PRINCIPAL DIFFERENCES BETWEEN BRAZILIAN GAAP AND IFRS
We maintain our books and records in reais, the official currency of Brazil, and prepare our consolidated financial statements for regulatory purposes in accordance with the accounting practices adopted in Brazil applicable to institutions authorized to operate by the Central Bank("Brazilian GAAP"), which are based on:
- Brazilian Law No. 6,404/76, as amended by Law No. 8,021/90, Law No. 9,457/97, Law No. 10,303/01, Law No. 11,638/07 and Law No. 11,941/09 (the "Brazilian Corporations Law"); and
- the accounting standards established by the Standard Chart of Accounts for Financial Institutions (Plano Contábil das Instituições do Sistema Financeiro Nacional) ("COSIF"), the Central Bank and the CMN.
Law No. 11,638/07 and Law No. 11,941/09 amended the Brazilian Corporations Law and introduced the process of conversion of financial statements into International Financial Reporting Standards ("IFRS"). However, the Central Bank did not fully adopt, as part of the accounting practices applicable to financial institutions, the provisions of Law No. 11,638. Instead, pursuant to Central Bank Communication No. 14,259, financial institutions that meet certain criteria are required to prepare supplemental consolidated financial statements in accordance with IFRS as originally issued by IASB and that are effective as of December 31, 2011. We are not including in this Offering Memorandum our supplemental financial statements prepared in accordance with IFRS.
There are certain differences between the accounting practices adopted in Brazil applicable to institutions authorized to operate by the Central Bank and IFRS (which incorporates existing International Financial Reporting Standards, IAS, as well as IFRIC and SIC interpretations) which may be relevant to the financial information presented herein. This section makes no attempt to identify or quantify the impact of these differences, nor can we give you any assurances that all differences have been identified. The following is a summary of certain differences; however, this summary does not purport to be complete and should not be construed as exhaustive.
In reading this summary, prospective investors in the Notes should also have regard to the considerations:
- This summary includes differences between accounting practices adopted in Brazil applicable to institutions authorized to operate by the Central Bank and IFRS as of December 31, 2017. Differences resulting from changes in accounting standards that will become effective after Decemberd 31, 2017 have not been considered in this summary.
- Differences among accounting practices adopted in Brazil applicable to institutions authorized to operate by the Central Bank and IFRS resulting from future changes in accounting standards or from transactions or events that may occur in the future have not been taken into account in this summary and no attempt has been made to identify any future events, ongoing work and decisions of the regulatory bodies that promulgate accounting practices adopted in Brazil applicable to institutions authorized to operate by the Central Bank and IFRS that could affect future comparisons among accounting practices adopted in Brazil applicable to institutions authorized to operate by the Central Bank and IFRS. The current differences disclosed in this summary are not intended to be complete and are subject to, and qualified in their entirety by, reference to the respective pronouncements of Brazilian professional accounting bodies and those of the International Accounting Standards Board and the International Financial Reporting Interpretations Committee.
- As differences among accounting practices adopted in Brazil applicable to institutions authorized to operate by the Central Bank and IFRS may be significant to the financial position or results of operations of the Bank, prospective investors unfamiliar with accounting practices adopted in Brazil applicable to institutions authorized to operate by the Central Bank should consult their own professional advisors for an understanding of the differences between accounting practices adopted in Brazil applicable to institutions authorized to operate by the Central Bank and IFRS and how those differences might impact the financial information presented herein.
- Unlike IFRS, under accounting practices adopted in Brazil applicable to institutions authorized to operate by the Central Bank, there are no specific principles relating to certain matters such as business combinations and financial instruments.
This summary does not address differences related solely to the classification of amounts in the financial statements or footnote disclosures.
Foreign Currency Translation
Under accounting practices adopted in Brazil applicable to institutions authorized to operate by the Central Bank, the financial statements of subsidiaries operating in non-hyper inflationary currency environments are translated using the current exchange rate. Financial statements presented in hyper inflationary currency environments are generally adjusted for the effects of inflation prior to translation. Translation gains and losses are taken to the income statement until the year ended December 31, 2016. From January 1, 2017, the assets and liabilities are translated using the closing (year-end) rate. Amounts in the income statement are translated using the average rate for the accounting period and the difference for the end of period rate is reported in equity (under the caption "asset valuation adjustment").
Under IFRS, when translating financial statements into a different presentation currency (for example, for consolidation purposes), IFRS requires the assets and liabilities to be translated using the closing (year-end) rate. Amounts in the income statement are translated using the average rate for the accounting period if the exchange rates do not fluctuate significantly. Any translation differences are reported in equity (other comprehensive income).
Consolidation and Proportional Consolidation
Under accounting practices adopted in Brazil applicable to institutions authorized to operate by the Central Bank, financial statements should consolidate the following entities: (a) entities on which the company has voting rights that provides it with the ability to have the majority on the social decisions and to elect the majority of the members of the Board; (b) overseas branches; and (c) companies under common control or controlled by shareholders agreements irrespective of the participation in voting stock. Joint ventures, including investees in which the company exerts significant influence through its participation in a shareholders agreement in which such group controls the investee, could be accounted for under the proportional consolidation method.
Under IFRS, the condition for consolidation is to have control, which is defined as the parent’s ability to govern the financial and operating policies of an entity to obtain benefits. Control is generally presumed to exist when the parent owns, directly or indirectly through subsidiaries more than half of the voting power of the entity, and potential voting rights must be considered. Notion of "de facto control" also may be considered. The standard also requires the effects of all transactions that result in decreases in ownership interest in a subsidiary without a loss of control are accounted for as equity transactions in the consolidated entity (that is, no gain or loss is recognized). For transactions that result in a loss of control of a subsidiary or a group of assets, any retained noncontrolling investment in the former subsidiary or group of assets is re-measured to fair value on the date control is lost, with the gain or loss included in income along with any gain or loss on the ownership interest sold.
Under IFRS, joint control is the contractually agreed sharing of control over an economic activity, and exists only when the strategic financial and operating decisions regarding the activities require unanimous consent of the members of the joint venture. IFRS 11 does not permit the proportionate consolidation method of accounting for interests in jointly controlled entities. The fair value option is not available to investors (other than venture capital organizations, mutual funds, unit trusts, and similar entities) to account for their investments in jointly controlled entities.
Under IFRS, specific guidance, is provided with respect to the consolidation of SPEs. A SPE may be created to accomplish a narrow and well defined objective. Such a special purpose entity may take the form of a corporation, trust, partnership or unincorporated entity and are often created with legal arrangements that impose strict and sometimes permanent limits on the decision-making powers of their governing board, trustee or management.
The sponsor frequently transfers assets to the SPE, obtains rights to use assets held by the SPE or performs services for the SPE, while other parties may provide funding. An entity that engages in transactions with the SPE (frequently creator or sponsor) may in substance control the SPE.
SPEs shall be consolidated when the substance of the relationship between an entity and the SPE indicates that the SPE is controlled by that entity.
Beginning on January 1, 2013, IFRS 10 Consolidated Financial Statements ("IFRS 10") became effective and consolidated in one single guidance the consolidation principles. IFRS 10 establishes principles for the presentation and preparation of consolidated financial statements when an entity controls one or more other entities.
IFRS 10 defines the principle of control and establishes control as the basis for determining which entities are consolidated in the consolidated financial statements. An investor controls an investee when it is exposed, or has rights, to variable returns from its involvement with the investee and has the ability to affect those returns through its power over the investee; Thus, the principle of control sets out the following three elements of control: (a) power over the investee; (b) exposure, or rights, to variable returns from involvement with the investee; and (c) the ability to use power over the investee to affect the amount of the investor’s returns.
IFRS 10 also requires an investor to reassess whether it controls an investee if facts and circumstances indicate that there are changes to one or more of the three elements of control.
Unlike IFRS 10, under accounting practices adopted in Brazil applicable to institutions authorized to operate by the Central Bank, there are no exceptions related to the investment entity concept.
Business Combinations, Purchase Accounting and Goodwill
Under accounting practices adopted in Brazil applicable to institutions authorized to operate by the Central Bank, combinations are not specifically addressed by accounting pronouncements. Application of the purchase method is based on book values. Goodwill or negative goodwill recorded on the acquisition of a company is calculated as the difference between the cost of acquisition and the net book value. Goodwill is subsequently amortized to income over a period not to exceed 10 years. Negative goodwill may be recorded in income over a period consistent with the period over which the investee is expected to incur losses.
Under IFRS 3 (Revised), Business Combinations requires, among other things, that all business combinations, except those involving entities under common control be accounted for by a single method - the acquisition method.
Under IFRS 3 (Revised), the acquiring company records identifiable assets and liabilities acquired at their fair values. The shares issued in exchange for shares of other companies are accounted for at fair value based on the market price. All payments to purchase a business are to be recorded at fair value at the acquisition date, with contingent payments classified as debt subsequently re-measured through the income statement. There is a choice on an acquisition-by-acquisition basis to measure the non-controlling interest in the acquiree either at fair value or at the non-controlling interest’s proportionate share of the acquiree’s net assets. All acquisition-related costs should be expensed.
In addition, IFRS 3 (Revised) sets out more detailed guidelines as to the recognition of "intangible assets." Under IFRS 3 and IAS 38, "Goodwill and Other Intangible Assets," goodwill and other intangible assets with indefinite lives are no longer amortized. If assets other than cash are distributed as part of the purchase price, such assets should be valued at fair value.
Under IFRS 3 (Revised) negative goodwill will be recognized as a gain in the statement of operations. Finite lived intangible assets are generally amortized on a straight line basis over the estimated period benefited. The intangible asset related to client deposit and relationship portfolios is recorded and amortized over a period in which the asset is expected to contribute directly or indirectly to the future cash flows.
Accounting for Guarantees by a Guarantor
Under accounting practices adopted in Brazil applicable to institutions authorized to operate by the Central Bank, guarantees granted to third parties are recorded in memorandum accounts. When fees are charged for issuing guarantees, the fee is recognized in income over the period of the guarantee. When the guaranteed party has not honored its commitments and the guarantor should assume a liability, a credit is recognized against the guaranteed party representing the right to seek reimbursement for such party with recognition of the related allowance for losses when considered appropriate.
Under IFRS, certain financial guarantees may be accounted for as insurance contracts if certain conditions are met. Otherwise, the guidance in IAS 39 applies: (i) record guarantee contracts at fair value upon initial recognition and (ii) subsequent measurement of the higher of the amount of expenditure needed to settle the obligation (measured under IAS 37) and the amount initially recognized less cumulative amortization, when appropriate, under IAS 18.
Under accounting practices adopted in Brazil applicable to institutions authorized to operate by the Central Bank, securities are classified based on the investment strategy of the financial institution as either trading securities, available for sale or held to maturity and defines the recognition of the fair market value of such securities as the basis for its presentation in the financial statements, except in the case where the investment strategy is to hold the investment until maturity. Recognition of changes in fair market value for trading securities is in income, while for available for sale securities is directly in shareholders’ equity. The rules to account for securities are stated more generally and are less comprehensive than the standards to account for securities under IFRS.
Under IFRS, financial assets including debt and equity securities can be categorized and accounted for as follows:
financial assets at fair value through profit or loss including both financial assets held for trading and any financial assets designated within this category at their inception;
held to maturity investments held with a positive intent and ability to be held to maturity and are recorded at amortized cost. Equity securities cannot be classified as held to maturity investments;
loans and receivables that correspond to financial assets with fixed or determinable payments not quoted in an active market and are measured at amortized costs; and
available for sale financial assets including debt and equity securities designated as available for sale, except those equity securities classified as held for trading and those not covered in the above categories which are measured at fair value. Changes in fair value are recognized in equity and recognized in the statement of income when realized.
For example, under accounting practices adopted in Brazil, debentures (a commonly traded security in Brazil which represents a credit against the issuer to the owner in certain terms defined) must be registered in the securities group of the balance sheet. This is different from the IFRS classification. Under IFRS rules, due to the essence of the operation being a form of credit to the issuer, the buyer of the debenture (creditor) must register it as a loan to a third party and therefore perform impairment tests under IFRS rules.
Accounting Practices Adopted in Brazil do not have the concept of comprehensive income. Also, as under accounting practices adopted in Brazil applicable to institutions authorized to operate by the Central Bank, statutory reserves are required to appropriate 5% of the annual local currency earnings, after absorbing accumulated losses, to a legal reserve, which is restricted to distribution. The reserve may be used to increase capital or absorb losses, but may not be distributed as dividends. Any income remaining after the distribution of dividends on the statutory records and appropriations to statutory reserves is transferred to the reserve for future investments. Such reserve may be distributed in the form of dividends upon approval of the shareholders. There are no similar provisions for IFRS.
Under IFRS, a statement of recognized income and expenses can be presented including net income as well as other items of income and expense recognized directly in equity such as: (i) fair value gains (losses) on lands and buildings, intangible assets, available for sale investments and certain financial instruments, (ii) foreign exchange translation differences, (iii) the cumulative effect of a change in accounting policy, and (iv) change in fair value on certain financial instruments if designated as cash flow hedges or net investment hedges.
Financial Derivative Instruments
Under accounting practices adopted in Brazil applicable to institutions authorized to operate by the Central Bank, for periods from June 30, 2002, the accounting principles prescribed by the Brazilian Corporate Law specifically applicable to accounting and reporting for marketable and equity securities and derivative financial instruments have been amended by accounting practices established by the Central Bank for all financial institutions. According to the accounting principles established by the Central Bank, derivative financial instruments are classified based on management’s intention to use them for hedging or non-hedging purposes.
Transactions involving derivative financial instruments to meet customer needs or for own purposes that did not meet hedge accounting criteria established by the Central Bank and primary derivatives used to manage the overall exposures are accounted for at fair value with unrealized gains and losses recognized currently in earnings. Deliverable forward and foreign exchange contracts also have specific accounting procedures set by the Central Bank that differs from IFRS accounting. Under the accounting practices adopted in Brazil applicable to institutions authorized to operate by the Central Bank, these operations are registered gross, which means that the long and the short positions of the trade needs to be registered. Under IFRS, these are netted and presented only the gain or loss in the operation.
Derivative financial instruments designed for hedging or to modify characteristics of assets or liabilities and (i) highly correlated with respect to changes in fair value in relation to the fair value of the item being hedged, both at the inception date and over the life of the contract and (ii) effective at reducing the risk associated with the exposure being hedged, are classified as hedges as follows:
- Fair value hedge. The financial assets and liabilities and the related derivative financial instruments are accounted for at fair value and offsetting gains or losses recognized currently in earnings; and
- Cash flow hedge and net investment hedge. The effective hedge portion of the derivatives is accounted for at fair value and unrealized gains and losses recorded as a separate component of shareholders’ equity, net of applicable taxes. The non-effective hedge portion is recognized currently in earnings.
IAS 39 "Financial Instruments: Recognition and Measurement" requires that a company recognize all derivatives as either assets or liabilities in the statement of financial position and measures those instruments at fair value. The accounting for changes in the fair value of a derivative (that is, gains and losses) depends on the intended use of the derivative and the resulting designation. Derivatives that are not designated as part of a hedging relationship must be adjusted to fair value through income.
Certain robust conditions including specified documentation requirements must be met in order to designate a derivative as a hedge. If the derivative is a hedge, depending on the nature of the hedge, the effective portion of the hedge’s change in fair value is either: (i) offset against the change in fair value of the hedged asset, liability or firm commitment through income; or (ii) held in equity until the hedged item is recognized in income. The ineffective portion of a hedge’s change in fair value is immediately recognized in income.
Revaluation of Property, Plant and Equipment
Revaluations may be recorded under accounting practices adopted in Brazil applicable to institutions authorized to operate by the Central Bank providing certain formalities are complied with. The revaluation increment, normally net of deferred tax effects, is credited to a reserve account in shareholders’ equity. As from July 1, 1995 companies may opt to carry property, plant and equipment at cost, monetarily adjusted up to December 31, 1995, or at appraised values, in which case the revaluations must be performed at least every four years and should not result in an amount higher than the value expected to be recovered through future operations. Deferred taxes must be recognized, on revaluation increments as from July 1, 1995. Amortization of the asset revaluation increments are charged to income and an offsetting portion is relieved from the revaluation reserve in shareholders’ equity and transferred to retained earnings as the related assets are depreciated or upon disposal.
Under IFRS, companies may use either the historical cost or carry their property, plant and equipment ("PP&E") at revalued amounts (based on fair value) as the accounting basis. When the revaluation model is selected, revaluations should be made with sufficient regularity. If an item of PP&E is revalued, the entire class of PP&E to which the asset belongs is required to be revalued. All revalued assets, including land, are subject, at the effective income tax rate from the sale of the asset, to deferred income tax. Gains and losses from the sale or disposal of assets are recorded as operating expenses.
Loan Accounting and Disclosure
Under accounting practices adopted in Brazil applicable to institutions authorized to operate by the Central Bank, loans are generally carried at cost. Until March 31, 2000 when changes were introduced by the Central Bank, loans were classified as overdue or doubtful based on the extent to which they were secured and the length of time for which payments were in arrears. Specific minimum allowances were required based on whether they were unsecured or not and the time overdue. As from March 31, 2000, loans should be categorized in 9 categories and the minimum allowance is determined by applying specific percentages to the loans in each category.
Loans are classified in accordance with management’s judgment of the risk level, taking into account the economic situation, past experience and specific risks in relation to the transactions, the debtors and the guarantors, complying with the parameters established by CMN Resolution No. 2,682 of December 21, 1999, as amended, which requires periodic analysis of the portfolio and its classification, by risk level, in 9 categories between AA (minimum risk) and H (maximum risk - loss). The minimum allowance is determined by applying specific percentages to the loans in each category.
Income from credit operations overdue for more than 60 days, independent from their risk level, is only recognized as revenue when effectively received. Operations classified as level H remain in such classification for nine months, after which time the loan is charged against the existing allowance and remain controlled in memorandum accounts for five years, no longer appearing in the balance sheet.
At a minimum, renegotiated loans are maintained at the same level at which they were classified prior to renegotiation. Renegotiated credit operations, which had already been charged against the allowance for loan losses and were in memorandum accounts, are classified as level H and any eventual gains resulting from the renegotiation of loans previously charged off are recognized as revenue on a cash basis.
Under IFRS, according to IAS 39 "Financial Instruments: Recognition and Measurement," loans and receivables are defined as financial assets with fixed or determinable payments not quoted in an active market. Loans and receivables are measured at amortized cost.
If there is objective evidence that an impairment loss on loans and receivables investments has incurred, the amount of the loss is measured as the difference between the asset’s carrying amount and the present value of estimated future cash flows (excluding future credit losses that have not incurred) discounted at the financial asset’s original effective interest rate. The carrying amount of the asset is reduced through the use of an allowance account and the amount of the loss is recognized in the income statement.
The calculation of the present value of the estimated future cash flows of a collateralized financial asset reflects the cash flows that may result from foreclosure less costs for obtaining and selling the collateral, whether or not foreclosure is probable. For the purposes of a collective evaluation of impairment, financial assets are grouped on the basis of similar credit risk characteristics.
Under accounting practices adopted in Brazil applicable to institutions authorized to operate by the Central Bank, the methods adopted for the recording of income taxes are similar to IFRS but their practical application may lead to different results in certain circumstances. The recognition of tax credits derived from temporary differences and tax losses is an area that requires considerable judgment. In general, tax credits are recognized when there is evidence of future realization in a continuous operation, and potential effects of Provisional Measures enacted by the Brazilian Government are evaluated and the effects of increases in enacted tax rates on deferred taxes may not be integrally recognized if the related legislation is being questioned. On December 30, 2002, the Central Bank issued Central Bank Circular No. 3,171, as amended, which revoked Central Bank Circular No. 2,746, that: (i) requires specific supporting analysis to recognize deferred tax assets; (ii) requires as a condition to recognize deferred tax assets a history of profitability presenting taxable income in three out of five fiscal years (including the year being reported); and (iii) prohibits recognition of deferred tax assets if it is expected that they will be realized in more than 5 years as from the reporting date. On March 31, 2006, Resolution No. 3,355 changed the period from 5 to 10 years for the realization of such tax credit.
Under IFRS, the liability method is used to calculate the income tax provision, as specified in IAS 12, "Income Taxes." Under the liability method, deferred tax assets or liabilities are recognized with a corresponding charge or credit to income for differences between the financial and tax basis of assets and liabilities to each year/period end. Deferred taxes are computed based on the enacted or substantially enacted tax rate of income taxes. Net operating loss carry forwards arising from tax losses are recognized as assets. The deferred tax asset shall be recognized to the extent that it is probable that future taxable profit will realize such deferred tax asset.
Dividends and Interest Attributable to Shareholders’ Equity
Subject to certain limitations, accounting practices adopted in Brazil applicable to institutions authorized to operate by the Central Bank permits companies to distribute or capitalize an amount of interest on shareholders’ equity based on the TJLP. Such amounts are deductible for tax purposes and are presented as a direct reduction of shareholders’ equity. By the end of the year, management is required to propose payment of dividends in those years which realize a profit, unless such profit has been absorbed by any accumulated losses. The entire proposed amount is accounted for as a liability at the balance sheet date.
Under IFRS, both the minimum dividends required by law and/or included in the entity’s by-laws meet the definition of present obligation and, therefore, should be accounted for at the end of the year.
Cash and Cash Equivalent
Under accounting practices adopted in Brazil applicable to institutions authorized to operate by the Central Bank, cash equivalents are defined in broader terms than in the context of IFRS, with no limitation of 90 days/three months original maturity. Cash equivalents in Brazil are usually readily available funds which involve cash and overnight applications and may include long term securities which can be negotiated in the secondary market.
Under IFRS, cash equivalents are defined as short term (less than 3 months), highly liquid investments that are readily convertible to known amounts of cash and which are subject to an insignificant risk of change in value. Generally, only investments with original maturities of three months or less qualify under that definition held for the purposes of meeting short term cash commitments rather than for investment or other purposes.
Held for Sale
Non-current Assets Held for Sale and Discontinued Operations: Under accounting practices adopted in Brazil applicable to institutions authorized to operate by the Central Bank, Held for Sale and Discontinued Operations is applicable only for fixed assets not in use anymore or received as a guarantee, that are measured based on independent experts appraisal report and do not require specific disclosure in financials, while in IFRS it is applicable for all assets, that are measured at the lower of carrying amount and fair value less costs to sell and are presented separately in the statement of financial position with specific disclosure. In some cases, Banco BTG Pactual adopts this IFRS concept to better reflect the nature and situation of the investment.
Day One Gain and Losses
IAS 39 (IFRS 9) and IFRS 13 acknowledge that the best evidence of the fair value of a financial instrument on initial recognition is normally the transaction price (i.e. the fair value of the consideration given or received), although this will not necessarily be the case in all circumstances. Although IFRS 13 specifies how to measure fair value, IAS 39 (IFRS 9) contains restrictions on recognizing differences between the transaction price and the initial fair value as measured under IFRS 13, often called day one profits, which apply in addition to the requirements of IFRS 13.
If an entity determines that the fair value on initial recognition differs from the transaction price, the difference is recognized as a gain or loss only if the fair value is based on a quoted price in an active market for an identical asset or liability (i.e. a Level 1 input) or based on a valuation technique that uses only data from observable markets. Otherwise, the difference is deferred and recognised as a gain or loss only to the extent that it arises from a change in a factor (including time) that market participants would take into account when pricing the asset or liability. Therefore, entities that trade in financial instruments are prevented from immediately recognizing a profit on the initial recognition of many financial instruments that are not quoted in active markets.
Under accounting practices adopted in Brazil applicable to institutions authorized to operate by the Central Bank, at initial recognition, if the measurement of fair value of a financial instrument and the transaction price differs, the entity recognizes the resulting gain or loss in profit or loss, with no exceptions, different from IFRS as mentioned above.