Chapter 2 — Form and Content of Financial Information

2.6 Foreign Investees

A registrant may have an equity method investment that is not incorporated in the United States (“foreign investee”). If a foreign investee does not conduct the majority of its operations in the United States, it often does not prepare its financial statements in accordance with U.S. GAAP.

Special considerations regarding foreign investees include, but are not limited to, the following:

Significance tests must use the GAAP results of the registrant.
Audits must be performed in accordance with U.S. GAAS when financial statements are required.
Financial statements of a foreign investee (when required) may be presented in accordance with U.S. GAAP, IFRS® Accounting Standards as issued by the International Accounting Standards Board (IASB®), or another comprehensive basis of GAAP.
A reconciliation to U.S. GAAP may be required.
Summarized financial data of a foreign investee (when required) must be presented by using the same GAAP as used in the registrant’s financial statements.

Additional relief from certain reporting requirements may be available for a foreign investee that meets the definition of a foreign business. A registrant is advised to consult with its SEC legal counsel in determining whether a foreign investee is also a foreign business.

Before applying the guidance on foreign investees, entities must understand the general application of the SEC reporting requirements for equity method investments.

2.6.1 Significance Tests Under Rule 3-09, Rule 4-08(g), and Rule 10-01(b)(1)

The significance tests for a foreign investee are the same as those for a domestic investee under Rules 3-09, 4-08(g), and 10-01(b)(1). When performing the significance tests, a domestic registrant must use the foreign investee’s U.S. GAAP results.

If the foreign investee uses IFRS Accounting Standards or another comprehensive basis of GAAP (i.e., local GAAP) when presenting its financial statements, the domestic registrant must reconcile the foreign investee’s financial statements to U.S. GAAP when performing the significance tests. The foreign investee’s financial statements do not have to be audited or reviewed for the significance tests to be performed. However, if the equity method investment exceeds the 20 percent significance level, an audit must be performed of the required annual foreign investee financial statements that will be filed with the SEC in accordance with Rule 3-09.

If a registrant is a foreign private issuer, as defined in paragraph 6110.2 of the FRM, that files its financial statements in accordance with IFRS Accounting Standards (i.e., as issued by the IASB), it must use the results of the foreign investee, prepared in accordance with IFRS Accounting Standards, when performing the significance tests. Foreign private issuers that use IFRS Accounting Standards do not need to perform Rule 4-08(g) and 10-01(b)(1) calculations; however, similar disclosures may be required under IFRS Accounting Standards.

2.6.2 Auditing Standards Applicable to a Foreign Investee’s Financial Statements

Instruction 2 of Form 20-F, Item 8.A.2, specifies that an audit of the financial statements of a foreign investee that are filed with the SEC must be performed, in accordance with AICPA or PCAOB standards, to meet the requirements of Rule 3-09. The SEC staff will not accept audit reports indicating that the audit was performed in accordance with local GAAS or ISA. The SEC staff has noted that it does not have authority to waive the requirement that the financial statements be audited in accordance with the standards of the PCAOB or AICPA (e.g., to provide relief by allowing a registrant to submit financial statements that are audited under ISA or other jurisdictional auditing standards). However, the SEC staff will not object if the audit report refers to compliance with both U.S. GAAS and another set of auditing standards.

2.6.3 Accounting Principles Applicable to a Foreign Investee’s Financial Statements

To satisfy the requirements of Rule 3-09, a foreign investee may prepare financial statements in accordance with U.S. GAAP, IFRS Accounting Standards, or local GAAP (i.e., a comprehensive basis of accounting other than U.S. GAAP or IFRS Accounting Standards) for filing with the SEC. If it uses IFRS Accounting Standards or local GAAP, that fact must be disclosed in the accountant’s report and, as discussed in Section 2.6.4, a reconciliation to U.S. GAAP may be needed.

As outlined by the SEC staff at the 2019 AICPA Conference on Current SEC and PCAOB Developments, there are certain circumstances in which the periods required for financial statements provided in accordance with SEC regulations, including Rule 3-09, may not be considered a full set of financial statements as defined under IFRS Accounting Standards. While the SEC staff rarely accepts qualified opinions, it would accept an audit opinion that is qualified solely with respect to the omission of the comparative period required by IFRS Accounting Standards if (1) a registrant acquires an equity method investment in the latest fiscal year and (2) Rule 3-09 requires financial statements to be provided only for the period in which the investee is accounted for under the equity method.

2.6.4 Reconciliation to U.S. GAAP May Be Required

If the foreign investee uses local GAAP or IFRS Accounting Standards when preparing its financial statements, a reconciliation to U.S. GAAP must be provided in accordance with Form 20-F, Item 18, which requires not only a quantified reconciliation of net income and shareholder’s equity but also all disclosures required by U.S. GAAP and Regulation S-X. However, there are certain exceptions to these requirements if the foreign investee meets the definition of a foreign business, as follows:

If an investee prepares its financial statements in accordance with IFRS Accounting Standards, it is eligible to omit the U.S. GAAP reconciliation.
If an investee uses local GAAP when preparing its financial statements and any of the conditions under Rule 1-02(w) exceed 30 percent, it is required to provide a reconciliation to U.S. GAAP, prepared in accordance with Form 20-F, Item 17. Note that Item 17 does not require the disclosures required by U.S. GAAP or Regulation S-X.

In addition, a foreign investee may meet the definition of a foreign private issuer in paragraph 6110.2 of the FRM if such investee were to file an initial registration statement with the SEC. A registrant is advised to consult with its SEC legal counsel in determining whether an investee meets the definition of a foreign private issuer. At the September 2011 CAQ SEC Regulations Committee joint meeting with the SEC staff, the staff stated that if the foreign investee would qualify as a foreign private issuer if it were to file a registration statement, registrants may wish to obtain preclearance from the SEC Division of Corporation Finance’s Office of the Chief Accountant regarding their use of financial statements prepared in accordance with IFRS Accounting Standards without a reconciliation to U.S. GAAP to comply with Rule 3-09. In determining whether a waiver is appropriate, the SEC staff will consider whether preparing a U.S. GAAP reconciliation presents significant issues for the foreign investee, whether the foreign investee prepares U.S. GAAP financial information for any other purpose, and the reasons why the foreign investee does not qualify as a “foreign business.” In such circumstances, registrants should also consider consultation with their auditors and SEC legal counsel.

2.6.5 Financial Statement Due Date for Foreign Equity Method Investees

As discussed in Section 2.2.4.1.2, when determining the due dates for filing the financial statements of a foreign equity method investee, a registrant must consider its own filling status and whether the equity method investee is a foreign business, as well as whether the registrant and the equity method investee have different fiscal year-ends.

Rule 3-09(b)(1) permits a registrant to file the financial statements of an equity method investee that is a foreign business within six months after the investee’s fiscal year-end. As also noted in paragraph 2405.10 of the FRM, if the separate financial statements of a foreign equity method investee are due after the registrant’s annual report due date, the financial statements should be filed in an amendment to the registrant’s annual report. If the foreign investee does not meet the definition of a foreign business, the registrant should refer to the due dates for domestic investees.

Example 2-13

Registrant A owns 30 percent of Company B and uses the equity method to account for its investment.

Company B meets the definition of a foreign business and is greater than 20 percent significant to A. Both entities have December 31 fiscal year-ends.

Registrant A must file B’s financial statements by June 30, 20X1. This can be accomplished by filing an amendment to A’s December 31, 20X0, annual report, regardless of A’s filing status.

2.6.6 Financial Statement Requirements of a Foreign Equity Method Investee in a Registration Statement or Proxy Statement

As discussed in Section 2.2.4.2, a registrant may need to update the separate financial statements of an equity method investee before it is required to include such statements in its annual report (and therefore before the filing due dates discussed above) if the registrant files a registration statement or proxy statement during the grace period.

If the foreign equity method investee is a foreign business, the audited balance sheet of the investee included in a registration statement or proxy statement cannot be more than 15 months old. Accordingly, if a registrant plans to file a registration or proxy statement more than 15 months after the equity method investee’s year-end, it is required to provide the financial statements of the investee for the most recently completed fiscal year even if they are not yet due to be filed on the basis of the annual report due dates. For more information, see paragraph 2405.11 of the FRM and the highlights of the March 2013 CAQ SEC Regulations Committee joint meeting with the SEC staff.

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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.