the values calculated for assets and liabilities and to reach all operations and not only those that have a balance sheet balance on the date of its closing.

It follows, thus, that the determining factor of the present value adjustment of credits and obligations is not the elimination of the presence of an expectation of future yield or charge embedded in monetary assets and liabilities, but rather the need to obtain values representative of the time of the operation.

The present value adjustment should not be confused with any other adjustments made to equity elements to translate them to their realization value, since that method does not seek to know the amount necessary to settle the operation performed on a certain date, but rather to eliminate value increases due to an operation with a pre-fixed value for settlement on a future date.

In the concept of pre-fixed value, for the purpose of the present value adjustment, it is important to note that values which, although fixed and subject to settlement on a future date, are recognized as classic cases of pure monetary items, such as advances to employees and dividends to be paid, which suffer inflationary erosion over time, and for whose loss or gain there is no anticipation, i.e., discount, are not included.

The main characteristic of the items referred to in the previous paragraph is that they are not formed in counterpart to revenues, expenses, or non-monetary assets and are already recorded in the currency of purchasing power of the date of the transaction. However, there are exceptions, such as amounts determined by negotiations different from those usually carried out for the purchase and sale of goods and services, and which are normally accepted as cash or present values, and therefore are also not subject to discounts, such as wages payable.

It should be noted that credits and obligations subject to post-fixed variations, having their values periodically updated, will always be recorded at the value of the currency on the date of disclosure of the financial statements.

Given the stipulation of the relevance convention, present value adjustments of credits and obligations, including those resulting from the acquisition or formation of non-monetary items, which result in an irrelevant amount, may not be performed.

THE INTEREST RATE OF THE PRESENT VALUE ADJUSTMENT

This Commission is determining that the interest rate to be used to quantify the present value adjustment of credits and obligations, resulting from pre-fixed operations, carried out by open companies, shall be the average nominal pre-fixed interest rate published daily by the National Association of Investment Banks - ANBID.

The use of this rate arises from the fact that its values are widely disseminated in the market and the need for homogenization of accounting procedures adopted by open companies, enabling more consistent sectoral economic-financial evaluations.

The use of the interest rate actually practiced in the transaction will only be applicable to pre-fixed financial operations involving financial institutions, when the effect of applying the actually contracted rate, on the period's result, does not present a relevant difference compared to the result obtained by applying the average pre-fixed rate of ANBID, observing the assumptions of the conservatism convention.

THE QUANTIFICATION OF THE PRESENT VALUE ADJUSTMENT

The average pre-fixed rate of ANBID must be applied to credits and obligations resulting from pre-fixed operations, to quantify their respective present value adjustments, based on an exponential “pro rata die”, from the date of origin of each transaction.

Exemplifying, to quantify the present value of an obligation or credit (PV), suppose:

1. Value of obligation assumed or credit granted (VOC):
   $ 10,000,000.00;
2. ANBID rate in effect on the date of the transaction (TXV): 1834.28% p.a., equivalent to 28.00% p.m.; and
3. Payment or receipt term (PPR): 40 (forty) days.

Transforming the monthly TXV rate into the daily TXV rate, we obtain:
TXVD = (1+ TXVM/100)^(1/30) =
TXVD = 0.8263 p.d.

Thus, since PV = VOC / (1+ TXVD/100)^PP, we have:
PV = $ 10,000,000.00 =
1.008263^40
PV = $ 7,195,264.92

For disclosure purposes, the value of credits and obligations must be presented net of their respective present value adjustments, and a contra account for the value of the obligation assumed or credit granted may be used.

However, this Commission, given the operational difficulties for implementing this system, is providing the possibility that the calculation of the present value adjustment may be performed differently, provided it is applied to all operations, including those that do not have an asset or liability balance at the end of each month, and that the difference relative to that methodology is not relevant.

Accordingly, open companies may adapt their computerized billing control systems and others so that, at the end of each month, based on weekly or even biweekly average movements, synthetic reports containing the information necessary for the correct appropriation of present value adjustments and their respective reversals are prepared.

APPROPRIATION OF THE PRESENT VALUE ADJUSTMENT.

The present value adjustments of credits and obligations and the inflationary losses and gains generated by them must be appropriated to the accounts to which they are linked, in order to provide disclosure in the income statement in constant purchasing power currency, of the real revenues generated and expenses incurred.

Consequently, the present value adjustments of credits will rectify the values of the respective revenues generated; the present value adjustments of obligations will rectify the values of the respective assets and expenses incurred.

A new concept, however, is being introduced: the reversals of present value adjustments are now appropriated as nominal financial revenues or expenses, rectified by the inflationary losses or gains generated by the corresponding credits and obligations, for their presentation in constant purchasing power currency.

Thus, adding the following information to the example in the previous topic:

1. Transaction date (DT): 10 (ten)th day; and
2. Variation verified in the purchasing power of the national currency, in the period between the transaction date and the end of the transaction month (VPCM): 16%,

We have:
A) On the transaction date:
CIRCULATING LIABILITY.............................$ 7,195,264.92 ACCOUNTS PAYABLE....................................$ 10,000,000.00 (-) PRESENT VALUE ADJUSTMENT..................$ 2,804,735.08

B) At the end of the transaction month:
Given that Gain or Loss Inflationary with Obligations or Credits (GPOC) = VOC X (VPCM/100):

GPOC= $ 7,195,264.92 X (16/100)= $ 1,151,242.39; and Given that PV, at the end of the month, will be:
PV = 10,000,000.00 / 1.008263^20
PV = $ 8,482,490.75

We have:
CIRCULATING LIABILITY......................................................... $ 8,482,490.75 ACCOUNTS PAYABLE.................................$10,000,000.00 (-) PRESENT VALUE ADJUSTMENT .............$ 1,517,509.25 REAL FINANCIAL EXPENSES............... $ 135,983.44 COMMERCIAL FIN. EXPENSES..................... $ 1,287,225.83 (-) INFLATION GAIN ON OBLIG.................. $. 1,151,242.39

Observation: the value appropriated as commercial financial expenses was obtained by the difference between the balance of the contra account for accounts payable (present value adjustment) on the transaction date and at the end of the month.

The commercial financial expenses or revenues, registered according to the previous example, must appear as a specific item of expenses or financial revenues, given their distinct nature from traditional financial expenses and revenues (charges or yields resulting from operations carried out with financial institutions), and their disclosure will be required in the income statement, whenever their values are relevant.

Given the rectification of nominal financial revenues or expenses by the inflationary losses or gains linked to the monetary items that generated them, in the disclosure of the income statements in constant purchasing power currency, their respective values may be presented with negative net balances.

The application of these procedures for the appropriation of present value adjustment will imply the recognition of an effective tax rate actually higher than that recorded in the tax document proving the sale, since taxes levied on the sale of goods and services must be confronted with their respective amounts of revenues earned, net of present value adjustments of originating credits.

ADAPTATION PERIOD

Considering the importance of open companies having an adaptation period, the possibility was created to begin, only from January 1993, the quantification of the present value adjustment on all transactions and the appropriation of the reversals of this adjustment in the manner stipulated in the previous topic, without the need to reprepare financial statements relating to the previous fiscal year.

Thus, for financial statements relating to the 1992 fiscal year, the present value adjustment may be calculated only on the balance of credits and obligations existing at the end of each month, and their reversals may be appropriated to the accounts with which they are identified.

At this point, it should be noted that this Commission understands that the immediate implementation of these new accounting practices, as well as the measurement of their effects on the financial statements of previous fiscal years, through their reappraisal, will provide a more adequate evaluation of the economic-financial situation of open companies, and is highly recommended.

ITEMS MAINTAINED IN UMC

CONCEPT OF NON-MONETARY ITEM

Non-monetary items represent those equity elements whose object of evaluation appears in the form of tangible or intangible assets, rights, and obligations representing ownership and/or future receipt or delivery of goods or services; they are the elements that make up the non-financial capital of a company.

The values representing these elements are not subject to corrosion caused by inflation, not resulting in any inflationary loss or gain in the maintenance of the Society's Equity.

Otherwise, although they cannot be considered non-monetary items, since they may or must be settled in currency, certain equity elements must, by force of specific fiscal legislation determination or due to their peculiar characteristics, be controlled as non-monetary items. Examples of these elements are mutual contracts entered into between related parties, advances for future capital increases, and active and passive provisions.

THE CONTROL IN QUANTITIES OF UMC.

For the above reasons, non-monetary items, as well as other equity elements equated to them, must have their values determined in quantities of UMC, by using the value of this monetary standard on the date of their formation or acquisition.

This procedure aims to maintain the value of these elements against the variation of the purchasing power of the currency, guaranteeing their adequate evaluation, in addition to facilitating the preparation of financial statements in constant purchasing power currency.

Especially regarding provisions for taxes and contributions levied on profit and provisions for labor charges (provisions for vacation, premium leave, 13th salary, and their additional charges), there will be an equitable distribution of the respective costs throughout the fiscal year, not overloading the month or months in which salary adjustments are negotiated.

The application of this procedure, however, may imply, in certain circumstances, the making of adjustments so that the values representing non-monetary items adequately reflect the company's equity situation. Thus, when applicable, it will be necessary to make the provision for adjustment to market value, if this is lower than the cost obtained in UMC, and to reverse the provisions constituted, when these prove to be in a value higher than what will be effectively realized.

It should be noted that, observing the relevance convention, non-monetary items of irrelevant value may receive differentiated treatment, and it is not mandatory to maintain their values in quantities of UMC. As a result, the real value reduction of these items will be recognized in the income accounts with which they are identified.

LEGAL ASPECTS OF NON-DISCLOSURE OF FINANCIAL STATEMENTS IN CORPORATE FORM

In compliance with corporate legislation and CVM determinations, open companies are obliged to disclose their financial statements, according to the two distinct forms of preparation existing, namely in the corporate form and in constant purchasing power currency.

Aiming to facilitate such disclosure by these companies, while maintaining at the same time the transparency and accuracy of the information they provide, which will be paramount for the capital market investor, during the negotiations to be carried out by him, this Commission, through the Instruction currently being commented on, authorizes that the disclosure be made solely in constant purchasing power currency.

Analyzing the competence of this Agency to do so, in consonance with relevant legislation, as well as with the principles governing administrative activity, it becomes clear that the CVM must always seek the limits of its action in the law, being forbidden to impose duties and establish prohibitions, exceeding the limits of the norms that grant it competence to regulate and supervise the securities market, or other norms that govern the legal order.

Having established Law No. 6,404, of December 15, 1976, the system and objectives of accounting records to be carried out by legal entities constituted in the form of joint-stock companies, Article 185 of said law provides that these companies, in their financial statements, must consider the loss of purchasing power of the currency due to the inflationary process, which will be done through the monetary updating of their equity and the results of the fiscal year.

Monetary correction thus constitutes an accounting procedure aimed at eliminating distortions arising from inflationary effects in financial statements, thereby achieving the objectives of the law to confer the necessary transparency to visualize, with due accuracy, the real patrimonial and financial situation of companies.

It is evident, therefore, the importance of presenting accounting elements fully corrected, in order to allow a more adequate analysis of the published financial statements.

The monetary updating system adopted by Law No. 6,404/76 constitutes an accounting model that meets the requirements to confer greater reliability to recorded values only in circumstances involving low inflation rates; however, regarding our reality, where inflationary evolution is an indisputable fact, its adoption causes indelible distortions in financial statements, precisely because it fails to express in a single monetary standard the patrimonial modifications occurring in a given period.

The use of a monetary standard with constant purchasing capacity to record elements of equity, the fiscal year result obtained, as well as other statements, is the most adequate way to eliminate such distortions, insofar as, considering the real loss of purchasing power of the currency due to the inflationary process affecting patrimonial elements, it results in financial statements that better reflect the companies' situation, thereby achieving the legal objectives. It is, therefore, the most appropriate system to proceed with the analysis of the economic and financial position of companies in situations of high inflation.

Thus, there is no doubt that the disclosure of financial statements in currency of constant purchasing capacity is the means by which greater credibility is conferred to the information provided to the investing public, as they are more correct and secure; it is through them that important conclusions regarding the companies' equity and financial situation can be drawn, which would not be possible solely by disclosing the data required by corporate law.

The normative power, inherent in the exercise of the function conferred by law to the CVM, which is responsible for the regulation and supervision of the securities market, aiming at its full development, was granted to it in order to make it capable of issuing norms guiding and disciplining the actions of those within its scope of competence, as a means to achieve legal objectives.

Law No. 6,385, of December 7, 1976, establishes in its Article 4, items IV and VI, that the CVM, in fulfilling its duties, will have, among other purposes, the objective of “ensuring public access to information regarding securities traded and the companies that issued them.”

Aiming to achieve such purposes, the aforementioned law expressly granted it the competence to supervise “the dissemination of information related to the market, the persons participating in it, and the securities traded therein,” which it did in item III of its Article 8.

With the concern of creating an instrument capable of protecting the investor, “full disclosure” was adopted by the law as a true principle governing negotiations in the capital market, as it constitutes the means by which those who invest in it are provided with all information that may influence them in evaluating the risks and advantages presented to them, allowing them to choose among various investment options. It is through full disclosure that investor confidence in the full revelation of facts is maintained; it therefore has direct influence on the trading of shares, as the adequate information provided will depend on their market quotation.

As financial statements constitute the form of communication used to report the results obtained by the company to the market as a whole, as well as its social equity position and future prospects, it becomes clear that “full disclosure” depends on the values conveyed by them, arising from the inescapable need for their effective adequacy.

If this is the case, the preparation of financial statements in currency of constant purchasing capacity is the best means to achieve the legal objective of disclosing information necessary for investors' decision-making in the trading of securities, due to conferring greater transparency to the economic-financial situation of companies.

Its adoption, however, may alter the net equity and the fiscal year result obtained in accordance with Law No. 6,404/76, especially for companies that do not correct all their non-monetary patrimonial elements.

This Commission, exercising its competence to regulate financial statements, accounting standards, and information to be disclosed by open companies, in accordance with paragraph 3 of Article 177 of Law No. 6,404/76 and Article 22, items I and IV, of Law No. 6,385/76, issues the Instruction currently commented upon, authorizing them to disclose only their financial statements in currency of constant purchasing capacity.

Note, however, that such authorization is restricted to open companies whose net equity and fiscal year result are identical both under corporate legislation and under the constant purchasing power monetary standard; conversely, in cases where results are determined that, in their essence, are different, due to the diversity of accounting criteria applied, the same must continue to disclose under both formats, the values obtained.

It should be recalled that, by disclosing only financial statements in currency of constant purchasing capacity, certain explanatory notes gain greater importance, such as the one dealing with the calculation basis for dividend distribution, taking as a basis the values obtained from financial statements prepared in accordance with corporate law.

GENERAL CONSIDERATIONS

Whenever the company adopts the option to disclose only the set of financial statements in currency of constant purchasing capacity, the disclosure of accounts or values, in accordance with corporate law, must be carried out when so required by specific legislation or government control agencies.

The disclosure of financial statements in currency of constant purchasing capacity will not create or extinguish rights or obligations other than or additional to those provided for in corporate legislation.

Original signed by
ROBERTO FALDINI
President