approval to perform the annual audit (financial examination) upon selection by the board, and the filing with SBA by such accountant of an executed IPA Statement, I Form 56, certifying as to his qualification and independence, unless the SBIC is otherwise advised by SBA. It is strongly recommended that the board give thorough consideration each year to the matter of selecting the public accountant to perform that year's audit. The board under this policy selects an accountant with whom it agrees as to the engagement and basis of compensation. The SBIC then furnishes notification of the board's selection to the Staff Accountant, Investment Division, Small Business Administration, 1441 L Street NW., Washington, D.C. 20416. Notification to SBA is not necessary when the same accountant or accountants are retained for successive years. This guide has been prepared, and made a part of the regulations, to inform Licensees under the Small Business Investment Act of 1958, as amended, and independent public accountants engaged by them as to SBA's minimum requirements concerning fidelity bonds, valuation of portfolio assets, and audits (financial examinations) of SBICs. It is not intended to be a complete manual of audit (financial examination) procedure, nor is it intended to supplant the accountant's judgment as to any additional work required to meet generally accepted auditing standards and to render adequate and appropriate reports. Through use of this guide by independent public accountants the Administration expects audits (financial examinations) of uniformly high quality to be made of all small business investment companies licensed by SBA. The procedures set forth herein apply generally to a type of audit technically termed a "financial examination." A financial examination is to be made in accordance with generally accepted auditing standards. The auditing procedures employed should include: (1) Review of the system of internal control and of the accounting principles followed; (2) independent sampling (through inspection, correspondence, etc.) to ascertain the existence of assets; (3) application of audit tests to determine that all liabilities are rejected in the balance sheet in actual or approximate amounts; (4) review and testing of the income and expense accounts; (5) review of the accounting records, with application of appropriate testing procedures, to determine the authenticity and general reliability of the financial statements prepared from the accounts; and (6) such other auditing procedures as the independent public accountant considers necessary in the circumstances. SBA expects the review and testing of operating transactions during the audit to be of sufficient scope to assure disclosure and correction of any erroneous recording or classification of income and expense items in the SBIC's books that would materially distort the statement of income and expense. SBA has prescribed a system of account classifications which is required to be used by licensed small business investment companies. The Agency requires uniform reporting and contemplates that generally accepted auditing standards will be maintained. The attainment of accounting and reporting uniformity and the maintenance of auditing standards will provide reliable information for use by SBIC management and SBA. Accountants engaged by SBICS should become familiar with: Small Business Investment Act of 1958, as amended. Regulations governing small business investment companies issued pursuant to the Small Business Investment Act of 1958, as amended. System of Account Classifications for Small General The financial statements referred to in this guide are those constituting the Financial Report, SBA Form 468, and should be prepared on such form. The accountant's examination should be directed toward the expression of an opinion as to whether the statements of (a) financial condition, (b) surplus reconciliations, (c) income and expense, and (d) realized gains and losses on investments, present fairly the financial position of the SBIC as of the audit date and the results of its operations for the period then ended in conformity with generally accepted accounting principles. The schedules of SBA Form 468 should be subjected to the audit procedures applied in the accountant's examination of the basic financial statements to enable him to express an opinion as to whether these schedules are fairly stated in all material respects in relation to the basic financial statements. If the SBIC prefers, it may have the accountant express an opinion on condensed financial statements consisting, as a minimum, of a statement of financial condition, a statement of surplus reconciliations, a statement of income and expense, and a statement of realized gains or losses on investments, and such other data as are considered necessary to disclose the SBIC's financial position at the close of the period under audit and the results of its operations for the period then ended in conformity with generally accepted accounting principles, all presented in a manner consistent with the presentation of accounts in SBA Form 468. If this optional audit report is prepared, it should be made to accompany the Financial Report, SBA Form 468, filed with SBA. The accountant's report accompanying the Financial Report should contain narrative comments summarizing the findings on each significant balance sheet account, and on the results of operations; they should also contain an explanation of any deviation from generally accepted auditing standards. (See the scope paragraph of "Accountant's Report.") The accountant should, when possible, provide an unqualified opinion. In cases in which he considers it necessary to qualify or disclaim an opinion, the accountant should cite, when applicable the specific loans, investments or other items causing such qualification or disclaimer, and also state the specific factors involved which led to the qualification or disclaimer. It is expected that all audit adjustments will be recorded in the SBIC's records before completion of the audit report, so that financial statements included in the audit report will agree with the books as adjusted to the balance sheet date, giving consideration to reclassifications of account balances for report purposes. Adjustments reflected in the audited statements, but not agreed to by the SBIC and not recorded on its books, must be commented upon in the report. The accountant's comments should be concise and meaningful. Comments stereotyped as to expression on the basis of previous reports are to be avoided. The agreement between the SBIC and the accountant with respect to the audit (financial examination) should provide that any information in the accountant's working papers will be made available upon request to the SBIC or to SBA. Three copies of the audit report, with SBA Form 468, properly executed by the appropriate officers of the SBIC shall be submitted to SBA by the SBIC or by the accountant if so requested by the SBIC. Any matters for SBA attention not included in the audit report are to be set forth in an accompanying letter by the Accountant. A copy of all adjusting journal entries recommended by the accountant should be attached to the inside of the back cover of each copy of the audit report submitted to SBA. Also attached to the inside of the back cover of each copy of the audit report should be a copy of any transmittal letter, special report, or similar communication furnished to the SBIC. All SBIC audit reports submitted to SBA should be sent to: Investment Division, Small Business Administration, 1441 L Street NW., Washington, D.C. 20416. Accountant's Report (Certificate) The accountant's report shall be dated, signed, and shall identify without detailed enumeration the financial statements covered by the report. The accountant's report shall state whether the audit was made in accordance with generally accepted auditing standards; and shall designate any auditing procedures generally recognized as acceptable or deemed necessary by the accountant under the circumstances of the particular case, which have been omitted, and the reasons for their omission. Nothing herein shall be construed to imply authority for the omission of any procedures which independent public accountants would ordinarily employ in the course of an audit made for the purpose of expressing the opinion required as stated hereinafter. The accountant's report shall (a) state clearly the opinion of the accountant as to the fairness with which the financial statements present the financial position of the Licensee at the audit date and the results of its operations for the period then ended in conformity with generally accepted accounting principles; (b) state whether the supplemental data contained in the schedules of SBA Form 468 have been subjected to the audit procedures applied in the examination of the basic financial statements and whether, in the accountant's opinion, these data are fairly stated in all material respects in relation to the basic financial statements; and (c) make reference to the consistent application of such principles or to any material changes in accounting principles or practices or method of applying the accounting principles or practices, which affect comparability of such financial statements with those of prior and future periods. Any matter to which the accountant takes exception shall be clearly identified, the exception thereto specifically and clearly stated, and, to the extent practicable, the effect of each such exception on the related financial statements given. The independent public accountant is expected to satisfy himself as to the reasonableness of the bases used by SBIC's Board of Directors in determining the valuation of loans and investments as presented under the pertinent headings of this Guide. The independent public accountant should determine and report in the narrative comments of his long-form report, whether the SBIC appears to have followed the valuation techniques and standards set forth in SBA Policy and Procedure Release No. 2006 dated December 31, 1965, in making the valuation. Except insofar as the valuations may affect the carrying values of investments shown on the financial statements, it shall be understood that the accountant's opinion on the financial statements contained in SBA Form 468 does not extend to the valuation of loans and investments given in the memorandum item after the end of the Statement of Financial Condition and in the memorandum columns of the applicable schedules. Procedure for Reporting Irregularities To meet its responsibilities SBA requires that the Investment Division be notified immediately in the event any apparent defalcation or other apparent criminal violation is disclosed. The examining accountant should determine that this has been done in every applicable case. AUDIT OF ACCOUNTS AND REPORT OF AUDIT The audit (financial examination), referred to herein shall be conducted in accordance with generally accepted auditing standards and therefore shall include such tests of the accounting records and such other procedures as deemed necessary to enable the independent public accountant to render an opinion on the statements reported upon. Among the procedures to which particular attention should be given are the following: Internal Control It is expected that the independent public accountant will review the company's procedures and form an opinion on the effectiveness of the internal control. In determining the extent and nature of the testing and checking of certain accounts consideration should be given to existing internal control. It is important that the accountant set forth his observations on the effectiveness of internal control in the general comments section of his report, together with any suggestions he may have for improvement. The accountant may if he considers it more appropriate, report on internal control in a supplementary letter report rather than commenting thereon in the general comment section on this report. Each Licensee is required to establish and maintain effective control arrangements covering its portfolio of investment securities, funds, and equipment. Dual control over disbursements of funds and withdrawals of securities from safekeeping, and the segregation of duties of employees represent key features of such arrangements. Fidelity Bond The independent public accountant should check the provisions of the SBIC's fidelity bond against the requirements of SBA as stated in Addendum I of this guide, and should comment in his report regarding the conformity of the bond to such requirements. Minutes The accountant should review the minutes, observe that they are up-to-date, and determine that appropriate actions of the SBIC are adequately covered by the minutes and that items covered in the minutes have been reflected in the financial statements to the extent applicable. Where, in the accountant's opinion, material actions of the SBIC are not adequately covered by the minutes and items covered in the minutes are not reflected in the financial statements, appropriate disclosure should be made in the accountant's report. Cash Cash on hand should be counted. Cash in banks should be reconciled with book balances and confirmed by correspondence. In addition to bank statements at balance sheet date of the audit, the independent public accountant should request and utilize cutoff statements as of a subsequent date to permit determination of the disposition of outstanding checks, deposits in transit, and other reconciling items. U.S. Government Obligations, Insured Temporary investments made from the company's general cash funds in direct and/ or fully guaranteed U.S. Government obligations should be verified by inspection or, when applicable, by confirmation from custodians. Verification should include ascertainment that proper interest coupons are attached to bearer bonds. The recorded cost or, in the case of U.S. bonds, the current redemption value should be verified. The accountant should ascertain that registered bonds are in the name of the SBIC or endorsed so as to be transferable to the company, or are accompanied by powers of attorney. Temporary investments of the company's general cash funds in savings institutions should be reconciled with book balances and confirmed by correspondence. Time certificates of deposits should be examined to verify the SBIC's ownership of time deposits and to ascertain correctness of the balances per books. Notes and Accounts Receivable, and Miscellaneous notes on hand should be examined and the details compared with the company's records. A representative number should be confirmed by correspondence with the makers. Accounts receivable for services rendered participating companies, for commitment fees, for declared dividends and sharings in income, and for management consulting, investigation, appraisal, and related services rendered, as shown by subsidiary records, should be reconciled to control accounts. The same should be done with respect to receivables representing participating companies' portions of principal and accrued interest receivable from financed small business concerns. The collectibility of notes and accounts receivable should be considered on the basis of the most reliable information the auditor can obtain. Such amounts due should be discussed with the executive officers of the company. Any contractual delinquency in payments to date should be given due consideration. Items considered uncollectible should be recommended for writeoff, and those of doubtful collectibility should be adequately provided for in the allowance for uncollectible notes and accounts receivable. If considered desirable, an adjusting entry to the allowance account should be recommended by the accountant for adoption by the SBIC. Comments concerning the adequacy of the allowance account should be included in the audit report. Accrued Interest Receivable and Allowance for Uncollectibles Determination should be made that interest receivable is currently and correctly accrued on the SBIC's records. This involves interest accrued on U.S. Government obligations, loans to and debt securities of small business concerns, notes receivable, sales contracts, and other interest-bearing amounts due from debtors. Comments concerning the adequacy of the allowance for uncollectible interest receivable should be included in the audit report. Due From Directors, Officers, and Employees Advances made to directors, officers, and employees should be reviewed for proper authorization and recording, and should be commented on if not authorized or has been outstanding more than 6 months. Funds in Escrow and Other Current Assets Funds in escrow pending closing of financing for small business concerns should be confirmed. Miscellaneous current assets should be reviewed for authenticity and appropriateness of classification. Loans, Debt Securities, Loans and Debt Securities Sold with Recourse, Allowances for Uncollectibles and Losses, and Unearned Discount, Fees, and Other Charges The independent public accountant should review notes, mortgages, and other obligation documents evidencing loans granted under section 305 of the Small Business Investment Act, as amended, and should confirm directly with the makers the amount of the unpaid balances. Debt securities of small business concerns, purchased by the SBIC under provisions of section 304 of the Act, as amended, should be subjected to a similar review and confirmation. Either type of financing instruments obtained from other SBICs through purchase or through exchange of portfolio securities should likewise be examined and confirmed with the issuers. All obligation documents should be checked for signing by authorized parties, including proper witnessing and acknowledgment, and for stated interest rate and term. Loans and debt securities pledged should be confirmed by correspondence with the holders. Determine if securities pledged are subject to SBA earmarking or nonhypothecation requirements and if so, that SBA has furnished written approval. The System of Account Classifications provides for carrying loans and debt securities at their unpaid principal balances, including any related uncollected discounts, fees, or other charges. In the case of any such financings in which participations are sold to others, only the portion retained by the selling company is shown in the seller's books. Loans and debt securities are to be reported in the Statement of Financial Condition of SBA Form 468 on the same basis as recorded in the accounts. Determination should be made that mortgages required to be recorded bear proper notation of such recording. The accountant should ascertain from such sources as the loan and debt security ledger cards or sheets, the collateral register, document files, minutes of board of directors' meetings, and statements of executive officers, what collateral documents should be on hand evidencing security for loans and debt securities, and should check for the presence of such collateral documents. The accountant should inspect each participation agreement under which the company has purchased a participation interest in a loan or debt security, should inspect the documents evidencing such participation and should request confirmation from seller to the extent considered necessary. Similarly, amount reflected in subsidiary records as participations of others in loans and debt securities of the company under audit should be reviewed in relation to the pertinent participation agreements and confirmed with the purchasers to the extent warranted. The amounts of loans and debt securities sold with recourse should be checked to the records of such sales and to the advices received from the purchasers as to payments made by the financed small business concerns. The independent public accountant should review the current financial statements of the concerns which are financed by the SBIC and provide comments when considered significant relative to the financial position of the concern financed. When such financial statements of the concerns are not available the accountant shall so state in his report. The board of directors of the SBIC has the responsibility of determining in good faith a realistic valuation for each specific loan and debt security, which shall be arrived at after consideration of all pertinent factors. Valuation techniques and standards for guidance of the board are set forth in SBA Policy and Procedural Release No. 2006. The independent public accountant should satisfy himself as to the reasonableness of the bases employed by the board of directors in making determinations of the value of loans and debt securities. No appreciation in value of debt securities is to be recorded in the books of account. The valuations as determined by the board of directors are to be shown in the memorandum column of the applicable schedule of the Financial Report, SBA Form 468. The accountant should discuss all marginal loans and debt securities with the executive officers of the SBIC. Writeoffs should be recommended in instances in which the unpaid balances of loans and debt securities are considered uncollectible. The allowance for uncollectible loans and the allowance for losses on debt securities should be reviewed as to adequacy and commented upon in the report. If considered desirable, adjusting entries to the allowance accounts should be recommended by the accountant for adoption by the SBIC. 91 Special attention should be given by the accountant to verification of all amounts of unearned discount, fees, and other charges shown as deducted from the unpaid balances of loans and debt securities. Capital Stock of Small Business Concerns; Warrants, Options, and Other Stock Rights Acquired from SBCs; and Allowances for Losses All capital stock of small business concerns in the possession of the SBIC should be verified by inspection of the stock certificates. Similar capital stock on the books which is not in the possession of the company should be confirmed by direct correspondence with those having possession thereof. Capital stock of small business concerns is to be recorded on the books of the SBIC at cost. In the case of any such financings in which participations are sold to others, only the portion retained by the selling company is shown in the seller's books. The independent public accountant should review the cost determinations made with respect to warrants, options, or other stock rights carried on the books at a monetary value. Only the selling company's portion of such stock rights is shown in its books when participations in the stock rights are sold to others. The accountant should inspect the agreement and other documents evidencing each participation purchased, and should request confirmation from sellers to the extent considered necessary. Similarly, amounts reflected in subsidiary records as participations of others in capital stock and warrants, options, or other stock rights acquired by the company under audit should be reviewed in relation to the pertinent participation agreements and confirmed with the purchasers to the extent warranted. It is the responsibility of the SBIC's board of directors to determine in good faith a realistic valuation for each capital stock investment and for warrants, options, or other stock rights for which a separate cost has been determined. This valuation shall be arrived at after consideration of all pertinent factors. Valuation techniques and standards for guidance of the board are set forth in SBA Policy and Procedural Release No. 2006. The independent public accountant should satisfy himself as to the reasonableness of the bases employed by the board of directors in making the value determinations. No appreciation in the value of capital stock or stock rights investments is to be recorded in the books of account. The valuations of the stock and stock rights as determined by the board of directors are to be shown in the memorandum column of the applicable schedule of the Financial Report, SBA Form 468. The financial position and earnings of the financed small business concerns are important factors in the board of director's determination of the real value of the stock and stock rights issued by such concerns. The independent public accountant should review the current financial statements of the concerns which are financed by the SBIC and provide comments when considered significant relative to the financial position of the concern financed. When financial statements of the concerns are not available the accountant shall so state in his report. Any material decrease in value of capital stock or stock rights, as determined by the board of directors, that is not obviously of a transistory nature should be compensated for by an increase in the allowance for losses on capital stock of small business concerns, or in the allowance for losses on their warrants, options, and other stock rights, as appropriate. These allowance accounts should be reviewed as to adequacy by the accountant and commented upon in his report. An adjusting entry to effect any necessary increase should be recommended by the accountant for adoption by the company. Likewise, entries should be recommended to write off any established loss on capital stock of small business concerns or on stock rights of such concerns. Venture Capital Under the Small Business Investment Act of 1958, as amended, SBICS are entitled to borrow additional funds from SBA if they have a qualifying amount of combined paid-in capital and paid-in surplus and maintain a minimum percentage of total funds available for investment in small business concerns invested or committed in "venture capital," as defined in § 107.3 of the regulations. The independent public accountant, referring to the official definition of venture capital and reviewing the lending instruments and related documents, should determine that the total amount of venture capital as indicated in the Financial Report, SBA Form 468, is substantially correct. Assets Acquired in Liquidation of Loans and Debt Securities, Accumulated Depreciation, Mortgages Payable, and Allowance for Losses These assets may include a wide variety of things of value, as, for example, collateral notes receivable, accounts receivable, judgments, sheriffs' certificates, and various types of real and personal property. Property taken in liquidation should be recorded at an amount determined by the board of directors on the basis of bid-in-price, agreed consideration, or fair appraised value, as deemed most suitable: Provided, That the net amount recorded shall not exceed the total amount of the related loan or equity security indebtedness involved. In the case of mortgaged real property acquired in liquidation of loans and debt securities, the property should be recorded at gross value as determined by the board of directors, reduced as necessary to bring the net recorded value within the above-stated limitation. The amount of the |