The Securities and Exchange Commission (SEC) issued final rule 33-10786, Amendments to Financial Disclosures about Acquired and Disposed Businesses, on May 20, 2020.
The amendments are intended to assist registrants in making more meaningful determinations whether an acquired or disposed business is significant.
The rule also seeks to improve the financial disclosure requirements applicable to acquisitions and dispositions of businesses and pro forma financial information.
The amendments are effective January 1, 2021, and voluntary early compliance is permitted.
The SEC adopted amendments that primarily impact:
- Measuring the significance of an acquired or disposed business
- Acquiree financial statements
- Form and content of pro forma financial information
The changes to the financial disclosure requirements in Regulation S-X for acquisitions and dispositions of businesses, including real estate operations, include amendments to Rules 3-05, 3-14, 8-04, 8-05, 8-06, and Article 11, as well as in other related rules and forms.
In addition, to address the unique attributes of investment companies and business development companies, the SEC adopted new requirements regarding fund acquisitions specific to registered investment companies and business development companies.
Whether an acquisition is significant is determined by applying the significance tests—investment test, income test, and asset test. These tests are also used to evaluate the significance of a disposition of a business.
The amendments update the significance tests in the following ways:
- Investment test—Revised to compare the registrant’s investment in the acquired or disposed business to the aggregate worldwide market value of the registrant’s common equity
- The aggregate worldwide market value is determined using the average of the last five trading days of the registrant’s most recently completed month-end before the earlier of the announcement of the transaction or the agreement date.
- If the registrant has no aggregate worldwide market value—for example, when common equity isn’t publicly traded including in an initial public offering (IPO)—total assets should be used consistent with the existing investment test.
- Income test—Added a revenue component that compares the acquiree’s revenue to registrant’s revenue for the most recently completed fiscal year
- The income test still compares the acquiree’s pretax income from continuing operations to that of the registrant.
- Significance is measured using the lower result of the revenue and pretax income from continuing operations calculations.
- The revenue component of the test is only performed when both the registrant and acquired business had material revenue in each of the two most recently completed fiscal years.
- Dispositions—Raised the significance threshold for reporting the disposition of a business on Form 8-K from 10% to 20% to conform to requirements for reporting business acquisitions
Acquiree Financial Statements
Periods to Be Presented
Previously, under Rule 3-05, registrants were generally required to provide three years of audited acquiree financial statements when the results of any of the three significance tests was greater than 50%. The amendments eliminate the requirement to provide the third year of audited acquiree financial statements.
The existing 20% and 40% significance thresholds for providing one and two years of audited acquiree financial statements remains unchanged.
Additionally, when only one year of audited acquiree financial statements are required, the amendments eliminate the requirement to provide comparative unaudited interim acquiree financial statements for the prior year.
Circumstances Requiring Acquiree Financial Statements
The amendments eliminate the requirement to provide acquiree financial statements for acquired businesses under the following circumstances:
- The acquired business exceeds 20% but doesn’t exceed 40% significance and the acquiree financial statements have been included in the registrant’s audited post-acquisition results for nine months.
- The acquired businesses exceeds 40% significance and the acquiree financial statements have been included in the registrant’s audited post-acquisition results for a complete fiscal year.
Previously, registrants were required to provide audited acquiree financial statements and pro forma information for the mathematical majority of individually insignificant acquisitions where the significance exceeded 50% in the aggregate in certain registration statements and proxy statements. The amendments eliminate this requirement.
Under the revised rule, registrants are only required to provide audited acquiree financial statements for any acquisition that exceeds the 20% threshold individually, along with pro forma financial information showing the aggregate impact of all the individually insignificant acquisitions.
Abbreviated Financial Statements
Registrants may acquire a component of an entity that’s a business as defined in Rule 11-01(d) but doesn’t constitute a separate entity, subsidiary, or division.
It may not be possible to prepare acquiree financial statements for these businesses because they often represent a small portion of the selling entity. Historically, registrants were required to request approval from the SEC staff to provide abbreviated financial statements.
The amendments permit registrants to provide audited abbreviated financial statements, without requiring approval from the SEC staff, when the acquired business was part of a larger entity and meets the following conditions:
- The total assets and total revenues, after intercompany eliminations, of the acquired business constitute 20% or less of the total assets and total revenue of the seller for the most recent completed fiscal year.
- The acquired business wasn’t a separate entity, subsidiary, or operating segment during periods for which acquiree financial statements are required.
- Separate acquiree financial statements for the business haven’t previously been prepared.
- The seller hasn’t maintained the distinct and separate accounts necessary to present financial statements that include the omitted expenses, and it’s impracticable to prepare such financial statements.
If the acquired business satisfies the above conditions, the audited abbreviated financial statements must also conform to certain presentation conditions including:
- Interest expense may only be excluded from the statements if the debt related to the interest expense won’t be assumed by the registrant.
- The statement of comprehensive income must include expenses incurred by the acquired business during the pre-acquisition periods to be presented.
- The notes to the financial statements include certain additional disclosures.
The amendments also include new Rule 3-05(f) that allows a registrant to present abbreviated financial statements of an acquired business engaged in oil and gas producing activities, which must include certain unaudited industry-specific disclosures specified in ASC Topic 932, Extractive Activities—Oil and Gas. The new Rule 3-05(f) generally codifies existing SEC staff guidance.
Pro Forma Financial Information
Registrants are generally required to provide pro forma financial information as prescribed by Article 11 when separate acquiree financial statements are required for a significant acquisition or when there is a significant disposition.
Historically, the pro forma financial information was based on the historical financial statements of the registrant and the acquired or disposed business. It generally includes adjustments intended to show how the acquisition or disposition might have affected those financial statements had the transaction occurred at an earlier time.
Article 11 required that the historic financial statements be adjusted only for amounts that were:
- Directly attributable to the transaction
- Factually supportable
- Expected to have a continuing impact on the registrant with respect to the statement of comprehensive income
The amendments significantly revise the pro forma adjustment criteria by replacing the criteria above with the following three categories of adjustments:
- Transaction accounting adjustments, which reflect the application of required accounting to the acquisition or disposition
- Autonomous entity adjustments, which are necessary to reflect the operations and financial position of the registrant as an autonomous entity when the registrant was previously part of another entity
- Management’s adjustments, which provide registrants the option to include forward-looking information that depicts synergies and dis-synergies of the acquisitions and dispositions
The transaction accounting and autonomous entity adjustments must be shown in two separate columns.
Management’s adjustments, if presented, would appear only in the explanatory notes to the pro forma financial information.
Financial Statements of Real Estate Operations
Disclosure requirements under Rule 3-14 currently differ from the requirements under Rule 3-05 because of the unique industry considerations for real estate operations.
Under Rule 3-14, a registrant that has acquired a significant real estate operation must file separate audited annual and unaudited interim abbreviated income statements with respect to such operations.
The amendments clarify the application of Rule 3-14 and align Rule 3-14 with Rule 3-05 in order to standardize the requirements for acquired business while retaining industry specific disclosure requirements.
Smaller Reporting Companies
The final rule includes corresponding changes to the requirements for smaller reporting companies (SRCs).
Previously, Article 8 required acquiree financial statements and pro forma financial information; however, it didn’t provide the same level of detailed guidance as Rule 3-05 and Article 11.
The amendments allow SRCs to continue to prepare acquiree financial statements in accordance with Article 8—the form and content requirements. However, SRCs must now refer to the requirements in Rules 3-05 and 3-14 for other requirements.
Similar changes were made for pro forma financial information. SRCs must now refer to Article 11 for the presentation and disclosure of such information—except for the condensed format allowed for SRCs.
For financial reporting purposes, investment company registrants, including business development companies, are generally required to apply the provisions in Articles 1, 2, 3, and 4 of Regulation S-X.
The amendments tailor the financial reporting requirements for investment companies with respect to their acquisitions of investment companies as follows:
- Revises the definition of significant subsidiary to provide one specifically tailored for investment companies
- Adds new Rule 6-11 and amends Form N-14 to cover financial reporting for fund acquisitions by investment companies and business development companies
- Eliminates the requirement to provide pro forma financial information for investment company registrants in connection with fund acquisitions and requires certain supplemental financial information in its place
Transition and Effective Dates
The amendments are effective January 1, 2021.
Voluntary early compliance is permitted.
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