[Federal Register Volume 60, Number 25 (Tuesday, February 7, 1995)]
[Rules and Regulations]
[Pages 7392-7402]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 95-2937]
[[Page 7391]]
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Part VIII
Small Business Administration
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13 CFR Part 107
Small Business Investment Companies; Accounting and Financial Reporting
Standards; Interim Final Rule
Federal Register / Vol. 60, No. 25 / Tuesday, February 7, 1995 /
Rules and Regulations
[[Page 7392]]
SMALL BUSINESS ADMINISTRATION
13 CFR Part 107
Small Business Investment Companies; Accounting and Financial
Reporting Standards
AGENCY: Small Business Administration.
ACTION: Interim final rule.
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SUMMARY: The Small Business Administration (SBA) currently provides
accounting guidance for Small Business Investment Companies (SBICs) in
two appendices to SBA regulations. These appendices have not been
significantly revised since 1986. Subsequent changes in generally
accepted accounting principles and in the SBIC program have caused the
accounting standards to become outdated and incomplete. This rule
updates the standards for accounting and financial reporting by SBICs,
as well as the guidelines for Independent Public Accountants (IPAs)
performing audits of SBIC financial statements.
The current appendix I includes SBA Form 468, on which SBICs
prepare the required Annual Financial Report to SBA. The current
appendix II includes the standard chart of accounts for SBICs. This
rule deletes both the Form 468 and the chart of accounts from the
regulations and consolidates the remaining material in appendices I and
II into one appendix.
DATES: This interim final rule is effective February 7, 1995. Written
comments on this rule must be received no later than March 9, 1995.
ADDRESSES: Written comments should be sent to Robert D. Stillman,
Associate Administrator for Investment, Small Business Administration,
Suite 6300, 409 3rd Street SW., Washington, DC 20416.
FOR FURTHER INFORMATION CONTACT:
Carol Fendler, Office of Program Support; telephone no. (202) 205-7559.
SUPPLEMENTARY INFORMATION: The accounting standards published by SBA on
August 28, 1986 (51 FR 30752) have since undergone only minor
revisions. As a result, these standards do not reflect subsequent
changes in the SBIC program mandated by the Small Business Investment
Act of 1958, as amended (Act), as well as changes in generally accepted
accounting principles (GAAP).
This rule updates the accounting standards for the SBIC program,
while also reorganizing the material to make information on specific
topics easier to find. The accounting, financial reporting and auditing
requirements included in the current appendices I and II to Part 107 of
SBA regulations are consolidated into a revised appendix I.
Two items currently included in the appendices are deleted: (1) The
schedules which constitute SBA Form 468, on which SBICs prepare their
Annual Financial Report to SBA, and (2) the standard SBIC chart of
accounts. SBA is deleting Form 468 in the interest of consistency,
since none of the other standard forms used in the SBIC program is
included in Part 107 of the regulations or its appendices. The SBIC
chart of accounts represents the type of explanatory material that SBA
considers more appropriate for inclusion in a Policy and Procedural
Release rather than in Agency regulations. SBA plans to provide updated
versions of both the Form 468 and the SBIC chart of accounts after this
rule is published. Until then, Licensees should continue to use the
existing versions.
While many of the topics covered in this rule should be familiar to
users of the current appendices, some are either new or significantly
revised, including the following:
1. Independent Auditors' Report--Includes a sample report which
satisfies current requirements of the American Institute of Certified
Public Accountants.
2. Access to Accountants' Working Papers--States explicitly that
SBA, in its discretion, may assign its examiners or other personnel to
review accountants' working papers prepared in connection with audits
of SBICs. Although this statement does not appear in the existing
appendices, it is consistent with SBA's current position that working
papers are subject to the requirements concerning records and reports
set forth in Sec. 107.1002 of the regulations.
3. Accounting for Income Taxes--Revised in accordance with FASB
Statement No. 109, issued in February 1992, which sets forth current
GAAP in this area.
4. Interest Income--Provides more specific guidance than before
concerning the accounting treatment of delinquent interest. This
section sets forth conditions which are deemed to create a presumption
that the collection of interest is doubtful; SBICs would have the
opportunity to rebut such a presumption. This approach is consistent
with the valuation guidelines for interest-bearing securities published
in the Federal Register on June 2, 1994 (59 FR 28471) and is intended
to achieve greater consistency in financial reporting by SBICs.
5. Undistributed Realized Earnings--Provides more detailed
definitions of Undistributed Net Realized Earnings and Noncash Gains/
Income, the two components of Undistributed Realized Earnings. These
definitions are consistent with the interpretations currently used by
SBA in practice.
6. Retained Earnings Available for Distribution--Corrects
contradictory statements in the current appendices and provides
additional detail concerning the computation of this amount, consistent
with the definition of Retained Earnings Available for Distribution
which was published in the Federal Register on April 8, 1994 (59 FR
16898).
7. Preferred Securities Leverage for Section 301(d) Licensees--
Provides guidance on accounting for 4% redeemable preferred securities,
a topic which is not addressed in the current appendices.
8. Participating Securities--Provides general guidance on financial
statement presentation of these new equity-type securities, which may
be issued by Licensees pursuant to the final rule published in the
Federal Register on April 8, 1994. Additional guidance and computer
software to perform the various profit and distribution computations
associated with Participating Securities will be provided to issuers of
such securities.
Compliance With Executive Orders 12866, 12612 and 12778, and the
Regulatory Flexibility and Paperwork Reduction Acts
Executive Order 12866 and Regulatory Flexibility Act
This rule will not constitute a significant regulatory action for
purposes of Executive Order 12866 because it is not likely to have an
annual impact on the national economy of $100 million or more, and, for
purposes of the Regulatory Flexibility Act, 5 U.S.C. 601 et seq., it
will not have a substantial impact on a significant number of small
entities.
1. The legal basis for this regulation is section 308(c) of the
Small Business Investment Act, 15 U.S.C. 687(c).
2. The potential benefits of this regulation have been set forth in
the discussion above, under Supplementary Information.
3. The potential cost of this regulation cannot be quantified or
estimated.
4. There are no Federal rules which duplicate, overlap, or conflict
with this rule.
5. SBA is not aware of regulatory alternatives that could achieve
the same objectives at lower cost.
This rule was not reviewed under Executive Order 12866.
[[Page 7393]]
Executive Order 12612
SBA certifies that this regulation has no federalism implications
warranting the preparation of a Federal Assessment in accordance with
Executive Order 12612.
Paperwork Reduction Act
For purposes of the Paperwork Reduction Act, 44 U.S.C., ch. 35, SBA
hereby certifies that this rule, in and of itself, will impose no new
reporting or recordkeeping requirements. This rule prescribes the
accounting treatment for certain types of financial transactions which
are new to the SBIC program; such treatment, however, is dictated by
the substance of these transactions, which has already been established
by statute (primarily section 403 of Pub. L. 102-366).
Executive Order 12778
SBA certifies that this rule is drafted, to the extent practicable,
in accordance with the standards set forth in Section 2 of Executive
Order 12778.
SBA certifies pursuant to 5 U.S.C. 553(b)(B) that notice and
comment in the promulgation of this regulation is impracticable. In
this regard, the rule provides necessary accounting guidance to
Licensees on recently implemented aspects of the SBIC program (such as
Participating Securities and commitments from Institutional Investors).
It also revises the guidelines to reflect recent regulatory changes in
such areas as valuations, Retained Earnings Available for Distribution,
and electronic reporting requirements. Licensees need to have access to
this information in order to prepare their year end financial
statements in a manner acceptable to SBA.
Other changes to the accounting guidelines are intended to bring
them into compliance with generally accepted accounting principles.
Some areas of the present guidelines (such as accounting for income
taxes and preparation of the Independent Accountant's Report) are so
out of date that they have become sources of significant confusion to
Licensees.
Finally, this rule provides for the deletion of the present SBA
Form 468 from the appendix to Part 107. This will allow SBA to
implement a revised 468 (subject to OMB approval) for companies with
fiscal years ending on or after December 31, 1994. The revised Form 468
is needed to accommodate reporting related to statutorily mandated
programs, and also to provide Licensees with a format in which to show
information such as economic impact data, investments in Smaller
Concerns, and computations of Regulatory and Leverageable Capital.
Without the new Form 468, Licensees will find it difficult to report
required financial information to SBA, and SBA will find it difficult
to monitor key aspects of their financial condition and regulatory
compliance.
Therefore, this rule is being promulgated as an interim final rule,
and the public is offered an opportunity to comment on it subsequent to
its publication. Comments will be taken into consideration in the
ultimate finalization of the rule.
List of Subjects in 13 CFR Part 107
Investment companies, Loan programs--business, Small businesses.
For the reasons set forth above, Title 13, Part 107 of the Code of
Federal Regulations is amended as follows:
PART 107--SMALL BUSINESS INVESTMENT COMPANIES
1. The authority citation for Part 107 continues to read as
follows:
Authority: Title III of the Small Business Investment Act, 15
U.S.C. 681 et seq.; 15 U.S.C. 687c; 15 U.S.C. 683; 15 U.S.C. 687d;
15 U.S.C. 687g; 15 U.S.C. 687b; 15 U.S.C. 687m, as amended by Pub.
L. 102-366.
2. Appendix I is revised to read as follows:
Appendix I to Part 107--Accounting Standards and Financial Reporting
Requirements for Small Business Investment Companies
Table of Contents
I. Introduction
II. Recordkeeping and Financial Reporting
A. Records and Reports
B. Account Classification
C. Annual Financial Report (SBA Form 468)
D. Filing of Annual Financial Report
E. Portfolio Financial Report (SBA Form 1031)
F. Interim Reports
III. Selection and Qualification of the Auditor
A. Selection of the Auditor
B. Qualification of the Auditor
C. Independence
IV. Annual Report
A. Generally Accepted Auditing Standards
B. Independent Auditors' Report
C. Access to Accountants' Working Papers
D. Accountants' Reponsibility for Valuations
E. Audit Adjustments
F. Reporting Irregularities
G. Detecting Noncompliance With Laws and Regulations
V. Accounting Policies and Procedures
A. Generally Accepted Accounting Principles
B. Accrual Basis of Accounting
C. Reporting Entity
D. Fair Value of Loans and Investments
E. Interest Income
F. Dividend Income
G. Profit Participation in Small Concerns
H. Fees Charged to Small Concerns
I. Accounting for Investments in Flow-Through Entities
J. Equity Method of Accounting
K. Accounting for Income Taxes
L. Realized Gain (Loss) on Investments
M. Nonmonetary Transactions
N. Interest, Notes and Accounts Receivable
O. Compensating Balances
P. Organization Costs
Q. Contingent Liabilities
R. Transactions with Related Parties
S. Leverage--Debentures Guaranteed or Purchased by SBA
T. Leverage--Participating Securities Guaranteed by SBA
U. Preferred Securities Leverage for Section 301(d) Licensees
V. Contributed Capital and Committed Capital
W. Unrealized Gain (Loss) on Securities Held
X. Undistributed Realized Earnings
Y. Retained Earnings Available for Distribution
Z. Partnership Capital Accounts
VI. Availability of Publications and Forms
I. Introduction
i. This appendix provides guidance to Small Business Investment
Companies (SBICs) on accounting policies and procedures, financial
reporting to SBA, and selection of an auditor. In addition, this
appendix contains guidelines for Independent Public Accountants
(IPAs) engaged to conduct annual audits of SBICs. This appendix is
not intended to be a comprehensive treatment of all accounting and
auditing issues which may arise in an SBIC; instead, its purpose is
to cover those topics that are particularly relevant to the SBIC
program and which may involve the application of specialized
industry practices. Therefore, Licensees and their IPAs should
consult other appropriate sources of information as needed.
Furthermore, as in any audit, the independent auditor of an SBIC
must exercise professional judgment as to the work required to
satisfy generally accepted auditing standards.
ii. This appendix contains references to Securities and Exchange
Commission (SEC) Rules and Regulations, pronouncements of the
Financial Accounting Standards Board (FASB) and its predecessors,
publications of the American Institute of Certified Public
Accountants (AICPA), and the Internal Revenue Code. Such references
are subject to change. It is the responsibility of the Licensee and
its advisors to be aware of any regulatory, accounting, or tax code
changes that could have an effect on the Licensee.
II. Recordkeeping and Financial Reporting
A. Records and Reports
All books, records, ledgers, and other supporting documents
shall be maintained in the English language. See Sec. 107.1002 for
specific requirements relating to the retention of records and the
filing of reports with SBA.
B. Account Classification
i. Licensees shall maintain their books of account in accordance
with the system of [[Page 7394]] account classification prescribed
by SBA. The system has been prescribed to insure that standard books
of account are maintained by Licensees and that uniform accounting
policies are followed.
ii. Books of account for a management consulting or other
subsidiary shall be maintained using accounts compatible with those
used by the Licensee.
C. Annual Financial Report (SBA Form 468)
i. The Small Business Administration, under authority granted by
the Small Business Investment Act of 1958, as amended (the Act),
requires each Licensee to submit an Annual Financial Report as of
the close of its fiscal year (see Sec. 107.1002(e)). The Annual
Financial Report consists of audited financial statements and
supplementary schedules prepared on SBA Form 468, the Independent
Public Accountant's report, the notes accompanying the financial
statements, and the required certifications.
ii. Preparation of the Annual Financial Report is the
responsibility of the Licensee. The Independent Public Accountant's
responsibility is to perform an audit and to express an opinion on
the financial statements and supplementary schedules based on the
audit.
D. Filing of Annual Financial Report
i. The Annual Financial Report on SBA Form 468 shall be
submitted to SBA by the Licensee no later than the last day of the
third month following the end of the Licensee's fiscal year.
The Licensee shall include in its filing a copy of any
transmittal letter, special report, or other communication furnished
by its auditor.
ii. For all fiscal years ending on or after June 30, 1994, SBA
Form 468 shall be submitted electronically, in accordance with
Sec. 107.101(h). All Licensees must use the electronic reporting
software provided by SBA for this purpose. A complete filing of Form
468 consists of the following:
(1) The electronic reporting data diskette;
(2) Two printed copies of the financial statements and
supplementary schedules;
(3) The signed management certifications which appear on the
last page of Form 468 (two copies, one with original signatures);
(4) The IPA's report (two copies, one with original signature);
and
(5) The notes to the financial statements (two copies).
E. Portfolio Financing Report (SBA Form 1031)
For each financing of a small concern, Licensees shall submit a
Portfolio Financing Report on SBA Form 1031 within 30 days of the
closing date of the financing. Such reports shall be prepared using
software provided by SBA. Licensees may submit a printout of the
form to SBA or transmit it electronically. The report, which is used
for program evaluation purposes, provides summary information
concerning the amount and terms of the financing, the financial
condition of the small concern and the intended use of proceeds, as
well as information which will be used to assess the economic impact
of the financing.
F. Interim Reports
SBA may require Licensees to submit interim reports containing
unaudited financial and/or management information, pursuant to
Sec. 107.1002(g). The form and content of such reports may be
standardized or determined by SBA on a case-by-case basis. Interim
reports shall be submitted in such manner and at such time as SBA
shall direct.
III. Selection and Qualification of the Auditor
A. Selection of the Auditor
i. The Licensee's Board of Directors or General Partner is
responsible for selecting the Independent Public Accountant (IPA).
Within 30 days of its engagement by the Licensee, the Independent
Public Accountant shall file with the SBA a completed IPA
Certification (CO Form 112) certifying as to its qualifications and
independence. The IPA shall be deemed approved unless the Licensee
is notified to the contrary by SBA within 90 days after receipt of
the IPA Certification.
ii. Submittal of the IPA Certification is required only upon the
initial engagement of the IPA. An IPA engaged to audit an SBIC on a
recurring basis does not need to submit a new Certification each
year.
iii. The Licensee shall notify the SBA in writing of a change in
accountants and shall explain the reason for the change.
B. Qualification of the Auditor
Any Certified Public Accountant or Public Accountant, licensed
by a regulatory authority of a State or other political subdivision
of the United States, may be considered qualified to render an
opinion on behalf of a Licensee, provided the following conditions
are met: (1) The accountant is independent with respect to the
Licensee, and (2) the accountant is duly authorized to practice and
is in good standing under the laws of the State or other comparable
authority in which so authorized.
C. Independence
i. Independent Public Accountants approved by SBA are to follow
the Code of Professional Conduct adopted by the AICPA. In
considering questions which may arise concerning the independence of
an accountant with respect to a Licensee, the SBA will give
appropriate consideration to all relevant circumstances, including
evidence bearing on relationships between the accountant and such
Licensee or any of its affiliates.
ii. Independence will be considered to be impaired by
circumstances including, but not limited to, the following:
1. During the professional engagement, or at the time of
expressing an opinion, the accountant or his/her firm:
a. Had or was committed to acquire any direct or indirect
financial interest in the Licensee; or
b. Had any joint closely held business investment with the
Licensee or any of its officers, directors or principal
stockholders, or any general or limited partner, which was material
in relation to the net worth of the accountant or his/her firm; or
c. Had any loan to or from the Licensee or any of its officers,
directors or principal stockholders, or any general or limited
partner.
2. During the period covered by the financial statements during
the professional engagement, or at the time of expressing an
opinion, the accountant or his/her firm:
a. Was connected with the Licensee as a promoter, underwriter,
or voting trustee, a director of officer or in any capacity
equivalent to that of a member of management or of an employee; or
b. Was a trustee of any trust or executor or administrator of
any estate is such trust or estate had a direct or material indirect
financial interest in the Licensee; or was a trustee for any pension
or profit-sharing trust of the Licensee; or
c. Rendered bookkeeping services to the Licensee; Provided
however, that SBA may approve the rendering of bookkeeping services
by independent accountants on a case by case basis.
iii. Independent public accountants who audit Licensees which
elect to qualify as Regulated Investment Companies should become
familiar with Section 600 (``Matters Relating to Independent
Accountants'') of the SEC's ``Codification of Financial Reporting
Policies.''
IV. Annual Audit
A. Generally Accepted Auditing Standards
The IPA shall perform an audit of the Licensee's financial
statements in accordance with generally accepted auditing standards
(GAAS) of the AICPA. It is the responsibility of accountants to be
informed of any changes in GAAS as they occur. AICPA recommendations
for the application of GAAS to audits of the financial statements of
investment companies are presented in the publication, ``Audits of
Investment Companies'', which is updated periodically. Although this
publication deals primarily with companies investing in marketable
securities, many of its recommended audit procedures are applicable
to SBICs.
B. Independent Auditor.s Report
i. The Independent Auditor's Report shall conform to current
AICPA recommendations regarding the application of generally
accepted auditing standards to reports on audited financial
statements of investment companies. As of the publication date of
these regulations, such recommendations are presented in chapter 9
of the AICPA publication, ``Audits of Investment Companies.'' It is
the responsibility of accountants to be aware of any changes in
generally accepted auditing standards which may affect reporting
requirements.
ii. The opinion expressed in the Independent Auditors' Report
must refer specifically to the financial statements as they appear
in SBA Form 468. An opinion expressed on financial statements
prepared for general purposes, or for any specific purpose other
than inclusion in SBA Form 468, is not acceptable. The financial
statements may be listed by name in the auditor's report, or listed
separately and referred to in the report (for example, the report
could refer to the financial statements [[Page 7395]] ``as listed on
the following page'' or ``as listed in the accompanying index'').
iii. In addition to expressing an opinion on the basic financial
statements (the statement of financial position, statement of
operations realized and statement of cash flows), the accountant
must express an opinion on the supplementary financial information.
The supplementary information should be addressed in a separate
paragraph of the Independent Auditors' Report. As with the basic
financial statements, the supplementary statements and schedules may
be listed in the report itself or listed separately and referred to
in the report.
iv. Almost all SBICs have Loans and Investments, the value of
which must be estimated by the Board of Directors or General
Partner(s) in the absence of readily ascertainable market values.
The auditor's reports for such SBICs must include an explanatory
paragraph addressing portfolio valuations, in which the auditor
states whether the valuation procedures are reasonable and the
underlying documentation is appropriate. It is no longer acceptable
to state that valuations involve subjective judgment which is not
susceptible to substantiation by auditing procedures. The paragraph
should follow the AICPA's reporting recommendations presented in
chapter 9 of ``Audits of Investment Companies''.
V. Sample Report. Following is a sample Independent Auditors'
Report which is acceptable to SBA, based on generally accepted
auditing standards in effect as of the publication date of these
regulations. Any subsequent changes in generally accepted auditing
standards which affect reporting requirements must be reflected in
the Independent Auditors' Report included in a Licensee's filing of
SBA Form 468, regardless of whether or not SBA has published an
updated sample report.
Independent Auditors' Report
The Board of Directors of [Licensee]
or
The General Partner(s) and Limited Partners of [Licensee]
We have audited the statement of financial position of
[Licensee] as of [closing date of fiscal year] and the related
statements of operations realized and cash flows for the year then
ended included in SBA Form 468. These financial statements are the
responsibility of the Company's management. Our responsibility is to
express an opinion on these financial statements based on our audit.
We conducted our audit in accordance with generally accepted
auditing standards. Those standards require that we plan and perform
the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes
examining, on a test basis, evidence supporting the amounts and
disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates
made by management, as well as evaluating the overall financial
statement presentation. We believe that our audit provides a
reasonable basis for our opinion.
In our opinion, the financial statements referred to above
present fairly, in all material respects, the financial position of
[Licensee] as of [closing date of fiscal year], and the results of
its operations and cash flows for the year then ended in conformity
with generally accepted accounting principles.
As explained in Note ____, the financial statements include
investments valued at $________ as of [closing date of fiscal year],
whose values have been estimated by the [Board of Directors]
[General Partner(s)], in the absence of readily ascertainable market
values. We have reviewed the procedures used by the [Board of
Directors] [General Partner(s)] in arriving at its estimates of
value of such investments and have inspected underlying
documentation, and, in the circumstances, we believe the procedures
are reasonable and the documentation appropriate. However, because
of the inherent uncertainty of valuation, those estimated values may
differ significantly from the values that would have been used had a
ready market for the investments existed, and the differences could
be material.
Our audit was made for the purpose of forming an opinion on the
basic financial statements taken as a whole. The supplementary
information contained in the [analysis of stockholders' equity]
[analysis of partners' capital], computations of retained earnings
available for distribution and of regulatory and leverageable
capital, schedules of commitments and guarantees, and schedules 1
through 7 is presented for purposes of additional analysis and is
not a required part of the basic financial statements. Such
information has been subjected to the auditing procedures applied in
the audit of the basic financial statements and, in our opinion, is
fairly stated in all material respects in relation to the basic
financial statements taken as a whole.
C. Access to Accountants' Working Papers
At its discretion, SBA may assign its examiners or other
personnel to review the accountant's working papers. The audit
engagement agreement between the Licensee and the IPA shall provide
that the accountant's working papers will be made available for
review upon request of the SBA.
D. Accountants' Responsibility for Valuations
i. The investment portfolios of virtually all SBICs contain
nonmarketable securities, the values of which must be estimated in
the absence of readily ascertainable market values. It is the
responsibility of the Board of Directors or the General Partner(s)
to estimate the value of such securities in good faith.
ii. The IPA does not act as an appraiser for security values
estimated by the Board of Directors or General Partner(s), and is
not expected to perform an audit of the portfolio concerns. The
IPA's review of a Licensee's portfolio valuations shall address the
following questions:
(1) Does the Licensee have a written valuation policy which has
been approved by SBA?
(2) Do the Licensee's valuations of its portfolio concerns
reflect consistent adherence to its valuation policy?
(3) Has the Licensee documented the basis for its valuations,
and does such documentation indicate that a reasonable analysis of
available information has been performed?
iii. Based upon the auditing procedures performed, the IPA shall
express an opinion as to whether the Licensee's valuation procedures
are reasonable and the documentation is appropriate.
iv. SBA requirements concerning portfolio valuations are set
forth in Appendix II to Part 107. Appendix II contains recommended
valuation techniques for securities of various types, as well as
requirements concerning written valuation policy, frequency of
valuation, and documentation. A Licensee has the option of adopting
the model valuation policy included in Appendix II or obtaining SBA
approval of an alternative valuation policy.
v. In addition to the SBA valuation requirements, IPAs may also
wish to review SEC Accounting Series Release No. 118 (section
404.03, ``Codification of Financial Reporting Policies'').
vi. The IPA shall test a sufficient number of valuations to
support an opinion. Testing of valuations representing less than 50
percent of the value of the entire portfolio shall be presumed to be
insufficient to support an opinion.
vii. If the audit discloses that the valuation procedures are
inadequate, unreasonable or inconsistent with the Licensee's
valuation policy, or that the underlying documentation does not
adequately support the valuations, the IPA's opinion shall be
modified to indicate a lack of conformity with generally accepted
accounting principles. The opinion may be qualified (using the
phrase ``except for'') or, depending upon the possibility of a
material misstatement, the accountant may determine that an adverse
opinion is appropriate.
E. Audit Adjustments
All audit adjustments shall be entered in the Licensee's records
before issuance of the Independent Auditors' Report. As a result,
the financial statements accompanying the report will agree with the
books as adjusted as of the statement date, giving consideration to
reclassification of account balances for report purposes. If the
adjustments are not so recorded on the Licensee's books, a statement
shall be made by the IPA to this effect.
F. Reporting Irregularities
i. Reporting Irregularities and Illegal Acts to SBA. An
independent public accountant that detects irregularities or illegal
acts individually or collectively material to the financial
statements, or irregularities or illegal acts relative to SBA
programs whether or not material, shall advise management in
writing. Management, in turn, shall immediately advise, in writing,
the Associate Administrator for Investment, Investment Division, 409
Third Street, SW, Washington, DC 20416. Management, in advising SBA,
shall, to the extent practicable, describe the irregularities or
illegal acts and their effects on the financial statements and SBA
programs. Auditors shall determine whether management reported the
irregularities or [[Page 7396]] illegal acts and, if management
fails to report, the auditor shall report to SBA at the address
listed above.
ii. Reporting Internal Control Structure Reportable Conditions.
Reportable conditions in an SBIC's internal control structure shall
be reported to SBIC management in writing and SBIC management shall
immediately transmit this auditor's report to SBA. Reportable
conditions and the manner of reporting such conditions are addressed
in AU Section 325, Codification of Statements on Auditing Standards,
issued by the American Institute of Certified Public Accountants.
G. Detecting Noncompliance With Laws and Regulations
i. Audits of SBICs are performed in accordance with generally
accepted auditing standards. These standards require IPAs to design
audit procedures which will provide reasonable assurance of
detecting instances of noncompliance with applicable laws and
regulations that could have a material effect on Licensees'
financial statements.
ii. A GAAS audit is neither a substitute for nor a duplication
of the examination of an SBIC performed by SBA's examiners. The
purpose of such examinations is to provide a comprehensive
evaluation of the Licensee's compliance with laws and regulations
governing the SBIC program. In contrast, IPAs perform audits in
which compliance issues are viewed in the context of the possible
effects of noncompliance on the financial statements.
iii. As part of the audit planning process, all IPAs shall be
responsible for reviewing and becoming familiar with the laws and
regulations applicable to SBICs. Auditors must have sufficient
knowledge of such laws and regulations to be able to design
appropriate audit procedures for an SBIC, and to recognize instances
of noncompliance which may become evident in the course of
performing such procedures. The laws and regulations governing the
SBIC program include the following:
1. Small Business Investment Act of 1958, as amended (Act). The
Act (15 U.S.C. 681 et seq.) provides a statement of the public
purpose of the SBIC program and establishes the legislative
framework upon which the regulations are based. Licensees are
permitted to engage in activities contemplated by the Act, and in no
other activities. Provisions of the Act governing SBICs are found
primarily in Title III.
2. Code of Federal Regulations, title 13, parts 107 and 121 (13
CFR 107 and 121). Part 107 contains the regulations governing the
SBIC program, and auditors should become familiar with this part in
its entirety. Part 121 contains small business size regulations
which apply to various SBA programs; particular attention should be
given to the definition of ``Affiliation'' (Sec. 121.401) and the
SBIC size standard (Sec. 121.802).
iv. In addition to the Act and regulations themselves, SBA has
various materials available which may assist auditors in developing
an overall understanding of the SBIC program. These include basic
informational brochures about the program; the preambles to final
rules published in the Federal Register, which provide rationales
for and interpretations of new regulations; and a regulatory
compliance checklist for small business financings.
v. Preparation for an SBIC audit should include a review of
AICPA Statement on Auditing Standards No. 54 (SAS 54). This
statement discusses the consideration an auditor should give to the
possibility of illegal acts by a client in a financial statement
audit performed in accordance with GAAS. As defined in the
statement, ``illegal acts'' include violations of laws or government
regulations.
vi. In addition to any specific audit procedures deemed
necessary which may relate to compliance issues, the IPA shall
obtain representation from the Licensee regarding its lawful
operation as contemplated by the Act.
V. Accounting Policies and Procedures
A. Generally Accepted Accounting Principles
i. As a general rule, Licensees shall follow generally accepted
accounting principles (GAAP) as promulgated by the Financial
Accounting Standards Board, its predecessors (such as the Accounting
Principles Board), and the AICPA. Sources of information concerning
specialized accounting and reporting principles for investment
companies include the AICPA publication, ``Audits of Investment
Companies'', as well as this accounting guide. In the event of any
conflict between this appendix and other sources, this appendix
shall govern for purposes of financial reporting to SBA.
ii. Licensees and their IPAs should be aware that some of the
specialized GAAP promulgated for investment companies is oriented
towards companies which do not share many of the characteristics of
SBICs. Appendix A of ``Audits of Investment Companies'' discusses
some of the distinctive characteristics of venture capital companies
in general, and of SBICs in particular, relative to other types of
investment companies. These characteristics may include active
rather than passive investment, illiquid portfolios with no public
market, relatively long holding periods for investments, and the
existence of significant debt in the case of SBICs.
iii. Appendix A includes the following statement: ``Though all
venture capital investment companies should prepare their financial
statements in conformity with generally accepted accounting
principles and are subject to audit as are other investment
companies, the statement presentation of some companies may need to
be tailored to present the information in a manner most meaningful
to their particular group of investors.'' SBA, as the regulator and
major creditor of the SBIC industry, has tailored Form 468 to
provide financial information in a format which will satisfy SBA's
analytical and regulatory requirements. An IPA should exercise
professional judgment in determining whether reporting on Form 468
requires a material departure from GAAP for a particular SBIC. If
such a departure exists, the Independent Auditors' Report should be
modified accordingly.
B. Accrual Basis of Accounting
Books of account shall be maintained on an accrual basis. All
accruals are to be entered in the records and posted at the end of
the fiscal year, and as of the closing dates of any other fiscal
periods to be covered by interim or special financial report to SBA.
C. Reporting Entity
i. For most SBICs, the reporting entity is the Licensee only.
Application of this general rule and certain exceptions to it are
discussed in this paragraph C.
ii. Investment in Management Services Company. The provisions of
Sec. 107.501(c) permit a Licensee to organize a wholly-owned
corporation solely to provide management services. The regulation
states that reports submitted to SBA shall reflect the consolidated
results of the Licensee and its subsidiary.
iii. Investment in Section 301(d) Licensee. Under Sec. 107.712,
a Section 301(d) Licensee may be licensed to operate as the
subsidiary of one or more Licensee companies (``Participant
Licensees''), with or without non-Licensee participation. Each
Participant Licensee shall own at least twenty percent of the voting
securities of the Section 301(d) Licensee. Such an investment should
be reported on the equity method, under the caption ``Investment in
301(d) Licensee'' on the Statement of Financial Position. SBA
recognizes that this accounting treatment may constitute a departure
from GAAP if the Participant Licensee is the majority owner of the
Section 301(d) Licensee. The independent public accountant may wish
to express a qualified opinion if the departure is considered
material.
iv. Temporary Control. Under certain circumstances, as described
in Sec. 107.801, a Licensee may temporarily own more than a 50
percent interest in a small business concern. These investments
shall be classified in the appropriate category of Loans and
Investments on the Statement of Financial Position (generally, this
will be ``Operating Concerns Acquired''), and shall be reported at
their fair value. This treatment is consistent with FASB Statement
No. 94, which provides an exception to the general rule of
consolidating majority-owned subsidiaries when control is likely to
be temporary.
D. Fair Value of Loans and Investments
i. In accordance with generally accepted accounting principles
for investment companies, SBICs shall report Loans and Investments
(presented on lines 1 through 10 of the Statement of Financial
Position, page 2 of SBA Form 468) at fair value. To the extent
possible, fair value shall be represented by quoted market prices
(appropriately discounted for such factors as restrictions on
marketability or large holdings relative to daily trading volume).
In the absence of quoted market prices, fair value shall be an
estimate determined in good faith by the Board of Directors or
General Partner(s), based on the application of valuation policies
which are consistent with SBA guidelines.
ii. In response to new statutory requirements concerning
valuations, SBA [[Page 7397]] published regulations which included
new Sec. 107.101(g) as well as a new Appendix II to Part 107,
``Valuation Guidelines for SBICs''. These new valuation regulations
supersede the guidelines previously published in SBA Policy and
Procedural Release #2006. Licensees may adopt the model valuation
policy included in Appendix II or submit an alternate policy to SBA
for approval. In addition to valuation policy, Sec. 107.101(g) and
Appendix II also set forth requirements concerning frequency of
valuation, documentation, and responsibility for valuations.
iii. The following statement is included in Sec. 107.101(g):
``The boards of directors of corporations and the general partners
of partnerships shall have sole responsibility for adopting the
Licensee's valuation policy and, pursuant thereto, for valuing Loans
and Investments of such Licensee.'' This statement establishes
responsibility for all valuations assigned to portfolio securities
by the Licensee. SBA, in its capacity as a regulator, retains the
same oversight responsibilities over valuations as it does over all
other issues affecting regulatory compliance.
iv. Accounting considerations. Licensees shall maintain separate
general ledger accounts for the original cost of Loans and
Investments and any valuation adjustments thereto. Valuation
adjustments shall be in the form of unrealized appreciation or
depreciation, respectively representing valuations above or below
cost. The sum of cost and unrealized appreciation or depreciation
represents fair value.
v. Unrealized appreciation may be recognized on equity
investments and debt investments which contain equity features, such
as options or warrants. Recognition of unrealized appreciation on
loans is not permitted under SBA's valuation guidelines.
vi. A general allowance for losses on Loans and Investments is
not utilized in fair value accounting. Rather, the Licensee's Board
of Directors or General Partner(s) shall value Loans and Investments
individually as of the financial statement date. This requirement
applies equally to Licensees engaged in equity investing and in
lending. A Licensee which is primarily engaged in lending, however,
may also identify additional anticipated losses on the basis of its
portfolio history, industry experience, or other relevant factors;
such amounts may be reported in the Statement of Financial Position
of SBA Form 468 as additional unrealized depreciation not associated
with specific portfolio assets.
vii. An appropriate tax provision shall be established for net
unrealized appreciation on securities held by taxable corporate
Licensees. There may also be circumstances in which a tax benefit
for net unrealized depreciation should be recognized, depending on
the likelihood of realization. Such a provision or benefit shall be
determined in accordance with FASB Statement No. 109, ``Accounting
for Income Taxes''.
E. Interest Income
i. Interest income shall be accrued according to the terms of
interest bearing loans and investments. Premiums or discounts
associated with debt instruments represent adjustments to interest
income which shall be amortized over the stated life of the debt
instrument.
ii. Collection in Doubt. Interest income shall not be recognized
if collection is doubtful. Licensees may choose to handle doubtful
interest receivable in either of two ways: (1) Make no entry to
accrue interest in the regular general ledger accounts and track
interest due in a memorandum account; or (2) accrue the interest and
provide a 100% reserve (debit provision for loss on receivables,
credit allowance for uncollectible interest receivable). The method
used by the Licensee must be disclosed in the footnote to the
financial statements summarizing significant accounting policies.
iii. Collection of interest is presumed to be in doubt when
either or both of the following conditions occur: (1) The small
concern is in bankruptcy, insolvent, or there is substantial doubt
about its ability to continue as a going concern; or (2) the small
concern is in default more than 120 days to the Licensee. Licensees
may rebut this presumption by providing evidence of collectibility
satisfactory to SBA. Such evidence may include the existence of
collateral, the value of which has been verified through an
appraisal by an independent professional appraiser acceptable to
SBA. Such an appraisal shall be at liquidation value (net of
liquidation costs) and shall have been performed within the 12
months immediately preceding the valuation date. In considering
whether collateral provides an appropriate basis for valuations, SBA
will consider the nature of a Licensee's claim on the collateral
(for example, whether other parties have security interests senior
to the Licensee's, or whether the Licensee's security interest in an
asset is perfected). SBA will also review the Licensee's operating
history for evidence concerning its willingness and ability to
pursue available remedies (including foreclosure) in default
situations.
iv. The two conditions cited in the preceding paragraph are not
the only possible indicators of a collection problem. Even if
neither condition is present, other circumstances may cause the
Board of Directors or General Partner(s) to conclude that collection
is in doubt.
v. When interest income is not being recorded on a loan or debt
security, the Licensee shall so note in its Annual Financial Report
on Form 468. The note should include the date at which interest
accrual was discontinued. In addition, the total amount of interest
not accrued because collection is in doubt shall be disclosed in a
footnote to the financial statements.
vi. When the accrual of interest is discontinued, the full
amount of any interest receivable recorded in prior periods must be
either reversed or fully reserved.
F. Dividend Income
i. Dividend income from investments in common or preferred stock
is normally recognized as of the date of record (the date at which
official ownership of shares is determined for the purpose of paying
the dividend). Dividend income shall not be accrued in the absence
of a dividend declaration by the small concern's board of directors.
This treatment shall apply to all dividends, including dividends on
redeemable preferred stock or similar securities with some debt-like
characteristics.
ii. Any cash distribution which is identified as a return of
capital shall not be recognized as income. Such distributions are a
reduction in the cost basis of an investment.
iii. Stock splits and stock dividends (in stock of the same
class as that owned) are not income because the Licensee's
proportional interest in the small business concern does not change
as a result of such events. The cost of the shares previously held
should be allocated, on a rational basis, to the number of shares
held after the split or dividend. Similarly, when stock rights are
received, a portion of the cost basis of the related investment may
be allocated to the rights.
iv. Dividends in kind are recorded as income at the fair value
of the property received. Such income should be classified as Non-
Cash Gains/Income in the Statement of Financial Position of SBA Form
468. If the Licensee has a choice between a dividend in cash or in
kind, and chooses to receive an in-kind dividend, the fair value is
deemed to be the amount of cash that could have been received.
G. Profit Participation in Small Concerns
Participation in the profits of a loan- or debt-financed small
business concern represents additional interest income to the
Licensee. For regulatory purposes, any profits received must be
included in the calculation of the Cost of Money.
H. Fees Charged to Small Concerns
i. Income from nonrefundable fees charged by SBICs in connection
with the origination of loans shall be deferred and amortized over
the term of the financing, regardless of whether or not such fees
are included in the Cost of Money. Licensees should be aware of the
provisions set forth in Sec. 107.402 (d) through (g) concerning
permissible fees, prepayment penalties, obligations of SBICs to
provide certain fee-related information in writing to small
concerns, and circumstances in which SBICs may be required to refund
fees paid by small concerns.
ii. If a Licensee has made a commitment for a financing which
does not take place, any processing fees which the Licensee is
permitted to retain pursuant to Sec. 107.402(d) shall be recognized
as income upon expiration of the commitment.
I. Accounting for Investments in Flow-Through Entities
i. On SBA Form 468, in the Statement of Operations Realized,
Licensees are asked to report income (loss) from investments in
partnerships or other types of flow-through entities. This category
of investments is intended to include any entity which allocates its
income and losses to its equity holders and is not taxed at the
entity level. Any such investments made by SBICs would most commonly
be in limited partnerships.
ii. For investments of this type, original cost is adjusted at
the end of each accounting [[Page 7398]] period to recognize the
investor's share of earnings or losses of the investee. The amount
of the adjustment is included in the net income of the investor.
Distributions received from an investee reduce the carrying amount
of the investment.
iii. It should be noted that the steps in the preceding
paragraph determine only the cost basis of investments. Any
investment included in an SBIC's portfolio of Loans and Investments
still must be valued by the Board of Directors or General Partner(s)
and presented at fair value in the Licensee's financial statements.
iv. Any income from investment in flow-through entities must be
included initially in Non-cash Gains/Income, as discussed in
paragraph X of this section V. When a Licensee actually receives a
distribution from the investee, the amount received should be
reclassified from Non-cash Gains/Income to Undistributed Net
Realized Earnings.
J. Equity Method of Accounting
i. The only type of investment which shall be accounted for
under the equity method is an investment in the common stock of a
Section 301(d) Licensee, as permitted under Sec. 107.712. Since a
Licensee investing in a Section 301(d) Licensee is required to have
an ownership interest of at least 20 percent, use of the equity
method will normally be appropriate. Under the equity method,
original cost is adjusted at the end of each accounting period to
recognize the investor's share of earnings or losses of the
investee. The amount of the adjustment is included in the net income
of the investor. Dividends or distributions received from an
investee reduce the carrying amount of the investment.
ii. Licensee should not use the equity method to account for
investments in the common stock of small business concerns, even if
a Licensee's ownership interest exceeds 20 percent. SBICs, whether
or not registered under the Investment Company Act of 1940, are
exempt from the usual requirements concerning use of the equity
method because they account for investments at fair value (see APB
Opinion No. 18, ``The Equity Method of Accounting for Investments in
Common Stock'', paragraph 2).
K. Accounting for Income Taxes
i. In February 1992, the FASB issued Statement No. 109,
``Accounting for Income Taxes''. The Statement is effective for
fiscal years beginning after December 15, 1992. Statement No. 109
supersedes FASB Statement No. 96, as well as APB Opinion No. 11,
which many companies continued to follow during the period when
adoption of Statement No. 96 was optional.
ii. Statement No. 109 establishes the following basic principles
to be applied in accounting for income taxes at the date of
financial statements:
(1) A current tax liability or asset is recognized for the
estimated taxes payable or refundable on tax returns for the current
period.
(2) A deferred tax liability is recognized for the estimated
future tax effects of ``taxable temporary differences'' (events
which will result in future taxes payable).
(3) A deferred tax asset is recognized for the estimated future
tax effects of ``deductible temporary differences'' (events which
will result in future tax savings), operating loss carryforwards,
and tax credit carryforwards.
(4) A valuation allowance is recognized to reduce the deferred
tax asset to the extent that the tax benefits are not expected to be
realized.
(5) Both current and deferred tax liabilities and assets are
based on provisions of the enacted tax law; the effects of future
changes in tax laws or rates are not anticipated.
iii. The ability to recognize deferred tax assets under certain
circumstances represents a significant change from earlier
pronouncements. Licensees which recognize deferred tax assets should
take careful note of the requirements of Statement No. 109 in
determining whether it is ``more likely than not'' that such assets
will be realized. Generally, application of the ``more likely than
not'' standard means that when ``negative evidence'' exists which
suggests that benefits will not be realized, there must be
sufficient ``positive evidence'' to outweigh it; otherwise, a
valuation allowance is required.
iv. Because SBICs must report their Loans and Investments at
value, many Licensees will find it necessary to apply the criteria
of Statement No. 109 in determining whether to recognize deferred
tax liabilities or assets reflecting the estimated future tax
effects of unrealized gains or losses. Both unrealized gains and
unrealized losses are temporary differences as defined in the
statement. Previously, SBA required Licensees with net unrealized
appreciation to record a provision for estimated future taxes, but
did not permit Licensees with net unrealized depreciation to record
a corresponding benefit. In accordance with current GAAP, such a
benefit may now be recorded.
v. The reporting of unrealized gains and losses and the related
tax effects must be consistent. Since SBIC program accounting
guidelines require that changes in unrealized appreciation or
depreciation be excluded from net income (that is, they do not
appear in the statement of operations realized), it follows that the
related tax effects must be similarly excluded. Both elements,
however, are included in ``comprehensive income'' (that is, they
affect the equity of Licensees). This is reflected in the
presentation of net unrealized appreciation or depreciation, net of
estimated future tax effects, as Unrealized Gain (Loss) on
Securities Held in the Capital section of the Statement of Financial
Position.
L. Realized Gain (Loss) on Investments
i. Realized gain or loss on investment shall be recorded by
Licensees in accordance with generally accepted accounting
principles.
ii. Capital gains realized on the sale of securities shall be
recognized provided that collection of proceeds is reasonably
assured and the earnings process is complete. For the earnings
process to be considered complete, the Licensee must have no further
obligation related to the transaction. Any transaction with recourse
upon the Licensee or involving any understanding, agreement, option,
privilege, or other rights to repurchase by and/or resell to the
Licensee shall not be considered as a final transaction.
Transactions which do not meet the criteria in this paragraph L for
current recognition of gains shall be accounted for using an
appropriate alternate method, such as the installment method or the
cost recovery method. Under the installment method, a portion of the
gain is recognized with each installment payment received; under the
cost recovery method, no gain is recognized until the full amount of
the seller's cost has been collected.
iii. Capital losses may arise not only from sales, but also from
write-offs or charge-offs of securities held (the two terms are
generally used synonymously in this appendix; in contrast, the term
``write-down'' refers to the recording of unrealized depreciation).
Write-offs may be either full or partial. Writing off an investment,
in comparison with recording unrealized depreciation, represents a
stronger judgment concerning loss of value. However, it is not
necessary to have a definitive event (such as bankruptcy of the
small business concern) in order to write off an investment.
Generally accepted accounting principles call for the recognition of
loss when it becomes evident that previously recognized future
economic benefits of an asset have been reduced or eliminated.
iv. A Licensee may also realize capital gains or losses in
connection with the exchange or non-reciprocal transfer of
securities. The treatment of such transactions is governed by APB
Opinion No. 29, ``Accounting for Nonmonetary Transactions'', and is
discussed in paragraph M of this section V.
v. If a Licensee acquires shares of an investee's stock (of the
same class) at different times and prices, SBA requires that the
average cost method be used to determine the cost of such securities
when sold.
vi. When a gain or loss is realized, whether as a result of the
sale, other disposal or write-off of an asset, any previously
recorded unrealized appreciation or depreciation associated with the
asset shall be reversed.
vii. Non-cash Gains. When a Licensee realizes capital gains, but
does not receive cash at the time of the transaction, SBA requires
Licensees to segregate such ``Non-cash Gains'' from other components
of Undistributed Realized Earnings, until such time as any non-cash
assets received are converted to cash. Non-cash Gains are realized
earnings which have been recognized in the Licensee's Statement of
Operations. They are segregated in the Statement of Financial
Position only because they are subject to certain restrictions under
SBA regulations, primarily concerning distributions. In effect, Non-
cash Gains can be considered a type of restricted retained earnings.
For further information on Non-cash Gains, see ``Undistributed
Realized Earnings'' in paragraph X of this section V.
M. Nonmonetary Transactions
i. Licensees should follow APB Opinion No. 29 to the extent
applicable when accounting for nonmonetary transactions. Such
transactions include both reciprocal and non-reciprocal transfers of
nonmonetary assets or liabilities between the Licensee and
[[Page 7399]] another entity or person, or between the Licensee and
its stockholders or partners. The cost of an asset acquired in a
nonmonetary transaction is the fair value of the asset relinquished
to obtain it, and a gain or loss should be recognized on the
exchange. Any gain recognized shall be reported on SBA Form 468 as a
Non-cash Gain.
ii. Nonmonetary transactions in which the Licensee exchanges
certain securities or assets for other securities or assets will
result in the realization of gain or loss for financial reporting
purposes, regardless of whether such transactions are taxable or
non-taxable exchanges.
iii. Fair value of a nonmonetary asset transferred to or from a
Licensee should be determined by referring to estimated realizable
values in cash transactions of the same or similar quoted market
prices, independent appraisals, estimated fair values of assets, or
other available evidence.
iv. In cases where the values are not clearly determinable,
assets received will have the same accounting basis as the assets
transferred.
v. Dividends In Kind and Spin-offs. Dividends or other
distributions in kind, consisting of shares of a small business
concern or other securities, are nonreciprocal transfers of non-
monetary assets from a Licensee to its owners. Such transfers shall
be reported at the fair value of the assets distributed.
N. Interest, Notes and Accounts Receivable
i. Interest Receivable. In reporting interest receivable,
Licensees should make certain that amounts are properly classified
between current and noncurrent assets. Current assets are those
providing benefits which are expected to be realized within the next
fiscal year.
ii. Interest receivable is reported net of an allowance for
uncollectible amounts, which represents a conservative estimate of
probable losses. The allowance shall be adjusted, at a minimum, as
of the end of the fiscal year. Interim adjustment to reflect changes
in the status of receivables is strongly encouraged. See paragraph E
(``Interest Income'') of this section V for guidelines to be used by
SBICs in evaluating the collectibility of interest income.
iii. Expense is recognized whenever the allowance for
uncollectible amounts is adjusted to reflect a change in the
valuation of interest receivable. An actual write-off of interest
receivable is normally recorded as a reduction of the receivable and
a corresponding reduction of the allowance, and does not result in
the recognition of expense.
iv. The total expense recognized during a fiscal year with
respect to uncollectible interest receivable appears on Form 468 in
the Statement of Operations Realized, under the caption, ``Provision
for Losses on Accounts Receivable.''
v. Requirements concerning the recording of interest receivable
and the related interest income appear in this appendix under the
heading, ``Interest Income.''
vi. Notes and Accounts Receivable. The accounting treatment of
notes receivable and accounts receivable shall be governed by the
same rules which apply to interest receivable, as previously
described in this paragraph N.
vii. Notes Receivable represents the unpaid balance of
miscellaneous notes which do not fit into any category of Loans and
Investments. It does not include notes representing amounts due from
purchasers of assets acquired in liquidation of portfolio
securities, which are presented separately in the Loans and
Investments section of the Statement of Financial Position on Form
468.
viii. Accounts Receivable represents amounts due on account,
such as for management consulting, appraisal, or other services
rendered. Accounts Receivable also includes accrued fees for
services rendered in connection with participations or joint
financings and accrued fees receivable from small concerns.
O. Compensating Balances
i. In those instances where idle funds are encumbered or are
required to be maintained at a financial institution as compensating
balances in connection with debt of the SBIC, the nature of the
encumbrance and the terms of any applicable agreements shall be
disclosed in a footnote to the financial statements.
ii. Depending upon the specific terms, it may be necessary to
classify idle funds subject to a compensating balance agreement as
non-current assets.
P. Organization Costs
i. Organization costs are incurred in the formation of an SBIC
and may include such items as legal fees, incorporation and various
other fees imposed by states, and promotional expenditures. SBICs
should amortize organization costs over a term of not more than five
years.
ii. If an SBIC incurs organization costs which are deemed by SBA
to be unreasonable or excessive, such costs must be excluded from
Regulatory Capital as long as they are carried as an asset by the
SBIC. Once such costs have been amortized to expense, the regulatory
deduction is no longer required. No deduction is ever required for
organization costs accepted by SBA as reasonable.
iii. Operating losses incurred by a company prior to licensing
as an SBIC are not considered organization costs and shall not be
capitalized.
Q. Contingent Liabilities
i. Licensees shall accrue or disclose contingent liabilities, as
appropriate, in accordance with the requirements of FASB Statement
No. 5. Such requirements vary depending upon whether the likelihood
of realizing a loss is evaluated as ``probable'', ``reasonably
possible'', or ``remote''. Contingent liabilities may arise from
such transactions or events as the issuance of guarantees, pending
litigation, and the sale of portfolio interests with recourse.
ii. In addition to the reporting requirements of FASB Statement
No. 5, Licensees and their IPAs should be familiar with SBA's
requirements for reporting of certain contingencies. These
additional requirements include the completion of the Schedule of
Guarantees (include in SBA Form 468) by Licensees which have
guaranteed the obligations of small concerns and the filing of a
litigation report by Licensees which become a party to litigation
(see Sec. 107.1002(f)).
iii. A Licensee which has sold portfolio securities (or any
interest therein) on a recourse basis should be aware that any
amounts for which it may be contingently liable must be treated as
investments in small concerns for overline purposes (see
Secs. 107.707(b) and 107.303).
R. Transactions with Related Parties
i. Licensees shall disclose material transactions with related
parties in accordance with FASB Statement No. 57. In applying the
requirements of this pronouncement to SBIC financial statements, a
Licensee shall consider the term ``related party'' to encompass any
person or entity which is an Associate as defined in Sec. 107.3.
Footnote disclosures of related party transactions shall include the
name of the related party as well as the nature of the relationship.
ii. Licensees and their IPAs should be aware that certain
transactions involving Associates are either prohibited by SBA
regulations or permitted only with SBA's prior written approval. See
Sec. 107.903 (``Conflicts of Interest'').
S. Leverage--Debentures Guaranteed or Purchased by SBA
i. SBICs which qualify on the basis of financial soundness and
regulatory compliance are eligible to receive long-term leverage in
the form of five-year or ten-year debentures guaranteed (or, in some
cases, purchased directly) by SBA. Debentures with an interest rate
subsidy of three percentage points for the first five years of their
term are available to Section 301(d) Licensees only.
ii. Debentures, net of current maturities, shall be classified
in the financial statements as long-term debt, and shall be shown at
face value in the Statement of Financial Position of Form 468.
iii. Licensees issuing debentures pay a user fee (currently 2
percent of the amount borrowed) and an underwriter's fee (currently
.625 percent). These fees shall be capitalized and amortized over
the life of the debenture. Generally accepted accounting principles
normally require that debt be reported net of the unamortized
portion of related fees; Licensees, however, should report the
unamortized fees as an asset and the debentures at their gross
amount. SBA does not believe that this treatment will constitute a
material departure from GAAP for most Licensees.
iv. Debentures are subject to the terms and conditions set forth
in SBA regulations. In most respects, debentures incorporate by
reference the regulations as amended from time to time. With respect
to events of default, however, debentures incorporate those events
and associated remedies in existence at the date of issue. Thus,
debentures issued at different times may be subject to different
default provisions. Events of default include both financial and
regulatory conditions, which may result in [[Page 7400]] the entire
indebtedness of the Licensee being declared due and payable.
v. If SBA decides to demand payment in accordance with the
acceleration provisions of the debentures, such demand ordinarily
will be presented in a letter specifying the violations that have
occurred.
T. Leverage--Participating Securities Guaranteed by SBA
i. Participating Securities are redeemable preferred equity-type
securities. Issuers are required to make equity investments in an
amount at least equal to the amount of Participating Securities
issued (see the defined term ``Equity Capital Investments'' in
Sec. 107.3 for the specific categories of investments permitted).
The structure, terms and conditions of the Participating Security
are set forth in detail in Secs. 107.240 through 107.247.
ii. The Act authorizes SBA to guarantee Participating Securities
issued in the form of limited partnership interests, preferred
stock, or debentures with interest payable only to the extent of
earnings. Currently, the only form of Participating Security for
which documentation has been created is a limited partnership
interest to be held by SBA. Other forms will be made available in
the future as required to meet the needs of Licensees.
iii. The Participating Security has the following significant
features:
(1) Licensees issue Participating Securities to SBA, which in
turn assigns certain of its interests in such securities to a pool.
Investors (known as ``certificate holders'') then purchase interests
in the pool through a public offering. Each Licensee issuing
Participating Securities pays a cumulative preferred return
(``Prioritized Payments'') which is passed through to the
certificate holders, but such payments are contingent upon the
profitability of the issuer. Any Prioritized Payments which exceed
the cumulative earnings of a Licensee will be paid to the
certificate holders by SBA as guarantor. The Licensee, however, will
be ineligible to make any other profit distributions until it has
paid all of its Prioritized Payments (including reimbursement of
amounts previously advanced on its behalf by SBA).
(2) In consideration for SBA's guarantee, profitable Licensees
must pay a percentage of earnings to SBA as ``Profit
Participation''. SBA's profit percentage (the ``Profit Participation
Rate'') depends upon the Licensee's ratio of Participating
Securities issued to Leverageable Capital, as well as the interest
rate on 10-year Treasury securities at the time each Participating
Security was issued.
(3) Except for Prioritized Payments, SBA (the ``Preferred
Limited Partner'') and the Licensee's private limited partners
receive distributions at the same time, allocated in accordance with
legislative formulas.
(4) The securities have a 10-year term, at the end of which
redemption is mandatory. It is expected, however, that most
Participating Securities will be redeemed, at least in part, before
the mandatory redemption date.
iv. Participating Securities will be reported in a ``Redeemable
Securities'' section of the Statement of Financial Position on SBA
Form 468. The amount of Participating Securities issued represents
the capital contribution of SBA, the Preferred Limited Partner.
SBA's capital account will increase by the amount of any Prioritized
Payments or Profit Participation which the License becomes obligated
to pay on the basis of profits earned, and will decrease as
distributions are actually received. Distributions to SBA will be
applied as Prioritized Payments, Profit Participation, or
redemptions of outstanding leverage in accordance with Secs. 107.243
through 107.245.
v. In a footnote to the financial statements, the Licensee shall
provide a description of the terms of the Participating Securities
issued, including disclosure of the mandatory redemption date. If
there are any ``accumulated'' Prioritized Payments (representing a
contingency for amounts paid to certificate holders by SBA on the
Licensee's behalf, which the Licensee must repay as profits are
realized), a footnote shall provide the dollar amount of the
accumulation for the current fiscal year period and the aggregate
amount accumulated.
vi. For companies licensed after March 31, 1993, the obligation
to pay Prioritized Payments and Profit Participation is conditioned
upon the profitability of the Licensee as a whole. Those licensed
earlier, however, may be permitted to exclude profits attributable
to portfolio assets in existence as of March 31, 1993.
vii. Because of the complexity of the required profit and
distribution computations, all Licensees issuing Participating
Securities shall use SBA-provided software to perform such
computations.
U. Preferred Securities Leverage for Section 301(d) Licensees
i. Four Percent Preferred Securities. Section 301(d) Licensees
which qualify on the basis of financial soundness and regulatory
compliance are eligible to receive long-term leverage by selling 4%
redeemable preferred securities (either preferred stock or a
preferred limited partnership interest) directly to SBA. Such
securities must be redeemed not later than 15 years from the date of
issuance, at which time any unpaid portion of the preferred and
cumulative 4% return due to SBA must also be paid. No distributions
may be made to any investor other than SBA unless the Licensee is
current on all amounts due SBA.
ii. Like Participating Securities, 4% preferred securities will
be reported in the ``Redeemable Securities'' section of the
Statement of Financial Position on SBA Form 468. Unlike
Participating Securities, however, which specifically provide for
the extinguishment of any obligation to pay Prioritized Payments in
excess of the issuer's profits, the legislation which authorized 4%
preferred securities does not set forth any circumstances in which
the 4% return would be extinguished.
iii. The initial carrying amount of 4% preferred securities
shall be the purchase price paid by SBA at the date of issue (for 4%
preferred stock issued by corporate Licensees, this amount must be
equal to the par value). At the end of each accounting period, the
carrying amount shall be increased by the amount of any 4% returns
not currently paid or declared. A breakdown of the total carrying
amount, showing separately the purchase price of 4% preferred
securities and the accrued 4% returns in arrears, is reported on the
Statement of Financial Position.
iv. Cumulative 4% returns in arrears must be recorded as a
charge against Undistributed Net Realized Earnings. For some Section
301(d) Licensees, these amounts may exceed Undistributed Net
Realized Earnings. Ordinarily, a company in these circumstances
would reduce paid-in capital or partners' contributed capital by the
amount of the excess. Because such treatment would reduce Regulatory
Capital, however, it could result in certain unintended regulatory
compliance problems for Licensees (such as overline violations).
Therefore, on SBA Form 468, Licensees shall report all 4% returns in
arrears as a reduction of Undistributed Net Realized Earnings, even
though this treatment may result in a deficit, and shall not reduce
paid-in capital or partners' contributed capital.
v. Because Section 301(d) Licensees must charge the 4% return to
Undistributed Net Realized Earnings whether it is paid or not, any
unpaid amounts must be added back in order to determine a Licensee's
Retained Earnings Available for Distribution. Unpaid 4% returns must
be paid in full from Retained Earnings Available for Distribution
before any other distributions can be made.
vi. In a footnote to the financial statements, the Licensee must
provide a description of the terms of the preferred securities
issue, including disclosure of the mandatory redemption date. If
there are 4% returns in arrears, a footnote shall provide the dollar
amount of the arrearage for the current fiscal period, the aggregate
amount in arrears, and the number of periods in arrears.
vii. Three Percent Preferred Stock. Before November 21, 1989,
corporate Section 301(d) Licensees were eligible to receive long-
term leverage by issuing 3% cumulative preferred stock to SBA at par
value. Three percent preferred stock has no mandatory redemption
date and is classified as equity for financial reporting purposes.
However, it shall not be treated as Regulatory or Leverageable
Capital for any purpose.
viii. No dividends may be paid to any investor other than SBA
unless the Licensee is current on all 3% preferred dividends due
SBA.
ix. Three Percent Preferred Stock Repurchase Program. SBA
published in the Federal Register a notice announcing the
implementation of a program under which Section 301(d) Licensees may
apply to repurchase their outstanding 3% preferred stock from SBA at
a set price of 35 percent of par value. Specific guidelines
governing repurchase transactions are set forth in SBA Policy and
Procedural Release #2021, issued June 14, 1994. Licensees will have
three years from the date of the Policy and Procedural Release
during which to apply for and complete the Repurchase Program.
x. Participants in the Repurchase Program will receive detailed
accounting guidance [[Page 7401]] from SBA at the time their
repurchases are completed. In general, when a company repurchases
its own stock at a discount (that is, for less than the original
issue price), it records an increase in paid-in surplus equal to the
discount. Section 301(d) Licensees will follow this general rule,
but the increase in surplus attributable to the repurchase must be
separately identified (as ``Restricted Contributed Capital
Surplus'') on SBA Form 468 because it is subject to certain
restrictions for regulatory purposes.
V. Contributed Capital and Committed Capital
i. In general, ``contributed capital'' refers to funds
contributed to a Licensee by private investors (although such funds
may also include ``qualified nonprivate funds'' from State and local
government sources, in accordance with the definition of Private
Capital in Sec. 107.3). Although some Licensees may obtain financial
assistance through the issuance of equity-type securities purchased
or guaranteed by SBA, such securities are reported on Form 468 as
SBA leverage rather than as contributed capital. The contributed
capital of a corporate Licensee consists of the par value of its
capital stock (which may consist of one or more classes or stock)
and its aggregate paid-in surplus, excluding Restricted Contributed
Capital Surplus obtained through the repurchase of 3 percent
preferred stock from SBA. For a partnership Licensee, contributed
capital consists of proceeds from the sale of partnership interests
to the general partners and the limited partners (other than SBA).
For all Licensees, contributed capital shall be recorded net of
expenses incurred to obtain the capital.
ii. Capital contributed to a Licensee in the form of non-cash
assets requires the prior approval of SBA, unless such assets are
physical assets to be currently employed by the Licensee in its
operations (see Sec. 107.705). Equity securities issued in exchange
for approved non-cash assets will be excluded from a Licensee's
Regulatory Capital until the assets received are converted to cash.
iii. Commitments from Investors. In addition to its contributed
capital, a Licensee may have outstanding commitments from
individuals or entities to invest additional funds in the Licensee
at a future date. Binding commitments from Institutional Investors
(as defined in Sec. 107.3) may be included in the Licensee's
Regulatory Capital; the principal effects of such inclusion are to
increase the Licensee's overline limitation (See Sec. 107.303) and
to increase the capital base used in the computation of Capital
Impairment (see Sec. 107.210(h)).
iv. Unfunded commitments from investors shall not be reported as
part of the contributed capital of the Licensee on SBA Form 468. The
amount of such commitments shall be disclosed in a footnote to the
financial statements, which shall separately identify commitments
included in Regulatory Capital and any other commitments
outstanding. Any significant terms and conditions associated with
investor commitments, including the timing of anticipated drawdowns
if known, shall also be disclosed.
W. Unrealized Gain (Loss) on Securities Held
i. Unrealized Gain (Loss) on Securities Held results from the
valuation of Loans and Investments by the Board of Directors or
General Partner(s). Unrealized appreciation is recognized for
valuations above cost and unrealized depreciation is recognized for
valuations below cost. Unrealized gain or loss is the aggregate
amount obtained by summing the unrealized appreciation or
depreciation of all Loans and Investments, net of any estimated
future income tax effects.
ii. Unlike some other types of investment companies, such as
mutual funds, SBICs do not report changes in net unrealized
appreciation or depreciation in the Statement of Operations.
Instead, such changes are recorded directly in the capital account,
Unrealized Gain (Loss) on Securities Held. SBA requires this
treatment for two reasons: (1) because most securities held by SBICs
have no readily ascertainable market values and valuation of such
securities is highly subjective, SBA prefers that reported net
income not be influenced by changes in valuation; and (2)
segregation of unrealized gains and losses on the Statement of
Financial Position makes it easier to perform certain computations
required by SBA regulations.
X. Undistributed Realized Earnings
i. Undistributed Realized Earnings is the defined term used in
SBA regulations to represent the earned capital of a Licensee. In
general, Undistributed Realized Earnings are the cumulative balance
of periodic net investment income (loss) and realized gain (loss) on
investments, less dividends or distributions (at times, an SBIC may
need to make an adjustment which is not reflected in this general
formula). To accommodate regulatory requirements, two components of
Undistributed Realized Earnings are presented separately in the
financial statements:
ii. Non-cash Gains/Income consists of (1) gains on the
disposition of securities realized in the form of notes, securities
or any other non-cash assets; (2) income from investments in pass-
through entities (such as limited partnerships) which has not been
distributed to the Licensee; (3) dividends received in kind; (4)
interest income accrued on deferred interest notes, zero coupon
bonds or similar instruments; and (5) delinquent accrued interest
converted into a new note or added to the principal of an existing
note (the amount of such interest which is included in Undistributed
Net Realized Earnings must be reclassified to Non-cash Gains/
Income).
iii. Non-cash Gains/Income represents realized earnings of an
SBIC which have been recognized in the Statement of Operations. Such
earnings are segregated in the Statement of Financial Position only
because they are subject to certain restrictions under SBA
regulations, primarily concerning distributions. In effect, Non-cash
Gains/Income can be considered a type of restricted retained
earnings.
iv. Classification of capital gains or other income as non-cash
items is intended to be temporary. As a Licensee receives payments
on a note, receives distributions from a partnership in which it has
invested, sells shares of stock received as a dividend or otherwise
converts non-cash assets to cash, amounts initially reported as Non-
cash Gains/Income shall be transferred to Undistributed Net Realized
Earnings.
v. Undistributed Net Realized Earnings is a residual, computed
by subtracting the balance in Non-cash Gains/Income from
Undistributed Realized Earnings. If an SBIC holds treasury stock,
Undistributed Net Realized Earnings are restricted (i.e., not
available for distribution) to the extent of the cost of such
treasury stock.
Y. Retained Earnings Available for Distribution
i. Retained Earnings Available for Distribution represents, in
most cases, the maximum amount that an SBIC may distribute to
investors. For SBICs which have received financial assistance from
SBA in a form other than debentures, the term ``investors''
encompasses SBA as well as private investors.
ii. In some instances, SBA is entitled to receive payments from
Retained Earnings Available for Distribution on a priority basis,
and must receive these payments before any amounts may be
distributed to investors or transferred to private capital.
Dividends (or equivalent distributions) on 4% preferred securities
issued by Section 301(d) Licensees are examples of such payments. In
other cases, SBA may be entitled to receive payments from Retained
Earnings Available for Distribution in proportion to any
distributions received by private investors. Profit participations
on Participating Securities are an example of this type of payment.
iii. For most Licensees, Retained Earnings Available for
Distribution is computed by subtracting unrealized depreciation on
Loans and Investments from Undistributed Net Realized Earnings
(excluding any restricted amounts). Unrealized depreciation and
unrealized appreciation are not netted in this computation.
iv. For Section 301(d) Licensees which have issued 4% preferred
securities, there is one additional element in the computation.
Because 4% distributions in arrears are accrued and charged against
Undistributed Net Realized Earnings, they must be added back to
determine Retained Earnings Available for Distribution.
v. Although partnerships do not ordinarily report retained
earnings as such, partnership SBICs must compute Retained Earnings
Available for Distribution in the same manner as corporate SBICs.
Further discussion of the equity classifications used by partnership
SBICs in financial reporting to SBA appears in paragraph Z
(``Partnership Capital Accounts'') of this section V.
vi. If a Licensee has negative Retained Earnings Available for
Distribution as of the end of a fiscal period, and has made or
declared a distribution during such period, the distribution may
have violated SBA regulations. It is the Licensee's responsibility
to show, to the satisfaction of SBA, that it had sufficient Retained
Earnings Available for Distribution at the time the distribution was
made. In particular, a Licensee should [[Page 7402]] consider the
adequacy of its unrealized depreciation before making a
distribution.
vii. Capitalization of Retained Earnings Available for
Distribution. Ordinarily, contributed capital and earned capital are
maintained and reported separately. In the SBIC program, however, a
Licensee which has attained positive Retained Earnings Available for
Distribution has the option of ``capitalizing'' such earnings by
permanently reclassifying them as contributed capital. As a result
of the reclassification, Undistributed Net Realized Earnings are
reduced, while paid-in capital is increased; the net effect is the
same as if the Licensee had made a distribution to its owners, who
then reinvested the same amount in the Licensee. From a regulatory
perspective, this action results in an increase in the Licensee's
Leverageable Capital, thus increasing its eligibility for SBA
leverage. Capitalization of Retained Earnings Available for
Distribution reflects the intent of a Licensee to pursue long-term
growth by reinvesting its earnings in small businesses.
viii. 1940 Act Companies. A Licensee which has registered under
the Investment Company Act of 1940 may elect to be taxed as a
regulated investment company under the Internal Revenue Code
(Secs. 851 through 855). In general, such a company can avoid
taxation at the corporate level if it distributes at least 90
percent of its investment company taxable income for a given year.
ix. Licensees which are (or contemplate becoming) 1940 Act
companies should be aware that the distribution requirements imposed
on such companies by the Internal Revenue Code may, under certain
circumstances, conflict with SBA regulations concerning
distributions to shareholders. SBA regulations allow profit
distributions to be made only from Retained Earnings Available for
Distribution. Any distribution which would exceed Retained Earnings
Available for Distribution requires the prior written approval of
SBA.
Z. Partnership Capital Accounts
i. To provide the information necessary to determine compliance
with various SBA regulations, Licensees which organize as limited
partnerships must divide partners' capital into specified
categories. The categories are (1) Partners' Contributed Capital,
(2) Unrealized Gain (Loss) on Securities Held, (3) Non-Cash Gains/
Income, and (4) Undistributed Net Realized Earnings (Partners'
Earned Capital). The sum of these four accounts is the equivalent of
the total partners' capital of a non-SBIC partnership. The Licensee
must also record the general and limited partners' shares of each
capital account, which results in eight separate control accounts
for partners' capital.
ii. Partners' Permanent Capital Contribution. This balance
represents proceeds from the sale of partnership units and any other
partners' contributions of cash or other consideration to the
partnership, less any returns of capital or other deductions.
iii. Undistributed Net Realized Earnings and Non-Cash Gains/
Income. The sum of these two accounts represents the total
undistributed earned capital of the Licensee. Separate totals must
be maintained because SBA rules and regulations do not permit Non-
cash Gains/Income to be distributed until they have been converted
to cash. Both of these terms are explained in detail in paragraph X
of this section V.
iv. Unrealized Gain (Loss) on Securities Held. This component of
partnership capital results from the valuation of Loans and
Investments by the Board of Directors or General Partner(s).
Unrealized appreciation is recognized for valuations above cost and
unrealized depreciation is recognized for valuations below cost.
Unrealized gain or loss is the sum of the unrealized appreciation or
depreciation of all Loans and Investments. Estimated future tax
effects associated with unrealized appreciation or depreciation are
not taken into account because partnerships are not taxed at the
entity level. For further information, see paragraph W of this
section V.
VI. Availability of Publications and Forms
i. This section contains information about where to obtain
various publications and forms cited in this appendix I.
ii. The following forms may be obtained from the Investment
Division of SBA, 409 Third Street, SW., suite 6300, Washington, DC
20416: Form 468 (Annual Financial Report), Form 1031 (Portfolio
Financing Report), and CO Form 112 (IPA Certification). Forms 468
and 1031 are provided to all Licensees in the form of electronic
reporting software. SBA Policy and Procedural Releases #2001 through
2021 may also be obtained from the Investment Division.
iii. Pronouncements of the Financial Accounting Standards Board
(FASB) and its predecessor, the Accounting Principles Board (APB)
may be purchased from the Order Department, FASB, 401 Merritt 7,
P.O. Box 5116, Norwalk, CT 06856-5116.
iv. Publications of the American Institute of Certified Public
Accountants (AICPA) may be purchased from the Order Department,
AICPA, Harborside Financial Center, 201 Plaza III, Jersey City, NJ
07311-3881.
3. Appendix II, Chart of accounts for SBICs, is removed and
Appendix III, Valuation Guidelines for SBICs, is redesignated as
Appendix II.
Dated: December 7, 1994.
Philip Lader,
Administrator.
[FR Doc. 95-2937 Filed 2-6-95; 8:45 am]
BILLING CODE 8025-01-M