B.2 Guidance Requiring Pro Forma EPS
This section includes excerpts from the SEC’s guidance and U.S. GAAP that refer
to the presentation or disclosure of pro forma EPS. The guidance below is not intended to
represent an all-inclusive list of the pro forma EPS information that should be disclosed in
documents filed with or furnished to the SEC. Entities are encouraged to consult with their
independent accountants and legal advisers in determining whether a transaction necessitates
the presentation or disclosure of pro forma EPS amounts.
B.2.1 Pro Forma EPS Required Under SEC Guidance
B.2.1.1 Article 11
SEC Regulation S-X, Article 11
210.11-01 — Presentation
Requirements.
(a) Pro forma financial information must be filed when any
of the following conditions exist:
(1) During the most recent fiscal year or subsequent
interim period for which a balance sheet is required by §210.3-01, a
significant business acquisition has occurred (for purposes of this section,
this encompasses the acquisition of an interest in a business accounted for
by the equity method);
(2) After the date of the most recent balance sheet filed
pursuant to §210.3-01, consummation of a significant business acquisition or
a combination of entities under common control has occurred or is
probable;
(3) Securities being registered by the registrant are to
be offered to the security holders of a significant business to be acquired
or the proceeds from the offered securities will be applied directly or
indirectly to the purchase of a specific significant business;
(4) The disposition of a significant portion of a business
either by sale, abandonment or distribution to shareholders by means of a
spin-off, split-up or split-off has occurred or is probable and such
disposition is not fully reflected in the financial statements of the
registrant included in the filing;
(5) [Reserved]
(6) Pro forma financial information required by §229.914
of this chapter is required to be provided in connection with a roll-up
transaction as defined in §229.901(c) of this chapter.
(7) The registrant previously was a part of another entity
and such presentation is necessary to reflect operations and financial
position of the registrant as an autonomous entity; or
(8) Consummation of other transactions has occurred or is
probable for which disclosure of pro forma financial information would be
material to investors.
210.11-02 — Preparation
Requirements.
(a) Form and content. . . .
(7)(ii)(A) If presented, Management’s Adjustments must be
presented in the explanatory notes to the pro forma financial information in
the form of reconciliations of pro forma net income from continuing
operations attributable to the controlling interest and the related pro
forma earnings per share data specified in paragraph (a)(9) of this section
to such amounts after giving effect to Management’s Adjustments. . . .
(9)(i) Historical and pro forma basic and diluted per share amounts based
on continuing operations attributable to the controlling interests and the
number of shares used to calculate such per share amounts must be presented
on the face of the pro forma condensed statement of comprehensive income and
only give effect to Transaction Accounting Adjustments and Autonomous Entity
Adjustments.
(9)(ii) The number of shares used in the calculation of
the pro forma per share amounts must be based on the weighted average number
of shares outstanding during the period adjusted to give effect to the
number of shares issued or to be issued to consummate the transaction, or if
applicable whose proceeds will be used to consummate the transaction as if
the shares were outstanding as of the beginning of the period presented.
Calculate the pro forma effect of potential common stock being issued in the
transaction (e.g., a convertible security), or the proceeds of which will be
used to consummate the transaction, on pro forma earnings per share in
accordance with U.S. GAAP or IFRS-IASB, as applicable, as if the potential
common stock were outstanding as of the beginning of the period
presented.
Pro forma financial information allows investors to understand and evaluate the impact of
a transaction, such as the acquisition or disposition of a business, by showing how that
transaction (or group of transactions) might have affected the registrant’s historical
financial position and results of operations if the transaction had occurred at an earlier
date. To prepare pro forma financial information, management must make the following two
types of adjustments:
- Transaction accounting adjustments — These adjustments reflect only the application of U.S. GAAP to the transaction (e.g., an acquisition or disposition). Such adjustments may include, for example, the recognition of goodwill and intangible assets and adjustments of assets and liabilities to fair value on the balance sheet, as well as the related impacts on the statement of comprehensive income, under the assumption that the balance sheet adjustments were made as of the beginning of the fiscal year presented. For transactions involving the issuance of common stock or potential common stock, an entity may need to make an adjustment to increase the weighted-average number of shares included in basic and diluted EPS.
- Autonomous entity adjustments — These adjustments, which are only required if the registrant was previously part of another entity, reflect 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., spin-off), its pro forma financial statements must include autonomous entity adjustments to reflect the incremental costs expected to be incurred as if it were a separate stand-alone entity. If the distributed entity’s historical financial statements include allocated overhead costs of $5 million but the entity expects such costs to be $8 million when it is a stand-alone entity, it would be required to make a $3 million adjustment for additional overhead costs.
Article 11 requires registrants to provide separate columns in their pro forma financial
information for (1) historical financial information, (2) transaction accounting
adjustments, and (3) autonomous entity adjustments. Such information must also contain a
pro forma total, including the (1) amounts of pro forma basic and diluted EPS from
continuing operations that are attributable to the controlling interests and (2) number of
shares used to calculate such amounts. The amounts of pro forma EPS must be presented on
the face of the pro forma statement of comprehensive income, and such calculations must
give effect to both transaction accounting adjustments and autonomous entity adjustments,
if applicable. Article 11 discusses the disclosures registrants must provide regarding pro
forma financial information.
The number of shares used in the calculations of pro forma EPS is determined on the basis
of the weighted-average number of shares outstanding during the period, adjusted by the
number of shares issued or to be issued to consummate the transaction or whose proceeds
will be used to consummate the transaction as if the shares were outstanding as of the
beginning of the period presented. Similarly, potential common shares issued in the
transaction (or the proceeds of which will be used to consummate the transaction) are
treated as if they were outstanding as of the beginning of the period presented.
In addition to the required adjustments noted above, Article 11 gives
registrants the option of presenting, in the explanatory notes to the pro forma financial
information, adjustments reflecting synergies and dis-synergies management identified when
evaluating whether to consummate an acquisition. Management’s adjustments may provide
insight into the potential effects of an acquisition as well as the plans that management
expects to execute after the acquisition (these plans may take forward-looking information
into account). To the extent that such adjustments do not qualify as transaction
accounting or autonomous entity adjustments, they may include, but are not limited to,
closing facilities, discontinuing product lines, and terminating employees. A registrant
that presents synergies must also present any related dis-synergies.
Connecting the Dots
An entity must always make transaction accounting adjustments and autonomous entity
adjustments (if applicable) when preparing pro forma financial information.
Management’s adjustments are always optional and may only “be presented in the
explanatory notes to the pro forma financial information” in the form of
reconciliations of (1) pro forma net income from continuing operations attributable to
the controlling interest and the related pro forma EPS data to (2) such amounts after
the effect of management’s adjustments is taken into account.
The preparation, presentation, and disclosure of pro forma financial
information by smaller reporting companies (SRCs) must substantially comply with Article
11. Under Article 11, pro forma EPS must be presented outside the financial statements and
therefore should be presented as unaudited information.
B.2.1.2 Allocation of Expenses and Related Disclosure in Financial Statements of Subsidiaries, Divisions, or Lesser Business Components of Another Entity
SEC Staff Accounting Bulletins
SAB Topic 1.B.1, Costs Reflected in
Historical Income Statements [Reproduced in ASC 220-10-S99-3]
Facts: A company (the registrant)
operates as a subsidiary of another company (parent). Certain expenses
incurred by the parent on behalf of the subsidiary have not been charged to
the subsidiary in the past. The subsidiary files a registration statement
under the Securities Act of 1933 in connection with an initial public
offering. . . .
Question 3: What are the staff’s
views with respect to the accounting for and disclosure of the subsidiary’s
income tax expense?
Interpretive Response: Recently, a
number of parent companies have sold interests in subsidiaries, but have
retained sufficient ownership interests to permit continued inclusion of the
subsidiaries in their consolidated tax returns. The staff believes that it
is material to investors to know what the effect on income would have been
if the registrant had not been eligible to be included in a consolidated
income tax return with its parent. Some of these subsidiaries have
calculated their tax provision on the separate return basis, which the staff
believes is the preferable method. Others, however, have used different
allocation methods. When the historical income statements in the filing do
not reflect the tax provision on the separate return basis, the staff has
required a pro forma income statement for the most recent year and interim
period reflecting a tax provision calculated on the separate return
basis.1
____________________
1 FASB ASC paragraph 740-10-30-27 (Income Taxes
Topic) states: “The consolidated amount of current and deferred tax expense
for a group that files a consolidated tax return shall be allocated among
the members of the group when those members issue separate financial
statements. . . . The method adopted . . . shall be systematic, rational,
and consistent with the broad principles established by this Subtopic. A
method that allocates current and deferred taxes to members of the group by
applying this Topic to each member as if it were a separate taxpayer meets
those criteria.”
SAB Topic 1.B.2, Pro Forma Financial
Statements and Earnings per Share [Reproduced in ASC 205-10-S99-7]
Question: What disclosure should
be made if the registrant’s historical financial statements are not
indicative of the ongoing entity (e.g., tax or other cost sharing agreements
will be terminated or revised)?
Interpretive Response: The
registration statement should include pro forma financial information that
is in accordance with Article 11 of Regulation S-X and reflects the impact
of terminated or revised cost sharing agreements and other significant
changes.
SAB Topic 1.B.1 specifically addresses the presentation of pro forma financial
information in situations in which the financial statements of a subsidiary do not
reflect income taxes on a separate-return basis. Footnote 37 in SAB Topic 5.T also
refers to SAB Topic 1.B.1 and states:
[I]n some circumstances it is
necessary to reflect, either in the historical financial statements or a pro forma
presentation (depending on the circumstances), related party transactions at amounts
other than those indicated by their terms. Two such circumstances are addressed in
Staff Accounting Bulletin Topic 1.B.1, Questions 3 and 4. Another example is where the
terms of a material contract with a related party are expected to change upon the
completion of an offering (i.e., the principal shareholder requires payment for
services which had previously been contributed by the shareholder to the
company).
Since SAB Topic 1.B.2 requires an SEC registrant to prepare pro forma financial
information in accordance with Article 11, the pro forma financial information must
include pro forma EPS, which should be labeled as unaudited. In accordance with Article
11, this information must be presented outside the financial statements.
B.2.1.3 Distributions From the Proceeds of an Offering
SEC Staff Accounting Bulletins
SAB Topic 1.B.3, Other Matters
[Reproduced in ASC 855-10-S99-1]
Question: What is the staff’s
position with respect to dividends declared by the subsidiary subsequent to
the balance sheet date?
Interpretive Response: The staff
believes that such dividends either be given retroactive effect in the
balance sheet with appropriate footnote disclosure, or reflected in a pro
forma balance sheet. In addition, when the dividends are to be paid from the
proceeds of the offering, the staff believes it is appropriate to include
pro forma per share data (for the latest year and interim period only)
giving effect to the number of shares whose proceeds were to be used to pay
the dividend. A similar presentation is appropriate when dividends exceed
earnings in the current year, even though the stated use of proceeds is
other than for the payment of dividends. In these situations, pro forma per
share data should give effect to the increase in the number of shares which,
when multiplied by the offering price, would be sufficient to replace the
capital in excess of earnings being withdrawn.
While the facts in SAB Topic 1.B.3 apply to a subsidiary of a parent company,
the SEC staff’s guidance also requires an entity to present pro forma EPS when the
proceeds from an offering will fund, or will be presumed to fund, distributions to the
entity’s promoters, owners, and shareholders. Sections 3420 and 7340 of the FRM provide
the SEC staff’s views on situations in which such distributions occur at or before the
closing of an IPO or another offering of securities.
FRM Topic 3
3420 Distributions to Promoters/Owners
at or Prior to Closing of an IPO [SAB Topic 1B.3]
3420.1 If a planned distribution
to owners, regardless of whether it has been declared or whether it will be
paid from proceeds, is not reflected in the latest balance sheet but would
be significant relative to reported equity, a pro forma balance sheet
reflecting the distribution accrual (but not giving effect to the offering
proceeds) should be presented alongside the historical balance sheet in the
filing.
3420.2 If a distribution to
owners, regardless of whether it is declared or whether it is reflected
already in the balance sheet, is to be paid out of proceeds of the offering
rather than from the current year’s earnings, pro forma per share data
should be presented (for the latest year and interim period only) giving
effect to the number of shares whose proceeds would be necessary to pay the
dividend (but only the amount that exceeds current year’s earnings) in
addition to historical EPS. The number of shares to be added to the
denominator for purposes of pro forma per share data should not exceed the
total number of shares to be issued in the offering. For purposes of this
interpretation, a dividend declared in the latest year would be deemed to be
in contemplation of the offering with the intention of repayment out of
offering proceeds to the extent that the dividend exceeded earnings during
the previous twelve months.
FRM Topic 7
7340 Offering Proceeds
7340.1 In addition to historical
EPS, if a material portion of the proceeds of an offering will be
distributed to shareholders, present pro forma EPS for the latest year and
interim period reflecting dilution equivalent to the number of shares whose
proceeds will be used to pay dividends.
7340.2 Even if the distribution is
not clearly to be paid from offering proceeds, pro forma EPS is required if
the distribution exceeds current year’s earnings.
As indicated in paragraph 3420.2 of the FRM, if a distribution to
owners/shareholders “is to be paid out of proceeds of the offering rather than from the
current year’s earnings,” an entity should present pro forma EPS, for the latest fiscal
year and interim period, to reflect this distribution. In accordance with Article 11,
this information must be presented outside the financial statements. Proceeds from an
offering that will be used for general corporate purposes should not result in the
inclusion of incremental common shares in the denominator of pro forma EPS amounts.
However, the SEC staff presumes that dividends declared before an IPO or offering are in
contemplation of the IPO or offering (and therefore are paid out of the offering
proceeds) if those distributions exceed the entity’s earnings during the preceding 12
months. Any pro forma EPS presented as a result of these requirements should be labeled
as unaudited.
Connecting the Dots
This unaudited pro forma presentation is required even if the payment of a dividend to owners/shareholders is not mentioned as a stated use of proceeds in the registration statement.
See Section B.3.2 for computational guidance related to distributions from proceeds of an offering. See Example B-1 for an illustration of this pro forma requirement.
B.2.1.4 Changes in Capitalization at or Before Closing of an IPO
FRM Topic 3
3430 Other Changes in Capitalization
at or Prior to Closing of an IPO
3430.1 Generally, the historical
balance sheet and statement of operations (including EPS) should not be
revised to reflect modifications of the terms of outstanding securities that
become effective after the latest balance sheet date, although pro forma
data may be necessary. Depending on the facts and circumstances, the staff
may not object if the registrant and its independent accountants elect to
present retroactively a conversion of securities as if it had occurred at
the date of the latest balance sheet included in the filing (with no
adjustment of earlier statements). However, if the original instrument
accrues interest or accretes toward redemption value after the balance sheet
date until the conversion actually occurs, or if the terms of the conversion
do not confirm the carrying value, only pro forma presentation would be
deemed appropriate.
3430.2 If terms of outstanding
equity securities will change subsequent to the date of the latest balance
sheet and the new terms result in a material reduction of permanent equity
or, if redemption of a material amount of equity securities will occur in
conjunction with the offering, the filing should include a pro forma balance
sheet (excluding effects of offering proceeds) presented alongside of the
historical balance sheet giving effect to the change in capitalization.
3430.3 If the conversion of
outstanding securities will occur subsequent to the latest balance sheet
date and the conversion will result in a material reduction of earnings per
share (excluding effects of offering), pro forma EPS for the latest year and
interim period should be presented giving effect to the conversion (but not
the offering).
In connection with an IPO, certain outstanding securities, such as convertible
securities or restricted share-based units, may be converted into common stock of the
entity. To provide financial statement users with transparent disclosure regarding a
prospective SEC registrant’s potential operating performance after such anticipated
changes in capitalization, paragraph 3430.3 of the FRM requires an entity to present pro
forma EPS when outstanding securities will be converted after the latest balance sheet
date and this conversion will cause a material reduction in EPS (excluding the effects
of the offering). In accordance with Article 11, this information must be presented
outside the financial statements and is unaudited.
The following decision tree illustrates the
application of this guidance:
A common situation involving a change in capitalization for which the
presentation of pro forma EPS is required is the mandatory conversion of preferred stock
into common stock in conjunction with an IPO. While not a reduction of equity, pro forma
EPS must be presented for this type of conversion if the conversion would materially
reduce EPS. In this case, pro forma basic EPS includes the preferred stock on an
as-converted basis.
FRM Topic 3
3620 Filings Subsequent to an IPO
Pro forma basic EPS reflecting the conversion of preferred
stock into common stock at the IPO date should not be presented in financial
statements issued subsequent to the IPO.
In Section 3620 of the FRM, the SEC staff indicates that the pro forma basic EPS
that was provided in the filing for an IPO should not be included in the registrant’s
financial statements filed under the Exchange Act after the IPO. This view is consistent
with Article 11, which requires that all pro forma financial information be presented
outside the financial statements.
See Section B.3.3 for computational guidance related to changes in capitalization at or before the closing of an IPO. See Example B-2 for an illustration of this pro forma requirement.
B.2.1.5 Use of Proceeds From Offering of Convertible Securities to Extinguish Preferred Stock or Debt
SEC Staff Accounting Bulletins
SAB Topic 3.A, Convertible
Securities
Facts: Company B proposes to file
a registration statement covering convertible securities.
Question: In registration, what
consideration should be given to the dilutive effects of convertible
securities?
Interpretive Response: In a
registration statement of convertible preferred stock or debentures, the
staff believes that disclosure of pro forma earnings per share (EPS) is
important to investors when the proceeds will be used to extinguish existing
preferred stock or debt and such extinguishments will have a material effect
on EPS. That disclosure is required by Article 11, Rule 11-01(a)(8) and Rule
11-02(b)(7) of Regulation S-X, if material.
As with the requirement to present pro forma EPS for changes in capital
structure in conjunction with an IPO, SAB Topic 3.A states that when an entity registers
convertible preferred stock or debentures and will use the proceeds from the offering to
extinguish existing preferred stock or debt, the entity should disclose pro forma EPS
outside the financial statements in the registration statement if the resulting effect
on EPS will be material. Although SAB Topic 3.A only specifically addresses the offering
of convertible securities, the SEC staff’s view would extend to situations in which an
entity is offering common securities to extinguish existing preferred stock or debt.
See Section B.3.4 for computational guidance related to proceeds from offerings of convertible securities to extinguish preferred stock or debt. See Examples B-3 through B-5 for illustrations of this pro forma requirement.
B.2.1.6 Changes in Tax Status in Conjunction With an IPO
FRM Topic 3
3410 Sub-Chapter S Corporations and
Partnerships
3410.1 If the issuer was formerly
a Sub-Chapter S corporation (“Sub-S”), partnership or similar tax exempt
enterprise, pro forma tax and EPS data should be presented . . . for the
periods identified below:
-
If necessary adjustments include more than adjustments for taxes, limit pro forma presentation to latest fiscal year and interim period
-
If necessary adjustments include only taxes, pro forma presentation for all periods presented is encouraged, but not required.
3410.2 In filings for periods
subsequent to becoming taxable, pro forma presentations reflecting tax
expense for earlier comparable periods should continue to be presented for
periods prior to becoming taxable and for the period of change if the
registrant elects to present pro forma information for all periods pursuant
to 3410.1(b). Such pro forma presentations should continue to calculate the
pro forma tax expense based on statutory rates in effect for the earlier
period.
3410.3 Undistributed earnings or
losses of a Sub-S registrant should be reclassified to paid-in capital in
the pro forma statements. [SAB Topic 4B] Similarly, undistributed earnings
or losses of partnerships should be reclassified to paid-in capital in the
pro forma statements. That presentation assumes a constructive distribution
to the owners followed by a contribution to the capital of the corporate
entity.
3410.4 Sub-S registrants or
partnerships that pay distributions to promoter-owners at the close or
effectiveness with proceeds of the offering (rather than out of retained
earnings) should consider the pro forma presentations specified in Section
3430.3.
As discussed in Section 3410 of the FRM, if an entity is organized as a
nontaxable entity (e.g., partnerships, LLCs, S corporations) and expects to be converted
to a taxable entity (e.g., a C corporation) in conjunction with an IPO, pro forma income
taxes and EPS should be presented to reflect the impact of the conversion. See Section B.3.5 for computational
guidance related to changes in tax status in conjunction with an IPO.
B.2.1.7 Other Guidance
In addition to the FRM, entities should consult other guidance (e.g.,
SEC Regulation S-X) for discussion of pro forma disclosure requirements, including those
related to pro forma EPS.
B.2.1.8 Form 8-K
Item 9.01(b)(1) of Form 8-K requires SEC registrants to “file any pro forma
financial information that would be required pursuant to Article 11 of Regulation S-X
(17 CFR 210) or Rule 8-05 of Regulation S-X (17 CFR 210.8-05) for smaller reporting
companies unless it involves the acquisition of a fund subject to Rule 6-11 of
Regulation S-X (17 CFR 210.6-11).”
B.2.1.9 Multiple Classes of Common Stock
In prior discussions, the SEC staff indicated that pro forma presentation of EPS
for multiple classes of stock for periods before their legal creation or issuance is
only permitted in registration statements used to register the newly created classes or
in proxy materials in which investors are asked to vote on the creation or issuance of
new classes. In those instances, the pro forma disclosure should be limited to the
issuer’s most recently completed fiscal year and subsequent interim period. The staff
has objected when a registrant presents pro forma amounts after new classes of stock
have been created and issued. For the period that includes the issuance of a tracking
stock, a company should present historical EPS for (1) its single class of stock up to
the issuance date of the tracking stock and (2) each class of stock for the periods for
which the tracking stock was outstanding. The creation of the tracking stock capital
structure should not be treated similarly to a stock split and therefore should not be
accounted for retroactively.
B.2.2 Pro Forma EPS Required by U.S. GAAP
The Codification does not specifically require the disclosure of pro forma EPS. However, certain guidance in U.S. GAAP addresses the disclosure of pro forma financial information, which could include pro forma EPS. Section 3610 of the FRM indicates that pro forma disclosures presented under U.S. GAAP may differ in style and content from those required by Article 11.
Codification references to pro forma disclosures include the following:
- ASC 450-20-50-10 indicates that for asset impairments or losses arising after the date of the financial statements, “[d]isclosure may best be made by supplementing the historical financial statements with pro forma financial data giving effect to the loss as if it had occurred at the date of the financial statements.”
- ASC 805-10-50-2(h) requires a public entity to disclose certain supplemental pro forma information related to business combinations to reflect the combined entity as though the combination had occurred as of the beginning of the comparable prior annual reporting period. Disclosure of pro forma EPS is not specifically required. However, Item 9.01 of Form 8-K requires SRCs and non-SRCs to file pro forma financial information for significant acquisitions, including EPS, through the issuer’s most recently filed balance sheet. See Deloitte’s Roadmap SEC Reporting Considerations for Business Acquisitions for more information about the pro forma EPS requirements for business combinations.
- ASC 855-10-50-3 states, in part, that “[a]n entity also shall consider supplementing the historical financial statements with pro forma financial data [regarding a material subsequent event]. Occasionally, a nonrecognized subsequent event may be so significant that disclosure can best be made by means of pro forma financial data. Such data shall give effect to the event as if it had occurred on the balance sheet date.”