5.2 Structure of the IPO Transaction

5.2.1 Carve-Out Considerations

“Carve-out financial statements” is a general term used to describe financial statements derived from the financial statements of a larger parent company. Carve-out financial statements may be included in an initial registration statement for a registrant and its predecessor when a portion of a larger parent company is sold to the public in an initial equity offering or when a public entity plans to spin off a business or group of businesses to shareholders as a separate public company (see the next section). When a portion of a larger parent company is sold to the public in an IPO, carve-out financial statements that comply with the general financial statement requirements in Regulation S-X, Rules 3-01 through 3-04, are generally required for a registrant and its predecessor in an initial registration statement (e.g., Form 10, Form S-1). In addition, carve-out financial statements of the registrant and its predecessor(s) for the comparative periods must be included in Forms 10-K and 10-Q after the initial registration statement is declared effective.

The form and content of the carve-out financial statements depend on the needs or requirements of financial statement users and any regulatory requirements applicable to the transaction for which the carve-out financial statements are being prepared. See Deloitte’s Roadmap Carve-Out Financial Statements for more information about preparing carve-out financial statements.

5.2.2 Spin-Off Transactions

ASC 505-60 defines a spin-off as “[t]he transfer of assets that constitute a business by an entity (the spinnor) into a new legal spun-off entity (the spinnee), followed by a distribution of the shares of the spinnee to its shareholders, without the surrender by the shareholders of any stock of the spinnor.” Entities that want to streamline their operations might enter into spin-offs as an alternative to selling those parts of the business since a spin-off may provide certain tax advantages that a sale does not.

ASC 845 provides guidance on accounting for a spin-off. The accounting for the distribution of nonmonetary assets to owners in a pro rata spin-off is based on recorded amounts (after reduction, if appropriate, for an indicated impairment of value). Generally, a pro rata distribution to existing shareholders does not result in a change in control of the distributed business; therefore, a change in accounting basis would not be appropriate.

Often, a spin-off will be executed concurrently with an initial listing of the shares of the spinnee. For a spinnee’s securities to be listed on public exchanges such as Nasdaq or the NYSE, its shares must be registered via Form 10 in a 1934 Act filing. In addition, a spinnee may initiate a 1933 Act filing, such as a Form S-1 or its equivalent, to register the sale of additional securities in the future.

Preparing financial statements for the spinnee can be complex. Both Form 10 and Form S-1 (or its equivalent) require audited historical financial statements of the spinnee; pro forma financial information; and, depending on the timing of the filing during the fiscal year, interim financial information.

Determining reporting requirements may be further complicated in a spin-off transaction accounted for as a reverse spin-off. A reverse spin-off occurs when the legal form of the transaction differs from its substance to such a degree that the financial statements of the spinnee will be the historical financial statements of the legal spinnor. In a spin-off transaction, an entity must consider the factors in ASC 505-60-25-8 when identifying the accounting spinnor and spinnee, which may differ from the legal spinnor and spinnee. At the 2014 AICPA Conference on Current SEC and PCAOB Developments, the SEC staff cautioned that significant judgment must be used in the determination of the accounting spinnor and spinnee and the related financial statement presentation and SEC reporting requirements for a reverse spin-off transaction:

[W]hen the spinoff is determined to be a reverse spin under Subtopic 505-60, some registrants have assumed that this conclusion dictates the financial statements that are presented in a registration statement that is filed to effect the spinoff. Specifically, some registrants have concluded that when a transaction is accounted for as a reverse spin, the financial statements of the existing registrant (i.e. — the legal spinnor) can be used to satisfy the financial statement requirements of the entity that will be spun off (i.e. — the accounting spinnor/legal spinnee). On this point, our colleagues in the Division of Corporation Finance view this as an assessment that is based on the unique facts and circumstances of each transaction, and there may be situations in which carveout financial statements are required for the accounting spinnor/legal spinnee in a registration statement relating to a reverse spin. Overall, the separation of an existing registrant into two or more registrants in a spinoff transaction may present a number of reporting questions, both with respect to the registration statement as well as the subsequent Exchange Act reports for each continuing entity. Given the significant judgments involved in determining the accounting spinnor as well as the appropriate financial statement presentation, the staff encourages registrants to continue to consult on their accounting and reporting conclusions relating to spinoffs, particularly when the transaction is expected to be accounted for as a reverse spin.

At the 2021 AICPA & CIMA Conference on Current SEC and PCAOB Developments, the SEC staff further emphasized that registrants should also evaluate the ongoing reporting obligations of the spinnee and spinnor, which may be particularly complex in a reverse spin-off. The SEC staff reminded registrants that SAB Topic 5.Z.7 prohibits an existing SEC reporting company from treating the spin-off transaction as a change in the reporting entity in which the spinnee’s operations would be removed from the spinnor’s financial statements as if the spinnor never held the business.

If management has concluded that a spin-off transaction is expected to be accounted for as a reverse spin-off, or if the determination is subject to a high degree of judgment, management should consider (1) consulting with its auditors and other professional advisers and (2) preclearing its conclusions about the accounting and reporting requirements with the SEC staff.

5.2.3 Reorganization in Anticipation of a Transaction

In anticipation of a spin-off or IPO of a portion of a larger parent entity, a parent entity may reorganize its business by transferring certain assets or liabilities to a newly formed or existing subsidiary that will be used to effect the transaction (the “receiving entity”). Because the assets and liabilities are under the control of the parent entity both before and after the reorganization, the transfer is accounted for as a common-control transaction and there is generally no change in basis in the assets and liabilities. However, the carrying amounts of the net assets in the transferred entity’s financial statements can sometimes differ from those in the parent entity’s consolidated financial statements. Such differences may arise, for example, if the net assets being transferred were acquired in a business combination but the transferring entity did not apply pushdown accounting at the time of acquisition. Under ASC 805-50-30-5, “the financial statements of the receiving entity shall reflect the transferred assets and liabilities at the historical cost of the parent of the entities under common control.” As a result, the receiving entity effectively applies pushdown accounting in its separate financial statements.

For more information about accounting for common-control transactions, see Deloitte’s Roadmap Business Combinations.