2.6 Form and Content of Acquiree Financial Statements
A registrant generally prepares preacquisition financial statements
of the acquiree on the same basis as if the acquiree were a registrant, except that
it uses the acquiree’s level of significance to determine the number of years of
audited financial statements to present. Although the determination of such periods
is based on significance, the form and content of the acquiree’s financial
statements must adhere to the relevant requirements of Regulation S-X (e.g.,
classification of equity that is subject to mandatory redemption requirements or
whose redemption is outside the control of the registrant under Regulation S-X, Rule
5-02.27) as well as the guidance in U.S. GAAP (or, if the acquiree is a foreign
entity, IFRS Accounting Standards; see Section 2.11). Supplemental schedules under
Regulation S-X, Articles 5 and 12, are not required.
2.6.1 Accounting Standards, Disclosures, and Adoption Dates
If the acquiree is not a public entity, the disclosures under
U.S. GAAP that apply only to public companies do not have to be provided. For
example, disclosures about the following would not be required in a such a case:
-
Segment information if the acquiree does not meet the definition of a public entity under ASC 280-10-20.
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Certain information about employers’ pensions and other postretirement benefits (see ASC 715-20-50-5) if the acquiree meets the definition of a nonpublic entity under ASC 715-20-20.
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Earnings per share if the acquiree does not have “publicly held common stock or potential common stock” in accordance with ASC 260-10-05-1 and as further described in ASC 260-10-15-2.
Acquiree financial statements that are included in a filing
under Rule 3-05
meet the definition of a public business entity (PBE) in U.S. GAAP.2 As stated in the ASC master glossary, a business entity is a PBE if it is
required by the SEC “to file or furnish financial statements, or does file or
furnish financial statements (including voluntary filers), with the SEC (including other entities whose financial statements or
financial information are required to be or are included in a filing)”
(emphasis added). Accordingly, such acquiree financial statements must adhere to
the PBE requirements in U.S. GAAP.
In accordance with U.S. GAAP, entities that meet the definition
of a PBE are not eligible to elect certain accounting and reporting alternatives
in U.S. GAAP, including those developed by the Private Company Council and
subsequently endorsed by the FASB. Therefore, the effects of any previously
elected private-company accounting alternatives cannot be applied in the
acquiree financial statements under Rule 3-05 and would have to be eliminated
from them.
In addition, companies that are not PBEs are permitted to use
certain practical expedients. For example, a non-PBE may use the risk-free rate
as its discount rate when applying ASC 842. At the October 2020 CAQ SEC
Regulations Committee joint meeting with the SEC staff, the SEC staff discussed
a situation in which (1) an acquired company has adopted ASC 842 by using the
risk-free-rate practical expedient and (2) a registrant must evaluate the
acquired company for significance and, in some cases, provide this company’s
separate financial statements. The SEC staff indicated that it would not object
if a registrant uses financial statements that reflect the risk-free-rate
practical expedient to measure significance, since doing so would result in
greater ROU assets and, thus, would yield a higher measure of significance when
the asset test is performed. The staff noted that the risk-free-rate practical
expedient should be “the only difference between those financial statements and
a PBE set of financial statements” but clarified that financial statements
provided in accordance with Rule 3-05 are PBE financial statements and thus may
not reflect this. Therefore, before providing such financial statements in
accordance with Rule 3-05, a registrant would need to assess whether an
adjustment to the PBE rate is material and must be revised.
Further, in certain accounting standards, the adoption dates and
disclosure requirements for PBEs differ from those for non-PBEs. If a standard
defines a public entity as a PBE with respect to the application of that
standard’s transition requirements, the acquiree’s financial statements that
must be provided under Rule 3-05 are required to conform to the PBE adoption
dates and disclosure requirements. Therefore, an acquiree that does not
otherwise meet the definition of a PBE (except for its requirement to include
its financial statements or financial information in another entity’s filings
with the SEC) may have to adopt certain accounting standards earlier than
planned and provide the incremental disclosures required for PBEs. However, the
SEC staff announced in 2017 that it would not object
if certain PBEs, when preparing the financial statements of non-PBE acquirees,
used the non-PBE effective dates for the sole purpose of adopting the FASB’s
standards on revenue and leasing. While the use of such dates was permitted,
once the standards were adopted, the financial statements were required to
reflect the disclosures applicable to PBEs.
Management should be mindful of other accounting standards in
which the adoption dates for PBEs and non-PBEs differ. While EGCs may not be
required to adopt certain accounting standards by using the PBE effective dates,
this accommodation does not apply to acquiree financial statements under Rule
3-05.
In November 2019, the FASB issued ASU 2019-10, which introduced
a “two-bucket” framework for staggering the effective dates of certain major
ASUs. Under this framework, the application of adoption dates would be grouped
as follows:
-
Bucket 1 — PBEs that are SEC filers (as defined in U.S. GAAP), excluding SRCs (as defined by the SEC).
-
Bucket 2 — All other entities, including SRCs, other PBEs that are not SEC filers, private companies, not-for-profit organizations, and employee benefit plans.
Entities that include or are required to include financial
statements or financial information in other entities’ filings (e.g., financial
statements or financial information that must be provided under Rule 3-05) are
examples of PBEs that are not SEC filers. Therefore, the Bucket 2 adoption dates
would be used for the financial statements of an acquiree. See Deloitte’s
November 19, 2019, Heads
Up for more information about ASU 2019-10 and the
two-bucket framework.
Also, when preparing pro forma financial statements under
Article 11, a
registrant must conform the acquiree’s date and method of adoption of new
accounting standards to those of its own. See Chapter 4 for additional information
regarding the pro forma requirements.
In the evaluation of adoption dates of new standards for a
nonpublic target that is an accounting acquirer in a reverse merger with a
public operating company, the use of non-PBE adoption dates for premerger
financial statements of the target included in a related Form S-4, proxy
statement, or Form 8-K will vary depending on the facts and circumstances. If
the registrant, target, and combined entity after the merger all qualify as EGCs
and the legal acquirer elected to defer adoption, the target may continue with
non-PBE adoption dates in the related filings. If the target would not
qualify as an EGC, if the postmerger entity would not qualify as an EGC,
or if both scenarios apply, non-PBE adoption dates would also be permitted in
the Form S-4 or proxy. However, PBE adoption dates would have to be used in the
target’s financial statements that must be filed in the amended Form 8-K that is
due 71 calendar days after the initial Form 8-K has to be filed. This is because
the financial statements of the target become those of the registrant
(predecessor financial statements) upon consummation of the merger.
Connecting the Dots
Registrants that apply the non-PBE adoption dates for the financial
statements included in the Form S-4 but would be required to apply PBE
adoption dates in the amended Form 8-K must ensure that they have
provided robust and comprehensive transition disclosures under
SAB Topic 11.M (SAB
74) in the footnotes to their financial statements and MD&A to
disclose the expected effects of the new standard on their financial
statements in the period of adoption.
See the highlights of the March 2021 and March 2022 CAQ SEC
Regulations Committee joint meetings with the SEC staff. Also see Sections 2.4.4.2 and
2.4.5.2 for a
discussion of audit requirements in this circumstance.
2.6.2 Audit Requirements
When audited financial statements of an acquiree are provided
under Rule 3-05, the audit may be performed in accordance with AICPA standards
(the public accounting firm does not need to be registered with the
PCAOB). However, compliance with PCAOB standards is required when an acquired
company is identified as a predecessor (e.g., an accounting acquirer in a
reverse acquisition [see Sections 2.4.4.2 and 2.4.5.2] or a target in a SPAC transaction
[see Section
2.4.6]).
2.6.3 Interim Financial Statements
A registrant that must provide an acquiree’s interim financial
statements under Rule 3-05 should ensure that the
statements adhere to the form and content requirements in Article 10. While
under SEC regulations, a registrant does not have to audit or review such
interim financial statements, the registrant should consider whether there are
other reasons to do so, such as in circumstances in which an underwriter
requires an independent auditor to review the interim information for
due-diligence or comfort-letter purposes.
2.6.4 Acquisition of a Portion of an Entity
A registrant sometimes acquires only certain parts of an entity. If those parts
represent substantially all of the entity, the registrant generally must provide
full audited financial statements of the entire entity because there is a
presumption that such statements convey the acquired business’s complete
financial history. In these circumstances, any of the assets, liabilities, and
operations not acquired by the registrant would be eliminated in the pro forma
financial statements.
If the acquired parts of an entity do not represent substantially all of the
entity, financial statements of the entire entity may not be useful. In this
case, the audited financial statements should represent only the acquired parts
of the entity and should exclude the operations retained by the seller. Such
financial statements — often referred to as carve-out financial statements —
include (1) balance sheets; (2) statements of operations, comprehensive income,
and cash flows and an analysis of changes in stockholders’ equity (which may be
in a note or separate statement) for the relevant periods; and (3) related
financial statement disclosures.
There may be circumstances in which full financial statements or
carve-out financial statements may not be practicable to prepare, such as when
the acquiree is a small portion or a product line of a much larger business and
separate financial records were not maintained. In such cases, the SEC staff
allows registrants to file abbreviated financial statements to comply with
Rule 3-05
provided that certain qualifying conditions (see the Section 2.6.4.1) and presentation and disclosure requirements
(see Section 2.6.4.2) are met. In
addition, as further discussed in Section 2.6.4.3, Rule 3-05(f) allows a
registrant to provide a form of abbreviated financial statements for an acquired
or to be acquired business that includes significant oil- and gas-producing
activities.
See Deloitte’s Roadmap Carve-Out Transactions for more
information. For a discussion of the performance of the significance tests when
only abbreviated financial statements are available, see Section
2.3.5.3.
2.6.4.1 Qualifying Conditions for Use of Abbreviated Financial Statements
Under Rule
3-05(e), registrants may file abbreviated financial
statements for an acquiree when all of the following conditions are met:
-
As of and for the most recently completed fiscal year, the assets and revenue (after intercompany eliminations) of the acquiree represent 20 percent or less of the assets and revenue of the seller.
-
The acquiree financial statements have not been previously prepared.
-
The acquiree was not a separate entity, subsidiary, operating segment, or division during the periods for which acquiree financial statements would be required.
-
The seller did not maintain the “distinct and separate accounts” that would be necessary for the registrant to present financial statements that include the omitted expenses, and the preparation of such financial statements would be impracticable.
In evaluating the “operating segment” condition above, a registrant should
consider the definition of that term in ASC 280 or IFRS 8, as applicable.
The operating segment condition for abbreviated financial statements applies
to all acquired businesses, whether public or private. Accordingly, a
company may have to evaluate whether the acquired entity would qualify as an
operating segment under ASC 280, if relevant.
There may be circumstances in which it is challenging for a
registrant to make the relevant allocations needed to provide carve-out
financial statements. If the qualifying conditions for abbreviated financial
statements have not been met but a registrant nevertheless believes that
such statements would provide sufficient disclosure for investors, the
registrant may request a waiver from the SEC staff under Rule 3-13.
Note also that while a registrant generally may not use
abbreviated financial statements for an acquiree that has been identified as
its predecessor, the SEC staff may consider requests under Rule 3-13 to
provide such statements (e.g., when full successor financial statements have
been presented in the initial registration statement for some periods). For
more information, see Section 1.5.
2.6.4.2 Presentation and Disclosure Requirements for Abbreviated Financial Statements
Abbreviated financial statements typically consist of a statement of (1)
revenues and expenses (in lieu of a full statement of operations) and (2)
assets acquired and liabilities assumed (in lieu of a full balance sheet).
The title of the statement of revenues and expenses must be appropriately
modified to indicate that it omits certain expenses.
The statement of revenues and expenses must include all
direct revenues and direct expenses associated with the revenue-producing
activities of the assets acquired and liabilities assumed. Typically, the
only costs excluded are those not directly connected to the revenue
producing activity. For example, all related costs incurred by or on behalf
of the acquiree for the periods required to be presented must include costs
of sales or services, selling, distribution, and marketing as well as
general and administrative expenses, depreciation and amortization, and
R&D expenses. As noted in the response to Question 2 of SAB Topic
1.B, if the abbreviated financial statements include a
reasonable allocation of costs directly related to the revenue producing
activity incurred by the seller on behalf of the business sold, the
footnotes should contain management’s assertion that the method used to
allocate those costs is reasonable. However, the registrant may exclude
allocated corporate overhead expenses, certain interest expense (i.e.,
interest expense for debt that will not be assumed by the registrant), and
income tax expense (collectively, “omitted expenses”). The auditor’s report
on these financial statements would include an explanatory paragraph
indicating the special purpose and incomplete nature of the presentation of
the results of operations, as discussed in AICPA SAS 122 (AU-C Section
805.24).
In accordance with Rule 3-05(e)(2)(iii), the footnotes to
the abbreviated financial statements should include the following
disclosures: (1) the nature of the omitted expenses and why they were
omitted, (2) an explanation of why it is impracticable to prepare financial
statements that include the omitted expenses, and (3) a statement that the
financial statements do not indicate the acquiree’s future financial
condition or operations because the omitted expenses have been excluded.
If a registrant presents abbreviated financial statements, it is not required
to provide a statement of cash flows. However, information (if available)
about the acquiree’s operating, investing, and financing cash flows must be
included in the footnotes to the financial statements.
2.6.4.3 Abbreviated Financial Statements for an Oil and Gas Acquiree
Rule
3-05(f) permits the financial statements of an acquired or to
be acquired business that includes significant oil- and gas-producing
activities (an “oil and gas acquiree”) to consist only of abbreviated
statements of revenues and expenses and to omit costs that are not
comparable to the proposed future operations. Such statements may therefore
exclude the omitted expenses described in Section 2.6.4.2 as well as
depreciation, depletion, and amortization.
A registrant may present abbreviated financial statements if
the oil and gas acquiree generates substantially all of its revenues from
oil- and gas-producing activities as defined in Regulation S-X, Rule
4-10(a)(16), and meets the qualifying conditions described in Section 2.6.4.1. Such
statements must also include footnote disclosures (see Section 2.6.4.2) as
well as the industry-specific disclosures required by ASC 932-235-50-3
through 50-11 and ASC 932-235-50-29 through 50-36. A registrant may provide
the industry-specific disclosures as unaudited supplemental information for
each annual period it presents for the oil and gas acquiree.
Note that the registrant does not have to provide an abbreviated statement of
assets acquired and liabilities assumed.
Connecting the Dots
Before issuance of the SEC’s May 2020 final rule, an
oil and gas acquiree that met certain conditions outlined in
Section
2065.1 of the SEC Financial Reporting Manual
(FRM) was not required to obtain preclearance from the SEC to
present abbreviated financial statements. However, the qualifying
conditions under Rule 3-05(e) (see Section 2.6.4.1 above) differ
from the conditions in the FRM and may be more difficult to satisfy
(e.g., assets and revenue of the oil and gas acquiree must represent
20 percent or less of the seller’s assets and revenue).
Therefore, preclearance from the SEC under Rule 3-13 to present
abbreviated financial statements for certain oil and gas acquirees
may now be necessary in accordance with Rule 3-05(f). For more
information, see Section 1.5.
Footnotes
2
Also see Section 8.1 of Deloitte’s Roadmap
Business
Combinations and Section 3.2 of Deloitte’s Roadmap
Initial Public
Offerings.