Brazil: The Adoption Of The True And Fair View And Substance Over Form Concepts In Brazil

On September 20, 2011, the Board of the Brazilian Securities and Exchange Commission (Comissão de Valores Mobiliários - CVM) decided to adopt the concepts of true and fair view or faithful representation (representação verdadeira e apropriada) and substance over form (primazia da essência sobre a forma) in the Brazilian accounting system. This decision was announced by means of CVM Opinion (Parecer de Orientação) No. 37, of September 22, 2011, and the arguments raised therein are outlined below.

According to CVM, the new accounting system brought from the enactment of Law No. 11638 of December 28, 2007 incorporated several innovations to Brazilian accounting in order to produce financial statements more useful to investors and other external users in their processes of resource allocation. This new system resulting from the adoption of international accounting standards (IFRS) aims to improve the informational infrastructure of the domestic capital markets, reducing asymmetries.

Many concepts brought by IFRS are not necessarily novel doctrine to Brazilian accounting but they are certainly new to the practice of many professional accountants and to the accounting environment of the Brazilian companies. This is an important change in a cultural paradigm that is very present in the Brazilian economic and financial environment under which economic events were interpreted and, consequently, recorded and measured mainly according to their legal form.

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

Thus, the change began with the enactment of Law 11638/2007 and rescues the fundamental characteristic of the financial statements, which should accurately represent the reality of the economic effects of transactions, regardless of their legal treatment.

The principle of "substance over form" permeates the whole process of recognition, measurement and disclosure of accounting information. Thus, the accounting rules should not serve as a shield that prevents the true and fair representation of the economic transactions. In the rare cases where the application of a certain rule conflicts full or partially with the proper representation of the economic reality, the latter shall prevail.

Therefore, the accounting rules should be subordinated to the principles of "true and fair view" and "substance over form". That is, not only the economic effects should prevail over form, regardless of the legal treatment as it is imperative that the representation of economic reality is true and appropriate. Even in case of conflict with the issued accounting rules, the faithful representation will be predominant.

The primacy of substance over form as a central element of the process of preparing financial statements that represent fairly the true economic reality applies to the entire accounting process in all subjects covered by the accounting rules. In the context of the Brazilian capital markets stands out among others the issue of classification of financial instruments as liabilities or equity instruments of economic reality in the representation of publicly-held corporations. In this topic, special attention should be given to the essence of these instruments vis-à-vis the extremely undesirable consequences that can lead to improper accounting for investors, creditors and others interested parties in the performance of companies.

CVM is particularly concerned with the accounting of debt and equity hybrid instruments in the companies´ balance sheets. Debt and equity are focal points of the capital market and mistakes in their representation can be disastrous for investors. An accounting rule cannot be used to mask the true nature of a transaction.

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 the classification of a financial instrument as a liability, should be analyzed taking into account the essence of the instrument and the type of obligation that it creates, in effect, to the issuer. Likewise, it is under the primacy of the essence in the form that must be considered an unconditional right to avoid delivering cash or another financial asset to settle a contractual obligation. This is because, subsisting such right, the obligation meet the definition of financial liability.

Based on the foregoing, CVM concluded that those involved in the process of preparing and auditing financial statements should guide their interpretations of economic events based on the primacy of substance over form so that the financial statements represent a true and fair view of the economic reality of the recorded transactions.


1. In this sense the Standard Basic Concept of the Brazilian Accounting Pronouncements Committee (Comitê de Pronunciamentos Contábeis - CPC), approved by CVM Deliberation No. 539 of March 14, 2008 establishes that:

"33. To be reliable, an information must represent faithfully the transactions and other events that it claims to represent. For example, the balance sheet at a given date should represent faithfully the transactions and other events that result in assets, liabilities and equity the entity and that meet the criteria for recognition.


35. For the information to represent faithfully the transactions and other events that it purports to represent, it is necessary that transactions and events are accounted for and presented in accordance with their substance and economic reality, not merely their legal form. The essence of the transactions or other events is not always consistent with what appears to be based on their legal form or artificially produced form. For example, an entity may sell an asset to a third party in such a way that the documentation indicate the legal transfer of ownership to that third party, however, there may be agreements to ensure that the entity will continue to enjoy the future economic benefits generated by the asset and will be entitled to repurchase the same asset after a certain time by an amount that approximates the original value of sales plus interest at market rates during this period. In such circumstances, reporting the sale does not represent properly the formalized transaction."

2. CVM pointed out that the reform of the basic conceptual framework of accounting held recently by the International Accounting Standards Board (IASB) which resulted in the Pronouncement on the Conceptual Framework for Financial Reporting and is now in the process of being introduced in the Brazilian accounting system by CPC and CVM, does not alter this scenario, despite the apparent omission of the phrase "substance over form" as explained in item BC3.26 of the Section "Basis for Conclusion": "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."

3. In this sense the Technical Pronouncement CPC 26 (Presentation of Financial Statements), approved by CVM Deliberation No. 595 of December 15, 2009, states that:

"19. In extremely rare circumstances in which the administration comes to the conclusion that compliance with a requirement of Pronouncement, Interpretation or Guidance would lead to a misleading presentation as it would conflict with the objective of financial statements set out in the Framework for the Preparation and Presentation of Financial Statements, the entity shall not follow this requirement and will apply the provisions of item 20, unless this procedure is strictly forbidden from a legal and regulatory standpoint.

20. When the entity does not apply a requirement of Pronouncement, Interpretation or Guidance, in accordance with item 19, must disclose:

(a) that management has concluded that the financial statements present fairly the financial position and assets, performance and cash flows of the entity;

(b) that applied the applicable Pronouncements, Interpretations and Guidelines, except for non-application of a specific requirement in order to obtain adequate representation;

(c) the title of the Pronouncement, Interpretation or Guidance that the entity has not applied, the nature of this exception, including the treatment that the Pronouncement, Interpretation or Guidance would require, the reason why that treatment would be inappropriate and in conflict with the objective of financial statements set out in the Framework for the Preparation and Presentation of Financial Statements and the treatment actually adopted, and

(d) for each period presented, the financial impact of not applying the Pronouncement, Interpretation or Guidance in force for each item in the financial statements that would have been informed if the not applied requirement has been fulfilled."

4. The preamble of article 176 of Law No. 6.404, of December 15, 1976 (the Brazilian Corporation Law) expressly establishes that, at the end of each fiscal year, the company, based on its entry files, shall prepare the following financial statements, which shall clearly indicate its assets and liabilities as well as the changes which occurred during the fiscal year: (i) balance sheet; (ii) statement of retained earnings; (iii) statement of income; and (iv) statement of changes in financial position.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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Walter Stuber
Adriana Maria Gödel Stuber
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