Practical tip A tip on applying financial reporting requirements Determining financial statement presentation

Practical tip
A tip on applying financial reporting
requirements
No. 2014-02
January 9, 2014
Determining 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.”
National Professional Services Group | CFOdirect Network – www.cfodirect.pwc.com
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Practical example
Scenario 1
Facts:
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 305 of Regulation S-X.
Analysis:
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.
Scenario 2
Facts:
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.
Analysis:
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 305 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.
National Professional Services Group | CFOdirect Network – www.cfodirect.pwc.com
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Questions
PwC clients that have questions about this Practical tip should contact their engagement
partner. Engagement teams that have questions should contact Wayne Carnall (1-973236-4233) or Ravi Rao (1-973-236-7066) in the National Professional Services Group.
National Professional Services Group | CFOdirect Network – www.cfodirect.pwc.com
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Authored by:
Wayne Carnall
Partner
Phone: 1-973-236-4233
Email: [email protected]
Ravi Rao
Partner
Phone: 1-973-236-7066
Email: [email protected]
Practical tips offer tips on applying financial reporting requirements and are prepared by the National Professional Services Group of PwC.
This publication is for general information purposes only, and should not be used as a substitute for consultation with professional advisors. To
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