Chapter 4 — Pro Forma Financial Information

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:

Transaction accounting adjustments — The most common type of pro forma adjustments.Transaction accounting adjustments 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 (such as depreciation and amortization of the fair value adjustments on property and equipment and intangible assets) 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.
Autonomous entity adjustments — Only required if the registrant was previously part of another entity. Autonomous entity adjustments include incremental expense or other changes in costs 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 Section 4.4.3 of this Roadmap and Section 5.4.2 of Deloitte’s Roadmap Carve-Out Financial Statements.
Management’s adjustments — Optional adjustments. In addition to the required adjustments noted above, registrants 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 in costs that do not qualify as transaction accounting or autonomous entity adjustments may be management’s adjustments, which 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 4.4.4.

Paragraph 3246.2 of the FRM includes 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). 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]” 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.

An autonomous entity adjustment to the pro forma balance sheet depicts a registrant as an autonomous entity if the registrant previously was a part of another entity. Autonomous entity adjustments must be presented on the face of the pro forma balance sheet in a separate column from transaction accounting adjustments.

Although not required, a registrant may choose to give pro forma effect for management’s adjustments to depict synergies and dis-synergies of an acquisition or a disposition transaction. However, as discussed in paragraph 3248.7 of the FRM, the pro forma effect of management’s adjustments should not be reflected on the face of the pro forma balance sheet. Instead, such adjustments must be presented in the form of a reconciliation in an explanatory note to the pro forma financial information.

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 must 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 (generally when inventory turnover is less than one year). 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, the assets acquired would be reflected at their fair values on the balance sheet (that is, the depreciation and amortization shown in the pro forma income statements is not reflected on the pro forma balance sheet). 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 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 initial filing (amended Form 8-K) 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.

In a manner consistent with the presentation of pro forma balance sheet information, autonomous entity adjustments must be presented on the face of pro forma income statements in a separate column from transaction accounting adjustments, while management’s adjustments are not permitted on the face of pro forma income statements.

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:

Recognize the consideration transferred — This may result in adjustments to (1) decrease cash for payment of cash consideration, (2) increase equity for shares issued as stock consideration, or (3) increase liabilities for the recognition of contingent consideration. Note that any additional shares issued as consideration must be included in the pro forma earnings per share calculation.
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:
- 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.
- 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 to the pro forma financial information.
- 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.
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.
Recognize transaction expenses — In a business combination, transaction expenses are expensed as incurred, and the pro forma financial information must reflect this accounting. Paragraphs 3250.4, 3250.5, and 3250.6 of the FRM address the treatment of transaction costs in pro forma financial information for a business combination. Those paragraphs note that the accounting for such costs depends on (1) which entity incurred them (i.e., the registrant or the 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:
- 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).
- 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).
- 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).
- Transaction costs expected but not yet incurred — The SEC staff did not directly address expected transaction costs not yet incurred by the registrant in paragraphs 3250.4, 3250.5, or 3250.6 of the FRM. 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.
- Costs of being a public company — Paragraph 3245.4 of the FRM indicates that transaction costs should not include the costs of being a public company, such as future expenses to meet the company’s filing obligations or to comply with SEC rules and regulations. The paragraph notes that such costs “do not represent a transaction”; therefore, it would not be appropriate to reflect such costs in the pro forma financial information.

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. However, as clarified in paragraph 3270.1 of the FRM, “[c]ompanies are not prohibited from using different rates if they are supportable.” If a registrant uses different rates or makes adjustments to reflect the “unusual effects of loss carryforwards or other aspects of tax accounting,” it should include an explanatory note describing the treatment. 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. For more information, see Section 8.3.2 of Deloitte’s Roadmap Income Taxes.

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 unless (1) the acquiree previously recognized a restructuring liability in accordance with ASC 420-10 in its preacquisition financial statements and (2) the acquirer assumes that obligation and will therefore not be able to recognize a liability assumed for restructuring costs in the business combination accounting. See Section 4.13 of Deloitte’s Roadmap Business Combinations for more information.

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 by reflecting the accounting for such disposal. 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.

Using transaction accounting adjustments 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. Thus, in a manner consistent with Rule 11-01(a)(8), if a disposition (or probable disposition) is material, 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. In addition, paragraph 3250.11 of the FRM states that, at a minimum, “the circumstances surrounding such expectations, any contingencies, and the reasonably possible impact” on the pro forma financial information should be disclosed in the introductory paragraph and footnotes to the pro forma financial information. Further, if the to-be-disposed operations represent a business that is significant, or do not represent a business but are material, the pro forma financial information should include a separate column to reflect the probable disposal.

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 acquisitions, the terms of the agreements should be finalized before pro forma adjustments are made. For adjustments pertaining to probable acquisitions, 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 acquirer may issue replacement share-based compensation awards to the employees of the acquiree. A registrant should first assess whether any of the replacement 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 acquiree awards 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 and 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.

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. Paragraph 3260.1 of the FRM indicates that adjustments reflecting the debt financing “generally should be based on either the current interest rate or the interest rate for which the registrant has a commitment.” 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.

Paragraph 3260.2 of the FRM states that using the current or committed interest rate is generally appropriate. Registrants should assess the facts and circumstances of each pro forma presentation to ensure that the selected rate is reasonable. In limited cases, another rate may be more appropriate, in which case the staff may expect the use of “rates that were prevailing during the period covered by the pro forma financial information.” Registrants should also include prominent disclosures in the introductory paragraph of the basis of presentation and the expected effects of the current interest rate environment.

Similarly, a registrant may refinance existing credit facilities or repay any debt of the acquiree upon consummation of the business acquisition. When preparing its pro forma financial information, the registrant may consider including transaction accounting adjustments to (1) add the impact of the refinancing or remove the historical balance sheet and income statement effects of any repaid debt and (2) recognize any significant changes to interest expense and deferred debt issuance costs.

4.4.2.1.7 Goodwill Impairment

An accounting acquirer or acquiree may have recognized goodwill impairment in its historical financial statements for one or more of the periods for which pro forma financial information is required. In such cases, paragraph 3245.3 of the FRM indicates that the accounting acquirer should not eliminate its goodwill impairment. However, the paragraph notes that “[b]ecause the pro forma condensed balance sheet gives effect to the accounting required by U.S. GAAP and U.S. GAAP requires the elimination of an accounting acquiree’s goodwill, the pro forma condensed statement of comprehensive income should also include a Transaction Accounting Adjustment to eliminate an acquiree’s historical goodwill impairment.” Note that this guidance on goodwill impairment does not apply to impairments related to other finite-life or indefinite-life assets or to financial assets, and historical impairments of those assets recorded by the acquiree should not be eliminated from the pro forma condensed statement of comprehensive income.

4.4.2.1.8 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. Paragraph 3160.2 of the FRM also clarifies that the term “’other transactions’ . . . encompasses other ‘events.’” 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.

4.4.2.1.9 Conforming the Accounting Policies of the Acquiree to Those of the Registrant

As indicated in paragraph 3250.2 of the FRM, if a registrant will need to change the accounting policies of an acquired business in its post-acquisition consolidated financial statements to conform with its own accounting policies, the pro forma financial information should include transaction accounting adjustments reflecting such changes. Transaction accounting adjustments should be applied consistently 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.

In addition, paragraph 3250.3 of the FRM indicates that if the registrant and a significant acquired business adopt a new accounting standard at different times or by using different transition methods, the pro forma financial information should reflect the acquired business as if it had adopted the standard on the same date and under the same method of adoption as the registrant. The paragraph notes that the SEC “staff will 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 as of June 30, 20X4, and pro forma income statements for the interim six-month period ended June 30, 20X4, and the year ended December 31, 20X3.

To be consistent with the timing of A’s adoption of the new accounting principle, 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 its historical financial statements of the previous annual periods when they are reissued. 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.” However, as indicated in paragraph 3303.1 of the FRM, if the adoption of a new standard will result in a material retrospective change, the explanatory notes to the pro forma financial information should include appropriate disclosure of the change in accounting policy.

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 as of June 30, 20X4, and pro forma income statements for the interim six-month period ended June 30, 20X4, and 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 income statement 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 prior annual financial statements). Also, if the adoption of the new accounting principle for the year ended December 31, 20X3, will have a material effect, A should disclose this in the explanatory notes to the pro forma financial information.

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 in its historical financial statements for the year ended December 31, 20X3, 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 in the notes to the pro forma financial information.

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. Note that paragraph 3302.1 of the FRM clarifies that it is generally not appropriate to eliminate the impact of unusual events from pro forma financial information; however, instead of presenting pro forma financial information, the registrant may consider filing a forecast.

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 in a table 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, Rule 11-02(a)(6)(i)(A) requires registrants to use the stock price as of the most recent practicable date before filing. In addition, the notes to the pro forma financial information 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.

Further, paragraph 3250.12 of the FRM specifies that if contingent consideration “is remeasured to fair value . . . until the contingency is resolved, with changes in fair value recognized in earnings, updated pro forma condensed statements of comprehensive income filed with a new or amended registration statement should not reflect any pro forma adjustments to give effect to changes in the fair value of contingent consideration in periods different than those in which such changes were recognized in the acquirer’s post-acquisition financial statements.” In addition, “known changes in fair value” should be disclosed in the notes to the pro forma financial information.

4.4.2.2.4 Fair Value of Assets Acquired and Liabilities Assumed

A registrant should allocate the consideration transferred to specifically identifiable tangible assets (e.g., inventories; property, plant, and equipment [PP&E]) and intangible assets (e.g., customer lists, contracts acquired, trademarks and 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.

As described in paragraph 3250.10 of the FRM, “[t]he 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, when a method other than the straight-line method is used to amortize the fair value of the acquired assets, the registrant should disclose in a note the effect on its operating results for the five years after the acquisition, if material. Any uncertainties regarding the effects of amortization periods assigned to the acquired assets should be highlighted.

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.”

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 (which may be based on the registrant’s stock price) is not yet known. The 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). Specifically, the note to paragraph 3244.3 of the FRM indicates that the explanatory notes “should include a sensitivity analysis for the range of possible outcomes based upon percentage increases and decreases in the recent stock price,” with the appropriate percentages based on what is “reasonable in light of the [registrant’s] stock price volatility.”

4.4.3 Autonomous Entity Adjustments and Related Disclosures

4.4.3.1 General Principles of Autonomous Entity Adjustments

If a business was previously part of another entity, it may be necessary to make autonomous entity adjustments to depict the operations of the registrant as a stand-alone entity. These adjustments are most often reflected in pro forma financial information included in an initial registration statement (normally, a Form 10) to register securities of a registrant that is being spun off (spinnee) from its parent. In that registration statement, the registrant’s separate historical financial statements must disclose all costs of doing business, including the historical expenses of the parent that were allocated to the registrant. As part of a spin-off, the registrant and its parent often have an agreement in place that sets forth the terms of (1) administrative and other services that the parent will continue to provide to the registrant (a transition services agreement) or (2) office space that the parent will provide to the registrant (a lease agreement). Because the costs to be incurred in these agreements typically differ from the historical allocations of the parent’s expenses to the registrant, an autonomous entity adjustment is necessary to depict the registrant as an autonomous entity and reflect such differences. Paragraph 3160.1 of the FRM clarifies that autonomous entity adjustments may also be required for other transactions that have occurred or are probable if such pro forma financial information would be material to investors, such as the termination or revision of tax or other cost-sharing agreements in a spin-off. However, registrants should note that autonomous entity adjustments should be limited to changes in costs that can be evidenced by agreements in place.

Paragraph 3246.2 of the FRM distinguishes autonomous entity adjustments from management’s adjustments, which can give effect to changes in the cost structure of the registrant that may not be covered by an agreement. The paragraph indicates that such changes may represent synergies or dis-synergies of the spin-off that may, in the registrant’s discretion, be presented as management’s adjustments (see Section 4.4.4).

Registrants should also note that in accordance with Rule 11-02(a)(6)(ii), autonomous entity adjustments must be presented on the face of the pro forma financial information “in a separate column from Transaction Accounting Adjustments.”

4.4.3.2 General Disclosure Requirement for Autonomous Entity Adjustments

Rule 11-02(a)(11)(iii) requires the following disclosure for autonomous entity adjustments:

A “description of the adjustment (including the material uncertainties).”
The “material assumptions.”
The “calculation of the adjustment.”
Any “additional qualitative information . . . necessary to give a fair and balanced presentation of the pro forma financial information.”

As stated in paragraph 3247.2 of the FRM, there may be a relationship between what the registrant reflects as autonomous entity adjustments and management’s adjustments to demonstrate the synergies and dis-synergies of a transaction. If a registrant chooses not to present such management’s adjustments, it may be appropriate to include additional qualitative information in the pro forma financial information. As an example, after a spin-off, certain functions may be captured in a transition services agreement, which would be reflected in autonomous entity adjustments in the pro forma financial information. However, there may be other necessary functions that were previously performed by the parent for which the registrant intends to hire new staff. If the registrant elects not to present management’s adjustments reflecting the dis-synergy, it should include additional disclosure about the fact that the pro forma financial information does not reflect the expected incremental costs associated with hiring professionals to perform certain services not captured in the transition services agreement.

4.4.4 Management’s Adjustments and Related Disclosures

4.4.4.1 General Principles of Management’s Adjustments

As discussed above, in addition to the required transaction accounting adjustments and autonomous entity adjustments, registrants have the option to present adjustments that reflect synergies and dis-synergies identified by management in connection with an acquisition or a disposition transaction for which pro forma effect is given. However, as noted in paragraph 3248.1 of the FRM, management’s adjustments may only be used (1) in connection with acquisitions or dispositions or (2) “for the autonomous entity condition described in [Rule] 11-01(a)(7) provided that the conditions for disclosure of Management’s Adjustments are met.”

It is important for preparers to note that under Rule 11-02(a)(7)(ii)(A), management’s adjustments should not be presented on the face of the pro forma financial information. Rather, and as clarified in paragraph 3248.7 of the FRM, if the registrant elects to present management’s adjustments, they should be included within the explanatory notes to the pro forma financial information. Such explanatory notes should include separate reconciliations showing the impact of management’s adjustments on (1) “pro forma net income from continuing operations attributable to the controlling interest” and (2) “pro forma earnings per share data.”

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 an acquisition or a disposition transaction. However, paragraph 3249.1 of the FRM notes that nonrecurring costs to achieve synergies are considered dis-synergies and can be presented as management’s adjustments. 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).

As explained in paragraph 3249.5 of the FRM, registrants should provide sufficient disclosure of actions to be taken by management after an acquisition or disposition to ensure that the pro forma information will not be misleading if management’s adjustments are not included in the pro forma financial information. For example, if a registrant elects not to include management’s adjustments reflecting the impact of synergies and dis-synergies, such as the termination of employees or closing of facilities, it should consider whether to include a narrative discussion related to such planned actions in the explanatory notes of the pro forma financial information. The registrant should also consider whether to include in MD&A a discussion of how these planned actions may affect the operations and liquidity of the company after the combination.

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.” Paragraph 3248.3 of the FRM acknowledges that “[w]hether there is a reasonable basis for a given Management’s Adjustment will require careful consideration of the facts and circumstances of the specific company and adjustment.”
“The adjustments are limited to the effect of such synergies and dis-synergies [for the periods presented] as if the synergies and dis-synergies existed as of the beginning of the fiscal year presented.”
Reductions in an expense do “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. As clarified in paragraph 3248.6 of the FRM, “[i]f synergies are presented, any dis-synergies must be separately presented; they should not be netted against the synergies.” Further, as explained in paragraph 3249.2 of the FRM, “[f]or each synergy and dis-synergy quantified, it is permissible to identify to which financial statement line item each relates. Similarly, the amounts that give effect to Management’s Adjustments require an appropriate label to clarify they are Management’s Adjusted Pro Forma amounts, thereby distinguishing them from the Pro Forma amounts from which they are derived.”

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.”

4.4.4.2 General Disclosure Requirement for Management’s Adjustments

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.”

Paragraph 3249.4 of the FRM notes that “[m]anagement may have varying levels of confidence about [the effects] of synergies and dis-synergies.” In such cases, registrants should provide a range of estimates if needed for understanding how one or more synergies or dis-synergies could affect the company’s pro forma financial statements. The paragraph notes that if such range is provided, “both ends of the range should be reconciled to pro forma [net] income from continuing operations attributable to the controlling interests and to related [pro forma earnings] per share data.”

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 (such as in amendments to registration or proxy statements).

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.

As indicated in paragraph 3242.3 of the FRM, if pro forma amounts reflecting management’s adjustments are presented outside the explanatory notes to the pro forma financial information (e.g., in MD&A or elsewhere in a registrant’s filing), a comparable pro forma measure (i.e., “the pro forma amounts to which they are required to be reconciled”) must also be presented “with equal or greater prominence” along with a cross-reference to such reconciliation in the explanatory notes to the pro forma financial information.

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This SEC Reporting Interpretations manual provides comprehensive guidance; however, the manual does not address all possible fact patterns, and the guidance is subject to change. Consult a Deloitte & Touche LLP professional regarding your specific issues and questions.