4.2 Registrant Financial Statements

A registrant’s financial statements must meet the “age of financial statements” and “staleness” requirements as of every filing date as well as when the registration statement is declared effective. The age of financial statements generally refers to the specific annual and interim periods for which financial statements are required in a filing. Regulation S-X, Rule 3-12, provides guidance on such periods and on when the financial statements become stale (i.e., should be updated). Regulation S-X, Rule 8-08, provides similar guidance for smaller reporting companies. As a result of accommodations provided by the FAST Act, a company that confidentially submits a draft registration statement may omit certain interim and annual periods from such submission if the company reasonably believes that those periods will not be presented in its public filing (for non-EGCs) or at the time of the contemplated offering (for EGCs); however, upon the first public filing or at the time of the contemplated offering for non-EGCs and EGCs, respectively, the appropriate interim and annual financial information would need to be included.

Sometimes the legal entity registering securities in an IPO is a newly formed company that will succeed to the operations of an existing business before the effective date of the initial registration statement. In such cases, the balance sheet of the recently organized registrant may need to be included in addition to the financial statements of the existing business. See Section 1160 of the FRM for additional guidance on newly formed entities. In addition, Regulation S-X, Rule 3-01, provides guidance on a registrant’s balance sheet requirements. For more information, see Section 2.2.1 of Deloitte’s Roadmap Initial Public Offerings.

Depending on the nature of the registrant and the registrant’s operations, it may be important to consider whether any predecessor financial information needs to be reflected in the registration statement. Section 1170 of the FRM addresses the requirements for predecessor financial information. It states that the designation “predecessor” is required when “a registrant succeeds to substantially all of the business (or a separately identifiable line of business) of another entity (or group of entities) and the registrant’s own operations before the succession appear insignificant relative to the operations assumed or acquired.” Because a predecessor’s historical financial information is considered important to an investing decision, when a predecessor is identified, the registration statement must also present the predecessor’s financial information and reflect such information as if it were the registrant’s. That is, financial statements for both the registrant and its predecessor should typically be presented as of and for all periods required by Regulation S-X, with no lapse in audited periods, so that the investor is given a complete picture of the registrant and any relevant reporting history.

In addition, the SEC staff has indicated that it has noticed an increase in put-together transactions in which a new company (i.e., a “newco”) is formed to acquire multiple entities. In such transactions, some of the entities are acquired before the IPO, in conjunction with the IPO, or by using the proceeds of the IPO. This has led to questions about how to identify the predecessor and the appropriate financial statements to include in an IPO registration statement. The staff believes that instances in which there is no predecessor would generally be rare (unless the registrant is a start-up business), even if the newco is substantive and is deemed the accounting acquirer. The staff has highlighted a number of factors for registrants to consider in determining the predecessor, including, but not limited to, (1) the order in which the entities are acquired, (2) the size of the entities, (3) the fair value of the entities, and (4) the historical and ongoing management structure. The staff also encourages registrants to evaluate their determination of predecessors in light of how management intends to discuss its business in the IPO registration statement as well as whether financial information in its subsequent Forms 10-K would provide sufficient information to investors.2 The staff has indicated that no one item is determinative on its own and that there could also be more than one predecessor. At the 2019 AICPA Conference, the SEC staff emphasized the importance of identifying any predecessors early in the IPO process and encouraged consultation with the CF-OCA. Registrants were reminded that identifying predecessors requires striking a balance between providing the history of the business and providing information on the specific operations in which the IPO investor is investing.

In the scenarios in which an entity presents predecessor and successor periods, analysis of the results of operations in MD&A may be complex, particularly if the acquisition of the predecessor occurred in the middle of the year. Although MD&A must address the periods presented in the historical financial statements, a registrant may also wish to combine the predecessor and successor periods to create a pro forma full fiscal year and present a supplemental MD&A discussion based on this pro forma information. However, the pro forma presentation should not merely combine the predecessor and successor periods since the predecessor and successor do not have the same basis of accounting and are therefore treated separately in the financial statements. Rather, any supplemental discussion should combine the predecessor and successor periods on a pro forma basis in accordance with Regulation S-X, Article 11, and in a manner that reflects the necessary transaction accounting adjustments. Further, registrants should not present the pro forma results more prominently than the discussion about the historical results of operations required by Regulation S-X, Item 303. See paragraphs 9220.6 through 9220.9 of the FRM for more information.

“Carve-out financial statements” is a generic term used to describe separate financial statements that are derived from the financial statements of a larger parent company. A carve-out occurs when a parent company segregates a portion of its operations and prepares a distinct set of financial statements for the segregated portion in preparation for a sale, spin-off,3 or IPO of the “carve-out entity.” Examples of a carve-out entity may include (1) all or part of a subsidiary of a parent company or (2) a line of business that was previously part of a larger parent company.

Often, the parent may not have historically accounted for the carve-out entity separately, and the registrant (i.e., the carve-out entity) may have relied on the parent for certain functions. SAB Topic 1.B indicates that the registrant’s historical income statements should present all of the costs of doing business, including expenses incurred by the parent on behalf of the registrant. Examples of such costs include salary, rent, depreciation, advertising, accounting and legal services, and other SG&A. Registrants must use a reasonable method to allocate common expenses from the parent to the registrant if specific identification is not practicable. The method for such allocation must also be disclosed in the notes to the financial statements, with an explanation of why management believes such method is reasonable. To the extent that the registrant and the parent have shared functions (e.g., treasury or cash management), these shared functions need to be evaluated so that the appropriate amount of expense to be allocated to the carve-out entity can be determined.

When financial statements of a carve-out entity are used in an IPO, it is critical that the carve-out financial statements identify the appropriate assets and operations of the registrant. A registrant’s determination of the composition of the carve-out financial statements depends on its specific facts and circumstances and may require significant judgment because the process of identifying appropriate assets and operations of the registrant in an IPO transaction may be complex.

For additional considerations related to carve-out financial statements, see Deloitte’s Roadmap Carve-Out Financial Statements.