Appendix D — SEC Reporting Considerations for Business Combinations

When an acquirer is an SEC registrant and consummates — or it is probable that it will consummate — a significant business acquisition, the SEC may require the filing of certain financial statements for the acquired or to be acquired business (the acquiree) under SEC Regulation S-X, Rule 3-05 or Rule 3-14. Registrants should carefully evaluate the factors below.

Separate financial statements under Rule 3-05 or Rule 3-14 are required only if the acquiree meets the definition of a business for SEC reporting purposes. Therefore, a company must carefully determine whether an acquiree qualifies as such. The definition of a business for SEC reporting purposes is not the same as the definition under U.S. GAAP, and financial statements may be required under Rule 3-05 or Rule 3-14 even if the acquisition does not meet the U.S. GAAP definition of a business.

The financial information, if any, that must be included in SEC filings is based on the size of the acquiree, which the SEC refers to as the acquiree’s “significance.” To determine the significance of the acquiree, the registrant must perform the investment test, the asset test, and the income test:

• Investment test — The GAAP purchase price is compared with the aggregate worldwide market value of the registrant’s common equity. If the registrant has no aggregate worldwide market value (e.g., when common equity is not publicly traded, including in an IPO), total assets should be used in the test instead.
• Asset test — The registrant’s share of the acquiree’s total assets is compared with the registrant’s total assets on the basis of the most recent preacquisition annual financial statements of each company.
• Income test — The income test consists of an income component and a revenue component:
  • Income component — The registrant’s share of the acquiree’s pretax income is compared with the registrant’s pretax income on the basis of the most recent preacquisition annual financial statements of each company. Pretax income is defined in SEC Regulation S-X, Rule 1-02(w), as “consolidated income or loss from continuing operations before income taxes (after intercompany eliminations) attributable to the controlling interests.”
  • Revenue component — If both the registrant and the acquiree have material revenue in each of the two most recently completed fiscal years, the revenue component is calculated by comparing the registrant’s share of the acquiree’s revenue with the registrant’s revenue on the basis of the most recent preacquisition annual financial statements of each company. If either the registrant or the acquiree does not have material revenue for each of the two most recently completed fiscal years, only the income component should be used, which includes the use of five-year income-averaging for the registrant.
  • An acquiree will only be considered significant under the income test if both the income component and the revenue component (if applicable) exceed the significance threshold (i.e., 20 percent). When both components exceed the significance threshold, the lower of the income or revenue component is used to determine significance in accordance with the income test.

Preacquisition financial statements of the acquiree are generally prepared on the same basis as if the acquiree were a registrant. Such acquirees need to comply with Regulation S-X. In addition, an acquiree that is not a public company does not need to comply with certain disclosure requirements that apply only to public companies, such as those related to segments or earnings per share. Also, some accounting standards differentiate between adoption dates for PBEs and those for nonpublic entities. Significant acquirees whose financial statements are included in a registrant’s filing under Rule 3-05 are considered PBEs under U.S. GAAP. Therefore, such acquirees should use the adoption dates and disclosure requirements for PBEs when preparing their financial statements. However, the SEC staff announced that it would not object to elections by certain PBEs to use the non-PBE effective dates for the sole purpose of adopting the FASB’s standards on revenue (ASC 606) and leases (ASC 842). In addition, since an acquired business meets the definition of a PBE, it is not eligible to elect certain accounting and reporting alternatives in U.S. GAAP, including those developed by the Private Company Council and subsequently endorsed by the FASB (see Chapter 8 for more information). Also, the effects of any previously elected private-company alternatives would have to be eliminated in the acquiree’s financial statements.

A pro forma balance sheet and income statement are generally required under SEC rules if the business acquisition is deemed to be significant. Such pro forma financial statements are required in Form 8-Ks that report such acquisitions and in any registration statements filed by the registrant, as follows: