Timothy S. Doupnik
UNIVERSITY OF SOUTH CAROLINA

THE EVOLUTION OF FINANCIAL STATEMENT INDEXATION IN BRAZIL

Abstract: Accounting for inflation is one of the more controversial topics in financial reporting. This paper traces the evolution of the system of inflation accounting used in one of the most highly inflationary economies in the world—Brazil. The history of inflation accounting in Brazil (known as monetary correction) is divided into three time periods: pre-1964, 1964 to 1976, and 1976 to the present. The events pertinent to the system of monetary correction in each of these periods are first discussed and then evaluated. It is shown that the system of monetary correction has been subject to massive political pressures since its inception, but gradual improvements have taken place over the years.

INTRODUCTION

Few countries have mandated procedures for the adjustment of historical cost financial statements for the effects of changing prices, and in those that have, inflation-adjusted data are typically required only as supplements to historical cost data1, 2. Brazil has experimented with inflation accounting since 1951. Inflation-adjusted financial statements have served as the primary statements in annual reports, and inflation-adjusted income has served as the basis for corporate taxation, since 1964. The objective of this paper is to trace the evolution of inflation accounting in Brazil.

This study divides the evolution of inflation accounting in Brazil (known as “monetary correction”) into three time periods: prior to 1964, 1964 to 1976, and since 1976. Prior to 1964, inflation ad-justments were made informally, but since 1964 all companies have been required to prepare inflation-adjusted financial statements annually, with a major revision in the system in 1976. The evolution of the system of monetary correction will be traced through each of these time periods, and the events of each period evaluated from conceptual and practical viewpoints.

Acknowledgment: The author wishes to thank Professor Eliseu Martins of the Uni-versity of São Paulo for his help in this study and the Arthur Andersen & Co. Foundation for providing financial assistance,

The accounting literature in Brazil reveals a paucity of scholarly material on monetary correction. Only two works could be found that address the theoretical and political aspects of the system’s evolution.3 They provide important information for tracing and understanding the evolution of inflation accounting in Brazil, but this study is based primarily upon the laws passed in Brazil requiring the system of monetary correction, and personal interviews with practitioners and academicians conducted in Brazil

Two types of law are cited throughout this study: Laws (Leis) and Decree-Laws (Decreto-Leis). Decree-Laws have been used only since the revolutionary government took control in 1964. Decree-Laws are not passed by Congress, but simply ordered by the President of the Republic. All Decree-Laws cited in the study are tax laws, whereas the Laws cited are of a broader nature. For example, Law No. 6.404, passed December 15, 1976, is the most recent corporations law [Lei das Sociedades por Ações], and is similar to the West German Handelsgesetz.

To illustrate the effects of changes in the system of monetary correction over the years, illustrative skeleton financial statements for the years 1952, 1965, 1975, and 1985 appear as Exhibits 1-4 at the end of the paper.

EVOLUTION OF THE SYSTEM Prior To 1964

Indexation of historical costs of fixed assets was introduced into Brazilian accounting practice in 1951. Law No. 1.474 of November 26, 1951 authorized the revaluation of fixed assets according to index coefficients fixed by that law, until December 31, 1952, but only for fixed assets acquired prior to December 31, 1946. No adjustment was permitted for assets acquired during the period 1947 to 1952. The objective of this legislation was to provide a more realistic basis for the excess profits tax. Excess profits were defined as the amount of profit exceeding some percentage of owners’ equity (the percentage changed from time to time) and were subject to a surtax based upon a series of progressive rates. Because of relatively high inflation throughout the 1940’s, owners’ equity was relatively low for many Brazilian companies. Law No. 1.474 was passed to facilitate a restatement of owners’ equity. Depreciation was not allowed on the restated fixed asset amounts, however, so there was no impact on either income reported in financial statements or on taxable income, as illustrated in Exhibit 1. Only the calculation of excess profits was affected.

The revaluation amount was subject to a tax of ten percent, but revaluation was voluntary rather than mandatory. Since the restated fixed asset amounts were not allowed as the basis for depreciation, the only benefit to be derived from revaluation was the increase in the basis upon which excess profits were calculated. The decision whether to revalue became an element of tax planning, minimizing either the sum of the normal income and excess profits taxes without revaluation, or the sum of these two plus the revaluation tax if the firm chose to revalue.

Because of continued high inflation during the early 1950’s, a second restatement of fixed assets was legislated in 1956 (Law No. 2.862 of September 4, 1956). Restatement once again was allowed only of those assets purchased more than six years earlier, and the revaluation amount was once, again subject to a ten percent tax.

Automatic regular restatement of fixed assets was introduced in 1958 through Law No. 3.470. For the first time, “revaluation of fixed assets” was replaced by “monetary correction” (correção monetária). As with previous legislation, however, the law of 1958 did not allow the monetarily corrected fixed asset amounts to be used as the basis for depreciation. Chacel, Simonsen, and Wald suggest that this prohibition was “due to the immediate needs of the National Treasury” in that depreciation based on corrected amounts would reduce income tax receipts. a The law provided that index coefficients be determined biannually by the National Economic Council for each of the previous two years. Because of this, monetary correction procedures could be applied only at the end of every two years. In 1963, legislation was passed providing for the annual calculation of indices (Law No. 4.242 of December 26, 1963). The procedures established by the laws of 1958 and 1963 remained in force until 1964 when a new revolutionary government created significant changes in the system.

Evaluation of the Period Prior to 1964

The most obvious feature of Brazilian inflation accounting prior to 1964 was its fiscal aspect. The major reason given for the re-statement of fixed assets was to provide firms with a more realistic basis for the calculation of an excess profits tax. The true objective is somewhat ambiguous, however, given that the restatement amount was itself subject to a tax. The legislature, although realizing that a surtax levied against inflation-induced profits was dam-aging, was unwilling to reduce an important source of revenues. One student of the system goes even further, claiming that “in fact, the principal objective (of inflation accounting prior to 1964) was to gather a large amount of resources for the federal coffers.”b Whatever the true objective, most observers believe that there were actually very few companies applying monetary correction procedures prior to 1964.

1964 To 1976

High rates of inflation persisted throughout the 1950’s and early 1960’s. At the time of the military takeover in April 1964, inflation was running at an annualized rate of 144 percent. The major effects of inflation visible in 1964 were the virtual disappearance of long-term finance (both for business investment and the housing market), the inability of government to finance itself, the deterioration and lack of public utility services, and extensive fictitious profits recorded by companies and taxed by government.

The Brazilian military hierarchy had stepped in to take control of government several times prior to 1964, but had always returned it to civilians after a short transition period. The new revolutionary government that took control in 1964 placed achievement of developed status for Brazil as a prerequisite for return to civilian control [Ness, 1974, p. 453]. For the first time in Brazilian history, the military decided to stay in power for an extended period of time in order to implement and carry out programs it felt necessary to allow the nation to develop in a secure and stable way. However, ministries and other government institutions were put in the hands of well-trained civilians who came to be known as technocrats. It was hoped that these individuals would be able to carry out policies without being subject to political pressures.

The major economic goals of the new government were to reduce existing economic distortions so that the price system could once again act as an efficient mechanism for the allocation of resources, and to reduce the inflation rate without causing a severe depression normally associated with a “shock treatment” approach [Baer, 1979, p. 169]. Thus, it became necessary for the country to put up with continued inflation. To mitigate some of the distortions caused by inflation during this period, the government devised the most extensive system of indexation in the world, extending the concept to the areas of public finance, long-term credit, wages, savings accounts, housing finance, and corporate income taxation. Basically indexation attempts to ensure a certain real rate of interest to creditors, and a certain real wage to workers.

In the case of loans, the face value of government and corporate bond indentures, real property mortgages, and amounts deposited in savings accounts are revalued using an inflation index, and interest payments are based upon the revalued amounts. For example, 1,000 cruzeiros (CR$) deposited in a 5% passbook savings account would grow to CR$1,205 with interest at the end of a month in which the rate of inflation was 20%: a CR$200 increase for revaluation of face amount and a CR$5 increase for interest [CR$1,200 x .05 x 712 = CR$5]. Although the depositor has CR$205 more in the savings account, the cruzeiros are worth 20% less.

The first law institutionalizing the system of indexation was dated July 17, 1964, just three-and-one-half months after the military takeover. With the intention of generating cash for the National Treasury, Law No. 4.357 created indexed treasury bonds [Obrigaçao Re-ajustável do Tesouro Nacional (ORTN)] and made mandatory the monetary correction of fixed assets by business enterprises for the very first time. Monetary correction of fixed assets helped fill government coffers through the tax imposed on the revaluation amount. Law 4.357 reduced this tax to five percent and offered companies a means to escape direct taxation by allowing them to purchase the newly created indexed treasury bonds in an amount equal to twice what the tax would have been. In this way the new law forced business to finance a portion of the public debt, either through payment of taxes or obligatory loans. The tax on the monetary correction amount was eventually eliminated in 1967.

Law 4.357 allowed depreciation on a portion of the monetarily corrected historical cost of fixed assets for the first time. For the year 1965, depreciation could be calculated on 50 percent of the corrected amount, and in 1966 on 70 percent. Beginning in 1967 depreciation was allowed on the full corrected amount of fixed assets. Chacel, Simonsen, and Wald herald this provision of the new law as the first time the Brazilian government explicitly recog-nized the existence of fictitious profits. With law 4.357

it became consecrated in Brazilian legislation that inflation is the source of fictitious profits which should not be subject to any fiscal charge.c
c1970, p. 102, translated by the author.

In assessing the new legislation, Fama concluded that:

Notwithstanding that this new law was interested in making financial statements more in conformity with reality … it still had a very pronounced preoccupation with taxation.

This conclusion can be drawn from two aspects of the law. First, although the tax on the monetary correction amount was reduced to five percent, all companies were now required to use monetary correction. Secondly, although the government explicitly recognized that fictitious profits should not be subject to income taxation, at least a portion of these profits continued to be taxed for the years 1965 and 1966 in order to help finance the federal deficit.
Maintenance of Working Capital

In addition to the innovations of making monetary correction mandatory and allowing depreciation to be based on the corrected fixed asset amounts, Law 4.357 created the concept of “maintenance of working capital” (manutenção de capital de giro proprio). An amount needed to “maintain working capital” was allowed as a deduction in arriving at profit subject to the excess profits tax, but not as a deduction in calculating profit subject to the normal income tax.

The law specifically defined “working capital” as current assets plus long-term receivables less liabilities (both short- and long-term). The amount needed to maintain working capital was calculated by applying the index coefficients of the National Economic Council to the beginning working capital amount. The maintenance amount was used solely in the calculation of excess profits and therefore did not appear in published financial statements. [This point is illustrated in Exhibit 2.]

Calculation of the amount needed to maintain working capital appears to have been a first attempt to measure the fictitious profits resulting from the valuation of inventory at historical cost and the purchasing power gains and losses which arise from holding monetary items during a period of inflation. Inventory was the only non-monetary balance sheet item included in the definition of “working capital”.

One imperfection associated with the maintenance of working capital was the stipulation that index coefficients be applied to the beginning net working capital position. This had the effect of ignoring any changes in working capital which might have occurred during the year, thereby potentially misstating the purchasing power gain/loss associated with a change in net monetary position. The provision for the maintenance of working capital lost its fiscal utility in 1967 when the excess profits tax was eliminated.

The set of inflation adjustments included in the law of 1964 was not the original set considered by the government for possible adoption. José Luiz Bulhões Pedreira, a tax attorney, was appointed by the new minister of finance in 1964 to head a project to draft a new tax law5. An expert in the legal aspects of taxation, Bulhões was assisted in the technical aspects of financial accounting by Manoel Ribeiro da Cruz Filho, a partner with Price Waterhouse in Rio de Janeiro. The original draft of the new tax law drawn up under the leadership of Bulhões in 1964 included a comprehensive plan to index the fixed assets and owners’ equity accounts of business enterprises in determining taxable income. This plan would have incorporated adjustments to depreciation expense and cost-of-goods-sold as well as purchasing power gains/losses in the calculation of normal taxable income, thereby providing firms with virtually total protection from paying taxes on fictitious profits6. The proposal was not accepted.

One explanation 1or the rejection of this proposal is that the government was reluctant to implement a system that completely eliminated fictitious profits because taxation of these represented a significant source of government revenues. One of the most important problems faced by the new military government was the national deficit. Financing the national deficit had higher national priority than protecting business firms from decapitalization through taxation of fictitious profits. This conclusion is supported by the facts that depreciation of the corrected fixed asset amounts was implemented on a gradual basis and that the provision for the maintenance of working capital was not allowed as a deduction from normal taxable income.

The procedures suggested by Bulhões and Cruz in 1964 were once again brought forth for consideration in 1966, this time being approved and incorporated in Decree-Law No. 62. This law, however, was subject to the stipulation that it would not go into effect until regulamentado, that is, not until a bulletin was issued by the Finance Ministry declaring that the law was in force. Due to pressures exerted by the Department of Income Taxation, the bulletin was never published. Studies made by that department advised against the new system, claiming that it was operationally complicated and fearing that it would reduce tax revenues too greatly [Chacel, Simonsen, and Wald, p. 105]. As a result, the procedures required by the law of 1964 continued in force. The procedures proposed by Bulhões and Cruz were finally put into practice in 1976.

As mentioned earlier, the excess profits tax was eliminated in 1967. In 1968, Decree-Law No. 401 required firms to deduct a provision for the “maintenance of working capital” from normal taxable income. This amount was also deducted from income for financial statement purposes with an equal amount set up as a reserve in the owners’ equity section of the balance sheet.

The apparent improvement in the calculation of financial statement and taxable income resulting from Decree-Law No. 401 was severely curtailed in 1969 when Decree-Law No. 433 declared that the provision for the maintenance of working capital could not exceed twenty percent of the current year’s income. That law further provided that at any time that the National Monetary Council should feel it necessary to increase tax receipts, the Ministry of Finance could eliminate the use of the maintenance of working capital provision. The government’s preoccupation with financing the national debt at the expense of protecting firms from paying taxes on fictitious profits was once again evident with Decree-Law 433. Decree-Law No. 1.302 raised the limit of the provision to 100 percent of net income in 1973. Any excess, however, could not be carried forward to offset income of future periods.

Previous laws had been silent as to the use of a provision for the maintenance of working capital should this amount turn out to be a gain (credit arising from a negative working capital position). In practice, gains from a negative working capital position were not included in income prior to 1974, whereas losses were. This assyme-try was corrected by Decree-Law No. 1.338 in 1974 which required gains of this nature to be taken to income in the current period. This was a significant change in Brazilian law, for the first time recognizing that inflation could be the cause of gains as well as losses

The monetary correction procedures as altered by Decree-Law 1.338 were used through 1976. The impact which these procedures had on published financial statements is illustrated in Exhibit 3 in the appendix. The new corporation law of 1976 and the tax law of 1977 substantially changed the system then in existence.

Evaluation of the Period 1964 to 1976

The major conceptual improvements during the period 1964 to 1976 were the depreciation of the full adjusted historical cost of fixed assets, and the provision for the maintenance of working capital, which provided a measure of purchasing power gains and losses and removed the fictitious component of gross profit. In addition, gains arising from the maintenance of working capital came to be recognized as a source of income and were required to be added in the calculation of taxable income. Due to the close relationship between financial reporting and tax accounting during this period, with financial statements generally conforming to the tax laws (Decree-Laws) in force, these adjustments were also reflected in the published financial statements of business enterprises. Thus, by the year 1975, the Brazilian system of monetary correction had evolved to the point where inflation-adjusted amounts for depreciation expense and cost-of-goods-sold, as well as purchasing power gains and losses, were incorporated in the calculation of both accounting and taxable income.

A conceptual difficulty of the system was the use of the beginning working capital for the calculation of the adjustment. A practical limitation concerned a time lag in recording monetary correction. Indices used for the correction of fixed assets were published on an ex post annual basis, that is, after the end of the year and only for the whole year in question rather than on a monthly basis. Fixed assets could not be adjusted from the date of purchase to the end of the year because monthly index coefficients were not available, and monetary correction could not be incorporated into the current year’s financial statements because indices were not divulged until well after the close of the year. The net effect was that fixed assets did not appear in financial statements at an adjusted amount until from one to two years after their purchase.

As of 1976, while Brazilian companies were required to incorporate inflation adjustments in primary financial statements and in the calculation of taxable income, U.S. companies were not re-quired to make any adjustments for inflation, either in published financial statements or in the calculation of taxable income. On the other hand, since 1976, some U.S. companies have been required to disclose certain replacement cost data.

THE CURRENT SYSTEM OF MONETARY CORRECTION

The Brazilian business environment historically has been dominated by closely held “family” companies and by foreign multinational corporations. Neither of these groups has made significant use of the Brazilian equity securities market to raise investment capital. The establishment of an effective, broadly-based securities market has been determined by Brazilian policymakers to be a necessary prerequisite for further economic development. A variety of incentives exist for companies to go “open,” that is, allow their equity shares to be traded on an organized stock exchange, and a number of incentives exist for individuals to invest in equity. For example, one of the largest components of the securities market is the so-called “157 Funds.” These are special mutual funds administered by investment banks to which individuals may apply a portion of their income tax payable rather than paying the tax to the government.

A new corporation law (Lei das Sociedades por Ações) was passed in 1976, replacing the previous one which had been in effect since 1940. The new corporation law, Law No. 6.404, has the objective “to create the legal structure necessary to strengthen the risk capital market” in Brazil.e To achieve this objective, the law emphasizes the protection of minority shareholders. The most important provision of the new law with respect to the rights of minority shareholders has been the obligatory distribution of dividends. Brazilian companies are required to pay dividends each period in an amount laid down in the corporate statute, or — if no provision for dividends in the corporate statute exists — one half of net profit after reduction of amounts appropriated to legal reserves.
The new corporation law also prescribes new procedures for the monetary correction of financial statements. Because the law forces firms to pay dividends, the law was obliged to define income in such a way that firms did not run the risk of decapitalization. Hence, the current procedures were established.7 The creation of an obligatory dividend has made the elimination of the fictitious component of profit all the more necessary as the business enterprise now becomes subject to the double jeopardy of income taxation and obligatory dividend distribution.

The general criteria of the current system of monetary correction are stated in the new corporation law; the methodology of implementation is specified in the tax law of 1977, Decree-Law No. 1.598. The corporation law requires the monetary correction of fixed assets and owners’ equity accounts. The law further requires that correction of these items be made at year-end, with the counterparts of these corrections accumulated in a “monetary correction account” taken to income. The tax law requires the use of the index used to adjust treasury bonds (the ORTN index) for monetary cor-rection purposes. Bulhões and Cruz were responsible for writing the general criteria into the new corporation law and the operational procedures into the tax law of 1977. This is essentially the same set of procedures proposed by them in 1964, twelve years earlier.

Exhibit 4 in the appendix illustrates the impact which these pro-cedures have on contemporary Brazilian financial statements. De-preciation based upon the full revalued fixed asset amount and the monetary correction amount both enter into the calculation of income before income taxes (and taxable income). The monetary correction amount taken to income is basically the same as the “provision for the maintenance of working capital” calculated prior to 1976. Rather than basing the adjustment on “working capital” (monetary) items, the calculation of the monetary correction amount is based upon adjustments of “non-working capital” (nonmonetary) items, i.e. fixed assets and owners’ equity.

The current monetary correction procedures eliminate the major technical problems of the previous system by requiring that the relevant items be corrected at year-end and by requiring the use of an index published monthly (the ORTN index). Although the use of a monthly index solves the time-lag problem discussed above, the most serious practical limitation in the current system stems from the use of the ORTN index. That index is not only used for monetary correction of financial statements, but also for the indexation of treasury bonds and other government financial contracts. The indexation of financial instruments in Brazil has itself been accused of contributing to further inflation through a so-called “inflation feedback” mechanism.8 To try to mitigate the feedback that indexation has on the rate of inflation, the government has deliberately suppressed the ORTN index, so that the index has reflected as little as 45 percent of the actual rate of inflation in recent years. For example, in 1981 the general price index increased 110 percent, but the ORTN index increased by only 50 percent. As a result, fixed assets and owners’ equity are greatly understated in corporate balance sheets, and firms have not been allowed to eliminate inflation-induced fictitious profits fully from both financial statements and taxable income.

12 The Accounting Historians Journal, Spring, 1986
SUMMARY AND CONCLUSIONS
This study has traced the evolution of financial statement indexation in Brazil from its inception in the early 1950’s to the present. The primary sources of information were Brazilian laws, writings of Brazilian scholars, and interviews with Brazilian accounting practitioners and academicians.
The Brazilians have experimented with a system of inflation ac-counting since 1951. Until 1976, the monetary correction of balance sheet items was regulated by tax legislation and was perceived by both national policymakers and businessmen almost exclusively as a component of taxation. Since 1976, monetary correction has taken on the added job of ensuring that firms do not pay obligatory dividends out of capital. There is still very little concern in Brazil with the possible usefulness that monetary correction data might have as information for investors, creditors, and other users of financial statements. This can be contrasted with the situation in the United States, where the information content of inflation accounting is greatly debated, but the tax ramifications have been virtually ignored.

One of the interesting aspects of the development of the system of monetary correction is that the national policymakers chose to improve accounts gradually rather than implement an integrated and more theoretically sound set of procedures as early as 1964. Manipulation of the monetary correction procedures took place prior to 1976 in order to continue generating revenues from the taxation of fictitious profits. Even after the 1976-1977 laws, the government has manipulated taxable income, perhaps inadvertently, through suppression of the ORTN index.

The Brazilian system of monetary correction has developed without any significant influence from the outside world. The procedures that have been used and are currently being used are unlike any proposed in the more developed countries. While the latter have been shifting support from general price-level adjustments to current value accounting, the Brazilians have steadfastly clung to a system of genera! price-level accounting. There is relatively little discussion in Brazil about the possibility of using current value systems of accounting. Inflation is the immediate problem in Brazil, and policymakers have chosen to continue with adjustments that deal with inflation alone.

To this researcher’s knowledge, Brazil is the only country where corporate income taxation is based upon inflation-adjusted income figures and inflation-adjusted financial statements serve as the only statements found in corporate annual reports. Since the intro-duction of indexation in 1951, inflation has averaged 38 percent per year, and over the most recent five-year period, inflation has averaged around 85 percent. In a country with such high rates of inflation, protecting business enterprises from decapitalization be-comes much more urgent than in countries with inflation rates hovering around ten percent or less. A second reason for the early and continued use of inflation accounting in Brazil is the authori-tarian form of government found since 1964. In this instance, dictatorships are more efficient than democracies. Legisation can be passed in a dictatorship that would either never make it out of a congressional or parliamentary committee, or would be researched and debated for many years before any legislative bill was intro-duced. A third reason is the preeminence which the military government has placed on big business for the economic development of the country. Although unable to control inflation, the government has gone to great lengths to try to create an environment where the adverse effects of inflation on business enterprises are minimized. This includes protecting firms from decapitalization through income taxation.

However, other countries have experienced continued “high in-flation,” a dictatorial government, and reliance on big business. The question, why Brazil alone pioneered inflation accounting, remains unanswered.

FOOTNOTES

1Hauworth [1980] discusses inflation accounting efforts in twelve countries. Choi and Mueller [1984] list eleven countries that either require or encourage the publication of inflation adjusted amounts in corporate financial statements [pp. 176-189].

2Only Argentina, Brazil, and France require adjusted amounts to appear in pri-mary financial statements [Choi and Mueller, 1984, pp. 176-189].
3They are: A Correção Monetária by Chacel, Simonsen, and Wald, which traces the overall system of indexation (including indexation of treasury bonds, savings accounts, mortgages, wages, and financial statements) through the 1960’s; and Retorno Sobre o Investimento . . ., a master’s thesis written by Rubens Fama at the University of Sao Paulo in 1980, which includes a chapter on the evolution of inflation accounting in Brazil.

4See Baer [1979, pp. 165-168] for a summary of the economic problems caused by inflation existing in Brazil when the military took control in 1964.
Information concerning the political process involved with the tax laws of 1964 and 1966 comes from personal interviews with Sr. Manoel Ribeiro da Cruz Filho conducted in his office in Rio de Janeiro.
6Models of GPL adjusted historical cost accounting concentrate on adjustments to depreciation expense and cost-of-goods-sold and the calculation of purchasing

14 The Accounting Historians Journal, Spring, 1986
power gains and losses. The constant dollar provisions of FASB Statement No. 33, for example, specifically require adjustments to depreciation expense and cost-of-goods-sold in the calculation of constant dollar income from continuing operations, with purchasing power gains and losses shown as a separate item [1979, para. 39-50].

7This rationale was presented by Alvaro Ayres Couto in a personal interview. Sr. Couto is chief accountant for the Commisão de Valores Mobiliários, the Brazilian securities commission.

8See Beckerman [1978] for a discussion of this phenomenon.

REFERENCES

Baer, Werner. The Brazilian Economy: Its Growth and Development. Columbus, Ohio: Grid Publishing Inc., 1979.

Beckerman, Paul. “Index-Linked Financial Assets and Brazilian Inflation Feedback Mechanism.” Unpublished working paper, College of Commerce and Business Administration, University of Illinois at Urbana-Champaign, October 1978.

Bulhões Pedreira, Jose Luiz and Manoel Ribeiro da Cruz Filho. Manual da Correção Monetária das Demonstrações Financeiras: 3a Edição. Rio de Janeiro: Editora Esplanada, 1978.

Chacel, Julian, Mario Henrique Simonsen, and Arnoldo Wald. A Correção Mone-tária. Rio de Janeiro: APEC Editora, 1970.
Choi, Frederick D. S. and Gerhard G. Mueller. International Accounting. Englewood Cliffs, N.J.: Prentice-Hall, Inc., 1984.

Decreto-Lei No. 62, de 21 de Novembro de 1966.
Decreto-Lei No. 401, de 30 de Dezembro de 1968.
Decreto-Lei No. 433, d 23 de Janeiro de 1969.
Decreto-Lei No. 1.302, de 31 de Dezembro de 1973.
Decreto-Lei No. 1.338, de 23 de Julho de 1974.
Decreto-Lei No. 1.598, de 26 de Dezembro de 1977.

Fama, Rubens. Retorno Sobre o Investimento – Sua Utilização no Brasil, Face a Inflação e A Evolução da Legislação Sobre A Correção Monetária nos Demon-strações Financeiras. Dissertação de Mestre em Administração, Universidade de São Paulo, Brazil, 1980.

Hauworth, William P. II. “A Comparison of Various International Proposals on In-flation Accounting: A Practitioner’s View.” International Journal of Accounting (Fall 1980): 63-82.

Lei das Sociedades por Ações: 11a Edição. Sao Paulo: Editora Atlas, 1980,

Lei No. 1.474, de 26 de Novembro de 1951.
Lei No. 2.862, de 4 de Setembro de 1956.
Lei No. 3.470, de 26 de Novembro de 1958.
Lei No. 4.242, de 26 de Dezembro de 1963.
Lei No. 4.357, de 16 de Julho de 1964.
Lei No. 6.404, de 75 de Dezembro de 1976.

Ness, Walter. “Financial Markets Innovation as a Development Strategy: Initial Re-sults from the Brazilian Experience.” Economic Development and Cultural Change (April 1974): 453-472.

Doupnik: The Evolution of Financial Statement Indexation in Brazil
EXHIBIT 1

BRAZILIAN FINANCIAL STATEMENTS IN 1952
Balance Sheet

Current assets Long-term receivables Fixed assets (carried at revalued amounts) Total assets

Current liabilities
Long-term liabilities
Owners’ equity (includes a reserve for the revaluation of fixed assets) Total equities

Income Statement
Sales
— Cost of goods sold
= Gross profit
— Selling and administrative expenses
— Depreciation expense (based upon the historical cost of fixed assets)
— Other expenses
= Income before income taxes (i.e., normal taxable income)
— Income taxes
= Net income
Note: excess profits were calculated as the amount of net income exceeding a specified percentage of owners’ equity and were subject to a surtax.

EXHIBIT 2 BRAZILIAN FINANCIAL STATEMENTS IN 1965
Balance Sheet

Current assets Current liabilities
Long-term receivables Long-term liabilities
Fixed assets (carried at revalued amounts) Owners’ equity
Total assets (includes a reserve for the revaluation of fixed assets) Total equities

Income Statement
Sales
— Cost of goods sold
= Gross profit
— Selling and administrative expenses
— Depreciation expense (based upon historical cost plus 50% of the revaluation
amount)
— Other expenses
= Income before income taxes (i.e., normal taxable income)
— Income taxes
= Net income

Note: a provision for the maintenance of working capital was deducted from net income in the calculation of excess profits upon which a surtax was levied, but was not reflected in the calculation of income before income taxes (or taxable income). As compared with the situation in 1952, the depreciation expense is now based upon the revalued fixed asset amounts, albeit only 50% of the revaluation amount.

EXHIBIT 3 BRAZILIAN FINANCIAL STATEMENTS IN 1975
Balance Sheet

Current assets Current liabilities
Long-term receivables Long-term liabilities
Fixed assets (carried at revalued amounts) Owners’ equity
Total assets (includes reserves for the revaluation of fixed assets and for the maintenance of working capital) Total equities

Income Statement
Sales

— Cost of goods sold
= Gross profit
— Selling and administrative expenses
— Depreciation expense (based upon 100% of the revalued amount)
— Other expenses
= Operating profit
± Provision for the maintenance of working capital = Income before income taxes (i.e., taxable income)
— Income taxes
= Net income

Note: as compared with the situation in 1965, the provision for the maintenance of working capital now appears in published financial statements and is deducted in arriving at taxable income. The provision results in an increase in income when total liabilities exceeds current assets plus long-term receivables and, conversely, a decrease in income when these assets exceed total liabilities. The provision is closed to a reserve for the maintenance of working capital which appears in the owners’ equity section of the balance sheet.

EXHIBIT 4 BRAZILIAN FINANCIAL STATEMENTS IN 1985
Balance Sheet

Current assets Current liabilities
Long-term receivables Long-term liabilities
Fixed assets (carried at revalued amounts) Owners’ equity (carried at
Total assets revalued amounts)
Total equities

Income Statement
Sales

— Cost of goods sold
= Gross profit
— Selling and administrative expenses
— Depreciation expense (based upon the revalued fixed asset amounts)
— Other expenses
= Operating profit

± Monetary correction (calculated as the counterpart to the current year’s revaluation of fixed assets and owners’ equity) = Income before income taxes (i.e., taxable income)
— Income taxes
= Net income

Note: the monetary correction amount results in a decrease in income before in-come taxes (and taxable income) when owners’ equity exceeds fixed assets and an increase in income when fixed assets exceed owners’ equity.