2.3 Measuring Significance

A registrant may consummate a business acquisition shortly after its most recent fiscal year-end but before it files its Form 10-K for that recently completed fiscal year. In such a case, when determining its initial Form 8-K filing requirements (i.e., four business days after the consummation of the acquisition), the registrant should use the financial statements included in its prior year’s Form 10-K to assess significance. However, as described in Regulation S-X, Rule 11-01(b)(3)(i)(C), the registrant may reevaluate significance by using its financial statements for the most recent fiscal year reported in the Form 10-K filed after the initial Form 8-K filing as long as the Form 10-K is filed before the due date of the amended Form 8-K (i.e., 71 calendar days after the initial Form 8-K was required to be filed). This is acceptable even if the reassessment results in a lower level of significance, thereby reducing the number of periods that must be filed. However, since the more recent financial statements were provided after the initial Form 8-K filing, the registrant is not obligated to use them, even if they would result in a higher level of significance.

Under Regulation S-X, Rule 11-01(b)(3)(i)(B), a registrant may evaluate an acquiree’s significance by using the registrant’s pro forma financial information that reflects a prior significant acquisition or disposition consummated after its latest fiscal year-end for which financial statements were required to be filed, provided that the following conditions are met:

• Audited historical financial statements for the previous significant business acquisition (including real estate operations under Rule 3-14) have been filed with the SEC in a Form 8-K or registration statement.
• Pro forma financial information reflecting the previous significant business acquisition or disposition has been filed with the SEC in a Form 8-K or registration statement.

The subsidiary of a registrant sometimes acquires (or it is probable that it will acquire) a business. If the subsidiary is not itself a registrant, the acquiree’s financial statements should be compared with the registrant’s consolidated financial statements (the parent of the subsidiary) to measure significance. That is, significance should not be measured by using the subsidiary’s stand-alone financial statements when the subsidiary is not a registrant.

When measuring significance, a registrant that plans to dispose of certain assets of an acquiree should not exclude those assets from the calculation. The acquiree’s financial statements must be used to measure significance, regardless of the plan for the assets after the acquisition’s consummation.

Under ASC 250, entities may need to retrospectively apply a change in accounting principle or a change in reporting entity. Likewise, they may need to retrospectively apply the transition provisions of certain newly issued standards or the classification of a component as a discontinued operation under ASC 205-20. Collectively, such changes are referred to below as “retrospective changes”; however, they do not include revisions resulting from the correction of an error for misapplication of U.S. GAAP.

A registrant sometimes is the successor to a predecessor company or presents financial statements that include predecessor and successor results. Examples include (1) the adoption of fresh-start accounting after emergence from bankruptcy, (2) the use of push-down accounting to reflect a change in basis because of an acquisition of the company, or (3) an acquisition, undertaken by a shell company (including a SPAC) and accounted for as a business combination, of another entity that is determined to be the shell company’s predecessor. In these situations, a registrant may not have a full year of income statement data reflecting the successor results. For example, if push-down accounting was applied, the period before the change in basis represents the predecessor period and the period after the change in basis represents the successor period.

A shell company (which may include a SPAC) may acquire an entity deemed to be its predecessor in a transaction that is accounted for as a business combination in which the shell company is the accounting acquirer (e.g., not accounted for as a reverse acquisition or a reverse recapitalization). After such a transaction, but before the newly combined company’s year-end, the registrant may acquire, or it may be probable that it will acquire, an unrelated business. In this situation, a registrant should assess the significance of an acquiree against the shell company’s (registrant’s) historical financial statements. That is, the predecessor financial statements should not be used to measure significance.

When a registrant consummates a business acquisition that is accounted for as a reverse acquisition or reverse recapitalization, the acquired business (legal acquiree) is treated as the continuing reporting entity that acquired the registrant (legal acquirer). A business acquisition may occur, or a probable business acquisition may be contemplated, after a reverse acquisition or reverse recapitalization was consummated but before a registrant files audited financial statements for the fiscal year in which the reverse acquisition or reverse recapitalization takes place. In these circumstances, the registrant should measure the significance of an acquiree as follows:

• Reverse acquisition — Use the accounting acquirer’s audited annual financial statements (i.e., legal acquiree’s) if they have been filed with the SEC. This is because the accounting acquirer’s financial statements become those of the registrant under U.S. GAAP.
• Reverse recapitalization — Use the private operating company’s audited annual financial statements (i.e., the legal acquiree’s) if they have been filed with the SEC.

Rule 1-02(w)(1)(i)(A)(1) indicates that the investment in the acquiree represents the “consideration transferred,” adjusted to exclude the carrying value of assets transferred to the acquiree that will remain with the combined entity after the acquisition. Such consideration transferred is consistent with the total U.S. GAAP purchase price of the acquiree, as specified in ASC 805. See Section 5.3 of Deloitte’s Roadmap Business Combinations for further guidance on determining the U.S. GAAP purchase price, including contingent consideration.

To determine the AWMV used for the investment test, a registrant should average the AWMV calculated daily for the last five trading days of the calendar month ending before the earlier of the acquisition’s announcement date or agreement date. The daily AWMV is calculated by using the price at which the common equity was last sold (or the average of the bid and asked price) and the total shares outstanding (both affiliate and nonaffiliate shares). Only publicly traded common shares should be used in the calculation; classes of equity that are not publicly traded should be excluded, even if they are exchangeable or convertible into classes of common equity that are publicly traded, because such securities do not represent traded common equity until the actual conversion or exchange occurs.

As noted in ASC 805-50-05-5, “[s]ome transfers of net assets or exchanges of shares between entities under common control result in a change in the reporting entity. In practice, the method that many entities have used to account for those transactions is similar to the pooling-of-interests method.”

A registrant may sometimes complete a debt or equity offering to provide the necessary capital to consummate a business acquisition. Because the offering may occur concurrently with, or shortly before, the acquisition, the registrant’s total assets used for the asset test would not reflect the receipt of such proceeds. In these circumstances, a registrant may not increase its assets by including the pro forma effect of proceeds received from a debt or equity offering after the balance sheet date. However, as noted in Section 2.3.1.2, it may sometimes be appropriate to use pro forma financial information to measure significance.

The income component of the income test is determined by comparing the absolute values of the registrant’s proportionate share of (1) the acquiree’s pretax income or loss from continuing operations with (2) the registrant’s own pretax income or loss from continuing operations.

If both the registrant and the acquiree have material revenue in each of the two most recently completed fiscal years, the revenue component is calculated by comparing the registrant’s proportionate share of (1) the acquiree’s revenue with (2) the registrant’s revenue.

A registrant must use its average income for the income component if (1) the revenue component does not apply (e.g., either the registrant or the acquiree did not have material revenue in each of the two most recently completed fiscal years) and (2) its pretax income or loss from continuing operations that is used for the income component is at least 10 percent lower than its average income for the last five fiscal years. Accordingly, in instances in which the revenue component is not applicable, the registrant is first required to calculate its average income to determine whether such amount must be used in the denominator of the income component of the income test. If a registrant must use its average income in the income component, it should calculate its five-year average by using the absolute value for any loss years.

The examples below illustrate the following:

• The income and revenue component when 100 percent of a business is acquired (Example 2-16).
• The income and revenue component when less than 100 percent of a business is acquired (Example 2-17).
• The use of average income when the revenue component does not apply (Example 2-18).

A registrant sometimes acquires or will acquire less than 100 percent of an entity’s equity. In such cases, when performing the significance tests, the registrant should compare the acquired or to be acquired percentage of assets, pretax income from continuing operations, or revenues of the acquiree with the registrant’s preacquisition consolidated assets, pretax income from continuing operations, or revenues. See Examples 2-15 and 2-17 for illustrations of the asset test and income test, respectively, in situations in which less than 100 percent of an entity is acquired. Note that the percentage of an entity acquired does not affect performance of the investment test. Note also that special considerations are required for acquisitions conducted through a parent’s non-wholly-owned consolidated subsidiary (see Section 2.3.5.2 for further information).

For certain complex capital structures, such as umbrella partnership C corporations (commonly known as “Up-C” structures), special considerations are necessary related to performing the significance tests because of the noncontrolling interest in the registrant’s consolidated subsidiaries. If a registrant directly acquires (or it is probable that it will acquire) a business, the significance tests should be performed in a manner consistent with the guidance in Sections 2.3.2 through 2.3.4. However, in circumstances in which a registrant’s non-wholly-owned consolidated subsidiary (rather than the registrant itself) acquires (or it is probable that it will acquire) a business, we understand that the SEC staff expects the significance tests to be performed as follows:

• The investment test — The registrant should compare 100 percent of the investment in the acquiree with the registrant’s AWMV. A registrant that has no AWMV should compare the investment in the acquiree with the registrant’s total assets. For example, under this test, if a registrant owns 60 percent of a consolidated subsidiary that acquires 100 percent of a business, 100 percent of the investment in the acquiree should be compared with the registrant’s AWMV.
   

  Connecting the Dots

  A registrant’s AWMV will not reflect the value of noncontrolling interests in the registrant’s consolidated subsidiaries. As a result, the investment test may yield anomalous results when there is a substantial noncontrolling interest in a registrant’s subsidiary and that subsidiary completes an acquisition. Registrants may consider requesting a waiver from the SEC staff if they believe that the investment test would result in the filing of financial statements that would not be material to investors. For more information, see Section 1.5.
• The asset test — The registrant should compare 100 percent of the acquiree’s total assets with the registrant’s consolidated total assets. For example, under this test, if a registrant owns 60 percent of a consolidated subsidiary that acquires 100 percent of a business, 100 percent of the acquiree’s assets should be compared with the registrant’s consolidated total assets.
• The income component of the income test — A registrant should compare its proportionate share of the acquiree’s pretax income or loss from continuing operations with the registrant’s own pretax income or loss from continuing operations. For example, under this test, if a registrant owns 60 percent of a consolidated subsidiary that acquires 100 percent of a business, 60 percent of the acquiree’s pretax income should be compared with the registrant’s pretax income or loss from continuing operations.
• The revenue component of the income test — If both the registrant and the acquiree have material revenue in each of the two most recently completed fiscal years, the registrant should compare 100 percent of the acquiree’s revenue with the registrant’s revenue. For example, under this test, if a registrant owns 60 percent of a consolidated subsidiary that acquires 100 percent of a business, 100 percent of the acquiree’s revenue should be compared with the registrant’s revenue.

The SEC staff permits a registrant (acquirer) to provide an acquiree’s abbreviated financial statements on the basis of the criteria in Rule 3-05(e). Such abbreviated financial statements are often referred to as statements of (1) assets acquired and liabilities assumed or (2) revenues and expenses. See Section 2.6.4 for further discussion.