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

2.7 Reporting Requirements for Equity Method Investees

Registrants with investments accounted for under the equity method (“equity method investees” [EMIs]) should consider the reporting and disclosure requirements in Regulation S-X, Rules 3-09, 4-08(g), and 10-01(b). These requirements ensure that investors receive relevant financial information about significant EMIs. For additional interpretive guidance on Rules 3-09, 4-08(g), and 10-01(b), see Deloitte’s Roadmap SEC Reporting Considerations for Equity Method Investees.

2.7.1 Separate Financial Statements (Rule 3-09)

For registrants that hold interests in EMIs (including any that are accounted for by using the fair value option14) that are considered significant, the investee’s separate financial statements must be included in the IPO registration statement. An interest in an EMI is considered significant if the results of either the investment test or the income test under Regulation S-X, Rule 1-02(w), exceed 20 percent for any annual period presented in the registrant’s financial statements. The following is a description of the investment test and income test:

Investment test — The registrant’s investments in, and advances to, the investee are compared with the registrant’s total assets as of the end of each fiscal year.
Income test — The income test consists of an income and revenue component.
- The income component is determined by comparing the absolute values of (1) the registrant’s equity in the investee’s pretax income or loss and (2) the registrant’s pretax income or loss. If the registrant has elected the fair value option for its investments, the income component is determined by comparing the absolute value of (1) the change in the investee’s fair value reflected in the registrant’s income statement and (2) the registrant’s pretax income or loss.
- If both the registrant and the investee have material revenue in each of the two most recently completed fiscal years, the revenue component is calculated by comparing the registrant’s proportionate share of the investee’s revenue with the registrant’s revenue. If either the registrant or the investee does not have material revenue for each of the two most recently completed fiscal years, only the income component should be used.
An investee will only be considered significant in accordance with the income test if both the income component and revenue component (if applicable) exceed the significance threshold (i.e., 20 percent for Regulation S-X, Rule 3-09).

If the EMI’s financial statements must be included in the registration statement, they should be as of the same dates and for the same periods as the audited consolidated financial statements that the registrant is required to file (if the EMI and the registrant have the same year-end)15 and they must be audited for each year for which the results of either significance test exceed 20 percent. The EMI’s comparative financial statements for any years for which significance did not exceed 20 percent under either test must still be presented, but they may be unaudited. While periods for which the investment is not significant need not be audited, if such periods were audited, professional standards may require an auditor to state this fact in its report. If such periods were not audited, professional standards may also require an auditor to state this fact in its report and, therefore, that the auditor assumes no responsibility for them.

Example 2-13

Assume the following:

Registrant A does not qualify as an EGC or an SRC and has a nonpublic EMI, Company B.
In 20X5, 20X6, and 20X7, B was significant at the 15 percent, 18 percent, and 30 percent levels, respectively.
Registrant A and Company B both have December 31 year-ends.

Registrant A is required to present audited financial statements for B as of and for the year ended December 31, 20X7, and either audited or unaudited financial statements as of December 31, 20X6, and for the years ended December 31, 20X6, and December 31, 20X5.

An acquisition or disposition of a significant equity method investee during a fiscal year results in a requirement to present the investee’s financial statements for a partial year. For additional considerations related to the acquisition or disposal of a significant equity method investment, see Section 5.1 of Deloitte’s Roadmap SEC Reporting Considerations for Equity Method Investees.

2.7.2 Summarized Financial Information (Rule 4-08(g))

Under Regulation S-X, Rule 4-08(g), a registrant must disclose summarized financial information in the footnotes to its annual financial statements for all EMIs whose significance, individually or in the aggregate, exceeds 10 percent in accordance with any of the three significance tests in Regulation S-X, Rule 1-02(w). In addition to the income test and the investment test (described above), the third test required is the asset test, in which the registrant’s proportionate share of the total assets of the EMI(s) is compared with the registrant’s total assets.

Under Regulation S-X, Rule 1-02(bb), summarized financial information should include, at a minimum:

Current and noncurrent assets, current and noncurrent liabilities, and (if applicable) redeemable preferred stock and noncontrolling interests.
“Net sales or gross revenues, gross profit (or . . . expenses applicable to net sales or gross revenues), income or loss from continuing operations, net income or loss, and net income or loss attributable to the entity.”

Additional line items may be appropriate depending on the EMI’s industry as well as its specific facts and circumstances.

Summarized financial information must be included in the notes to the financial statements for all periods presented and may not be labeled as “unaudited.”

2.7.3 Summarized Interim Financial Information (Rule 10-01(b))

A registrant is not required to include separate financial statements of significant EMIs for interim periods. However, if the individual significance of any EMI is greater than 20 percent under the investment test or the income test as of and for the appropriate interim periods presented, the registrant must disclose summarized income statement information under Regulation S-X, Rule 10-01(b) (as described in Section 2.7.2), in its interim financial statements. However, such information need not be provided for any EMI that would not be required to file quarterly information with the SEC if it were a registrant (e.g., an FPI).

Footnotes

See Section 3.1.3.6 of Deloitte's Roadmap SEC Reporting Considerations for Equity Method Investees for guidance on application of the fair value option in these circumstances.

In accordance with Rule 3-09(b)(2), if the EMI and the registrant have different fiscal year-ends, the separate financial statements of the EMI may be as of the investee’s year-end.