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Financial Statement Requirements for a Significant Acquisition

It is important to understand the implications of acquiring a business as a U.S. Securities and Exchange Commission (“SEC”) registrant. Additional financial statement requirements often arise upon a “significant” acquisition. The requirements for financial statements may apply before completion of the acquisition, i.e., when the acquisition becomes probable. Determining “significance”, the requirement for additional audited financial statements, and the filing of the Form 8-K can be challenging and complex for the registrant – often catching the registrant off guard.

Measuring Significance

Registrants must measure the significance of an acquired business under Rule 3-05 of the SEC’s Regulation S-X. Under S-X 3-05 and S-X 8-04, three tests are utilized. No single test is more or less important than the others. Instead, the significance level for an acquired business is the highest level calculated by any one of the three tests. These tests include:

• Asset Test – Compare the acquiror’s share of the acquired business’s total assets to the acquiror’s consolidated total assets. Ordinary receivables and other working capital amounts not acquired should nevertheless be included as part of the assets of the acquired enterprise in tests of significance relative to the acquiror’s assets because that working capital is expected to be required and funded after the acquisition.
• Investment Test – Compare the total Generally Accepted Accounting Principles (“GAAP”) purchase price of the acquired business, as adjusted below, to the acquiror’s consolidated total assets.
  o GAAP purchase price in this context means the “consideration transferred”.
  o The adjustment – For purposes of the “investment” test, “consideration transferred” should be adjusted to exclude the carrying value of assets transferred by the acquiror to the acquired business that will remain with the combined entity after the business combination.
• Pre-Tax Income Test – Compare the acquiror’s equity in the acquired business’s income from continuing operations before income taxes, extraordinary items, and cumulative effect of a change in accounting principle to that of the acquiror.

When performing these tests, the registrant is to compare the most recent pre-acquisition, annual audited consolidated financial statements of the acquiror to the most recent pre-acquisition annual (or quarterly if in existence for less than a year) financial statements of the acquired business (or group of businesses).

Additional Considerations When Measuring Significance

• Absolute Values – In the case of a single acquisition, if either the acquiror or the acquired business reported a pretax loss and the other entity reported pretax income, use the absolute values.
• Denominator – The acquired business is not considered part of the acquiror’s denominator in determining significance.
• Definition of a Business – The SEC does not limit the definition of a business to the usual notion of a stand-alone company. In addition, the SEC’s definition of a business under S-X is not the same as the definition under U.S. GAAP and instead is based upon specific facts and circumstances. For example, a separate entity, a subsidiary, or a division is presumed to be a business, but less substantial components may also constitute a business for purposes of the significance analysis. A key determining factor is whether the nature of the revenue-producing activity of the acquired assets remain generally the same as before the acquisition.
• Related Businesses – Acquisitions of “related businesses” must be treated as a single business acquisition. Businesses are related under S-X 3-05 if:
  o they are under common control or management, or
  o their acquisitions are dependent on each other or a single common event or condition.
• Intercompany Transactions – When measuring significance for all three tests, intercompany transactions between the acquiror and acquiree should be eliminated in the same way that would occur if the acquiree were consolidated.
• Rounding – Do not round the results of the significance tests.

Financial Statement Filing Requirements

• 20% Significance or Less – No separate financial statements needed.
• 20% Significance but Less than 40% Significance – Audited financial statements for the most recent fiscal year must be included.
• 40% Significance but Less than 50% Significance – Audited financial statements for the two most recent fiscal years must be included.
• Greater than 50% Significance – Audited financial statements for the three most recent fiscal years must be included.

In addition, for all significance levels exceeding 20%, unaudited interim financial statements for any stub period may also be required depending on the timing of when the acquisition takes place as well as staleness rules.

Reporting Requirements for Registration Statements and Under Form 8-K

• Registration Statements and Proxies
  o If less than or equal to 50% significance, financial statements of a recent or probable acquisition need not be included unless the registration statement (or post-effective amendment) is declared effective (or proxy statement is mailed) 75 days or more after the acquisition is consummated. This rule does not apply to “blank check” issuers.
  o If significance exceeds 50%, financial statements of a recent or probable acquisition must be included in a registration statement (or post-effective amendment) at the effective date.
• Form 8-K
  o Item 2.01, Form 8-K reporting the transaction is required within 4 business days of the consummation of any business acquisition exceeding 20% significance or for any asset purchase exceeding 10% significance that does not meet the definition of a business.
  o If the required financial statements of the business acquired are not required to be provided with the initial report, they must be filed by amendment within 71 calendar days after the date that the initial report on Form 8-K must be filed.
  o A registrant that was a shell company, other than a business combination related shell company immediately before it acquires a business, must file the acquired business financial statements and related pro forma information. The 71 calendar day extension is not available.

How Centri Can Help

The summary presented above is not meant to be all inclusive, but rather provides an overview of the key considerations of when to include acquired business financials in SEC filings. There are numerous exceptions and special situations described in the SEC Financial Reporting Manual.

Centri’s team of experts can help navigate the financial reporting complexities that may be encountered as an acquisition is consummated. Centri can assist companies with preparing accounting memorandums, complex valuations, purchase price allocations, impairment analyses and associated financial statement disclosures in connection with the transaction. In addition, Centri can help prepare or compile other supporting documentation for management to provide to auditors to give comfort over the amounts recorded in these high-risk areas.

Centri is comprised of seasoned professionals with extensive GAAP and SEC reporting experience including former international and Big 4 accounting firm partners, directors, and managers. Our technical expertise and extensive research into these requirements makes Centri an asset for any company.