2.3 Measuring Significance
The financial statement requirements for an acquiree are specified
in Rule 3-05, which
refers to the definition of a significant subsidiary in Rule 1-02(w). However, the thresholds in Rule
3-05 for determining the significance of an acquiree differ from those in Rule
1-02(w).
Under Rule 1-02(w), a registrant must perform the following three tests to determine
the significance of an acquiree:
-
The investment test (see Section 2.3.2).
-
The asset test (see Section 2.3.3).
-
The income test (which includes an assessment of a pretax income component and, in certain circumstances, a revenue component; see Section 2.3.4).
When evaluating significance, a registrant must use U.S. GAAP
amounts.1 The test that results in the highest significance level will be used to
determine the number of the acquiree’s audited and interim financial statement
periods that the registrant must present.
The table below outlines the various
significance thresholds and the general financial statement requirements for an
individual acquiree under Rule 3-05. Note that a registrant that files a
registration or proxy statement must also consider the aggregate significance
requirements (see Section
2.9). For additional guidance on when, and in which SEC filings,
acquiree financial statements are required, see Section 2.4.
Table 2-1
Financial Statement Requirements for an Individual Acquiree
|
Level of Significance
| Financial Statements Required |
|---|---|
|
Consummated Business
Acquisition
| |
|
Does not exceed 20 percent
|
None; acquisition is not individually
significant
|
|
Exceeds 20 percent but not 40 percent
|
|
|
Exceeds 40 percent
|
|
|
Probable Business
Acquisition (Only Applicable to Registration and Proxy
Statements)
| |
|
Does not exceed 50 percent
|
None
|
|
Exceeds 50 percent
|
|
As indicated in paragraph
2920.15 of the FRM, the results of the significance tests should
not be rounded. (Note that for practical purposes, many of the significance
calculations in the examples in this Roadmap have been rounded to the nearest whole
percent.) If, in accordance with the significance calculation, an acquiree is
exactly 20 percent significant to the registrant, no financial statements are
required under Rule 3-05.
Rule 3-06 permits a registrant
to provide audited financial statements of an acquiree for a period of nine to
twelve months to satisfy the one-year financial statement requirement under Rule
3-05. It further permits the registrant to provide an audited period of nine to
twelve months along with another full fiscal year to satisfy the two-year financial
statement requirement under Rule 3-05. That is, the registrant cannot satisfy the
two-year financial statement requirement by using two periods of more than nine
months but less than twelve months.
Note that under ASC 805-10-50-1 through 50-8, annual and interim financial statements
must include certain disclosures for business combinations that occur during the
current reporting period or after the reporting date but before the financial
statements are issued or available to be issued. Materiality under ASC 805 is not
the same as significance under Rule 3-05, and the materiality threshold in ASC 805
is generally lower than that in Rule 3-05. Therefore, registrants must separately
determine which financial statement disclosures ASC 805 requires for an individually
material business combination (or for individually immaterial business combinations
that are collectively material).
2.3.1 Financial Statements Used to Measure Significance
Under Regulation S-X, Rule
11-01(b)(3)(i), the significance of an acquiree is generally
measured by using the amounts in (1) the registrant’s most recent preacquisition
annual financial statements that are required to be filed on or before the
acquisition date and (2) the acquiree’s preacquisition financial statements for
the same fiscal year as the registrant. In accordance with paragraph 2915.6 of the FRM, if the
acquiree’s fiscal year differs from the registrant’s, significance is measured
by using the acquiree’s preacquisition financial statements for the most recent
fiscal year that would be required as if the acquiree were a reporting company
and had the same filer status as the registrant. In this case, it is possible
that the acquiree financial statements used to test significance may be more
recent than the acquiree financial statements that would actually be filed if
significance thresholds were met (see the note to paragraph 2915.6 of the FRM).
When measuring significance, a registrant should not conform the fiscal
year-ends. Further, as stated in paragraph
2915.1 of the FRM, unaudited annual financial statements of
an acquiree that is not a registrant can be used to perform the significance
tests so long as the financial statements comply with U.S. GAAP or IFRS
Accounting Standards. However, if a business acquisition exceeds the 20 percent
significance level, an audit must be performed of the required annual acquiree
financial statements that will ultimately be filed with the SEC in accordance
with Rule 3-05.
Example 2-2
Registrant A’s fiscal year-end is
December 31. On June 30, 20X9, it acquires Company B,
whose fiscal year-end is also December 31.
To perform the significance test, A
should compare B’s financial statements for the year
ended December 31, 20X8, with A’s audited financial
statements for the year ended December 31, 20X8.
2.3.1.1 Acquisitions Early in the Year
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. See paragraph
2915.3 of the FRM for further information.
If a registrant files a registration statement late in the
year, the financial statements required to test significance may be more
recent than the financial statements used by the registrant to test
significance for acquisitions completed early in the year. As discussed in
paragraph
2915.3 of the FRM, a registrant is not required to
reassess individual significance when filing a registration statement that
uses more recent financial statements if the registrant appropriately
assessed significance when the acquisition was completed earlier in the year
(see paragraph 2915.3 of the FRM for an example). However, that acquisition
must be considered in the aggregate significance calculation required for
the registration statement (see Section 2.9).
Example 2-3
Registrant A’s fiscal year-end is December 31. On
February 21, 20X9, A acquired Company B, a
nonregistrant whose fiscal year-end is September
30.
As of February 21, 20X9, the December 31, 20X8,
audited financial statements of A were not yet filed
(or required to be filed) with the SEC. On the basis
of B’s financial statements as of and for the year
ended September 30, 20X8, and A’s financial
statements as of and for the year ended December 31,
20X7, B exceeds the 40 percent significance
level.
On February 25, 20X9, A filed a Form 8-K announcing
the consummation of the acquisition of B (i.e.,
within four business days of the consummation of the
acquisition) and must file its Form 8-K/A on or
before May 7, 20X9 (i.e., within 71 calendar days of
the initial Form 8-K filing), including B’s
financial statements and the required pro forma
financial information.
On March 1, 20X9, A filed its
December 31, 20X8, Form 10-K. Since A filed its Form
10-K before it was required to file the Form 8-K/A,
A had the option of reassessing B’s significance by
using A’s December 31, 20X8, audited financial
statements filed on March 1, 20X9. Although it did
not have to perform such reassessment, A chose to do
so.
To reassess significance, A compared
B’s latest annual financial statements with A’s more
updated December 31, 20X8, audited financial
statements since these were the latest audited
financial statements that A was required to file. In
accordance with the reassessment, A determined that
B was 30 percent significant. Thus, A was required
to file only one year (instead of two years) of B’s
audited financial statements and present (1) B’s
audited annual financial statements as of and for
the year ended September 30, 20X8, (2) B’s unaudited
interim financial statements as of and for the
period ended December 31, 20X8, and (3) the required
pro forma financial information.
In a manner consistent with the guidance in paragraph
2915.5 of the FRM, when a registrant elects to
reevaluate significance for the income and asset tests by using its
financial statements for the most recent fiscal year reported in the Form
10-K, the registrant may use the financial statements of the acquiree for
either (1) the most recent fiscal year or (2) the preceding fiscal year.
Note that the preceding fiscal year may only be used if the original
assessment date is before the date on which the most recent financial
statements are due.
Example 2-4
Assume the same facts as in Example 2-3 except
that Company B’s fiscal year-end is December 31 (the
same as Registrant A’s).
If A elects to reevaluate significance on the basis
of its financial statements for the year ended
December 31, 20X8, it may use the acquiree’s
financial statements for either the year ended
December 31, 20X7, or the year ended December 31,
20X8.
As noted above, Rule 11-01(b)(3)(i) states that when
measuring significance, a registrant should use the most recent annual
financial statements that are required to be filed
on or before the acquisition date. However, many registrants may voluntarily
file their Form 10-Ks earlier than such date. Paragraph
2915.4 of the FRM indicates that if a registrant files
its Form 10-K early (i.e., before it was required to file it) and then
consummates an acquisition before its Form 10-K was due, it has the option
of measuring significance by using either of the two most recent annual
financial statements preceding the acquisition.
Example 2-5
Registrant A is a nonaccelerated filer whose fiscal
year-end is December 31. It is required to file its
December 31, 20X8, Form 10-K by March 30, 20X9, but
filed it early, on March 1, 20X9.
On March 5, 20X9, A acquired Company
B. To assess B’s significance on the acquisition
date, A has the option of using either its
December 31, 20X7, or December 31, 20X8, financial
statements.
2.3.1.2 Use of Pro Forma Financial Information
Under Regulation S-X, Rule 11-01(b)(3)(i)(B), and as stated in
paragraph 2915.7 of the
FRM, 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 publicly filed 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 publicly filed registration statement.
-
The pro forma amounts are used to measure the significance of all subsequent acquisitions and dispositions up until the filing date of the registrant’s next annual report on Form 10-K.
-
Pro forma financial information is used in all of the significance tests, with the exception of the investment test if the investment test is based on aggregate worldwide market value (AWMV).
-
The pro forma amounts only depict the previous significant acquisitions or dispositions for which the required financial statements were filed and only include the related transaction accounting adjustments.
To measure significance in an IPO registration statement, a
registrant can also use pro forma financial information that reflects the
effect of a prior significant acquisition (or disposition) consummated
after the latest fiscal year-end for which a registrant’s audited
financial statements are required to be presented provided that the
financial statements of the prior significant acquiree and related pro forma
financial information are included in the registration statement. If the
registrant includes the financial statements and related pro forma financial
information of the prior significant acquiree in a draft registration
statement, it must ultimately provide them in a public filing as well. It
would not be appropriate to use pro forma financial information to evaluate
the significance of an acquiree if such information were only included in
the draft registration statement but not the registration statement that was
publicly filed. For more information, see Section
2.5 of Deloitte’s Roadmap Initial Public Offerings.
A registrant should apply the following guidance if it elects to use pro
forma financial information to measure significance:
-
Income test — Use the pro forma financial information for the latest audited annual period included in the Form 8-K or registration statement. The tests should not be performed with annualized data.
-
Asset test and investment test (if aggregate worldwide market value is not available) — Use the pro forma balance sheet representing the latest audited annual balance sheet. This pro forma balance sheet may not be the one included in the Form 8-K or registration statement.
The acquiree’s total assets, revenues, and pretax income from continuing
operations should not be adjusted for acquisition accounting, and its
pro forma financial information may not be used to measure its
significance.
The registrant’s pro forma amounts used to measure
significance should represent the total pro forma amounts after transaction
accounting adjustments are made that reflect all significant
acquisitions and dispositions occurring after the registrant’s latest fiscal
year-end for which financial statements are required to be filed. We
understand that such adjustments should include the effect of material
financing transactions related to the acquisitions and other material
transactions that were entered into with such acquisitions and were included
in the respective pro forma financial information. Article 11 permits
autonomous-entity adjustments and management’s adjustments; however, such
adjustments are not allowed in a significance evaluation that uses pro forma
financial information.
Example 2-6
Registrant M’s fiscal year-end is
December 31. On March 15, 20X9, M acquired Company
P, a nonregistrant whose fiscal year-end is also
December 31.
On March 19, 20X9, M filed a Form
8-K announcing the consummation of the acquisition
of P. On April 25, 20X9, M filed a Form 8-K/A with
(1) the required audited historical financial
statements of P and (2) unaudited pro forma
financial information as of and for the year ended
December 31, 20X8. On June 15, 20X9, M acquired
Company R, a nonregistrant whose fiscal year-end is
December 31.
To measure the significance of the
acquisition of R, M could use either (1) the pro
forma information as of and for the year ended
December 31, 20X8, that reflected the acquisition of
P or (2) its historical audited financial statements
in its December 31, 20X8, Form 10-K that did not
reflect the acquisition of P. Registrant M must use
the option it elects for all three significance
tests. If it elects to use the pro forma financial
information, M must continue to use such information
for future acquisitions and dispositions until it
files its Form 10-K for the year ending December 31,
20X9.
Since Article 11 refers to consummated transactions
that occurred after a registrant’s latest fiscal year-end for which
financial statements are required to be filed, it would not be appropriate
to measure significance by using pro forma financial information that
reflects either of the following:
-
A probable acquisition.
-
An acquisition that occurred before the latest fiscal year-end.
For example, if an acquisition closes on December 15, a calendar-year-end
registrant would not be permitted to use pro forma information to evaluate
the significance of a subsequent transaction once the registrant is required
to file or has filed its annual financial statements for that year, even
though the historical income statement will only reflect 15 days of
postacquisition results.
Pro forma information that is voluntarily provided
for insignificant acquisitions or dispositions may not be used in the
significance evaluation. Further, a registrant may only use pro forma
information that reflects an acquisition for which the registrant has also
provided audited financial statements in accordance with Rule 3-05. Therefore,
a registrant may not use aggregate pro forma financial information that
reflects acquisitions that are individually insignificant.
2.3.1.3 Acquisition by a Registrant’s Subsidiary
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.
However, if the subsidiary is also a registrant, both it and
the parent must determine whether the acquisition or probable acquisition is
significant by comparing the acquiree’s financial statements with those of
the parent and the subsidiary. In addition, if an acquisition or probable
acquisition is conducted through a registrant’s non-wholly-owned
consolidated subsidiary, special considerations are necessary related to
performing the significance tests. See Section 2.3.5.2 for more
information.
Example 2-7
Registrant A has multiple
consolidated subsidiaries and owns 100 percent of
the equity in each of them. One of A’s subsidiaries,
Subsidiary B, is also a registrant because it has
outstanding public debt. On October 1, 20X9, B
consummated the acquisition of Company C, a
nonregistrant. The fiscal year-end of Registrant A,
Subsidiary B, and Company C is December 31.
Both A and B must determine whether the acquisition
of C is significant under Rule 3-05. To measure
significance, each registrant must use its
respective financial statements as of and for its
most recently completed audited fiscal year that is
required to be filed with the SEC.
The results of the significance tests indicate that
the acquisition of C is 30 percent significant to B
but only 5 percent significant to A. Accordingly, B
complies with the Form 8-K requirements and files
audited financial statements of C for one year,
unaudited financial statements as of and for the
appropriate interim period preceding the
acquisition, and the required pro forma financial
information. Under Rule 3-05, A is not required to
file any financial statements of C because the
acquisition is not significant to A.
2.3.1.4 Measuring Significance When the Disposal of Certain Acquired or to Be Acquired Assets Is Planned
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.
2.3.1.5 Measuring Significance When Previously Issued Financial Statements Must Be Retrospectively Adjusted
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 may elect or be required (e.g., when filing a
new registration statement) to provide updated financial statements that
reflect the retrospective adjustments for periods before a retrospective
change. If a registrant’s previously issued financial statements have been
revised to reflect a retrospective adjustment, in accordance with
paragraph
2915.14 of the FRM, the registrant must calculate
significance by using its retrospectively adjusted financial statements for
the most recently completed fiscal year for (1) "individual businesses
acquired after the date the retrospectively
adjusted financial statements are filed” (emphasis added), (2) “probable
acquisitions,” and (3) acquisitions that have occurred “since the date of
the [registrant’s] most recent audited balance sheet that are required to be
assessed in the aggregate” (see Section 2.9).
The note to paragraph 2915.14 of the FRM
indicates that for businesses acquired on or before the
date on which the retrospectively adjusted financial statements are
filed, the significance of individual acquisitions may be measured on
the basis of “either (A) the registrant’s audited financial statements for
its most recently completed fiscal year that were filed prior to the
retrospectively adjusted financial statements giving effect to the
discontinued operation or change in accounting principle or (B) the
registrant’s filed financial statements for the most recently completed
fiscal year that reflect retrospective application of the discontinued
operation or change in accounting principle.” This paragraph goes on to
state that a “registrant must consistently use the financial statements it
chooses (i.e., either (A) or (B) above) to measure significance of all
individual acquisitions completed on or before the date the retrospectively
adjusted financial statements are filed.”
A registrant is not required to remeasure individual
significance for previously consummated acquisitions upon filing the
retrospectively adjusted financial statements. However, for an IPO
registration statement, the acquirer must use the retrospectively adjusted
financial statements included in the IPO registration statement to measure
the significance of all historical acquisitions. These requirements can
differ from those for equity method investments under Regulation S-X, Rules
3-09 and 4-08(g). See Section 3.2 of Deloitte’s Roadmap SEC Reporting Considerations for Equity Method
Investees for further discussion.
Example 2-8
Registrant A’s fiscal year-end is
December 31. It filed its December 31, 20X8, Form
10-K on March 1, 20X9. On April 30, 20X9, A disposed
of a component of an entity that was classified as a
discontinued operation in accordance with ASC
205-20. The component met the criteria to be
classified as a discontinued operation as of
February 25, 20X9. Registrant A disclosed the nature
and estimated financial impact of this subsequent
event in its December 31, 20X8, Form 10-K in
accordance with the disclosure requirements in ASC
855. However, because held-for-sale classifications
are considered to be nonrecognized subsequent
events, discontinued operation treatment was not
reflected in the financial statements in the
December 31, 20X8, Form 10-K.
On May 1, 20X9, A filed its March 31, 20X9, Form
10-Q, which reflected discontinued operation
treatment for the quarters ended March 31, 20X9 and
20X8.
On May 2, 20X9, A filed a recast
Form 8-K that revised the annual financial
statements included in its December 31, 20X8, Form
10-K to reflect, for all periods presented, the
component that was disposed of as a discontinued
operation. Registrant A filed the recast Form 8-K
because it intended to file a new registration
statement (after the March 31 Form 10-Q had been
filed) that would incorporate the most recently
filed annual and interim financial statements.
On September 1, 20X9, A consummated
the acquisition of Company B, a nonregistrant whose
fiscal year-end is December 31. To measure the
significance of the acquisition of B, A used the
revised financial statements included in the Form
8-K filed on May 2, 20X9.
2.3.1.6 Measuring Significance When a Registrant Presents Predecessor and Successor Results
In certain circumstances, a registrant may be the successor
to a predecessor company or present financial statements that include
predecessor and successor results. Such circumstances may include (1) the
adoption of fresh-start accounting after emergence from bankruptcy, (2) an
acquisition in which the registrant’s own operations before the acquisition
appear insignificant relative to the acquired entity’s operations (see
Section 2.3
of Deloitte’s Roadmap Initial Public Offerings), 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.
If a registrant performing the income test does not have a
full year of income statement information available to use as the
denominator in the calculation, it should use the audited results of
operations of the successor period in accordance with paragraph
2915.10 of the FRM. Accordingly, the registrant would
compare a full year of operations (revenue and pretax income from continuing
operations) of the acquiree with the registrant’s operations (revenue and
pretax income from continuing operations) for the successor period, which
may be only a few days or a few months.
If the results of the income test are anomalous, it may be
acceptable, if precleared by the SEC, for the registrant to perform the
significance test by using pro forma amounts. Such amounts would be computed
as if the predecessor had been acquired at the beginning of the fiscal year
and would be determined in accordance with Article 11. As stated in
paragraph
2915.10 of the FRM, the SEC staff generally believes
that using the combined historical results of operations of the successor
and predecessor for a full year without the appropriate pro forma
adjustments is not an appropriate surrogate for the significance test. In
circumstances in which preclearance with the SEC staff is required,
registrants should also consider consultation with their auditors and SEC
legal counsel.
Example 2-9
Registrant A’s fiscal year-end is
December 31. On November 1, 20X8, A was acquired in
its entirety by an unrelated entity and applied
push-down accounting as a result of the acquisition.
Consequently, its basis of accounting changed in its
stand-alone financial statements. In its December
31, 20X8, Form 10-K, A showed the predecessor period
(January 1, 20X8, through October 31, 20X8)
separately from the successor period (November 1,
20X8, through December 31, 20X8).
In May 20X9, A acquired Company X, a nonregistrant
whose fiscal year-end is December 31. The periods
before A’s application of push-down accounting
represented the predecessor periods, and the periods
after such application represented the successor
periods. Given the change in basis of accounting,
the predecessor and successor periods were not
comparable.
When performing the significance
tests, A compared the financial statements of X as
of and for the year ended December 31, 20X8, with
the financial statements of A as of December 31,
20X8, and for the successor period from November 1,
20X8, through December 31, 20X8. That is, for both
the income component and the revenue component of
the income test, twelve months of operating results
of X were compared with two months of successor
operating results of A.
Note that for the income test, the SEC staff may have
permitted A to compare X’s financial statements for
the year ended December 31, 20X8, with A’s pro forma
financial information for the year ended December
31, 20X8, as though A had applied push-down
accounting on January 1, 20X8. However, A would have
been required to preclear such treatment with the
staff.
See Section 2.3.1.7
for measurement considerations for registrants with audited financial
statements that do not include successor periods (i.e., in normal
circumstances).
If the acquiree is a successor to a
predecessor company and does not have a full year of income statement
information available to use as the numerator in the calculation of the
income test, in accordance with paragraph
2915.11 of the FRM, the registrant should generally use
pro forma amounts as if the predecessor had been acquired at the beginning
of the fiscal year. In accordance with Article 11, such amounts should be
determined by using the historical basis of the acquired successor business
and not the registrant’s subsequent new basis. The SEC staff generally
believes that combining the historical results of the successor and
predecessor without the appropriate pro forma adjustments is not appropriate
and that Rule 3-06 should not be applied by analogy. In these circumstances,
registrants should consult with the CF-OCA before filing.
See Section 2.3.4.2 for guidance on
evaluating whether the revenue component applies when a registrant and
acquiree present predecessor and successor results in their respective
financial statements (i.e., whether a registrant and the acquiree have
material revenue in each of the two most recently completed fiscal
years).
2.3.1.7 Measuring Significance After a Shell Company Acquires a Predecessor
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, the registrant may use the pro forma financial statements that
were filed when the shell company acquired its predecessor in accordance
with Regulation S-X, Rule 11-01(b)(3)(i)(B) (see Section 2.3.1.2).
Registrants that achieve unusual test results may consider
seeking a waiver with the SEC staff as well as consulting with their
auditors and SEC legal counsel. For additional guidance on Rule 3-13 waivers
and prefiling letter requests, see Section
2.5 of Deloitte’s Roadmap Initial Public Offerings.
2.3.1.8 Measuring Significance After a Reverse Acquisition or a Reverse Recapitalization
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). Another 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 — As stated in paragraph 2915.8 of the FRM, 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 — As stated in paragraph 2915.9 of the FRM, use the private operating company’s audited annual financial statements (i.e., the legal acquiree’s) if they have been filed with the SEC.
Example 2-10
Reverse Acquisition
Registrant A is an operating company whose fiscal
year-end is December 31. On July 1, 20X8, A (the
legal acquirer) acquired Company B (the legal
acquiree), a nonregistrant operating company whose
fiscal year-end is December 31. The transaction was
accounted for as a reverse acquisition in which B
was the accounting acquirer and A was the accounting
acquiree.
On July 5, 20X8, A (the legal acquirer) filed a Form
8-K to report the consummation of the reverse
acquisition. Audited financial statements of B as of
December 31, 20X7, and December 31, 20X6, and for
the three years ended December 31, 20X7, were
available and included in the initial Form 8-K,
along with applicable interim and pro forma
financial information.
On August 15, 20X8, after the
reverse acquisition, the combined company acquired
Company C, a nonregistrant whose fiscal year-end is
December 31.
Company C’s annual financial
statements for the year ended December 31, 20X7,
were compared with B’s (the accounting acquirer’s)
previously filed audited financial statements for
the year ended December 31, 20X7, to determine
significance. Registrant A’s financial statements
were not used to determine the significance of the
acquisition because B’s (the accounting acquirer’s)
financial statements had been filed with the
SEC.
Example 2-11
Reverse
Recapitalization
Registrant A is a SPAC that completed its IPO on
November 30, 20X7. Its fiscal year-end is December
31. On July 1, 20X8, A (the legal acquirer) acquired
Company B (the legal acquiree), a nonregistrant
operating company whose fiscal year-end is December
31.
Before the July 1, 20X8, acquisition, A had nominal
operations and assets other than cash and was
therefore a shell company. The transaction was
accounted for as a reverse recapitalization, as
though B issued its equity for the net assets of
A.
On July 5, 20X8, A (the legal
acquirer) filed a Form 8-K to report the
consummation of the reverse recapitalization.
Audited financial statements of B as of December 31,
20X7 and 20X6, and for the three years ended
December 31, 20X7, were required in the Super 8-K
(see Section
2.4.1.1), along with applicable interim
and pro forma financial information.
On August 15, 20X8, after the
reverse recapitalization, the combined company
acquired Company C, a nonregistrant whose fiscal
year-end is December 31.
In the determination of
significance, C’s annual financial statements for
the year ended December 31, 20X7, were compared with
B’s previously filed audited financial statements
for the year ended December 31, 20X7. Registrant A’s
financial statements were not used to determine the
significance of the acquisition because B’s
financial statements had been filed with the
SEC.
2.3.2 Investment Test
Under the investment test in Rule 1-02(w)(1)(i), a registrant
determines the significance of an acquiree by comparing the investment in the
acquiree (see Section
2.3.2.1) with the AWMV of the registrant’s voting and nonvoting
common equity (see Section
2.3.2.2). A registrant that has no AWMV (e.g., when common equity
is not publicly traded, including during an IPO) should determine significance
by comparing the investment in the acquiree with the registrant’s total assets.
At the 2021 AICPA & CIMA Conference on Current SEC and PCAOB Developments,
the SEC staff indicated that once an entity completes its IPO, it should use its
AWMV when performing the investment test. Additional considerations are
necessary related to performing the investment test for a group of combined
entities. (For guidance on calculating aggregate significance, see Section 2.9.4.1; for
discussion of the significance of related businesses, see Section 2.7.2.1.) Special
considerations are also required for acquisitions conducted through a
registrant’s non-wholly-owned consolidated subsidiary (see Section 2.3.5.2 for
further information).
2.3.2.1 Investment in the Acquiree
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.
2.3.2.1.1 Transaction Costs
As stated in paragraph 2920.4 of the FRM,
if an acquiree meets the definition of a business in ASC 805,
acquisition-related transaction costs should be excluded from the
consideration transferred because they are treated as an expense under
ASC 805. For an acquiree that does not meet the definition of a business
in ASC 805, transaction costs should be included in the consideration
transferred if U.S. GAAP or IFRS Accounting Standards require
capitalization since those costs are generally viewed as part of the
cost of the asset acquisition. Likewise, in a manner consistent with the
guidance in ASC 323-10-30-2, the transaction costs should be included in
the consideration transferred for an acquiree that is an investment
accounted for under the equity method when such costs are required to be
capitalized under U.S. GAAP or IFRS Accounting Standards.
2.3.2.1.2 Contingent Consideration
An acquisition agreement may stipulate that the acquirer
transfer additional assets or equity interests to the former owners of
the acquiree if a specified future event occurs or conditions are met.
Consideration that depends on the occurrence of a future event is called
contingent consideration.
For acquisition agreements in which contingent
consideration is contemplated, as stated in paragraph
2920.4 of the FRM, the registrant should include the
acquisition-date fair value of all contingent consideration in the
consideration transferred when such contingent consideration must be
recognized at fair value on the acquisition date under U.S. GAAP or IFRS
Accounting Standards (e.g., contingent consideration for an acquiree
that meets the definition of a business in ASC 805 or contingent
consideration that is a derivative for an asset acquisition that does
not meet the definition of a business under ASC 805). However, if
recognition of the contingent consideration at fair value is not
required under U.S. GAAP or IFRS Accounting Standards (e.g., contingent
consideration accounted for under ASC 450 for an asset acquisition that
does not meet the definition of a business in ASC 805 or contingent
consideration for the acquisition of an investment accounted for under
the equity method), the consideration transferred must include the
maximum amount of contingent consideration, except amounts for which the
likelihood of payment is remote.
Contingent payments to employees or selling shareholders
that compensate them for future services or use of property are not
contingent consideration. ASC 805 requires entities to account for such
payments separately from the business combination. Accordingly, we do
not believe that these payments should be included in the investment
test.
At the April 2008 CAQ SEC
Regulations Committee joint meeting with the SEC staff, the SEC staff
addressed whether significance has to be remeasured if the preliminary
estimate of the fair value of contingent consideration changes during
the measurement period, which may extend a year from the acquisition
date. At that meeting, the SEC staff agreed with the view that
“[s]ignificance need not be remeasured when the preliminary estimate of
the fair value of contingent consideration changes as long as a good
faith estimate was made at the time of acquisition.”
2.3.2.2 Determining AWMV
Rule 1-02(w)(1)(i)(A)(3) indicates that 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.
The AWMV will differ from the value currently used to determine a
registrant’s filer status because such status is calculated by using the
value of common equity (1) held by only nonaffiliates, often referred to as
“public float,” and (2) as of the last business day of the registrant’s most
recently completed second fiscal quarter.
The investment test may yield anomalous results for
registrants that are highly leveraged or have unique or complex capital
structures. 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 additional
guidance on Rule 3-13 waivers and prefiling letter requests, see Section 2.5 of Deloitte’s Roadmap Initial Public Offerings). In
addition, registrants may also wish to consult with the SEC staff if, after
the announcement date, meaningful changes have been made to the terms of the
transaction that may warrant a change to the date for determining AWMV.
Example 2-12
Registrant A agreed to acquire 100 percent of Company
B on July 15, 20X9. The acquisition was announced on
August 1, 20X9, and was consummated on November 15,
20X9. The fiscal years of both A and B end on
December 31.
As of December 31, 20X8, A has total assets of $150
million. For the last five trading days of June
20X9, A had a five-day average share price of $30
per share as well as the following shares of common
equity outstanding: (1) 10 million shares of
publicly traded common equity and (2) 5 million
shares of common equity that are not publicly
registered or traded.
Under the acquisition agreement, A paid the following
amounts to acquire B:
-
$60 million in cash to the former owners of B.
-
$15 million in contingent consideration (acquisition-date fair value is $12 million), if certain targets are met for periods following the acquisition.
-
$3 million in acquisition-related costs.
The investment test calculation is
performed as follows:
If A did not have an AWMV, it would
perform the investment test as follows:
Connecting the Dots
At the March 2025 CAQ SEC
Regulations Committee joint meeting with the SEC staff, the staff
discussed whether an entity should adjust amounts used in the
investment test for acquisitions that include repurchases of its own
shares (i.e., when the acquiree holds common equity in the
registrant). The SEC staff indicated that a registrant with this
fact pattern should not analogize to paragraph
2920.12 of the FRM, which is meant to address historical intercompany transactions
between entities in a business combination. Rather, the registrant
should refer to Rule 1-02(w), which allows intercompany eliminations
for both the asset and income tests but does not include any such
allowance for the investment test. The SEC staff observed that this
is true for both AWMV as well as circumstances in which total assets
should be used instead of AWMV (i.e., when a company does not have
AWMV). Therefore, there are no allowances in Rule 1-02(w) to
eliminate intercompany transactions in the investment test.
Similarly, the staff also noted that for consideration transferred
in the investment test, if the registrant includes the value of its
own shares repurchased as part of the consideration transferred (as
defined in ASC 805), it should include that portion of the
consideration in the numerator of the test.
2.3.2.3 Investment Test for Acquirees That Are Under Common Control With the Registrant
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.”
Rule 1-02(w)(1)(i)(B)
addresses the measurement of significance for an acquiree that will be
accounted for as a combination between entities under common control. It
states, in part:
[T]his test is met when either the net book value of the tested subsidiary
exceeds 10 percent of the registrant’s and its subsidiaries’
consolidated total assets or the number of
common shares exchanged or to be exchanged by the registrant
exceeds 10 percent of its total common shares outstanding at the
date the combination is initiated. [Emphasis added]
In addition, Rule 11-01(b) specifies that when evaluating
the significance of an acquired business a registrant substitutes “20
percent for 10 percent in each place it appears [in Rule 1-02(w)].”
Therefore, a registrant must perform both of the
following investment tests for a reorganization of entities under common
control:
-
Net book value — Compare the net book value of the acquiree to the registrant’s total assets.
-
Common shares — Compare the number of shares exchanged in the transaction to the registrant’s total outstanding common shares on the date the combination is initiated. We believe that a business combination is initiated on the earlier of the date on which the major terms of the plan are (1) disclosed publicly or (2) disclosed to shareholders (which may occur before consummation).
Example 2-13
Registrant A merged with Company B, a nonregistrant,
on June 30, 20X9. For the past eight years, Company
C has controlled A and B. The fiscal year-end of
both A and B is December 31.
The merger of A and B was a transaction between
entities under common control and was therefore
accounted for in a manner similar to a pooling of
interests. In exchange for all the outstanding
common stock of B, A issued 1 million shares of its
common stock. Before issuing the 1 million shares, A
had 10 million shares outstanding.
As of December 31, 20X8, A had total consolidated
assets of $30 million. As of December 31, 20X8, B
had a net book value of $10 million.
The two investment tests are calculated as
follows:
Net Book Value
Number of Shares
Exchanged
On the basis of the investment test,
significance is 33 percent since it is the highest
level calculated in the two tests above. In
addition, A must consider the results of the asset
and income tests to determine the financial
statement filing requirements.
2.3.3 Asset Test
Under the asset test in Rule
1-02(w)(1)(ii), an acquiree is significant if the following
condition is met:
[T]he registrant’s and its other subsidiaries’
proportionate share of the tested subsidiary’s consolidated total assets
(after intercompany eliminations) exceeds 10 percent of such total
assets of the registrant and its subsidiaries consolidated as of the end
of the most recently completed fiscal year.
In addition, Rule 11-01(b) states that when evaluating the
significance of an acquired business, a registrant substitutes “20 percent for
10 percent each place it appears [in Rule 1-02(w)].” Thus, when performing the
asset test, the registrant should compare its share of the acquiree’s total
assets, before any adjustments to step up the acquiree’s basis for the
acquisition, with its preacquisition consolidated total assets. As described in
Section 2.3.1,
such amounts are generally for the most recently completed fiscal year that is
required to be filed with the SEC. However, in certain situations, the
registrant may use pro forma financial information filed for a previous significant acquisition when performing the asset test
for a subsequent acquisition (see Section 2.3.1.2 for additional
information).
In accordance with paragraph 2920.12 of the FRM,
intercompany transactions between the registrant and acquiree should be
eliminated in the same manner as if the acquiree were consolidated. Also, as
stated in paragraph
2920.3 of the FRM, in the performance of the asset test, ordinary
receivables and other working capital amounts that were not acquired by a
registrant must be included as part of the acquiree’s assets. This is because it
is assumed that the acquiree’s operation requires such working capital assets
and would continue to require them after the acquisition.
Example 2-14
Registrant A’s fiscal year-end is December 31. On
November 15, 20X1, it acquired Company B, a
nonregistrant whose fiscal year-end is June 30. Except
for $1 million of trade accounts receivable, which will
be retained by the previous owner of B, A acquired all
of B.
On December 31, 20X0, A had consolidated
total assets of $40 million. On June 30, 20X1, B had
consolidated total assets, including the $1 million of
trade accounts receivable not acquired, of $14
million.
The asset test calculation is performed
as follows:
Additional considerations are necessary related to performing
the asset test for a group of combined entities. (For guidance on calculating
aggregate significance, see Section 2.9.4; for guidance on calculating the significance of
related businesses, see Section 2.7.2.1.) Special considerations are also required for
acquisitions conducted through a registrant’s non-wholly-owned consolidated
subsidiary (see Section
2.3.5.2 for further information).
2.3.3.1 Proceeds From an Offering
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,
in accordance with paragraph 2920.19 of the FRM, 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, a registrant may sometimes use pro forma
financial information to measure significance if certain conditions are
met.
2.3.4 Income Test
The income test in Regulation S-X, Rule 1-02(w)(1)(iii),
includes the following two components:
- The income component — Under Rule 1-02(w)(1)(iii)(A)(1), the income component is determined by comparing the absolute values of (1) the registrant’s proportionate share of the acquiree’s “income or loss from continuing operations before income taxes (after intercompany eliminations) attributable to the controlling interest“ (pretax income or loss from continuing operations) with (2) the registrant’s pretax income or loss from continuing operations (see Section 2.3.4.1).
- The revenue component — Under Rule 1-02(w)(1)(iii)(A)(2), 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 the acquiree’s revenue with the registrant’s revenue. If either the registrant or the acquiree does not have material revenue for each of the two most recently completed fiscal years, only the income component should be used (see Section 2.3.4.2). In such a situation, a registrant should average its income for the income component when applicable (for the denominator of the test; see Section 2.3.4.3).
In accordance with paragraph 2920.12 of the FRM, if the
registrant and acquiree have a preexisting business relationship, transactions
between them should be eliminated from pretax income and revenue as if the
acquiree were consolidated.
As described in Section 2.3.1, such amounts are generally
for the most recently completed fiscal year that is required to be filed with
the SEC. However, in certain situations, it may be appropriate for the
registrant to use pro forma financial information filed for a previous significant acquisition when performing the income test
for a subsequent acquisition (see Section 2.3.1.2 for additional
information).
A registrant must consider both components when evaluating
significance. As highlighted in the note to paragraph 2920.8 of the FRM, to determine the number of
periods for which acquiree financial statements are required, the registrant
uses the lower of the two component calculations only if
it finds the results of each to be significant (i.e.,
each exceeds 20 percent). If one or both of the components are not significant
(i.e., do not exceed 20 percent), the registrant does not need to provide
acquiree financial statements under the income test (but may need to do so under
the asset test or investment test).
Additional considerations are required related to performing the
income test for a group of combined entities. (For guidance on calculating the
aggregate significance, see Section 2.9.4.2; for guidance on calculating the significance of
related businesses, see Section 2.7.2.2.) Special considerations are also required for
acquisitions conducted through a parent’s non-wholly-owned consolidated
subsidiary (see Section
2.3.5.2 for further information).
2.3.4.1 Income Component
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.
Under the income component, if a registrant or an acquiree
presents equity in earnings (or losses) of equity method investees on a
net-of-tax basis, it treats such equity, on a pretax basis, as a component
of pretax income or loss from continuing operations. Similarly, if a
registrant or acquiree has income or loss attributable to noncontrolling
interests (which are presented on a net-of-tax basis), the registrant must
nevertheless determine income or loss attributable to controlling interests
on a pretax basis. Even though these items may be presented after tax in the
income statement, a registrant should use pretax amounts in the
calculation.
When performing the income component, the registrant should
not adjust pretax income or loss from continuing operations to exclude any
special or nonrecurring items, such as restructuring charges or impairments.
In addition, if a registrant or an acquiree has existed for less than 12
months, its pretax income from continuing operations should not be
annualized when the income component is performed.
2.3.4.2 Revenue Component
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.
As discussed in paragraph
2920.9 of the FRM and in a manner consistent with Rule
1-02(w)(1)(iii)(A)(2), the revenue component applies when a registrant and
the acquiree have material revenue in each of the two most recently
completed fiscal years. At the 2020 AICPA Conference on Current SEC and
PCAOB Developments, the SEC staff indicated that in most cases, it should be
readily apparent whether a registrant and acquiree have material revenue in
each of the two most recently completed fiscal years. Therefore, a detailed
analysis of materiality in accordance with SAB Topic 1.M would not be required.
However, when determining whether the revenue component applies, the
registrant should evaluate whether its or the acquiree’s revenue is so low
that the revenue component would be meaningless in the assessment of the
significance of the acquiree.
Further, as stated in paragraph 2920.14 of the FRM, the revenue component
should not be adjusted to exclude noncontrolling interests in the acquiree.
Since there is no distinction under U.S. GAAP, or under IFRS Accounting
Standards as issued by the International Accounting Standards Board
(IASB®), between controlling and noncontrolling interests for
revenue, the revenue component should be based on the registrant’s
proportionate interest in the consolidated revenue of the acquiree.
When performing the revenue component, the registrant should
not adjust revenue to exclude any special or nonrecurring items. In
addition, revenue should not be annualized when the revenue component is
used to perform the significance test. Rather, the registrant should measure
significance by using the audited historical statement of comprehensive
income that complies with the age of financial statement requirements (see
Section 2.5) regardless of the
number of months it includes.
As noted in Section 2.3.1.6, a registrant or an
acquiree may present financial statements that include predecessor and
successor results. Further, as stated in paragraph 2920.9 of the FRM, a “registrant should
consider the activity without regard to the separation of predecessor and
successor periods in determining whether [the registrant and acquiree have]
material revenue in each of the two most recently completed fiscal years.”
That is, the registrant and acquiree are not limited to considering only the
successor period. However, in such a situation, if the successor has existed
for less than 12 months, its revenue should not be annualized or combined
with that of the predecessor when the revenue component is performed.
As stated in paragraph 2920.9 of the FRM, the
determination of whether the acquiree has material revenue is separate from
that for the registrant. That is, the determination of whether an acquiree
has material revenue should be in the context of that acquiree and not that
of the registrant. Further, as stated in paragraph 2920.8 of the FRM, the
revenue component of the income test applies both to acquisitions of
investees that are accounted for under the equity method and to acquisitions
of investees for which a registrant has elected to apply the fair value
option as permitted by ASC 323.
2.3.4.3 Using Average Income When the Revenue Component Is Not Applicable
As discussed in paragraph 2920.10 of the FRM and
in a manner consistent with Rule 1-02(w)(1)(iii)(B)(2), 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 required to
calculate its average income (by using the absolute value for any loss
years) over the last five years to determine whether such amount must be
used in the denominator of the income component of the income test.
The use of average income in the income component is only
available to the registrant (acquirer); the acquiree cannot average its
pretax income or loss from continuing operations. In addition, we understand
that it would not be appropriate to use income averaging in circumstances in
which a registrant is a successor to a predecessor since the financial
statements for the predecessor and successor periods are not comparable.
2.3.4.4 Illustrative Examples of the Income Test
The examples below illustrate the following:
- The income and revenue component when 100 percent of a business is acquired (Example 2-15). (For an illustrative example of how to perform the income and revenue components of the income test when less than 100 percent of a business is acquired, see Example 2-18.)
- The use of average income when the revenue component does not apply (Example 2-16).
Example 2-15
Registrant A’s fiscal year-end is
December 31. On November 15, 20X5, it acquired 100
percent of Company B, which is not a registrant.
Company B has no noncontrolling interests or equity
method investees and its fiscal year-end is June
30.
The table below lists certain income
statement information of A for the year ended
December 31, 20X4 (in millions).
Therefore, A has $4 million of
pretax net income from its equity method investees
and $8 million of pretax net income
attributable to noncontrolling interests.
For the year ended June 30, 20X5, B
had revenues of $45 million and pretax income from
continuing operations of $15 million.
The income component of the income
test is calculated as follows:
The revenue component of the income
test is calculated as follows:
Significance under the income test
is 23 percent, the lower of the results of the
income component (42 percent) and the revenue
component (23 percent) calculations.
Example 2-16
Registrant A’s fiscal year-end is
December 31. On April 15, 20X6, it acquired Company
B, a nonregistrant whose fiscal year-end is also
December 31.
Registrant A’s pretax income from
continuing operations for the previous five years is
as follows:
- 20X1 — $4 million.
- 20X2 — $6 million.
- 20X3 — $5 million.
- 20X4 — ($6 million).
- 20X5 — $1 million.
Company B’s pretax income from
continuing operations for the year ended December
31, 20X5, was $0.8 million, and it had no material
revenue for the last two fiscal years.
Registrant A’s average pretax income
from continuing operations for this five-year period
is calculated by using absolute values as
follows:
Because A’s current-year income, $1
million, is at least 10 percent lower than its
average income for the last five fiscal years, $4.4
million, A must use its five-year average income
when performing the income test:
The acquisition is not significant
under the income test because the income component
(18 percent) does not exceed 20 percent.
2.3.5 Application of the Significance Tests in Special Circumstances
2.3.5.1 Performing the Significance Tests When Less Than 100 Percent of the Entity’s Equity Is Acquired
A registrant sometimes acquires or will acquire less than
100 percent of an entity’s equity. Paragraph 2920.13 of the FRM
indicates that in such cases, the registrant performing the significance
tests should compare (1) the acquired or to be acquired percentage of
assets, pretax income from continuing operations, or revenues of the
acquiree with (2) the registrant’s preacquisition consolidated assets,
pretax income from continuing operations, or revenues, (see Example 2-17 and
Example
2-18 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).
If only certain assets are acquired or liabilities are assumed (e.g., a
segment of an entity), the income test calculation should be based on 100
percent of the pretax income from continuing operations generated from the
assets acquired or liabilities assumed, as reflected in the carve-out
financial statements or abbreviated financial statements (see
Section 2.3.5.3).
Example 2-17
Asset Test
Registrant A’s fiscal year-end is
December 31. It acquired 60 percent of Company B, a
nonregistrant with a June 30 fiscal year-end, on
November 15, 20X4.
As of December 31, 20X3, A had total
consolidated assets of $80 million. As of June 30,
20X4, B had total consolidated assets of $60
million.
The asset test calculation is
performed as follows:
Example 2-18
Registrant A’s fiscal year-end is
December 31. On November 15, 20X5, it acquired 80
percent of Company B, which is not a registrant.
Company B has no noncontrolling interests or equity
method investees, and its fiscal year-end is June
30. Registrant A has $8 million of pretax net
loss attributable to noncontrolling interests.
The table below identifies certain income statement
information of A for the year ended December 31,
20X4 (in millions).
Therefore, A has $4 million of
pretax net income from its equity method investees
and $8 million of pretax
loss attributable to noncontrolling
interests.
For the year ended June 30, 20X5, B
had revenues of $45 million and pretax income from
continuing operations of $15 million.
The income component of the income
test is calculated as follows:
The revenue component of the income
test is calculated as follows:
Significance under the income test
is 18 percent, the lower of the results of the
income component (23 percent) and the revenue
component (18 percent). The acquisition is not
considered significant under the income test because
the lower of the results of the two components
(i.e., the revenue component) does not exceed 20
percent.
2.3.5.2 Acquisition by a Registrant’s Non-Wholly-Owned Consolidated Subsidiary
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 Section 2.3.2, Section 2.3.3, and
Section
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, paragraph 2920.23 of the FRM states
that the significance tests should 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 DotsA 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 additional guidance on Rule 3-13 waivers and prefiling letter requests, see Section 2.5 of Deloitte’s Roadmap Initial Public Offerings.
-
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.
Example 2-19
Registrant A’s fiscal year-end is
December 31. It owns 60 percent of consolidated
Subsidiary B. On July 15, 20X4, B purchased 90
percent of Company C for $100 million. The
acquisition was announced on June 15, 20X4. The
fiscal year-end of B and C is December 31, and
neither is a registrant.
As of December 31, 20X3, A had total assets of $16
million and C had total assets of $7 million. For
the year ended December 31, 20X3, A had pretax
income from continuing operations of $16 million
attributable to controlling interests and revenue of
$40 million, and C had pretax income from continuing
operations of $7 million and revenue of $18 million.
Registrant A’s AWMV for the last five business days
of May 20X4 was $300 million.
The investment test calculation is performed as
follows:
The asset test calculation is
performed as follows:
The income component of the income
test calculation is performed as follows:
The revenue component of the income test calculation
is performed as follows:
2.3.5.3 Performing the Significance Tests When Criteria to Provide Abbreviated Financial Statements Are Met
The SEC staff permits a registrant (acquirer) to provide
abbreviated financial statements of an acquiree 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.
Rule 11-01(b)(3)(i)(A) states that significance may be
determined by using abbreviated financial statements when the criteria are
met. However, questions may arise related to applying the significance tests
in Rule 1-02(w) with abbreviated financial information since the income
statement does not reflect interest expense, corporate overhead, or income
taxes. As indicated in paragraph
2920.20 of the FRM, a registrant should not adjust the
denominator to exclude expenses such as corporate overhead from pretax
income (or loss) when such expenses are not included in the acquiree’s
abbreviated financial statements that are used for the numerator of the
significance calculation. For more information about abbreviated financial
statements, see Section
2.6.4.2.
Footnotes
1
Foreign private issuers should refer to Section 6350 of the FRM as well as
SEC Final Rule Release No. 33-8879,
which indicates that when performing the significance tests required by Rule
3-05, an issuer should use amounts determined under
IFRS Accounting Standards when its financial statements are prepared in
accordance with such standards. A registrant that files its financial
statements in accordance with, or is required to provide reconciliation to,
U.S. GAAP should assess significance by using amounts determined under U.S.
GAAP for both the acquired business and the registrant. See Section 2.11.