Pro Forma Financial Information: Regulation S-X Article 11

Video Apr 17, 2017

Pro forma financial information is required in certain circumstances, such as significant business combinations or dispositions. In this video, PwC’s Rick Ruiz highlights the pro forma financial information requirements, as governed by Article 11 of Regulation S-X, including common pro forma adjustments, and shares common pitfalls for preparers.

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This video is part of The quarter close publication and video perspectives series.

Transcript

Hi, I’m Ricardo Ruiz.

Pro forma financial information is required in certain circumstances to show how transactions might have affected historical financial statements had they occurred at an earlier date. Typical transactions requiring pro forma presentation include significant business combinations or dispositions of a significant portion of a business.

In this video, I would like to highlight the pro forma financial information requirements, as governed by Article 11 of Regulation S-X, including common pro forma adjustments, and common pitfalls.

Generally, Article 11 requires the following:

  • A pro forma balance sheet as of the end of the most recent period for which a consolidated balance sheet of the registrant is required,
  • a pro forma income statement for the most recent annual period, and
  • a pro forma income statement for the most recent subsequent interim period, if applicable.

While not required, the SEC staff will not object to inclusion of a pro forma income statement for the corresponding prior interim period.

In two specific circumstances, Article 11 requires that a pro forma income statement be provided for all periods for which the historical income statements of the registrant are required. A pro forma presentation for all periods is required:

  • When there has been a business combination that is accounted for as a reorganization of entities under common control; and
  • when there is a discontinued operation that has not yet been reflected in the historical financial statements.

Pro forma financial information is generally included in registration statements and current reports on Form 8-K that report a significant business combination or disposition. Form 8-K reports are due within 4 business days after the occurrence of a triggering event. Historical financial statements of an acquired business and pro formas must be filed no later than 71 calendar days after the initial 8-K is required to be filed. But pro formas for dispositions, must be provided in the initial Form 8-K; there is no 71-day extension for dispositions. While that’s the general rule, keep in mind that the due date of the pro forma financial information may be accelerated if a new registration statement is submitted by the registrant during the extension period.

When preparing pro forma financial statements, historical results are adjusted for the impact a transaction would have had, if it had occurred earlier. Only adjustments directly attributable to the transaction and factually supportable should be made. As interpreted by the SEC, to be factually supportable, there needs to be reliable, documented evidence in support of the adjustments, such as executed contracts and/or consummated transactions. In addition to the fact that pro forma income statement adjustments must be expected to have a continuing impact, the pro forma balance sheet is also prepared as if the transaction occurred as of the latest balance sheet date, whereas a pro forma income statement assumes the transaction occurred as of the beginning of the period. These differences in the requirements can be confusing as the amount of the adjustments to the pro forma balance sheet and pro forma income statement may not agree.

There are a variety of common pro forma adjustments. Let me highlight a few of them, which are listed on the left side of the screen:

For a business combination: The adjustments will show the allocation of the consideration transferred, including fair value steps up and related depreciation and amortization. In addition, the adjustments will reflect the impact of any financing necessary to complete the transaction, specifically, interest expense. This adjustment is generally based on the current rate or a fixed interest rate for debt used to finance the transaction.

  • Debt or equity proceeds: This adjustment reflects the proceeds of the debt or equity used to fund the acquisition.
  • Transaction costs: These are reflected in the pro formas as a reduction to retained earnings, but because they do not have a continuing impact, they would not be reflected in the pro forma income statement.
  • Compensation expense: This is a common adjustment when a business combination results in new compensation contracts.
  • Conforming accounting policies: These pro forma adjustments should also be made as if the acquisition occurred at the beginning of the fiscal year, and should consistently apply the newly adopted accounting principle to all periods presented.

Now that I’ve addressed the basics of the pro forma requirements and some of the more common adjustments, I want to share some of the common pitfalls in the preparation of pro forma information. The first that comes to mind relates to historical “unusual” charges, such as impairments or restructurings unrelated to the transaction. Because management may consider these a nonrecurring or one-time charge, they may want to remove them from the pro forma presentation. But since such charges are not directly attributable to the transaction, these charges cannot be reversed as a pro forma adjustment. Second, the SEC staff has indicated a clear distinction between pro forma information and projections; therefore, a pro forma presentation should not include adjustments, assumptions, and hypothetical scenarios which, by their nature, present alternative courses of action. Adjustments such as expected cost savings (for example, due to economies of scale) should not be reflected in pro forma financial statements. Lastly, I want to highlight that Article 11 pro forma information, differs from the unaudited supplemental pro forma information, required in the notes to the financial statements, prepared pursuant to the business combination guidance in ASC 805. Companies should follow the respective guidance when preparing each type of pro forma presentation.

For more information on pro forma reporting, including additional common pitfalls, as well as related disclosure requirements, please visit CFOdirect.com.

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