firm 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 signatures, 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. 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 sellers to the extent considered necessary. Similarly, amounts 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 accounts 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 on the findings thereof. When such financial statements 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, dated December 31, 1965. 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, and taken into consideration in developing the data required for the memorandum item following the Statement of Financial Condition in such report. 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. 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 principal 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 possesssion 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, dated December 31, 1965. 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, and taken into consideration in developing the data required for the memorandum item following the Statement of Financial Condition in such report. 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 current financial statements of the small business concerns should be reviewed and comments on the resultant findings should be given in the audit report. When such financial statements 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 paidin capital and paid-in surplus and maintain a minimum percentage of total funds avail able for investment in small business concerns invested or committed in "venture capital," as defined in section 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 existing mortgage or mortgages on such property should be included among the SBIC's liabilities. The accountant should verify each asset through application of procedures generally accepted for audit of the particular class of assets involved. Board authorization for recording these assets at the amounts shown should be ascertained. The amount recorded will correctly represent only the selling company's portion of any such assets in which participations are sold to others. It is the board of directors' responsibility to determine in good faith a realistic valuation for each security or other item of property comprising assets acquired through liquidation of loans and debt securities. Such 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, dated December 31, 1965. The independent public accountant should satisfy himself as to the reasonableness of the bases employed by the board in determining the values. No appreciation in the original recorded value of assets acquired in liquidation of loans and 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, and taken into consideration in developing the data required for the memorandum item following the Statement of Financial Condition in such report. The accumulated depreciation on assets acquired in liquidation of loans and debt securities should be reviewed by the accountant to assure that it is not less in amount than a conservative estimate of the expired service life of such property while owned by the SBIC. Insurance coverage should be reviewed as to adequacy. Such acquired assets should be discussed with the executive officers of the company. Writeoff should be recommended for items considered worthless. The allowance for losses on assets acquired in liquidation of loans and debt securities should be reviewed as to adequacy and commented upon in the report. If considered desirable, adjusting entries to the allowance account should be recommended by the accountant for adoption by the SBIC. Corporate Premises Owned, Furniture and Equipment, and Accumulated Depreciation The independent public accountant, during the first audit of the SBIC, should examine the documents showing title to the property owned as corporate premises. It should be ascertained that the land is carried at acquisition cost, plus the cost of subsequent benefit assessments and improvements (other than buildings and improvements related thereto), and that the charging of such additional costs to the land account has been proper. The building owned as a part of the corporate premises should be recorded at acquisition cost plus cost of subsequent improvements thereto. The basis for recorded cost should be verified and capital additions should be checked to ascertain that only properly capitalizable items have been added to book cost. Vouchers and invoices covering such additions should be examined. Retirements and sales should be reviewed to see that all transactions have been properly reflected in the accounts. Insurance coverage should be reviewed as to adequacy. The accumulated depreciation on the building and related improvements owned as a part of the corporate premises should be reviewed to assure that it is not less in amount than a conservative estimate of the expired service life of such building and improvements. On occasion, an SBIC may be found operating in the same or communicating office or building with a bank or other financial institution. Sometimes both institutions are managed by the same individuals and the same facilities may be used for transacting business. The accountant should satisfy himself that safeguards are maintained which effectively segregate the books. records, and assets of the separate institutions at all times. The audit findings concerning corporate premises owned should be set forth in the report. The accountant should ascertain that furniture and equipment, including automo biles, are recorded on the books at cost. Documents showing ownership of automobiles by the company should be inspected and invoices for all major additions to furniture and equipment during the audit period should be examined. Sales and tradeins of furniture and equipment should be tested to determine that they have been appropriately recorded. Insurance coverage should be reviewed as to adequacy. The accumulated depreciation on furniture and equipment, including automobiles. should be reviewed for adequacy. The report should contain comments concerning unusual conditions, if any, found with respect to these assets. Organization Costs Legal fees, promotional expense, stock certificate costs, incorporation fees, taxes, and other charges which may comprise organization costs on the books should be audited for propriety as capital charges pending amortization or writeoff to the organization expense account. Following the first audit, the review of organization costs will ordinarily be concerned chiefly with a determination and evaluation of the basis for amortization and the consistency with which the planned elimination of this balance sheet item is being accomplished. The audit report comments on organization costs (at the first audit) should describe the components of this asset. Other Accounts relating to long-term notes receivable, leasehold improvements, supplies on hand, insurance prepayments, and other prepayments and deferred items should be reviewed. All significant items should be examined for propriety, for applicability to future periods, and for appropriateness of the basis for writeoff. Particular note should be taken of any amounts deferred as the result of improper accounting or failure to identify the correct purposes of the charges. In reviewing insurance prepayments the independent public accountant should prepare for inclusion in his report a summary of insurance coverage. Improvements to leased property used as the company's office quarters (if this situation exists) should be checked against invoices, contracts, and other supporting documents. Determination that all capitalized improvements are properly capitalizable should be made and the basis and accounting for writeoffs should be examined for appropriateness. The audit report should contain adequate information on prepayments and deferred charges. Miscellaneous assets of the company not included under other captions should be commented upon here, including recoverable amounts (exclusive of short-term loans (section 305) or equity financing (section 304)) advanced for the protection and pres ervation of the company's investments. Miscellaneous assets should be reviewed for validity and for propriety of their retention on the books. Accounts Payable Accounts payable for participating companies' portions of principal and accrued interest receivable from financed small business concerns, compensation for services rendered on participations purchased, for commitment fees on deferred participations by others, and for other values received, as shown by subsidiary records, should be verified and reconciled to control accounts. The accruals of compensation payable and commitment fees payable should be reviewed with reference to the related participation agreements. Unusually large amounts and a reasonable proportion of other amounts due on open account should be confirmed by correspondence with the creditors. Other Current and Accrued Liabilities Subsidiary records on other current and accrued liabilities, including those for interest, salaries, taxes, dividends, unapplied receipts, trust receipts, amounts due directors, officers, and employees (other than salaries), and other deferred credits, should be checked and reconciled with the control accounts. A certificate, signed by an executive officer of the company, should be obtained stating that all actual liabilities have been entered in the books and that all existing contingent liabilities have been reported to the auditor. The accountant should communicate with the SBIC's attorney to determine the existence of any claims in litigation or pending against the company for the purpose of establishing any contingent liability. The accountant should (following upon the fact) state in the report that certificates were received from the executive officer and the attorney concerning the recording of actual liabilities and the existence of any claims in litigation or pending against the company. The report should also present pertinent information concerning unusual current and accrued liabilities. Special attention and comment should be directed to any amounts due directors, officers, and employees, and to any contingent liabilities, including commitments and guarantees. Funds Borrowed and Other Liabilities Indebtedness to SBA should be reconciled to the current statements from the Small Business Administration. Direct confirmation from SBA is required and should be requested on the basis of a statement, submitted in triplicate to the Director, Office of Budget and Finance, Small Business Administration, 1441 L Street NW., Washington, D.C. 20416, showing the unpaid balances of principal and interest at the balance sheet date of the audit. Adequate identification of each obligation, using execution date and SBA loan symbols, should be given. Debt to others than SBA for funds borrowed likewise should be confirmed by correspondence. Loan agreements, contracts, and mortgages, and minutes of board meetings pertaining thereto should be examined in relation to SBA financing and loans from others to determine whether there has been compliance with such of their terms as have direct bearing on the financial position as represented in the audited statements. The other liabilities and deferred credits should be checked for validity. If these items are material in amount, appropriate comments thereon should be included in the report. Special attention and comment should be directed to any amounts due directors, officers, and employees, and to any contingent liabilities, including commitments and guarantees. The independent public accountant should ascertain that the appropriate schedule of the Financial Report, SBA Form 468, reflects all commitments, guaranteed obligations, and other contingent liabilities, and that the total of all contingent liabilities is shown as a footnote at the bottom of page 2 of SBA Form 468. Capital Stock and Surplus Verification of capital stock should be carried out by examination of the stock records and the stock certificate books, or by direct confirmation from the registrar and transfer agent, if applicable. Cash records or other records showing the consideration received for capital stock should be reviewed in connection with capital stock transactions during the period. Authorizations of the board of directors and also the charter and bylaws should be referred to. Determination should be made as to the existence of stock options, warrants, rights, conversion privileges, sales of stock on special terms, or reservations of shares of stock for sale to particular groups or for options and other rights. It should also be determined that all such transactions have been appropriately recorded and set forth in the statement of financial condition, notes thereto, or schedules, as applicable. The independent public accountant should look for and disclose the existence of any arrearages in the payments on capital stock subscribed or in the payment of dividends on outstanding capital stock. Treasury stock transactions should be analyzed and determination made that appropriate accounting has been effected. The audit report should contain thoroughly informative comments regarding capital stock transactions during the period. Changes in the surplus accounts during the period should be reviewed for propriety of the accounting entries effecting the changes. Although all earnings for the year are ultimately transferred to a single retained earnings account, it should be determined that appropriate distinction has been made in classifying items in the Profit and Loss Summary and the Realized Gain and Loss Summary accounts as between (1) income and expense from operations and (2) realized gains and losses on investments. Paid-in surplus debits and credits must also be checked for appropriateness of classification. Loans and Investments at Market or Review should be made of the valuation of loans and investments. The independent public accountant should determine and report whether the SBIC has followed the instructions for the memorandum item following the Statement of Financial Condition in SBA Form 468 in making the valuation. 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 such memorandum item. Income and Expense and Gain and Loss Appropriate tests should be made of income and expense and gain and loss accounts for the period under review. The tests should be sufficient, when combined with information obtained in other phases of the audit, to satisfy the accountant that transactions summarized in these accounts are genuine and have been properly authorized and accurately recorded. The verification procedures applied to income and expense and gain and loss accounts should be based on the same testcheck principles as are applied to the balance sheet accounts. After examining representative transactions for the period or periods he has selected for testing, the accountant should scan the accounts and examine any entries which appear unusual. Special attention should be given to transactions contributing to the recorded gain or loss realized on sale of investments. In this connection, reference should be made to SBA requirements concerning the realization and use of income and gains, as set forth in Addendum II of this guide. The accountant should include in his comments information as to the latest year through which federal income tax returns of the SBIC have been audited by the Internal Revenue Service. ADDENDUM I-FIDELITY BOND 1. NEED FOR BOND Each Licensee shall obtain and maintain a fidelity bond which must be executed by a surety holding a certificate of authority from the Secretary of the Treasury pursuant to sections 6-13 of Title 6 of the United States Code as an acceptable surety on Federal bonds. Each officer and employee who has control over or access to cash securities or other property of the Licensee shall be covered by such fidelity bond. The form of bond must meet the provisions of paragraphs 2 and 6 below. 2. TYPE OF BOND Each Licensee shall be covered by a Brokers Blanket Bond, Standard Form No. 14. A Licensee may be covered by Bankers Blanket Bond, Standard Form No. 24, if it meets the provisions of paragraph 3 following. In general, riders to such standard form bonds are unacceptable and should not be used unless they patently increase the benefits under the policy. SBA has held the following riders to be unacceptable with respect to Brokers Blanket Bond, Standard Form No. 14: SR 5307, Valuation Clause Rider; A Licensee, the majority (more than 50 percent) of whose voting stock is owned by one or more commercial banks that are members of the Federal Deposit Insurance Corporation, or the majority of whose voting stock is owned by a single bank holding company whose subsidiary banks are members of the Federal Deposit Insurance Corporation, may be included as a joint insured under a Bankers Blanket Bond, Standard Form No. 24, which insures the parent commercial bank(s) or the parent bank holding company. In those instances when and to the extent that coverage under Bankers Blanket Bond, Standard Form No. 24, has been restricted by the use of one or more deductible insuring clauses which would apply to the Licensee also, a Brokers Blanket Bond, Standard Form No. 14, must be employed to furnish coverage for the deductible amounts. 4. APPROVAL OF BANK DIRECTORS In order for the provisions of paragraph 3 above to be applicable, the board of directors of the commercial bank(s) or the bank holding company must approve extending the Bankers Blanket Bond, Standard Form No. 24, to include the Licensee as a joint insured. They also must approve any Brokers Blanket Bond, Standard Form No. 14, needed to furnish the coverage restricted by deductible insuring clauses as set forth in paragraph 3. A certified copy of the minutes of the meeting(s) of the board of directors of such parent organization(s) at which such bond or bonds were approved shall be retained in the permanent records of the Licensee. 5. APPROVAL OF LICENSEE'S DIRECTORS The board of directors of the Licensee must approve the fidelity bond or bonds of the Licensee. A certified copy of the minutes of the meeting(s) of the board of directors at which such approval was given must be retained in the permanent files of the Li |