Appendix B — Pro Forma EPS in SEC Filings
Appendix B — Pro Forma EPS in SEC Filings
B.1 Background
SEC Regulation S-X, Article 11, describes the circumstances in which pro forma
financial information should be presented in filings with the SEC, the form of such
presentation, and the guidance for an entity to consider in preparing such
information. Article 11 does not require that pro forma financial information be
presented in a Form 10-K or Form 10-Q filed under the Exchange Act or in the
historical financial statements of an acquired entity. Rather, the types of SEC
filings for which Article 11 may require entities to present pro forma financial
information, such as pro forma EPS, include the following:
-
Registration statements under the Securities Act.
-
Registration statements under the Exchange Act (i.e., a Form 10).
-
Form 8-K.
-
Proxy statements.
When Article 11 requires pro forma financial information in a filing with the
SEC, each pro forma income statement should include pro forma basic and diluted EPS
from continuing operations that applies to the controlling interest and that
reflects the transaction that has occurred, or whose occurrence is probable, for
which the pro forma financial information is needed.
In addition to Article 11, other SEC guidance and U.S. GAAP may also require the
presentation or disclosure of pro forma EPS in certain circumstances. Article 11
prohibits registrants from presenting pro forma financial information on the face of
their historical financial statements or in the accompanying notes except when such
presentation is required by U.S. GAAP. Therefore, pro forma EPS should only be
presented outside the historical financial statements unless the information must be
included or disclosed in the historical financial statements in accordance with U.S.
GAAP. Item 9.01 of Form 8-K also refers to certain requirements to present pro forma
financial information under Article 11 (see Section B.2.1.8). In all cases, pro forma EPS
amounts should be labeled as unaudited.
Section B.2
discusses SEC and other guidance (not all-inclusive) that may require an entity to
present or disclose pro forma EPS. Section B.3 addresses considerations related to the calculation of
pro forma EPS. Section
B.4 provides examples illustrating the calculation of pro forma EPS.
The discussion in this appendix includes references to the FRM (updated as of
December 2022).
In addition to this appendix, the following Deloitte Roadmaps contain guidance relevant to pro forma financial information:
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 Combinations 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.”
B.3 Calculating Pro Forma EPS
B.3.1 General
Article 11 and Section
3200 of the FRM include computational guidance related to pro
forma EPS. However, there is no such computational guidance in U.S. GAAP.
SEC Regulation S-X, Rule 11-02(b)(9)(i), contains the following description of
the pro forma EPS information that must be included in pro forma financial
statements:
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.
In addition to describing the pro forma EPS information to be included in pro
forma financial statements, SEC Regulation S-X, Rule 11-02(b)(9)(ii), discusses
the calculation of pro forma EPS and states:
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.
Under Article 11, an entity will generally include in the denominator of pro forma EPS only those common shares whose proceeds are being reflected in pro forma adjustments in the income statements, such as proceeds used for debt repayment or business acquisitions. However, an entity may be required to reflect in its pro forma EPS calculation incremental shares arising from an offering whose proceeds are assumed to pay a distribution/dividend to shareholders, even if such a distribution is not reflected in the pro forma income statement. See further discussion in Section B.3.2.
Regardless of the reason for presenting or disclosing pro forma EPS in a filing with the SEC, the pro forma EPS amounts should be accompanied by transparent disclosure of how such amounts were calculated.
Connecting the Dots
The presentation of pro forma EPS should not alter in any way the calculations
of historical basic and diluted EPS under ASC 260. That is, calculations
of basic and diluted EPS under ASC 260 should not incorporate any of the
assumptions about the use of offering proceeds or other transactions
that have not yet occurred but that may trigger a requirement to present
or disclose pro forma EPS. Rather, transactions affecting EPS should be
reflected in EPS calculations under ASC 260 only after they have
occurred.
B.3.2 Distributions From the Proceeds of an Offering
The objective of calculating pro forma EPS is to include an additional number of
common shares in the denominator to reflect that the entity would have to raise
proceeds through the issuance of common stock to fund dividends that exceed
current-period earnings. That is, pro forma EPS should be calculated by
including an incremental number of common shares (not to exceed the total number
of common shares being offered) that, on the basis of the offering price, would
be needed to pay the portion of the dividend that exceeds earnings. See
Example B-1 for
an illustration.
B.3.3 Change in Capitalization at or Before Closing of an IPO
When outstanding securities, such as convertible securities or restricted share-based units, will be converted into common stock in conjunction with an IPO, and that conversion will occur after the latest balance sheet presented and result in a material reduction of EPS (excluding the effects of the offering), pro forma EPS amounts should reflect the conversion of the securities into common stock. The pro forma EPS amounts should not, however, reflect any additional shares of common stock being offered in the IPO.
The nature of the pro forma adjustments to the historical EPS amounts will depend on the specific facts and circumstances. Such adjustments may include adjustments to the numerator in addition to the inclusion of additional common shares in the denominator. If the security to be converted is a participating security, an entity would be required to adjust the numerator to remove the effects of such participation from the historical EPS amounts. Moreover, for convertible securities, the numerator for basic EPS would need to be adjusted to remove any interest or dividends that reduced income available to common stockholders. A similar type of adjustment may also be required in the calculation of pro forma diluted EPS. However, in some cases, diluted EPS and pro forma diluted EPS will be the same. See Example B-2 for an illustration.
B.3.4 Use of Proceeds From Offering of Convertible Securities to Extinguish Preferred Stock or Debt
The pro forma adjustments required under SAB Topic 3.A will depend on the circumstances associated with the existing security being extinguished, the offered security, and other equity or participating securities in the entity’s capital structure. In certain situations, the pro forma adjustments will involve the initial application, alteration, or cessation of the two-class method of calculating EPS. This may be the case when (1) the extinguished security was a participating security, (2) the offered security is a participating security, or (3) the entity has other participating securities or multiple classes of common stock. Regardless of the facts and circumstances related to the extinguished security, the offered security, or the other equity or participating securities in the entity’s capital structure, the following are always true in the calculation of pro forma EPS:
- The pro forma adjustments to the denominator as a result of the offered security should be limited to the portion of the offering proceeds that will be used to extinguish the existing security. This amount will be determined by considering both the redemption price of the existing security and the proceeds that must be raised in the offering to repay that redemption price. The quantity of securities needed to pay the redemption price of the existing security should be based on the offering price in the registration statement. Additional proceeds raised in the offering that will be used for general corporate purposes do not affect the calculations of pro forma EPS.
- The pro forma adjustments should be calculated in a manner that reflects only the time during which the existing security or offered security was (or would be) outstanding during the financial reporting period. For example, if an entity is retiring nonconvertible debt that was issued at the beginning of the second quarter of a fiscal year with the proceeds from an offering of convertible securities at or after the end of the fiscal year, the adjustments to the numerator would only reflect interest expense on the existing debt for three quarters. Similarly, the adjustments to the numerator and the incremental potential common shares added to the denominator of the calculation of pro forma diluted EPS under the if-converted method would also be weighted for three quarters during the annual period.
The table below discusses various other matters not specifically addressed in
the SEC’s computational guidance that may be relevant to the calculation of pro
forma EPS under SAB Topic 3.A.1
Table B-1
Additional Matter
|
Additional Considerations
|
---|---|
The existing security that is being
extinguished was accounted for at fair value through
earnings.
|
The mark-to-market adjustments should be
reversed since they would not have been recorded if the
existing security was extinguished.
|
The existing security that is being
extinguished contained an embedded derivative that was
separately recognized under ASC 815.
|
The mark-to-market adjustments on the
embedded derivative should be reversed since they would
not have been recorded if the existing security was
extinguished.
|
The existing security that is being
extinguished was preferred stock that was classified in
temporary equity and remeasured to its redemption
amount.
|
The adjustments previously recognized
for changes in the redemption amount should be reversed
since they would not have been recorded if the existing
security was extinguished (i.e., the amounts that
reduced income available to common stockholders would be
added back to the numerator).
|
The existing security allowed for
conversion to be settled in cash or common stock.
|
The adjustments to historical EPS should
be based on an assumption that the security would be
share-settled.
|
The offered security will be accounted
for at fair value through earnings.
|
If potential mark-to-market adjustments
on the offered security that will be recognized after
the issuance of the security are not included in the
calculation of pro forma EPS amounts for the period
after the issuance of the offered security, the
disclosure should indicate that these adjustments are
not included in the calculation of pro forma EPS because
such amounts are not reasonably determinable.
|
The offered security will contain an
embedded derivative that must be separated under ASC
815.
|
Management should estimate the initial
fair value of the embedded derivative to calculate the
interest expense or dividends on the host contract for
the offered security under the interest method. If
potential mark-to-market adjustments on the embedded
derivative that will be recognized after the issuance of
the security are not included in the calculation of pro
forma EPS amounts for the period after the issuance of
the offered security, the disclosure should indicate
that these adjustments are not included in the
calculation of pro forma EPS because such amounts are
not reasonably determinable.
|
The interest or dividends on the offered
security are variable.
|
The entity should use judgment on the
basis of the specific terms and other GAAP. If the
variability is based solely on a market index, the
relevant spot index should be used.
|
The interest or dividends on the offered
security are at an increasing rate or contain other
unique terms.
|
The entity should consider the interest
or dividend terms in the offering document in
determining the application of the interest method.
|
The offered security is puttable or
callable.
|
Such calls or puts should not be
considered to result in a life of the offered security
that is shorter than the period during which the
existing security was outstanding. Entities should use
judgment and consider the requirements of other GAAP in
evaluating whether the puts or calls affect the interest
or dividend yield on the offered security.
|
The offered security will need to be
classified in temporary equity and remeasured to its
redemption amount.
|
In assessing the impact of potential
redemption amount adjustments on the calculation of pro
forma EPS, an entity will need to use judgment and
consider the facts and circumstances as well as its
selected accounting policies under ASC 480-10-S99-3A.
For example:
If the redemption price is variable, the
entity should consider the nature of the variability to
determine the redemption amount adjustments or should
disclose that such an estimate is not reasonably
determinable.
|
The offered security is a convertible
security for which a conversion may be settled in cash
or stock.
|
Entities are required to assume share
settlement when calculating pro forma EPS.
|
The entity historically applied the
two-class method as a result of the existence of other
participating securities or multiple classes of common
stock (i.e., in the absence of the existing security or
offered security, the two-class method of EPS is
required).
|
The adjustments to historical basic and
diluted EPS arising from the extinguishment of the
existing security and the offered security may affect
the historical application of the two-class method
(e.g., the allocation of undistributed earnings); thus,
an entity will be required to take additional
considerations into account in calculating pro forma
EPS.
|
B.3.5 Changes in Tax Status in Conjunction With an IPO
The financial statements presented in a registration statement on Form S-1 for
the periods in which an entity was a nontaxable entity should not be restated
for the effects of income taxes. Rather, as discussed in paragraph 3410.1 of the
FRM, the entity should provide pro forma disclosures to illustrate the effect of
income taxes on those years in accordance with Article 11. Section 3270 of the FRM
states that the tax rate used for the pro forma calculations should normally
equal the “statutory rate in effect during the periods for which the pro forma
income statements are presented.”
For more information about the implications of a change in tax status, see
Deloitte’s Roadmap Income
Taxes. Note that there are several ways in which an
entity’s tax and legal structure may change as a result of the IPO process, all
of which may have unique impacts on income tax measurement, presentation, and
disclosures. Management should consult with tax advisers in determining the
income tax implications of such changes well in advance of the IPO.
Footnotes
1
The matters discussed below may also be relevant to
certain changes in capitalization in conjunction with an IPO.
B.4 Examples
B.4.1 Distributions From the Proceeds of an Offering
Example B-1
Assume the following:
- Company A, a calendar-year-end entity, plans to complete an IPO in June 20X9.
- Before its IPO, A had 5,000 shares of common stock outstanding.
- In the IPO, A expects to issue 1 million shares of common stock at an expected offering price of $100 per share.
- For the year ended December 31, 20X8, A has net income of $100,000.
- On December 31, 20X8, A declares a dividend of $1,000 per share to its owners (i.e., a total dividend of $5 million). No other dividends are paid or declared in 20X8.
Because the dividends for 20X8 exceed A’s net income for this year, the SEC
staff would consider the dividend payments to have been
made in contemplation of A’s planned IPO. Accordingly,
in the Form S-1 filing for its IPO, A should present pro
forma EPS outside the financial statements for the year
ended December 31, 20X8, and for the three months ended
March 31, 20X9, that reflects an additional 49,000
common shares in the denominator of both basic and
diluted EPS.
The incremental number of shares of common stock included in the denominator is calculated as follows:
Since the 49,000 incremental common shares required for the pro forma EPS disclosure do not exceed the common shares being offered in the IPO, all of the incremental shares should be included in the calculation of pro forma EPS.
B.4.2 Change in Capitalization at or Before Closing of an IPO
Example B-2
Assume the following:
- Company B, a calendar-year-end entity, plans to complete an IPO in March 20X5. The latest financial statements included in the Form S-1 registration statement are as of and for the year ended December 31, 20X4.
- Company B has the following outstanding securities:
- 100,000 shares of common stock.
- 100,000 shares of participating convertible preferred stock that are automatically converted into common shares upon the occurrence of an IPO (the “preferred shares”). The aggregate liquidation preference of the preferred shares is $1 million. Each preferred share is convertible into one share of common stock. The preferred shares receive dividends, on a cumulative basis, at an annual rate of 8 percent (or $80,000 per annum). In addition, after such payments, the holders are entitled to participate in dividends with common shareholders on a 35:65 basis and such participation is determined on the basis of the number of shares of common stock issuable on conversion of the preferred shares.
- Options that allow the holders to purchase 50,000 shares of common stock that are not automatically exercised upon the occurrence of an IPO. The options do not represent participating securities.
- For the year ended December 31, 20X4:
- Company B reports net income of $500,000.
- No dividends are paid or declared on common stock.
- Under the treasury stock method, the options result in 25,000 incremental shares.
Company B’s calculation of EPS for the year ended December 31, 20X4, is as follows:
Basic EPS:
Diluted EPS:
Diluted EPS is presented under the if-converted method since it is more dilutive than the two-class method of calculating diluted EPS.
(a) Two-class method:
(b) If-converted method:
Company B calculates pro forma EPS for the year ended December 31, 20X4, which
would be presented outside the financial statements, as
follows:
Pro Forma Basic EPS:
Pro Forma Diluted EPS:
Note that diluted pro forma EPS is not calculated under the two-class method because, after the conversion of the preferred shares, there are no remaining participating securities.
B.4.3 Use of Proceeds From Offering of Convertible Securities to Extinguish Preferred Stock or Debt
Example B-3
Assume the following:
- Company C is offering $500 million of convertible preferred stock (the “preferred stock”).
- The “use of proceeds” section in the registration statement for the offering states that the proceeds from issuance of the preferred stock will be used to redeem C’s outstanding senior secured notes (the “notes”) and for general corporate purposes.
- Key terms and characteristics of the notes include:
- The notes are not convertible into common stock.
- The notes are not participating securities.
- The notes are accounted for at amortized cost.
- The current amortized cost of the notes is $245 million.
- The outstanding principal amount of the notes is $250 million.
- The notes do not contain any embedded derivatives that must be accounted for separately.
- The notes contain an embedded call option that allows C to redeem them at any time for the principal amount plus a make-whole premium. The current redemption amount is $260 million. Therefore, the redemption will result in a pretax extinguishment loss of $15 million or $12 million, net of tax.
- The notes are outstanding during the entire year ended December 31, 20X1.
- Interest expense on the notes during the year ended December 31, 20X1, net of tax, is $9 million.
- Key terms and characteristics of the preferred stock include:
- The conversion option in the preferred stock must be settled in common stock.
- Upon full conversion, C would be required to issue 8 million shares of common stock.
- The conversion option in the preferred stock is not “in-the-money” as of the issuance date.
- The preferred stock is not a participating security.
- Dividends on the preferred stock, which are cumulative and not tax-deductible, accrue at a rate of 3.5 percent per annum.
- The preferred stock will be classified in permanent equity.
- The preferred stock will not contain any embedded derivatives that must be accounted for separately.
- Before the offering, C’s capital structure consists solely of the notes, common stock, and options to purchase common stock, which are not participating securities. For the year ended December 31, 20X1, on a weighted-average basis, C has 10 million shares of common stock outstanding and 1 million incremental potential common shares, as calculated under the treasury stock method.
- Company C reports net income of $50 million for the year ended December 31, 20X1.
Company C presents basic and diluted EPS for the year ended December 31, 20X1, as follows:
Basic EPS:
Diluted EPS:
The adjustments to C’s historical basic and diluted EPS to arrive at pro forma basic and diluted EPS for the year ended December 31, 20X1, are as follows:
EPS | Nature of Pro Forma Adjustments |
---|---|
Basic | Numerator:
The numerator in the historical calculation of
basic EPS should be decreased by $12.1 million,
calculated as the $12 million loss on
extinguishment of the notes, net of tax, plus the
$100,000 difference between interest on the notes
and dividends on the preferred stock, which is
calculated as follows: Denominator: There are no adjustments to the denominator in the historical calculation of basic EPS. |
Diluted | Numerator: The numerator in the historical calculation of diluted EPS should be decreased
by $3 million, representing the $12 million loss
on the extinguishment of debt, net of tax, less
the add-back of $9 million of interest on the
notes, net of tax. The dividends on the preferred
stock do not affect the numerator for pro forma
diluted EPS because the preferred stock is
dilutive under the if-converted method. Denominator: The denominator in the historical calculation of diluted EPS should be increased
by 4.16 million shares of common stock,
representing the number of shares of common stock
to be issued from the application of the
if-converted method to $260 million of preferred
stock (i.e., 8 million common shares issuable upon
full conversion × [$260 million ÷ $500 million]).
No additional adjustments are necessary since the
notes are not convertible into common stock. |
The calculation of pro forma basic and diluted EPS for
the year ended December 31, 20X1, which would be
presented outside the financial statements, is as
follows:
Pro Forma Basic EPS:
Pro Forma Diluted EPS:
Example B-4
Assume the following:
- Company D is offering 100 million common shares (the “common stock”) and detachable warrants to purchase 100 million common shares (the “warrants”). On the basis of the offering prices, D expects to raise $900 million.
- The “use of proceeds” section in the registration statement for the offering states that the proceeds from issuance of common stock and warrants will be used to redeem all of D’s outstanding senior secured debentures (the “debentures”) and an amount of outstanding convertible preferred stock (the “preferred stock”) that is tendered by the holders in accordance with the terms of a tender offer but not to exceed $500 million. Company D expects that the tender offer will result in the repurchase of half of the outstanding preferred stock for $500 million. The anticipated purchase price is equal to the carrying amount of the preferred stock to be redeemed.
- Key terms and characteristics of the debentures include:
- The debentures are not convertible into common stock.
- The debentures are not participating securities.
- The debentures are accounted for at amortized cost.
- The current amortized cost of the debentures is $400 million.
- The outstanding principal amount of the debentures is $400 million.
- The debentures do not contain any embedded derivatives that must be accounted for separately.
- The debentures contain an embedded call option that allows D to redeem them at any time after December 31, 20X2, at the outstanding principal amount.
- The debentures were outstanding during the entire year ended December 31, 20X2.
- Interest expense on the debentures during the year ended December 31, 20X2, net of tax, was $18 million.
- Key terms and characteristics of the preferred stock include:
- The conversion option in the preferred stock must be settled in common stock.
- Upon full conversion, D would be required to issue 50 million shares of common stock.
- The preferred stock is not in-the-money on the issuance date.
- The preferred stock is not a participating security.
- Dividends on the preferred stock, which are cumulative and not tax-deductible, accrue at a rate of 6 percent per annum.
- The preferred stock is classified in permanent equity.
- The preferred stock does not contain any embedded derivatives that must be accounted for separately.
- The aggregate liquidation preference of the preferred stock is $1 billion.
- The preferred stock is outstanding during the entire year ended December 31, 20X2.
- Key terms and characteristics of the warrants include:
- The warrants are not participating securities.
- The exercise price of the warrants will be set at a 35 percent premium to the market price of D’s common stock.
- At no point during the year ended December 31, 20X2, did the fair value of D’s common stock exceed the exercise price of the warrants.
- Before the offering, D’s capital structure consists solely of the debentures, preferred stock, common stock, and options to purchase common stock, which are not participating securities. For the year ended December 31, 20X2, on a weighted-average basis, D has 300 million shares of common stock outstanding and 10 million incremental potential common shares related to the options to purchase common stock, as calculated under the treasury stock method.
- Company D reports net income of $500 million for the year ended December 31, 20X2.
Company D presents basic and diluted EPS for the year ended December 31, 20X2, as follows:
Basic EPS:
Diluted EPS:
The adjustments that D makes to its historical basic and diluted EPS to arrive at pro forma basic and diluted EPS for the year ended December 31, 20X2, are as follows:
EPS | Nature of Pro Forma Adjustments |
---|---|
Basic | Numerator: The numerator in the historical calculation of basic EPS should be increased by
$48 million, calculated as follows: Denominator: The denominator in the historical calculation of basic EPS should be increased by 100 million for the common shares to be issued in the offering. Note that the issuance of the warrants does not affect the calculation of pro forma basic EPS since the warrants do not represent participating securities. |
Diluted | Numerator: The numerator in the historical calculation of diluted EPS should be increased by $18 million, representing the add-back of interest, net of tax, on the notes. No adjustment is needed for dividends on the preferred stock because the numerator in the historical calculation of diluted EPS included an add-back for such dividends under the if-converted method. Denominator: The denominator in the historical calculation of diluted EPS should be increased by
75 million shares of common stock, calculated as follows: There is no incremental dilutive impact of the warrants to be issued in the offering because they are out-of-the-money. |
The calculation of pro forma basic and diluted EPS for
the year ended December 31, 20X2, which would be
presented outside the financial statements, is as
follows:
Pro Forma Basic EPS:
Pro Forma Diluted EPS:
Example B-5
Assume the following:
- Company E is offering $500 million of convertible notes (the “notes”).
- The “use of proceeds” section in the registration statement for the offering states that the proceeds from issuance of the notes will be used to retire E’s outstanding preferred stock (the “preferred stock”).
- Key terms and characteristics of the preferred stock include:
- There are 500,000 shares of preferred stock outstanding.
- Each share of preferred stock has a liquidation preference of $1,000 per share.
- The preferred stock is not convertible.
- Dividends on the preferred stock, which are cumulative and not tax-deductible, accrue at a rate of 6 percent per annum. The preferred stock also participates in dividends declared on E’s common stock on a 1:1 basis, calculated on the basis of the number of shares outstanding.
- The preferred stock is classified in permanent equity.
- The preferred stock does not contain any embedded derivatives that must be accounted for separately.
- Company E has a call option that allows it to redeem the preferred stock for $500 million.
- The preferred stock is recorded at $500 million on E’s balance sheet.
- The preferred stock is outstanding during the entire year ended December 31, 20X2.
- Key terms and characteristics of the notes include:
- The notes are convertible into common stock at a conversion rate of 50 shares for each 1,000 principal amount (or 25 million shares of common stock upon full conversion).
- The notes bear interest at an annual rate of 3.375 percent. Interest on the notes is tax-deductible (assume a 20 percent tax rate).
- The notes also participate in dividends paid on common stock on an as-converted basis.
- The notes will be accounted for at amortized cost.
- The notes will not contain any embedded derivative that must be accounted for separately.
- Before the offering, E’s capital structure consists solely of the preferred stock, common stock, and options to purchase common stock, which are not participating securities. For the year ended December 31, 20X2, on a weighted-average basis, E has 150 million shares of common stock outstanding and 5 million incremental potential common shares related to the options to purchase common stock, as calculated under the treasury stock method.
- Company E reports net income of $250 million for the year ended December 31, 20X2.
- Company E does not declare any dividends on common stock during the year ended December 31, 20X2.
- Company E is subject to the two-class method because the preferred stock is a participating security.
Company E presents basic and diluted EPS for the year ended December 31, 20X2, as follows:
Basic EPS:
Diluted EPS:
The adjustments that E makes to its historical basic and diluted EPS to arrive at pro forma basic and diluted EPS for the year ended December 31, 20X2, are as follows:
EPS | Nature of Pro Forma Adjustments |
---|---|
Basic | Numerator: The numerator in the historical calculation of basic EPS should be decreased by $16,554,817, calculated as follows: The extinguishment of the preferred stock will
not result in an adjustment to retained earnings
because the redemption amount and the carrying
amount of the preferred stock are the same;
therefore, no adjustment is necessary for the
extinguishment on the basis of the facts in this
example. Denominator: There are no adjustments to the denominator in the historical calculation of basic EPS. |
Diluted | Numerator: The numerator in the historical calculation of diluted EPS should be decreased by $15,639,827, calculated as follows: Denominator: There are no adjustments to the denominator in the historical calculation of diluted EPS because EPS is more dilutive under the two-class method than under the if-converted method. |
The calculation of pro forma basic and diluted EPS for the year ended December
31, 20X2, which would be presented outside the financial
statements, is as follows:
Pro Forma Basic EPS:
Pro Forma Diluted EPS:
Pro forma diluted EPS is presented under the two-class method since it is more dilutive than the if-converted method.
(a) Two-class method:
(b) If-converted method: