2.8 Acquisition of an Additional Equity Interest (Step Acquisition)
When a registrant owns an equity interest in a business and
subsequently acquires (or it is probable that it will acquire) any additional equity interest in that business, the registrant must
consider the requirements in Rule
3-05 related to the additional interest in that business. Such an
acquisition (or probable acquisition) is generally referred to as a step acquisition
for SEC reporting purposes. This may or may not be consistent with a step
acquisition for U.S. GAAP accounting purposes.
Example 2-31
As of December 31, 20X3, Registrant A owns
40 percent of Company B. On March 15, 20X4, A acquires an
additional 20 percent interest in B.
Because A acquired an additional interest in
B, the transaction is considered a step acquisition for SEC
reporting purposes and the additional 20 percent interest
must be evaluated for significance under Rule 3-05.
Example 2-32
Assume the same facts as in the previous
example, except that Registrant A acquired only an
additional 5 percent interest in Company B and, after the
acquisition, continued to use the equity method to account
for its investment in B. The acquisition of the additional 5
percent interest is also considered a step acquisition for
SEC reporting purposes and must be evaluated for
significance under Rule 3-05.
Both an initial acquisition of an investment that is accounted for
under the equity method and subsequent acquisitions in the same entity are subject
to the requirements of Rule 3-05. Similarly, if a registrant already consolidates a
business and acquires additional interests, the acquisition of such additional
interests is subject to the requirements of Rule 3-05. However, when determining
what financial statements may be required, the registrant would consider how long it
has consolidated the business (see Section 2.8.2.1).
The filings in which the financial statements of step acquisitions are required are
the same as those discussed in Section
2.4.
2.8.1 Performing the Significance Tests for a Step Acquisition
To determine the significance of a step acquisition, a registrant should perform
the investment, asset, and income tests. However, significance under the asset
and income tests should be based on the increase in the registrant’s
proportionate interests in the step acquisition’s assets, pretax income from
continuing operations, and revenue rather than on the cumulative interest to
date. Note that significance should be determined in this manner irrespective of
whether the interest acquired results in a change in accounting for the
investment (e.g., begin applying the equity method, consolidate the entity).
After considering the above guidance and specific requirements for certain tests
(see below), a registrant performs the significance tests for step acquisitions
the same way it performs them for initial acquisitions of a business. (See
Section 2.3 for additional information
about performing the tests.)
Under the asset test, the registrant is required to compare its proportionate
interest in the step acquisition’s assets with its own total assets. The
registrant’s total assets for the asset test (or investment test, if applicable)
includes the initial investment in the acquiree before the step acquisition.
Under ASC 805, when control is obtained after an acquirer already owns a
noncontrolling interest in an entity’s equity, the acquirer’s initial investment
in the entity is remeasured as of its acquisition-date fair value, with a
resulting gain or loss recorded in earnings. The SEC has clarified that the
remeasurement of the previously held equity interest and the resulting gain or
loss from remeasurement would be excluded from the asset and income test because
such amounts are not included in the registrant’s most recently completed fiscal
year.
A registrant may complete step acquisitions of the same entity
over a period, acquiring additional interests in a series of separate
transactions. While each step acquisition is generally evaluated separately,
registrants should aggregate any that are consummated or planned to be
consummated within a short period, generally 12 months.
Example 2-33
As of December 31, 20X2, Registrant X
owned 22 percent of Company Y, and X used the equity
method to account for Y. Both X and Y have a December 31
fiscal year-end.
On August 10, 20X4, X acquired an
additional 25 percent interest in Y for $10 million. For
the year ended December 31, 20X3, X had pretax income
from continuing operations of $5 million, revenue of $20
million, and total assets of $40 million.
For the year ended December 31, 20X3, Y
had pretax income from continuing operations of $3
million, revenue of $8 million, and total assets of $20
million.
The AWMV of X based on the last five
trading days of July 20X4 was $45 million, and X’s
pretax income from continuing operations does not
include any intercompany profits from transactions with
Y since they were eliminated in the application of the
equity method of accounting.
Because X acquired an additional equity
interest in Y, the transaction is considered a step
acquisition for SEC reporting purposes and the
additional interest must be evaluated for significance
under Rule 3-05.
The income test calculation is as
follows:
Income
Component
Revenue
Component
The asset test calculation is as
follows:
The investment test calculation is as
follows:
The highest level of significance is 22
percent.
2.8.2 Financial Statement Requirements for a Step Acquisition
The significance thresholds and respective financial statement
presentation requirements that apply to individual acquirees (see Section 2.3) are the same
as those that apply to a step acquisition. Therefore, if any of the results of
the significance tests exceed 20 percent for a step acquisition, separate
financial statements of the acquiree may be required. To determine whether it
must file financial statements for an acquiree in accordance with Rule 3-05, a registrant
must first consider how it accounted for its ownership interest in the acquiree
before the step acquisition.
2.8.2.1 Registrant Acquires an Additional Equity Interest in an Already Consolidated Entity
If the registrant increases its equity interest in an entity that was already
consolidated in its audited financial statements, acquiree financial
statements are not required if the registrant’s audited financial statements
reflect the operating results of the acquiree for at least:
- Nine months if any of the results of the significance tests for the step acquisition are greater than 20 percent but none are greater than 40 percent.
- A complete fiscal year if the results of any of the significance tests for the step acquisition are greater than 40 percent.
However, even though separate acquiree financial statements
are not required in such cases, the registrant may have to file a Form 8-K
with pro forma financial information (see Chapter 4). While Regulation S-X, Rule
11-01(c), states that pro forma financial information need
not be presented if the acquiree’s separate financial statements are not
presented, Rule
11-01(a)(8) requires the presentation of pro forma financial
information when it is material to investors, which may apply to step
acquisitions. Registrants may consider whether they can describe the effects
of the step acquisition narratively. For example, the impact may be limited
to adjustments between noncontrolling interest and shareholders’ equity on
the balance sheet as well as income attributable to the parent and
noncontrolling interests in the statement of comprehensive income.
2.8.2.2 Registrant Acquires an Additional Equity Interest in a Previously Unconsolidated Entity
If the registrant is making an additional equity investment
in an entity that it previously did not consolidate (e.g., equity method
investment), it may be required to file a Form 8-K with separate financial
statements of the acquiree and pro forma financial information, depending on
the significance of the additional investment.
Example 2-34
Registrant X owned 25 percent of
Company Y as of December 31, 20X3, and used the
equity method to account for Y. On April 1, 20X4, X
acquired the remaining 75 percent of Y. The highest
level of significance for the additional interest
acquired in Y was determined to be 48 percent.
Because the acquisition of the
additional 75 percent interest in Y exceeds 20
percent, X will be required to file separate
financial statements of Y in a Form 8-K and include
pro forma financial information. See Section
2.4 for more information about filings
for which the financial statements of a significant
business acquisition or significant probable
business acquisition are required.