5.2 Financial Statements of Businesses Acquired or to Be Acquired (SEC Regulation S-X, Rule 3-05)

Carve-out financial statements are often used to satisfy the requirements of Rule 3-05, under which a registrant must file separate preacquisition historical audited financial statements when the registrant and its predecessor acquire (or it is probable that they will acquire) selected parts of an entity that meet the definition of a business8 that is significant. The number of audited financial statement periods that must be filed (i.e., one or two years of audited financial statements) will be based on the significance level determined by performing the tests described in SEC Regulation S-X, Rule 1-02(w) (i.e., the asset, income, or investment test). Unaudited financial statements as of and for the appropriate interim periods preceding the acquisition may also be required. In addition, the registrant must provide pro forma financial information in accordance with SEC Regulation S-X, Article 11, to reflect the acquisition.

Sections 5.2.1 through 5.2.4 discuss various considerations related to reporting and financial statement form and content when carve-out financial statements are filed to meet the requirements of Rule 3-05. For additional SEC interpretive guidance on Rule 3-05, see Chapter 2 of Deloitte’s Roadmap SEC Reporting Considerations for Business Acquisitions.

5.2.1 Form and Content of Acquiree Carve-Out Financial Statements

While the determination of the number of audited financial statement periods to be presented for an acquiree is based on the level of significance, the form and content of the acquiree’s carve-out financial statements are generally the same as if the acquiree were a registrant and must meet the relevant requirements of SEC Regulation S-X9 and U.S. GAAP.10 Supplemental schedules under SEC Regulation S-X, Articles 5 and 12, are not required. The disclosures required will depend on whether the carve-out entity is a public entity11 or a PBE (see Section 5.2.2) in accordance with U.S. GAAP.

If the acquiree is not a public entity, it does not have to provide the disclosures required under U.S. GAAP that apply only to public companies. For example, disclosures about the following would not be required in such a case:

EPS, if the acquiree does not have “publicly held common stock or potential common stock,” as stated in ASC 260-10-05-1 and as further defined in ASC 260-10-15-2.
Segment information, if the acquiree does not meet the definition of a public entity under ASC 280-10-20.
Certain disclosures identified in ASC 715-20-50-5 about employers’ pensions and other postretirement benefits, if the acquiree meets the definition of a nonpublic entity under ASC 715-20-20.

5.2.2 Public Business Entities

The definition of a PBE in the ASC master glossary includes a business entity that is required by the SEC “to file or furnish financial statements, or does file or furnish financial statements (including voluntary filers), with the SEC (including other entities whose financial statements or financial information are required to be or are included in a filing)” (emphasis added). Therefore, PBEs include entities whose financial statements or financial information is required under Rule 3-05 and other SEC regulations, and such carve-out financial statements must address the PBE requirements in U.S. GAAP even if the entity is not considered a “public entity” as defined in U.S. GAAP.

Entities that meet the definition of a PBE are not eligible to elect certain accounting and reporting alternatives in U.S. GAAP, including those developed by the PCC and subsequently endorsed by the FASB. Accordingly, such private-company accounting alternatives cannot be applied in carve-out financial statements of an acquiree under Rule 3-05. Further, the effects of any previously elected private-company accounting alternatives would have to be eliminated in the financial statements that management prepared to comply with Rule 3-05.12

In addition, a company that is not a PBE is permitted to use certain practical expedients (e.g., the risk-free rate as its discount rate when applying ASC 842). As discussed at the October 2020 CAQ SEC Regulations Committee joint meeting with the SEC staff, the staff indicated that it would not object to a registrant’s use of financial statements that reflect the risk-free rate practical expedient to measure the significance of an acquisition. However, the staff clarified that financial statements provided in accordance with Rule 3-05 are PBE financial statements and thus may not reflect the risk-free rate practical expedient. Therefore, a registrant would need to assess whether an adjustment to the PBE rate is material and must be revised before providing such financial statements in accordance with Rule 3-05. For additional information, see Section 2.6 of Deloitte’s Roadmap SEC Reporting Considerations for Business Acquisitions.

5.2.3 Abbreviated Financial Statements

There may be situations in which it is not practicable for management to prepare full carve-out financial statements of an acquiree, such as when the acquiree is a small portion or a product line of a much larger business and separate financial records were not maintained. In such instances, the SEC staff allows registrants to file abbreviated financial statements — that is, audited statements of assets acquired and liabilities assumed (in lieu of a full balance sheet), and audited statements of revenues and direct expenses (in lieu of a full statement of operations) — to satisfy the financial statement requirements of Rule 3-05, provided that certain qualifying conditions as well as presentation and disclosure requirements are met. In addition, Rule 3-05(f) allows a registrant to provide a form of abbreviated financial statements for an acquired or to be acquired business that includes significant oil-and-gas-producing activities. For additional information, see Section 2.6.4 of Deloitte’s Roadmap SEC Reporting Considerations for Business Acquisitions.

5.2.4 Other Considerations Related to Carve-Out Financial Statements of an Acquiree

When audited financial statements of an acquiree are provided under Rule 3-05, the audit must be performed in accordance with AICPA standards but compliance with PCAOB standards is not required.13 SEC regulations generally do not require registrants to obtain an audit or review of interim financial statements provided under Rule 3-05. However, a company’s underwriters will often require that a review of interim information be performed by its independent auditors for due-diligence or comfort purposes.

Footnotes

Separate financial statements of an acquiree are required only if the acquiree meets the definition of a business under Rule 11-01(d). The definition of a business for SEC reporting purposes is not the same as the definition for U.S. GAAP accounting purposes. See Section 2.1.1 of Deloitte’s Roadmap SEC Reporting Considerations for Business Acquisitions for further discussion of the definition of a business for SEC reporting purposes.

Such requirements include classification of redeemable securities or securities whose redemption is outside the control of the issuer as temporary equity in accordance with (1) SEC Regulation S-X, Rule 5-02.27, and (2) ASR 268 (FRR Section 211).

If the acquiree is a foreign business or a foreign private issuer, see Topic 6 of the FRM.

As defined in the ASC master glossary, a public entity is “[a] business entity or a not-for-profit entity that meets any of the following conditions:

It has issued debt or equity securities or is a conduit bond obligor for conduit debt securities that are traded in a public market (a domestic or foreign stock exchange or an over-the-counter market, including local or regional markets).
It is required to file financial statements with the Securities and Exchange Commission (SEC).
It provides financial statements for the purpose of issuing any class of securities in a public market.”

In accordance with the definition of a PBE in the ASC master glossary, an “entity may meet the definition of a public business entity solely because its financial statements or financial information is included in another entity’s filing with the SEC. In that case, the entity is only a public business entity for purposes of financial statements that are filed or furnished with the SEC.” Accordingly, an acquiree can elect to use private-company accounting alternatives in its stand-alone financial statements that are not included in an SEC filing. However, an acquiree that makes such an election would be required to maintain two sets of accounting records and financial information.

If an acquiree is identified as a predecessor, the audit must be performed in accordance with PCAOB standards. In certain circumstances, a reference to both auditing standards generally accepted in the United States (i.e., AICPA standards) and the standards of the PCAOB may be appropriate for a predecessor in an initial registration statement (i.e., if the entity does not meet the definition of an issuer).