4.4 Pro Forma Adjustments
4.4.1 General Principles
In a business acquisition, the pro forma balance sheet and pro forma income
statement(s) begin with the registrant’s historical financial information, which
are followed by the acquiree’s historical financial information. The historical
financial information may then be adjusted as follows:
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Transaction accounting adjustments — These are limited to adjustments that reflect the accounting for the transaction in accordance with U.S. GAAP or IFRS Accounting Standards, as applicable. They may include, among other items, (1) the recognition of intangible assets and goodwill and adjustments of assets and liabilities, typically to fair value, on the balance sheet and (2) the related impacts on the income statement under the assumption that the balance sheet adjustments were made as of the beginning of the fiscal year presented. See Section 4.4.2.1 for guidance on determining appropriate transaction accounting adjustments.The SEC staff has also indicated that transaction accounting adjustments should generally be shown gross rather than net so that the reader can understand the nature and amount of each adjustment. Alternatively, a more detailed explanation of the components of the adjustments may be presented in the notes to the pro forma financial information. In such a case, the transaction accounting adjustments should contain references to notes that clearly explain the assumptions involved and other relevant information for each adjustment. See Section 4.4.2.2 for a discussion of the disclosure requirements for transaction accounting adjustments.
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Autonomous entity adjustments — These adjustments, which are only required if the registrant was previously part of another entity, include incremental expense or other changes necessary to reflect the registrant’s financial condition and results of operations as if it were a separate stand-alone entity. For example, if a public entity plans to distribute a portion of its business to its shareholders as a separate public company (e.g., a spin-off), the spinnee’s pro forma financial information (e.g., those included in a registration statement on Form 10) must include autonomous entity adjustments to reflect the incremental costs expected to be incurred as if the spinnee were a separate stand-alone entity. See also Section 5.4.2 of Deloitte’s Roadmap Carve-Out Financial Statements.
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Management’s adjustments — In addition to the required adjustments noted above, registrants also have the option to present management’s adjustments within the explanatory notes. As the SEC notes in its final rule on the disclosure requirements for business acquisitions, these types of adjustments “include forward-looking information that depicts the synergies and dis-synergies identified by management in determining to consummate or integrate the transaction for which pro forma effect is being given.” Such adjustments may also give investors insight into the potential effects of the transaction. Further, changes that do not qualify as transaction accounting or autonomous entity adjustments may include, among other things, closing facilities, discontinuing product lines, and terminating employees. Note, however, that when synergies are presented, any related dis-synergies must also be presented. See Section 4.4.3.
At the 2021 AICPA & CIMA Conference on Current SEC and PCAOB
Developments, the SEC staff addressed considerations related to distinguishing
between autonomous entity adjustments and management’s adjustments. For example,
changes to a spinnee’s cost structure that are supported by a contractual
arrangement may be considered autonomous entity adjustments (e.g., a new lease
agreement or a transition services agreement with the former parent). By
contrast, changes in spinnee costs that are not supported by contractual
arrangements generally do not represent autonomous entity adjustments. However,
such changes may represent synergies or dis-synergies that may be presented as
management’s adjustments if they meet the conditions in Rule 11-02(a)(7). The SEC
staff also clarified that a registrant that presents synergies must separately
present any related dis-synergies; the dis-synergies may not be presented “net”
against the synergies. For examples of adjustments to historical financial
information and disclosures of pro forma financial information that may be
required, see Appendix
A.
4.4.1.1 Pro Forma Balance Sheet
Under Rule
11-02(a)(6)(i)(A), transaction accounting adjustments to the
pro forma balance sheet should (1) reflect “the accounting for the
transaction required by [U.S. GAAP] or, as applicable, [IFRS Accounting
Standards as issued by the IASB]” and (2) be calculated by “using the
measurement date and method prescribed by the applicable accounting
standards.” In the transaction accounting adjustments related to the pro
forma balance sheet, it should be assumed that the transaction occurred as
of the date of the most recent balance sheet. For a probable transaction,
transaction accounting adjustments should be calculated by using the most
recent practicable date before the effective, mailing, or qualification
date, and this date should be disclosed.
4.4.1.2 Pro Forma Income Statement
Rule 11-02(a)(6)(i)(B)
specifies that transaction accounting adjustments related to the pro forma
income statement should reflect the income statement impact of the
adjustments made to the pro forma balance sheet. Transaction accounting
adjustments that did not affect the pro forma balance sheet should reflect
the accounting required by U.S. GAAP or IFRS Accounting Standards, as
applicable. When applying the transaction accounting adjustments related to
the pro forma income statement, a registrant should assume that adjustments
made to the pro forma balance sheet were made as of the beginning of the
fiscal year presented and should carry them forward to any interim period,
if applicable.
There is no requirement that adjustments made to the pro
forma income statement will have a continuing (recurring) impact.
Accordingly, a pro forma income statement must reflect nonrecurring effects
of the transaction, which may include items such as transaction expenses,
one-time compensation charges, and adjustments to inventory. In addition, it
is not appropriate to include a transaction accounting adjustment to
eliminate or omit the effects of nonrecurring items that had already been
reflected in the historical financial statements (such as
acquisition-related costs). Rather, a registrant should separately disclose
in a note to the pro forma financial information the amounts associated with
revenues, expenses, gains and losses, and related tax effects that will not
recur in the income of the registrant beyond 12 months after the
transaction. See Section
4.4.2.2.1 for further discussion of nonrecurring items.
Because adjustments to a pro forma balance sheet and pro
forma income statement to reflect the accounting for a transaction would be
made on different dates (i.e., the most recent balance sheet date vs. the
beginning of the fiscal year presented for the pro forma income statement),
the adjustments reflected in the pro forma balance sheet will not
necessarily align with the adjustments in the pro forma income statement.
For example, the pro forma income statement will reflect at least one year
of depreciation and amortization on newly acquired assets; however, since
the pro forma balance sheet is adjusted to reflect the accounting for the
transaction on the most recent balance sheet date, there is no need to
adjust retained earnings for the depreciation and amortization reflected in
the pro forma income statement.
Example 4-11
Registrant A, a calendar-year-end
company, acquired Company B on November 20, 20X8. On
the basis of the significance of this acquisition, A
must file an initial Form 8-K within four business
days of the acquisition date and amend the Form 8-K
within 71 calendar days of initial filing to include
B’s separate preacquisition financial
statements.
Further, A has to include a pro
forma balance sheet as of September 30, 20X8, in the
amended Form 8-K. It should also make a transaction
accounting adjustment to reflect the accounting for
the business combination in the September 30, 20X8,
pro forma balance sheet.
Registrant A must include a pro
forma income statement for the year ended December
31, 20X7, and for the nine-month period ended
September 30, 20X8, in the amended Form 8-K. In
addition, A should depict the effects of the
accounting for the acquisition of B that were
reflected in the pro forma balance sheet in both pro
forma income statements for the year ended December
31, 20X7, and for the interim nine-month period
ended September 30, 20X8, assuming those adjustments
were made on January 1, 20X7.
4.4.2 Transaction Accounting Adjustments in a Business Acquisition
4.4.2.1 General Principles of Transaction Accounting Adjustments
Since transaction accounting adjustments must reflect the
accounting required by U.S. GAAP or IFRS Accounting Standards, as
applicable, a registrant must first determine the appropriate accounting
treatment for the transaction (e.g., business combination or asset
acquisition). The appropriate transaction accounting adjustments would then
be based on this determination.
4.4.2.1.1 Transaction Accounting Adjustments in Business Combinations
Deloitte’s Roadmap Business Combinations
provides guidance on the accounting under U.S. GAAP for these
transactions. Since the pro forma financial information begins with the
registrant’s and acquiree’s historical financial information, the
registrant must first make transaction accounting adjustments to
eliminate (1) the equity balances of the acquiree and (2) the assets and
liabilities of the acquiree that were not acquired by the registrant.
The registrant would then make the following transaction accounting
adjustments to:
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Recognize the consideration transferred — This may result in adjustments to (1) decrease cash, (2) increase equity for shares issued as consideration, or (3) increase liabilities for either the recognition of contingent consideration or debt issued to fund the transaction (see Section 4.4.2.1.6). Note that any additional shares issued as consideration must be included in pro forma earnings per share. Further, additional interest expense should be reflected for any new debt issued.
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Adjust the assets acquired and liabilities assumed to fair value, and recognize intangible assets and goodwill — A registrant must perform a preliminary allocation of the consideration transferred to the assets acquired and liabilities assumed and reflect transaction accounting adjustments on the pro forma balance sheet to recognize the acquiree’s assets (including identifiable intangible assets) and liabilities on the basis of the measurement requirement in ASC 805, which is typically at their respective fair values. The registrant would also recognize on the pro forma balance sheet the goodwill resulting from the transaction. Further, the registrant must consider the impact of each of these transaction accounting adjustments in the pro forma income statement. Examples of such adjustments could include those related to the following:
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Depreciation and amortization — Adjustments should reflect the additional (or reduced) depreciation and amortization necessary as a result of the fair value adjustments to tangible and intangible assets. These amounts are often determined by calculating the required depreciation and amortization on the basis of the newly established fair values of the assets and their useful lives and by deducting the depreciation and amortization reflected in the acquiree’s historical financial information.
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Inventory — Adjustments should reflect the additional (or reduced) cost of revenue resulting from recognizing inventories at fair value. These adjustments would be recognized from the beginning of the fiscal year presented over the expected inventory turnover period. For inventory turnover periods of less than 12 months, the pro forma income statement adjustment to reflect the fair value would generally be considered nonrecurring. In such cases, that fact, along with the amount of the adjustment, should be disclosed in the notes.
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Adjustments to outstanding debt — Adjustments should reflect the increase or decrease in interest expense attributable to the recognition of the acquiree’s debt at fair value. The fair value adjustments would be recognized as if they were made as of the beginning of the fiscal year presented and would have to be amortized over the remaining life of the assumed debt.
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Eliminate transactions between the registrant and acquiree — A registrant must identify transactions between the registrant and acquiree and eliminate them from the pro forma income statement and balance sheet.
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Recognize transaction expenses — In a business combination, transaction expenses are expensed as incurred, and the pro forma financial information must reflect this accounting. At the 2022 AICPA & CIMA Conference on Current SEC and PCAOB Developments, the SEC staff addressed the treatment of transaction costs in pro forma financial information for a business combination. The staff noted that the accounting for such costs depends on (1) which entity incurred them (i.e., the registrant or acquiree), (2) whether they were reflected in the historical financial statement periods presented, and (3) whether they were incurred in periods after the historical financial statement periods presented.For transaction costs applicable to the acquiree, the staff noted the following:
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Transaction expenses reflected in the historical period — Any costs that were reflected in the historical income statement periods presented should remain as presented (i.e., transaction accounting adjustments should not eliminate or move such costs to another period).
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Transaction costs incurred in periods after the historical financial statement periods presented — No transaction accounting adjustments are needed for transaction costs incurred by the acquiree in periods after the historical financial statement periods presented. This is because the pro forma financial information is intended to present the registrant’s accounting for the transaction, which does not include the acquiree’s transaction costs.
For transaction costs applicable to the registrant, the staff indicated the following:-
Transaction expenses reflected in the historical period — Any costs that were reflected in the historical income statement periods presented should remain as presented (i.e., transaction accounting adjustments should not eliminate or move such costs to another period).
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Transaction costs incurred in periods after the historical financial statement periods presented — Transaction accounting adjustments should be made in the pro forma income statement to reflect the accounting for such costs provided that such adjustments were made at the beginning of the fiscal year presented (i.e., in the annual pro forma income statement period presented).
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Transaction costs expected but not yet incurred — At the 2022 AICPA & CIMA Conference on Current SEC and PCAOB Developments, the SEC staff did not directly address expected transaction costs not yet incurred by the registrant. However, we believe that such costs should be estimated and included as transaction accounting adjustments in the pro forma income statement provided that such adjustments were made as of the beginning of the fiscal year presented (i.e., in the annual pro forma income statement period presented).Registrants should also include on the pro forma balance sheet transaction costs that are not reflected in the historical financial statements presented (i.e., costs incurred after the pro forma balance sheet date and expected costs that have not yet been incurred) as pro forma transaction accounting adjustments to accrued expenses and retained earnings. Since transaction costs are generally nonrecurring, registrants should disclose that fact in the notes.
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4.4.2.1.2 Tax Effect of Pro Forma Adjustments
Generally, the statutory rate should be applied to
transaction accounting adjustments, and the tax effect of such
adjustments should be reflected as a separate adjustment. If taxes are
not calculated on that basis, or if unusual effects of loss
carryforwards or other aspects of tax accounting are depicted, an
explanation should be provided in a note to the pro forma financial
information. Further, under Rule
11-02(b)(5)(ii), if the registrant’s historical financial
statements do not reflect a tax provision on a separate-return basis,
pro forma adjustments should be included that do so.
If the registrant or acquiree has recognized valuation
allowances on deferred taxes, further considerations may be necessary.
For example, the registrant must assess whether it would be required to
release such valuation allowances as a result of (1) the acquiree’s
sources of income or (2) deferred tax liabilities recognized in purchase
accounting that could become a source of future taxable income. Such a
release would be reflected in the pro forma income statement at the
beginning of the fiscal year presented.
4.4.2.1.3 Research and Development Expenses of an Acquiree
ASC 805 requires a registrant to capitalize acquired
in-process research and development (IPR&D) and does not permit the
immediate write-off of such amounts. In addition, an acquiree may have
historically incurred R&D expenses associated with projects for
which the registrant has capitalized IPR&D as part of the allocation
of consideration transferred. No adjustment should be made to eliminate
any preacquisition R&D expenses historically incurred by the
acquiree.
4.4.2.1.4 Presenting Expected Costs Associated With Exit or Disposal Activities (Restructuring Costs)
A registrant may be permitted to present expected
restructuring costs as transaction accounting adjustments if they
reflect the accounting for the relevant transaction depicted by the pro
forma financial information, in accordance with U.S. GAAP or IFRS
Accounting Standards, as applicable.
ASC 805 prohibits an acquirer from recognizing
restructuring costs as liabilities assumed in an acquisition unless the
acquirer meets the recognition criteria in ASC 420-10-25-1 as of the
acquisition date. In most business combinations, the acquirer will not
be able to meet such criteria as of the acquisition date and will
therefore not be able to recognize a liability assumed for restructuring
costs in the business combination accounting.
As part of a business combination, a registrant may
commit to a plan to dispose of a revenue-producing activity. In such a
case, the registrant may include transaction accounting adjustments to
depict the effects of exiting revenue-producing activities if they
reflect the accounting for the relevant transaction. The SEC staff has
indicated that only revenues and costs specifically identifiable with a
particular revenue-producing activity may be included in the pro forma
adjustments. Allocations of corporate costs already reflected in the
historical financial statements should not be adjusted for the
disposition of a revenue-producing activity.
Adjusting pro forma results to depict the effects of the
accounting for exiting revenue-producing activities is consistent with
the requirement to provide pro forma financial information depicting
material dispositions. If a disposition (or probable disposition) is
significant, the presentation of pro forma financial information may be
required unless the disposition is already recognized in the historical
financial statements.
For example, if either the registrant or its acquiree expects to dispose
of certain operations as part of being granted regulatory approval, the
disposal should be reflected in the pro forma financial information if
the operations are identifiable. If operations to be disposed of are not
presently identifiable with any reasonable certainty, the contingency
and reasonably possible impact on the pro forma financial information
should be disclosed in the footnotes to the pro forma financial
information.
4.4.2.1.5 New Contractual or Compensation Arrangements, Including Share-Based Compensation
A registrant should generally adjust the pro forma
financial information for new contractual arrangements (e.g.,
compensation or management agreements) entered into as part of a
business acquisition. When such arrangements are entered into in
conjunction or concurrently with the acquisition agreement, the
registrant should include transaction accounting adjustments. For
adjustments pertaining to consummated transactions, the terms of the
agreements should be finalized before pro forma adjustments are made.
For adjustments pertaining to probable transactions, written agreements
should be expected to be finalized by the time of effectiveness of the
registration statement containing the pro forma financial
information.
In a business acquisition, the acquiree’s employees may
be offered new or replacement share-based compensation awards or cash
retention awards (e.g., stay bonuses). A registrant should first assess
whether any of the awards should be considered part of consideration
transferred in the business combination under ASC 805. The registrant
must analyze the terms of both the preexisting and the replacement
awards to determine what portion of the replacement awards is related to
precombination vesting (i.e., past goods or services) and, therefore,
part of the consideration transferred in the business combination. The
portion of replacement awards that is related to postcombination vesting
(i.e., future goods or services) should be recognized as compensation
cost in the postcombination period. Any incremental postcombination
expense should be reflected as a transaction accounting adjustment to
the pro forma income statement. The transaction accounting adjustment
would be recognized from the beginning of the fiscal year presented over
the remaining vesting period. Similarly, any cash retention awards would
be recognized as additional expense over the required vesting period (if
any).
4.4.2.1.6 Effects of Additional Financing Arrangements
Any debt financing necessary to complete the acquisition
should be recognized in the pro forma financial information, including
additional interest expense as necessary. The SEC staff has indicated
that adjustments reflecting the debt financing generally should be based
on either the current interest rate or the interest rate to which the
registrant has committed. The registrant should perform and disclose a
sensitivity analysis on the basis of an eighth of a percent increase or
decrease if the actual interest rate used in the pro forma financial
information could vary, such as with variable-rate debt.
Similarly, a registrant may refinance existing credit
facilities or repay any debt of the acquiree upon consummation of the
transaction. Transaction accounting adjustments to remove the historical
balance sheet and income statement effects of any refinanced or repaid
debt and to recognize any significant changes to interest expense and
deferred debt issuance costs should also be considered in the
preparation of pro forma financial information.
4.4.2.1.7 Other Material Transactions
In some cases, Rule 11-01(a)(8) may require a
registrant to give pro forma effect to the accounting for other
transactions that have occurred or are probable if such pro forma
financial information would be material to investors. For example, a
registrant may issue new debt or equity in advance of the transaction.
While this is not part of the business acquisition, it may be considered
a material transaction that should be recognized as a transaction
accounting adjustment in the pro forma financial information on the
basis of Rule 11-01(a)(8).
Example 4-12
Registrant A enters into an
agreement to acquire Company B, a significant
business. Registrant A expects to finance the
acquisition by using cash already on hand and cash
proceeds obtained from the issuance of new debt in
the private-placement market. Because B is
significant, A must present pro forma financial
information for the business acquisition upon the
close of the transaction in a Form 8-K. While the
issuance of debt is not part of the business
combination accounting, it is considered material
information for investors. Registrant A therefore
must present (1) transaction accounting
adjustments for the financing transaction (e.g.,
additional debt and interest expenses) in the pro
forma financial information as well as (2) the
transaction accounting adjustments reflecting the
accounting for the acquisition of B.
4.4.2.1.8 Conforming Accounting Principles of the Acquiree to Those of the Registrant
A registrant generally should conform an acquiree’s
accounting principles to its own and make corresponding transaction
accounting adjustments. The SEC staff has indicated that when conforming
changes are made to accounting principles adopted by a registrant, such
principles should be applied consistently in the pro forma financial
information for all periods presented.
Example 4-13
Registrant A acquires Company B. On the basis of
the significance of this acquisition, A determines
that B’s separate preacquisition financial
statements and pro forma financial information
must be included in a Form 8-K or a registration
or proxy statement.
Whereas A accounts for taxes collected on behalf
of governmental authorities for revenue-producing
activities with customers on a gross basis (i.e.,
the taxes collected from the customer are included
in the transaction price), B reports similar taxes
on a net basis (i.e., B has elected the accounting
policy alternative provided by ASC 606-10-32-2A).
As a result of the acquisition, A will conform B’s
policy with A’s policy and include taxes collected
from customers as part of the transaction price.
Accordingly, A will need to adjust the pro forma
income statement to reflect the conformed
accounting method.
The above guidance would also apply to circumstances in
which a registrant has adopted a new accounting principle (voluntarily
or to reflect adoption of a new standard) that has not yet been adopted
by an acquiree or adopted as of a different date. In such circumstances,
pro forma financial information should be adjusted to conform the
accounting policies of the acquiree as if it had adopted the accounting
principle at the same time by using the same transition method as the
registrant. The SEC staff has indicated that if a registrant adopts a
new accounting standard as of a different date or by using a different
transition method than that of the acquiree, the registrant must conform
the acquiree’s date or method of adoption (or both) to its own in its
pro forma financial information. The SEC staff may consider requests for
relief from this requirement. For more information, see Section 1.5.
Example 4-14
Registrant A acquired Company B, a nonreporting
entity, on August 30, 20X4. Both A and B have
calendar fiscal year-ends. On January 1, 20X3, A
prospectively adopted a new accounting principle
that B adopted on January 1, 20X4.
As a result of the significance
of the business acquisition, A must file an
initial Form 8-K within four business days of the
acquisition date and amend the Form 8-K within 71
calendar days to include a pro forma balance sheet
and income statement as of and for the interim
six-month period ended June 30, 20X4, and a pro
forma income statement for the year ended December
31, 20X3.
To be consistent with A’s
accounting principles, the pro forma financial
information should include transaction accounting
adjustments to reflect B’s adoption on January 1,
20X3, of the new accounting principle.
Certain new accounting standards must be applied
retrospectively. When a registrant adopts such standards in an interim
period, it is generally required to retrospectively revise previous
annual periods when they are reissued. However, Rule
11-02(c)(2)(ii) states that “[r]etrospective revisions
stemming from the registrant’s adoption of a new accounting principle
must not be reflected in pro forma statements of comprehensive income
until they are depicted in the registrant's historical financial
statements.”
Example 4-15
Registrant A acquired Company B,
a nonreporting entity, on August 30, 20X4. Both A
and B have calendar fiscal year-ends. On January
1, 20X4, A retrospectively adopted a new
accounting principle that B has not adopted. As a
result of the business acquisition, A must file an
initial Form 8-K within four business days of the
acquisition date and amend the Form 8-K within 71
calendar days of the initial filing to include a
pro forma balance sheet and income statement as of
and for the interim six-month period ended June
30, 20X4, and a pro forma income statement for the
year ended December 31, 20X3.
To be consistent with A’s
accounting principles, the pro forma financial
information should include transaction accounting
adjustments to reflect B’s adoption of the new
accounting principle on January 1, 20X4. However,
A is not required to reflect the adoption of the
new accounting principle in the pro forma
financial information for the year ended December
31, 20X3, since A has not yet been required to
revise the historical financial statements for
that period to reflect the new accounting
principle (i.e., the pro forma requirement does
not accelerate the requirement to retrospectively
revise the financial statements). However, if A
subsequently files a registration statement before
filing its Form 10-K for the year ending December
31, 20X4, it would need to retrospectively revise
its prior annual financial statements for the
retrospective adoption. If A reflects the adoption
retrospectively to December 31, 20X3, in its
historical financial statements, the pro forma
financial information would similarly reflect the
retrospective adoption.
4.4.2.2 Disclosure Requirements for Transaction Accounting Adjustments
4.4.2.2.1 Nonrecurring Items and Unusual Results
Any revenues, expenses, gains and losses, and related
tax effects that will not recur in the income of the registrant beyond
12 months after the transaction should be disclosed.
Further, unusual results reflected in the registrant’s
or acquiree’s most recent fiscal year should be disclosed in the notes
to the pro forma financial information (see Rule 11-02(a)(11)(i)). Registrants
may also consider providing a pro forma income statement for the most
recent 12-month period, in addition to the periods required, if such
additional pro forma income statement better reflects normal
operations.
4.4.2.2.2 Consideration Transferred or Received
The notes to pro forma financial information should
include a table showing the total consideration transferred or received,
including the components of such consideration and how it was measured
(see Rule 11-02(a)(11)(ii)). For
example, it would not be sufficient to merely disclose the number of
shares to be issued to consummate the acquisition without disclosing the
fair value assigned to those shares.
Example 4-16
Registrant A acquired Company B
on February 1, 20X4. On the basis of the
significance of this acquisition, A determines
that B’s separate preacquisition financial
statements and pro forma financial information
must be included in the Form 8-K.
Registrant A should disclose that it acquired B
by paying cash of $800 and issuing 200 shares of
common stock with a fair value of $1 per share on
February 1, 20X4, for total consideration
transferred of $1,000.
For probable transactions, registrants should use the
stock price as of the most recent practicable date before filing. In
addition, the notes to the pro forma balance sheet should disclose the
date on which the stock price was determined and a sensitivity analysis
for the range of possible outcomes based on percentage increases and
decreases in the stock price. The percentages should be reasonable
relative to the recent volatility in the registrant's stock price.
4.4.2.2.3 Contingent Consideration
An acquisition agreement may include contingent consideration, which is
the obligation to transfer additional assets or equity interests to the
former owners of an acquiree if specified future events occur or
conditions are met. Occasionally, however, contingent consideration may
also represent the right to the return of previously transferred
consideration upon the satisfaction of certain conditions.
ASC 805 requires an acquirer to recognize the fair value
of contingent consideration as of the acquisition date as part of the
consideration transferred. Rule 11-02(a)(11)(ii)(A) indicates
that if total consideration transferred includes contingent
consideration, the notes to the pro forma financial information should
disclose the terms of the contingent consideration arrangements, the
basis for determining the amount of payments or receipts, and an
estimate of the range of outcomes (undiscounted). If a range cannot be
estimated, that fact, and the reasons why, should be disclosed.
4.4.2.2.4 Fair Value of Assets Acquired and Liabilities Assumed
A registrant should allocate the consideration
transferred to specifically identifiable tangible and intangible assets
(e.g., inventories; property, plant and equipment (PP&E); customer
lists; contracts acquired; trademarks; patents; IPR&D) and
liabilities. The consideration transferred should generally not, for
example, be allocated solely to goodwill. The allocation of the
consideration transferred can be presented in either a tabular or
narrative format, although a tabular presentation is generally easier to
follow.
The expected useful lives or amortization periods of
significant assets acquired in a business acquisition, including
identified intangibles, should be disclosed in a note to the pro forma
financial information. In addition, any uncertainties regarding the
effects of amortization periods assigned to the acquired assets should
be highlighted. When something other than the straight-line method is
used to amortize the fair value of the acquired assets, the effect on
operating results for the five years after the acquisition should be
disclosed in a note, if material.
Below is an example of a
footnote disclosure within the pro forma financial information that
specifies the consideration transferred and the acquisition-date fair
value of assets acquired and liabilities assumed.
Example 4-17
Registrant A acquired Company B
by paying cash of $800 and issuing 200 shares of
A’s common stock with a fair value of $200 (based
on the closing price of such shares on February 1,
20X4, the acquisition date).
The pro forma financial
information reflects the following
acquisition-date fair value of assets acquired and
of liabilities assumed:
Purchased PP&E is being depreciated on a
straight-line basis over its weighted-average
remaining useful life of approximately five
years.
4.4.2.2.5 When the Consideration Transferred or Determination of Fair Value Is Incomplete
A registrant’s estimate of the fair value of assets
acquired and liabilities assumed in a business acquisition (or probable
acquisition), or the amount of consideration transferred, may not be
final when the pro forma financial information is prepared. In such a
case, the registrant should disclose this preliminary status and the
areas that are subject to change. Rule 11-02(a)(11)(ii)(B)
explicitly requires disclosure of the following:
- A statement that the accounting is incomplete.
- The specific “items for which the accounting . . . is incomplete.”
- A “description of the information that the registrant requires, including, if material, the uncertainties affecting the pro forma financial information and the possible consequences of their resolution.”
- An “indication of when the accounting is expected to be finalized.”
- Any “other available information that will enable a reader to understand the magnitude of any potential adjustments to the measurements depicted.”
The SEC staff has suggested that a registrant may need
to provide a sensitivity analysis for a change in a variable that may
produce different results. For example, this may be the case when
reflecting a probable transaction for which the actual consideration
transferred is not yet known. A registrant would disclose the possible
outcomes and how this would affect the assets and liabilities recognized
(e.g., an increase in consideration transferred would be recognized as
additional goodwill).
4.4.3 Management’s Adjustments and Related Disclosures
4.4.3.1 General Principles of Management’s Adjustments
In addition to the required transaction accounting
adjustments and autonomous-entity adjustments discussed in the previous
sections, registrants have the option to present, in the explanatory notes
to the pro forma financial information, adjustments that reflect synergies
and dis-synergies identified by management as part of evaluating whether to
consummate a transaction. In accordance with Rule 11-02(a)(7), such adjustments can
be presented if, in management’s opinion, they “would enhance an
understanding of the pro forma effects of the transaction.”
While the SEC has not defined “synergies” or
“dis-synergies,” we believe that they refer to the benefits (i.e., increased
revenue or decreased expenses) or costs (i.e., decreased revenue or
increased expenses), respectively, that may result from a transaction.
Management’s adjustments also may give investors insight into the potential
effects of a transaction and the subsequent plans that management expects to
take (which may include forward-looking information). Such adjustments, to
the extent that they do not qualify as transaction accounting adjustments,
may include, among other things, closing facilities, discontinuing product
lines, and terminating employees. When synergies are presented, any related
dis-synergies must also be presented.
A registrant must meet certain conditions to ensure that it
presents management’s adjustments consistently and in a manner that would
enhance an investor’s understanding of the transaction. Rule 11-02(a)(7)(i)
specifies that management’s adjustments may only be presented if:
- “There is a reasonable basis for each such adjustment.”
- “The adjustments are limited to the effect of such synergies and dis-synergies” for the periods presented.
- Reductions in an expense “must not exceed the amount of the related expense [reflected in] the pro forma period presented.”
- All such adjustments “that are, in the opinion of management, necessary to a fair statement of the pro forma financial information” are reflected.
- Dis-synergies are presented when related synergies are presented.
Under Rule 11-02(a)(7)(ii)(A), “If
presented, Management’s Adjustments must be presented in the explanatory
notes . . . in the form of reconciliations of pro forma net income . . . and
the related pro forma earnings per share data . . . to such amounts after
giving effect to Management’s Adjustments.” If pro forma amounts reflecting
management’s adjustments are disclosed elsewhere in a filing (e.g.,
MD&A), pro forma amounts excluding management’s adjustments must also be
presented with equal or greater prominence, along with a reference to the
reconciliation provided in the explanatory notes.
Rule
11-02(a)(7)(ii)(C) specifies that “[i]f Management’s
Adjustments will change the number of shares or potential common shares,”
the change must be reflected within such adjustments in accordance with U.S.
GAAP or IFRS Accounting Standards, “as applicable, as if the common stock or
potential common stock were outstanding as of the beginning of the period
presented.”
4.4.3.2 General Disclosure Requirement for Management’s Adjustments
Management’s adjustments are prohibited from the face of the
pro forma financial information. They must be presented in the form of a
reconciliation of pro forma net income from continuing operations
attributable to the controlling interest and the related pro forma earnings
per share data in the explanatory notes. Under Rule 11-02(a)(7), certain disclosures,
such as the following, must also be provided to help investors evaluate
management’s adjustments:
- A statement that, in the opinion of management, all management’s adjustments “necessary to a fair statement of the pro forma financial information” are reflected.
- The “basis for and material limitations of each [adjustment], including any material assumptions or uncertainties.”
- An “explanation of the method of the calculation of the adjustment, if material.”
- The “estimated time frame for achieving the synergies and dis-synergies.”
Since these adjustments must reflect the most current assumptions available
as of the effective date of a registration statement or filing date, changes
to previously issued pro forma financial information may be required when
such information is provided in later filings.
Further, in accordance with Rule
11-02(a)(7)(ii)(B) on the disclosure requirements for
business acquisitions, if management’s adjustments are included or
incorporated by reference into a registration statement, proxy statement,
Regulation A offering statement, or Form 8-K, such adjustments should be “as
of the most recent practicable date prior to the effective date, mail date,
qualification date, or filing date as applicable, which may require that
they be updated if previously provided in a Form 8-K that is appropriately
incorporated by reference.” Therefore, when registrants present management’s
adjustments, they must be prepared to update them in each registration
statement or amendment.
If pro forma amounts reflecting management’s adjustments are disclosed
elsewhere in a filing (e.g., MD&A), pro forma amounts excluding such
adjustments must also be presented with equal or greater prominence, along
with a reference to the reconciliation provided in the explanatory notes.
The presentation requirements for management’s adjustments are consistent
with a few of the primary requirements for non-GAAP measures (see Deloitte’s
Roadmap Non-GAAP Financial Measures and Metrics for more
information). The adjustments must be presented in a reconciliation format,
and when such measures are presented outside pro forma financial
information, pro forma amounts, excluding management’s adjustments, must
also be presented with equal or greater prominence.