This Practical tip highlights the guidance related to the determination of the financial statement presentation for the acquisition of selected parts of an entity.
When an SEC registrant acquires a business, it is required to assess the significance of the acquired business to determine whether the acquiree's historical financial statements (and associated pro forma financial information) need to be filed with the SEC on a Form 8-K and/or included in a registration statement under Rule 3-05 of Regulation S-X. The significance tests are described in Rule 1-02(w) of Regulation S-X.
A registrant might acquire selected parts of an entity as opposed to the entire operations of an entity. Whether the significant business acquired represents “substantially all” of an entity or “less than substantially all” of an entity will determine the financial statement presentation of the acquired business for purposes of complying with the separate financial statement reporting requirements described above. There is not a bright line test to make this assessment; rather, it is a judgemental decision based on the particular facts and circumstances. In certain situations a company may want to review its conclusion with the Division of Corporation Finance’s Office of the Chief Accountant.
The SEC staff has provided guidance on this issue as articulated in the following sections of the Division of Corporation Finance’s Financial Reporting Manual (“FRM”).
FRM 2065.1 states the following:
“If the registrant acquires or succeeds to substantially all of the entity's key operating assets, full audited financial statements of the entity are presumed to be necessary in order to provide investors with the complete and comprehensive financial history of the acquired business. In these circumstances, elimination of specified assets and liabilities not acquired or assumed by the registrant is depicted in pro forma financial statements presenting the effects of the acquisition.”
FRM 2065.2 goes on to say:
“In some circumstances, a registrant does not acquire or succeed to substantially all of the assets and liabilities of another entity. For example, the selling entity may retain significant operating assets, or significant operating assets that comprised the seller may continue to be operated by an entity other than the registrant. In these circumstances, financial statements of the larger entity of which the acquired business was a part may not be informative. In that case, audited financial statements usually should be presented for the acquired component business, excluding the continuing operations retained by the larger entity.”
Company A, an existing SEC Registrant owns and operates a national chain of convenience stores. Company A will acquire 100 percent of the shares of Acquiree B in a transaction that represents a business combination that will be accounted for as an acquisition in accordance with ASC 805, Business Combinations. Similar to Company A, Acquiree B also owns and operates a national chain of convenience stores. Prior to its acquisition by Company A, Acquiree B will transfer 60 stores that are not being acquired by Company A to Acquiree B’s shareholder. The 40 stores remaining in Acquiree B represent approximately 40% of the key operating assets of Acquiree B prior to its acquisition. The acquisition of Acquiree B and the remaining stores is significant to Company A and require the presentation of separate financial statements under Rule 3-05 of Regulation S-X.
In preparing financial statements under Rule 3-05 of Regulation S-X, Company A would present separate carve-out financial statements for the 40 store component of Acquiree B excluding the 60 stores that were not acquired. Because the 60 stores that Company A will not acquire represent significant operating assets retained by the seller, Company A has determined that the full financial statements of Acquiree B including all 100 stores would not be appropriate. The footnotes to the audited financial statements for the acquired component business should disclose that they represent the financial statements of the acquired component of Acquiree B (i.e., the 40 stores acquired). The financial statements would not represent that they consist of the consolidated financial statements of legal Acquiree B since the consolidated financial statements of legal Acquiree B would include all 100 stores.
Assume the same facts as Scenario 1 except that prior to its acquisition by Company A, Acquiree B will transfer only five stores to Acquiree B’s shareholder. Thus in its acquisition of Acquiree B, Company A will be purchasing 95 stores which represent 95% of the key operating assets of Acquiree B prior to its acquisition.
In preparing financial statements under Rule 3-05 of Regulation S-X, Company A would present separate financial statements of Acquiree B including all 100 stores in its Form 8-K. Because Company A has acquired “substantially all” of Acquiree B’s key operating assets. The elimination of the remaining assets and liabilities not acquired (i.e., the 5 stores transferred out prior to the acquisition by Company A) will be depicted in pro forma financial information in accordance with Article 11 of Regulation S-X.
The above guidance relates to the acquisition of selected parts of an entity and the related separate presentation of those financial statements provided in accordance with Rule 3-05 of Regulation S-X. Different rules apply with respect to separate carve-out financial statements provided in connection with a spin off or an IPO of the carve-out entity itself. See SAB Topic 5.Z.7 for transactions related to spin-offs and IPOs. SAB Topic 5.Z.7 or analogies to this guidance are not relevant in determining the financial statements that are prepared to comply with Rule 3-05 of Regulation S-X.
PwC clients that have questions about this Practical tip should contact their engagement partner. Engagement teams that have questions should contact Wayne Carnall (1-973-236-4233) or Ravi Rao (1-973-236-7066) in the National Professional Services Group.