5.3 Acquired or to Be Acquired Real Estate Operations (SEC Regulation S-X, Rule 3-14)
As discussed in Section
5.2, Rule 3-05 usually requires a registrant and its predecessor to provide
separate preacquisition historical audited financial statements for significant acquired or
to be acquired businesses. However, Rule 3-14 permits a registrant and its predecessor to
provide only carve-out abbreviated income statements for significant acquired or to be
acquired real estate operations (real estate acquirees).13 That is, Rule 3-14 does not require a registrant and its predecessor to present
balance sheets, statements of changes in equity, or cash flow statements for the
registrant’s significant real estate acquirees.
There are other differences between Rule 3-14 and Rule 3-05. For example, Rule
3-14:
- Addresses only one significance test described in Rule 1-02(w) (i.e., the investment test).
- Does not have a tiered threshold for disclosure requirements (i.e., a single 20 percent threshold results in one year of audited statements).
The audited abbreviated income statements described above are carve-out
statements that are presented in the form of revenues and direct expenses. Rule 3-14(c)(1)
indicates that the abbreviated income statements may exclude “expenses not comparable to the
proposed future operations such as mortgage interest, leasehold rental, depreciation,
amortization, corporate overhead and income taxes.” Like the audits of financial statements
filed under Rule 3-05, audits of such abbreviated financial statements filed under Rule 3-14
do not need to be performed in accordance with PCAOB standards. Entities that prepare
carve-out financial statements for real estate acquirees are also PBEs and should consider
the guidance in Section 5.2.2
regarding adoption dates.
Since these income statements are abbreviated and subject to the specific requirements of
Rule 3-14, they are considered special-purpose financial statements. Auditors’ reports on
these financial statements would include an explanatory paragraph indicating the special
purpose and the incomplete nature of the presentation of the results of operations, as
discussed in AICPA SAS 122 (AU-C Section 805.24).
Further, Rule 3-14(c)(2) states:
The notes to the financial statements must include the
following disclosures:
(i) The type of omitted expenses and the reason(s) why they are excluded from the
financial statements;
(ii) A description of how the financial statements presented are not indicative of
the results of operations of the acquired real estate operation going forward because
of the omitted expenses; and
(iii) Information about the real estate operation’s operating, investing and
financing cash flows, to the extent available.
In addition, for each real estate operation for which financial statements are required,
the registrant must provide certain supplemental information. Material factors the
registrant considered when assessing the real estate operation must be described with
specificity in the filing, along with sources of revenue (including, but not limited to,
competition in the rental market, comparative rents, and occupancy rates) and expenses
(including, but not limited to, utility rates, property tax rates, maintenance expenses, and
capital improvements anticipated). The registrant must also assert that it is not aware of
any other material factors related to the specific real estate operation that would cause
the reported financial statements not to be indicative of future operating results.
For additional SEC interpretive guidance on Rule 3-14, see Chapter 3 of Deloitte’s Roadmap
SEC Reporting Considerations for
Business Acquisitions.
Footnotes
13
See footnote
3.