The U.S. Securities and Exchange Commission (SEC) recently adopted amendments to the financial disclosure requirements in Regulation S-X for acquisitions and dispositions of businesses.1 These amendments are part of the SEC’s continuing initiative to improve the quality and efficiency of such disclosure and facilitate more timely access to capital.
Currently, following the acquisition of a “significant” business, registrants generally must file separate audited annual and unaudited interim pre-acquisition financial statements of that business. Similarly, certain unaudited pro forma financial information must be provided for significant acquisitions or dispositions. Three separate tests are used to compute “significance”: the investment test, the asset test, and the income test. The relative significance of the acquisition or disposition dictates the period of the required historical and pro forma financial statements.
Highlights of these amendments are summarized below:
- Updating applicable significance tests.
- The investment test compares the registrant’s and its other subsidiaries’ investments in, and advances to, the tested subsidiary (i.e., the business acquired or disposed) to the aggregate worldwide market value of the registrant’s voting and non-voting common equity.
- The income test includes a new revenue component and a simplified net income component.
- Eliminating, for acquisitions for which financial statements are not required (or are not yet required), historical financial statements for insignificant businesses and expanding the pro forma financial information to depict the aggregate effect in all material respects.
- This modified pro forma presentation is expected to facilitate investor understanding of the overall effect of those acquisitions on the registrant.
- Requiring the financial statements of the acquired business to cover only up to the two most recent fiscal years.
- The SEC recognizes that financial information from the third most recent fiscal year is less likely to indicate the financial condition and results of operations of the acquired business.
- Permitting the use of financial statements that omit certain expenses for certain acquisitions of a component of an entity.
- The statement of comprehensive income must include expenses incurred by or on behalf of the acquired business during the pre-acquisition financial statement periods to be presented, but may otherwise omit corporate overhead expenses.
- Allowing the use of, or reconciliation to, International Financial Reporting Standards as issued by the International Accounting Standards Board (IFRS-IASB) in certain circumstances.
- Eliminating the requirement for separate acquired business financial statements once the business has been included in the registrant’s post-acquisition financial statements for nine months or a complete fiscal year, depending on significance.
- The amendments allow the omission of pre-acquisition financial statements for businesses that exceed 20% but do not exceed 40% significance once they are included in the registrant’s audited post-acquisition results for nine months.
- Pre-acquisition financial statements for businesses that exceed 40% significance may be omitted once they are included in the registrant’s post-acquisition results for a complete fiscal year.
The amendments will be effective on January 1, 2021, but early voluntary compliance is permitted. Registrants should familiarize themselves with the amendments and assess their impact on the reporting of near-term acquisitions or dispositions.
1 See “Amendments to Financial Disclosures about Acquired and Disposed Businesses,” SEC Release No. 33-10786 (May 21, 2020), available at https://www.sec.gov/rules/final/2020/33-10786.pdf. The SEC also made conforming changes to applicable rules and Forms to provide uniform treatment on these matters.