Chapter 2 — Identifying the Required Financial Statements for the Registration Statement

2.5 Financial Statements of Businesses Acquired or to Be Acquired (Rule 3-05)

When a significant business acquisition is consummated, or it is probable that it will be consummated, the registrant may be required to file certain financial statements of the acquired business or to be acquired business (acquiree) in accordance with Rule 3-05. While existing registrants are subject to periodic reporting requirements for significant acquisitions,5 a company is not subject to such requirements before an IPO. Therefore, in the context of an initial registration statement, a company must evaluate recent acquisitions, as further described below.

The following factors govern whether and, if so, for what period, the acquiree’s financial statements are required for a consummated or probable acquisition:

Definition of a business — Rule 3-05 applies to an acquisition of a business. The definition of a “business” for SEC reporting purposes differs from the definition under ASC 805 for U.S. GAAP purposes and focuses primarily on the continuity of revenue-producing activities.6 Note that an acquisition can take many forms (i.e., acquisition of assets vs. acquisition of a legal entity) and that such forms typically will not affect the determination of whether the acquiree is a business.
When the acquisition was completed — The acquiree’s financial statements are not required once the registrant’s audited financial statements reflect the operating results of the acquiree for at least:
- Nine months if any of the results of the significance tests are greater than 20 percent but none are greater than 40 percent.
- A complete fiscal year if the results of any of the significance tests are greater than 40 percent.
As a result, acquisitions that occurred in the second or third back year of annual financial statements presented by the registrant will not need to be presented in separate preacquisition financial statements unless the omission of such financial statements would be misleading.
Significance — The highest level of significance based on the following three tests is used to determine the financial statements, if any, that an entity is required to provide in the registration statement:
- Investment test — The GAAP purchase price is compared with the total assets of the registrant on the basis of its most recent preacquisition annual financial statements. While the investment test stipulates the use of the aggregate worldwide market value (AWMV) of the registrant’s common equity (i.e., market capitalization) when available rather than total assets, companies undertaking an IPO would not yet have an observable AWMV and thus must use total assets. Once an entity completes its IPO, it should use its AWMV when performing the investment test. For example, if a registrant consummates an acquisition on March 15, 2022; completes its IPO on June 15, 2022; and consummates an acquisition on November 15, 2022, it should use total assets and AWMV to perform the investment test for the March and November acquisitions, respectively.
- Asset test — The registrant’s share of the acquiree’s total assets is compared with the registrant’s total assets on the basis of the most recent preacquisition annual financial statements of each company.
- Income test — The income test consists of an income component and a revenue component:
  - Income component — The registrant’s share of the acquiree’s pretax income from continuing operations7 is compared with the registrant’s pretax income from continuing operations on the basis of the most recent preacquisition annual financial statements of each company.
  - Revenue component — If both the registrant and the acquiree have material revenue in each of the two most recently completed fiscal years, the revenue component is calculated by comparing the registrant’s share of the acquiree’s revenue with the registrant’s revenue on the basis of the most recent preacquisition annual financial statements of each company. If either the registrant or the acquiree does not have material revenue for each of the two most recently completed fiscal years, only the income component should be used.
  - An acquiree will only be considered significant if both the income component and the revenue component (if applicable) exceed the significance threshold (i.e., 20 percent). When both components exceed the significance threshold, the lower of the two components is used to determine the number of periods for which the acquiree’s financial statements are required.

Pro forma financial information is generally required under SEC rules if the acquiree is deemed to be significant. The significance tests in Rule 1-02(w) can be quite complex. Entities are advised to consult with their independent auditors and legal counsel when applying the tests in special circumstances. For more information about pro forma financial information, see Section 4.4.

2.5.1 Preacquisition Financial Statements Required

The table below summarizes whether preacquisition financial statements are required for an acquiree on the basis of the timing of the acquisition and the significance threshold.8

Significance	Acquisition Closed Before the Most Recent Full Fiscal Year Presented	Acquisition Closed During the Most Recent Full Fiscal Year Presented	Acquisition Closed After the Most Recent Full Fiscal Year Presented	Probable Acquisition (Not Yet Consummated)
20 percent or less	No	No	No	No
Exceeds 20 percent but not 40 percent	No	If the acquisition closed during the first quarter, no; otherwise yes. See Section 2.5.1.1 for further details.	Yes — See Section 2.5.1.1 for further details.	No — See Section 2.5.1.2 for further details.
Exceeds 40 percent but not 50 percent	No	Yes — See Section 2.5.1.1 for further details.	Yes — See Section 2.5.1.1 for further details.	No — See Section 2.5.1.2 for further details.
Exceeds 50 percent	No	Yes	Yes	Yes

2.5.1.1 Grace Period

Financial statements of a significant acquired business that are not more than 50 percent significant (on the basis of any of the three tests) are not required in a registration statement that is filed or declared effective before the 75th day after the consummation of the acquisition. (See paragraph 2040.1 of the FRM and the discussion of Company D in Example 2-5.) However, these requirements may be accelerated if certain acquisitions are significant in the aggregate, as noted below.

2.5.1.2 Aggregate

Separate financial statements are generally not required for a significant probable acquisition whose significance does not exceed 50 percent or for a significant consummated acquisition whose significance does not exceed 50 percent within the grace period discussed above. However, an entity must perform an additional test to calculate the aggregate significance of (1) probable acquisitions whose significance does not exceed 50 percent; (2) consummated acquisitions within the grace period whose significance is greater than 20 percent but not greater than 50 percent; and (3) any individually insignificant (i.e., the significance does not exceed 20 percent) businesses acquired since the end of the registrant’s most recently completed fiscal year presented.

The acquirees in all three of these categories are commonly referred to as individually insignificant acquirees, and if their aggregate significance exceeds 50 percent, the registration or proxy statement must include:

The audited preacquisition financial statements for the most recent fiscal year and interim period for any acquirees in categories 1 and 2 above whose significance exceeds 20 percent and that have not yet been filed.
Pro forma financial information to reflect the aggregate effects of all individually insignificant acquisitions (i.e., all three categories).

See Section 2.9 of Deloitte’s Roadmap SEC Reporting Considerations for Business Acquisitions for more information. In addition, companies should consult with their independent auditors and legal counsel in such circumstances.

2.5.1.3 Periods of Preacquisition Financial Statements Required

If preacquisition financial statements are required, the significance level is used to determine the periods as follows:

Significance exceeds 20 percent but not 40 percent:
- One year of audited preacquisition financial statements.
- Interim financial statements (1) as of the acquiree’s last fiscal quarter-end completed before the closing of the acquisition and (2) for the year-to-date interim period ending on that date.
Significance exceeds 40 percent:
- Two years of audited preacquisition financial statements.
- Interim financial statements (1) as of the acquiree’s last fiscal quarter-end completed before the closing of the acquisition, (2) for the year-to-date interim period ending on that date, and (3) for the corresponding year-to-date interim period in the prior year.

When the registrant’s audited balance sheet is for a date after the consummation of the acquisition, the separate balance sheet(s) of the acquiree may be omitted, since the acquiree’s balances are included in the acquiring company’s balance sheet.

Example 2-5

Assume the following:

Registrant A, a calendar-year-end company, is planning to file its initial registration statement on or around September 15, 20X6.
Registrant A does not qualify as an EGC.
Registrant A will include its historical financial statements for the following periods in its initial registration statement:
- Audited balance sheets as of December 31, 20X5, and December 31, 20X4.
- Audited statements of operations, comprehensive income, cash flows, and changes in stockholders’ equity for each of the three years in the period ended December 31, 20X5.
- Unaudited financial statements as of and for the periods ended June 30, 20X6, and June 30, 20X5.

Registrant A made the following acquisitions:

Company	Acquisition Date	Highest Level of Significance	Years Required	Financial Statements Required9
B	December 15, 20X4	60%	N/A	Because the acquisition of Company B occurred before the most recent full fiscal year presented by Registrant A, B’s preacquisition financial statements are not required.
C	January 15, 20X5	55%	2	Because Company C has not been included in A’s audited results for a complete fiscal year, A must provide two years of preacquisition financial statements: C’s financial statements as of and for the years ending December 31, 20X4, and December 31, 20X3.
D	July 15, 20X6	25%	1	While one year of audited financial statements will eventually be needed, as of the initial filing date, no financial statements of Company D are required on the basis of the accommodation for recently consummated business acquisitions, commonly referred to as the grace period, discussed in Section 2.5.1.1. In any amendment to the IPO registration statement filed 75 or more days after the acquisition date of July 15, 20X6, audited financial statements as of and for the year ended December 31, 20X5, as well as unaudited interim information as of and for the six-month period ended June 30, 20X6, would be required. In addition, if Company A completes its IPO during the grace period, the required financial statements and pro forma financial information must be filed on Form 8-K within 75 days of the close of the acquisition.

2.5.2 Form of Financial Statements

Preacquisition financial statements of the acquiree are generally prepared on the same basis as if the acquiree were a registrant, except that the level of significance is used to determine the number of years of audited financial statements. The financial statements must comply with Regulation S-X and SAB topics, including requirements related to mezzanine equity (see ASC 480-10-S99-3A and SAB Topic 14.E) and separately presenting revenue from products and services (see Regulation S-X, Rule 5-03(b)). However, if the acquiree is not public, it does not need to comply with certain disclosure requirements that only apply to issuers, such as those related to segments or EPS.

Some accounting standards differentiate between the accounting disclosure requirements or adoption dates for PBEs and those for non-PBEs. Significant acquirees whose financial statements are included in a registrant’s filing under Rule 3-05 are considered PBEs under U.S. GAAP10 Therefore, such acquirees should use PBE adoption dates and disclosure requirements when preparing their financial statements. However, the SEC staff announced in 2017 that it would not object if certain PBEs,11 when preparing financial statements of non-PBE acquirees, use the non-PBE effective dates for the sole purpose of adopting the FASB's leasing standard. While the use of such dates is permitted, once the standard is adopted, the financial statements must reflect the PBE disclosures.

Management should be mindful of other accounting standards in which the adoption dates for PBEs differ from those for non-PBEs. While EGCs may not be required to use the PBE effective dates in adopting certain accounting standards, this accommodation does not apply to acquiree financial statements under Rule 3-05.

In November 2019, the FASB issued ASU 2019-10, which provides a framework for staggering the effective dates of future major accounting standards and amends the effective dates of some new standards to give implementation relief to certain types of entities. The standard introduces a new “two-bucket” framework for determining the effective dates of future major accounting standards. Under the Board’s new framework, the buckets are defined as follows:

Bucket 1 — All PBEs that are SEC filers (as defined in GAAP), excluding SRCs (as defined by the SEC).
Bucket 2 — All other entities, including SRCs, other PBEs that are not SEC filers, private companies, not-for-profit organizations, and employee benefit plans.

Significant acquirees whose financial statements are included in a registrant’s filing under Rule 3-05 would qualify as “PBEs that are not SEC filers”; therefore, such acquirees should use Bucket 2 adoption dates and disclosure requirements when preparing their financial statements.

In addition, such acquirees should comply with the accounting and disclosure requirements applicable to PBEs. Some standards permit practical expedients or elections for non-PBEs (e.g., the use of a risk-free discount rate in lieu of the incremental borrowing rate in the accounting for leases or the amortization of goodwill). However, these expedients and elections may not be used in financial statements that an entity prepares to meet the requirements of Rule 3-05. For example, at the October 2020 CAQ SEC Regulations Committee joint meeting with the SEC staff, the staff discussed a situation in which (1) an acquired company has adopted ASC 842 by using the risk-free-rate practical expedient and (2) a registrant must evaluate the acquired company for significance and, in some cases, provide this company’s separate financial statements. The SEC staff indicated that it would not object if a registrant uses financial statements that reflect the risk-free-rate practical expedient to measure significance, since doing so would result in greater ROU assets and, thus, a higher measure of significance when the asset test is performed. The staff noted that the risk-free-rate practical expedient should be “the only difference between those financial statements and a PBE set of financial statements” but clarified that financial statements provided in accordance with Rule 3-05 are PBE financial statements and thus may not reflect this expedient. Therefore, before providing such financial statements in accordance with Rule 3-05, a registrant would need to assess whether an adjustment to the PBE rate is material and must be revised.

Generally, the annual financial statements for a significant acquisition may be audited in accordance with AICPA standards.12 SEC regulations do not require registrants to audit or review interim financial statements provided under Rule 3-05. However, the company’s underwriters will often require that the interim information be reviewed by an independent registered public accounting firm for due diligence or comfort letter purposes.

2.5.2.1 Full Financial Statements

In some instances, the acquisition may constitute only a portion of a legal entity. If the acquired asset or group of assets represents substantially all of an entity, the entire entity’s full audited financial statements are generally required. In these circumstances, the registrant would remove any assets, liabilities, or operations not acquired in the pro forma financial information presented.

2.5.2.2 Carve-Out Financial Statements

If the acquired asset or group of assets does not represent substantially all of the selling entity, the selling entity’s financial statements may not be useful. Therefore, the audited financial statements should only represent the selected parts of the entity acquired, excluding the operations retained by the seller. These financial statements are often referred to as carve-out financial statements. Carve-out financial statements include, for the appropriate periods, balance sheets; statements of operations, comprehensive income, and cash flows; changes in stockholders’ equity; and the respective notes to the financial statements. The SEC staff believes that carve-out financial statements should reflect (1) all assets and liabilities of the acquired business even if the assets and liabilities that are directly related to the operation of the acquired business are not acquired or assumed as part of the acquisition and (2) all costs of doing business. For further discussion, see Deloitte’s Roadmap Carve-Out Transactions.

2.5.2.3 Abbreviated Financial Statements

In certain circumstances, carve-out financial statements may not be practicable to prepare, such as when the acquired asset or group of assets 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 may allow registrants to provide 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 expenses (in lieu of a full statement of operations) — to meet the financial statement requirements in Rule 3-05 provided that certain qualifying conditions and presentation and disclosure requirements are met. Registrants may present such abbreviated financial statements for an acquiree without seeking permission from the SEC staff when the following qualifying conditions in Rule 3-05(e) are met:

The assets and revenue of the acquiree represent 20 percent or less of the assets and revenue of the seller as of and for the most recently completed fiscal year.
The acquiree’s financial statements have not been previously prepared.
The acquiree was not a separate entity, subsidiary, operating segment,13 or division during the periods for which its financial statements would be required.
The seller did not maintain the “distinct and separate accounts” that would be necessary to present financial statements that include the omitted expenses, and the preparation of such financial statements is impracticable.

When presented, abbreviated financial statements must also meet the presentation and disclosure requirements in Rule 3-05(e)(2).

The title of the statement of revenues and expenses must be appropriately modified to indicate that it omits certain expenses. The statement of revenues and expenses must include all direct revenues and direct expenses associated with the revenue-producing activities of the assets acquired and liabilities assumed. Typically, the only costs excluded are those not directly connected to the revenue-producing activity. For example, all related costs incurred by or on behalf of the acquiree for the periods required to be presented must include costs of sales or services, selling, distribution, and marketing as well as general and administrative expenses, depreciation and amortization, and research and development expenses. As noted in the response to Question 2 of SAB Topic 1.B, if the abbreviated financial statements include a reasonable allocation of costs directly related to the revenue-producing activity incurred by the seller on behalf of the business sold, the footnotes should contain management’s assertion that the method used to allocate those costs is reasonable. However, the registrant may exclude allocated corporate overhead expenses, certain interest expense (i.e., interest expense for debt that will not be assumed by the registrant), and income tax expense (collectively, “omitted expenses”).

In accordance with Rule 3-05(e)(2)(iii), the footnotes to the abbreviated financial statements should include the following disclosures: (1) the nature of the omitted expenses and why they were omitted, (2) an explanation of why it is impracticable to prepare financial statements that include the omitted expenses, and (3) a statement that the financial statements do not indicate the acquiree’s future financial condition or operations because the omitted expenses have been excluded.

A registrant that presents abbreviated financial statements is not required to provide a statement of cash flows. However, information (if available) about the acquiree’s operating, investing, and financing cash flows must be included in the footnotes to the financial statements.

When the qualifying conditions are not met but a registrant nevertheless believes that such financial statements would provide sufficient disclosures for investors, the registrant may request a waiver from the SEC staff under Rule 3-13.

2.5.3 Other Considerations

In addition to the general financial statement requirements related to the consummation of a significant business acquisition, other considerations might affect the reporting requirements. The following table summarizes such potential considerations:

Topic	Considerations
Audited period less than a year	Regulation S-X, Rule 3-06, permits the use of an acquiree’s audited financial statements for a period of nine to twelve months to satisfy one year of financial statement requirements. For example, for a transaction that closed in the fourth quarter (e.g., November 15, 20X6) for which one year of audited preacquisition financial statements is required, a registrant could provide audited financial statements for the nine months before acquisition (e.g., the nine months ended September 30, 20X6) in lieu of audited financial statements for the prior fiscal year (e.g., the year ended December 31, 20X5) and unaudited information for the appropriate interim period (e.g., the nine months ended September 30, 20X6).
Related businesses	Related businesses must be treated as a single business acquisition in the assessment of significance. Businesses are related if (1) they are under common control or management or (2) their acquisitions depend on each other or on a single common event or condition. See Rule 3-05(a)(3)(i)-(iii).
Put-together transactions	When a put-together transaction14 occurs concurrently with an initial registration statement, a registrant must first determine which entity is the acquiring entity. It must then measure the significance of all other businesses in the put-together transaction against that of the acquiring entity. Since these acquired businesses are considered related under Rule 3-05(a)(3), a registrant must aggregate all the other businesses (besides the acquiring entity) in the put-together transaction and measure their significance against that of the acquiring entity as if they were a single acquisition.

2.5.4 Omission of Financial Statements of Acquired Entities From Draft Registration Statements

In a manner consistent with the accommodations discussed in Section 2.4.4, a company may omit from its draft registration statement Rule 3-05 financial statements (and the related pro forma financial information discussed in Section 4.4) if the company reasonably believes that those financial statements will not be required at the time of the public filing or contemplated offering, as applicable.

Example 2-6

A calendar-year-end company that plans to submit a draft registration statement in the fall of 20X7 completes a significant acquisition in the fourth quarter of 20X6. The acquisition is significant in such a way that one year of the acquiree’s financial statements would generally be required under Rule 3-05. The company plans to update its draft registration statement to include its 20X7 annual financial statements before a public filing in 20X8. Thus, after that update, the acquired business will have been part of the company’s financial statements for a sufficient amount of time to eliminate the need for separate financial statements. In this scenario, the staff of the Division will not delay its review of the draft registration statement in the fall of 20X7 even though the acquiree’s financial statements and the related pro forma financial information are omitted from the submission.

Footnotes

Under Item 2.01 of Form 8-K, a registrant is required to file a Form 8-K to announce a significant business acquisition within four business days of consummation and to include the required financial statements within 71 calendar days.

Regulation S-X, Rule 11-01(d), states, in part, “[T]he term business should be evaluated in light of the facts and circumstances involved and whether there is sufficient continuity of the acquired entity’s operations prior to and after the transactions so that disclosure of prior financial information is material to an understanding of future operations. A presumption exists that a separate entity, a subsidiary, or a division is a business.”

Regulation S-X, Rule 1-02(w), indicates that pretax income from continuing operations is “consolidated income or loss from continuing operations before income taxes (after intercompany eliminations) attributable to the controlling interests.”

A company may be able to omit the financial statements of an acquired business from its draft registration statement for certain periods. See Section 2.5.4 for more information.

Assumes that all acquired companies are calendar-year-end companies and that the registrant is not using the accommodation to omit the acquiree’s balance sheet, when applicable.

Paragraph BC12 of ASU 2013-12 states that an entity meets the definition of a PBE when it “is required by the SEC to file or furnish financial statements or does file or furnish financial statements with the SEC” (e.g., its “financial statements or financial information that is required to be or is included in a filing with the SEC [, such as the information required under Regulation S-X, Rules 3-09, 3-05, and 4-08(g)]”).

The relief only applies to a PBE that would not meet the definition of a PBE if it were not for the fact that its financial statements or financial information is included, or must be included, in another entity’s filing with the SEC.

In certain cases, if an acquired company is identified as a predecessor (see Section 2.3), the audit must be performed in accordance with PCAOB standards.

In evaluating the “operating segment” condition above, a registrant should consider the definition of that term in ASC 280 or IFRS 8, as applicable. The operating segment condition for abbreviated financial statements applies to all acquired businesses, whether public or private. Accordingly, a company may have to evaluate whether the acquired entity would qualify as an operating segment under ASC 280, if relevant.

See Section 2.3.2 for more information.