Pro forma financial information: A guide for applying Article 11 of Regulation S-X

SEC Financial Reporting Series

Pro forma

financial

information

A guide for applying Article 11 of

Regulation S-X

November 2023

 
Pro forma financial information  |  i 
Contents 
Overview ................................................................................................................... 1 
1  Section highlights .................................................................................................................. 1 
2  EY publications ...................................................................................................................... 1 
3  Other considerations .............................................................................................................. 2 
3.1  ASC 805 pro forma requirements .................................................................................. 2 
3.2  Pro forma financial information in non-SEC offering documents ...................................... 3 
Events requiring pro forma financial information .......................................................... 1 
1  Overview ............................................................................................................................... 1 
2  Significant business acquisitions and disposals ........................................................................ 2 
2.1  Definition of a business .................................................................................................. 3 
2.1.1  Definition of a real estate operation ................................................................... 4 
2.2  Measuring significance .................................................................................................. 4 
2.2.1  Significant business acquisitions ....................................................................... 7 
2.2.2  Related businesses........................................................................................... 7 
2.2.3  Business acquisitions that are individually insignificant ....................................... 8 
2.2.4  Significant business disposals ........................................................................... 8 
2.2.5  Acquisitions of significant real estate operations ................................................ 8 
2.2.6  Acquisition of individually insignificant real estate operations .............................. 9 
2.2.7  Exchange transactions ..................................................................................... 9 
3  Spin-off of a portion of an entity ............................................................................................. 9 
Forms requiring pro forma financial information ........................................................ 10 
1  Form 8-K ............................................................................................................................. 10 
1.1  Exchange transaction .................................................................................................. 11 
2  Registration statements and proxy statements ...................................................................... 11 
3  Foreign private issuer forms ................................................................................................. 13 
Preparation of pro forma financial information ............................................................ 14 
1  General form and content..................................................................................................... 14 
2  Required statements and periods presented .......................................................................... 15 
2.1  Pro forma condensed balance sheet ............................................................................. 16 
2.2  Pro forma condensed income statement ...................................................................... 16 
2.2.1  Pro forma income statement required for all fiscal years presented ................... 17 
2.2.2  Pro forma information reflects common control (or discontinued operations) 
and other transactions ................................................................................... 17 
2.2.3  Historical results include unusual events .......................................................... 18 
2.3  Filing of a Form 10-Q or Form 10-K during the Form 8-K extension period ..................... 18 
2.4  Combining entities with different fiscal years ................................................................ 19 
2.5  Changes in fiscal year end ........................................................................................... 20 
2.6  Narrative disclosure only ............................................................................................. 21 
3  Updating pro formas ............................................................................................................ 22 

Contents 
Pro forma financial information  |  ii 
4  Pro forma adjustments ......................................................................................................... 23 
4.1  Transaction accounting adjustments ............................................................................ 23 
4.1.1  Nonrecurring items ........................................................................................ 24 
4.2  Autonomous entity adjustments .................................................................................. 25 
4.3  Management’s adjustments ......................................................................................... 25 
4.3.1  Identifying and quantifying the adjustments ..................................................... 26 
4.3.2  Disclosures about each adjustment ................................................................. 27 
4.3.3  Updating the disclosures ................................................................................ 27 
4.3.4  Disclosing management’s adjustments elsewhere in a filing ............................... 27 
5  Other content requirements ................................................................................................. 27 
5.1  Introductory section .................................................................................................... 27 
5.2  Columnar presentation ................................................................................................ 28 
5.3  Explanatory notes ....................................................................................................... 29 
6  Specific or unique circumstances .......................................................................................... 30 
6.1  Pro formas involving multiple transactions ................................................................... 30 
6.2  Transactions with range of possible results ................................................................... 31 
6.3   Cross-border business combinations ............................................................................ 32 
Pro forma adjustment illustrations ............................................................................ 34 
1  Business combinations ......................................................................................................... 34 
1.1   Calculation of purchase price ....................................................................................... 34 
1.2   Contingent consideration ............................................................................................ 35 
1.3   Preliminary purchase price allocation ........................................................................... 35 
1.4   Debt ........................................................................................................................... 36 
1.4.1   Acquired business’s debt assumed by the registrant ......................................... 36 
1.4.2   Additional debt financing ................................................................................ 37 
1.4.3   Obtaining new debt and refinancing acquiree debt to complete acquisition ......... 37 
1.4.4   Bridge loan financing ...................................................................................... 38 
1.5   Intangible assets ......................................................................................................... 39 
1.6   Long-lived tangible assets ............................................................................................ 41 
1.7   Transaction costs ........................................................................................................ 41 
1.8   Gains and losses attributable to the acquisition ............................................................. 42 
1.9   Inventory valuation ..................................................................................................... 43 
1.10   In-process research and development .......................................................................... 43 
1.11   Deferred tax asset valuation allowances ....................................................................... 43 
1.12   Compensation arrangements ....................................................................................... 45 
1.12.1   Change-in-control provisions .......................................................................... 45 
1.12.2   New or replacement compensation agreements ............................................... 47 
1.13   Accounting policies and financial statement presentation .............................................. 47 
1.14   Business combinations involving foreign entities ........................................................... 49 
1.14.1   Basis of accounting ........................................................................................ 49 
1.14.2  Foreign currency adjustments ......................................................................... 50 
1.15  Regulatory effects of a business combination ............................................................... 51 
1.16  Management’s adjustments ......................................................................................... 52 
2  Acquisition of equity method investments ............................................................................. 53 
3   Disposals ............................................................................................................................. 54 
4  Spin-off transactions ............................................................................................................ 56 

Contents 
Pro forma financial information  |  iii 
5   Other transactions ............................................................................................................... 56 
5.1  Reorganization of entities under common control ......................................................... 56 
5.2   Emergence from bankruptcy ....................................................................................... 57 
5.3   Use of proceeds in securities offerings ......................................................................... 59 
Other pro forma considerations ................................................................................ 61 
1  IPO considerations ............................................................................................................... 61 
1.1  Planned distributions not reflected in the historical balance sheet .................................. 61 
1.2  Distributions in excess of earnings ............................................................................... 62 
1.3  Changes in tax status .................................................................................................. 63 
1.4  Other changes in capitalization .................................................................................... 64 
1.5  Example — disclosure of pro forma financial information in an IPO .................................. 64 
2  Financial forecasts ............................................................................................................... 65 
2.1  Presentation and disclosure requirements .................................................................... 67 
3  Roll-up transactions ............................................................................................................. 67 
4  Tender offers....................................................................................................................... 68 
5  Pro forma MD&A .................................................................................................................. 69 
6  Pro forma effects on non-GAAP financial measures of performance or liquidity ....................... 70 
Auditor involvement ................................................................................................. 71 
1  Comfort letters .................................................................................................................... 71 
2  Reporting on pro forma financial information ........................................................................ 71 
 

Pro forma financial information | 1

1 Overview

We are pleased to present this publication, Pro forma financial information: a guide for applying Article 11

of Regulation S-X. Pro forma financial information (pro formas) presents historical balance sheet and

income statement information adjusted as if a transaction had occurred at an earlier time. Pro formas are

intended to provide investors with information about the effect of a transaction by showing how a

transaction or a group of transactions might have affected historical financial statements to illustrate

the scope of the change in the registrant’s financial position and results of operations.

Article 11 of Regulation S-X, Pro forma financial information, describes the requirements of the

Securities and Exchange Commission (SEC) for registrants to provide pro formas.

1.1 Section highlights

The following is an overview of the sections in this publication:

• Section 2 describes the events and circumstances that require registrants to present Article 11

pro formas in SEC filings.

• Section 3 discusses which SEC forms require Article 11 pro formas.

• Section 4 walks through the content requirements for pro formas, including the required historical

financial information and adjustments to the historical information.

• Section 5 shows the pro forma adjustments and disclosures typically required for common transactions.

• Section 6 highlights other considerations, including pro forma disclosure related to initial public

offering (IPO) transactions, disclosure in management’s discussion and analysis (MD&A) and the

use of non-GAAP measures.

• Section 7 covers auditors’ responsibilities and their involvement with respect to pro formas.

1.2 EY publications

Our publications provide interpretive guidance to help registrants prepare various SEC forms and

schedules. These documents are available from any EY representative.

• Technical Line, Applying the SEC’s requirements for significant acquired businesses (updated April

2023) — This publication discusses all of the disclosure requirements for reporting on common

acquisition transactions and provides examples of how to apply these requirements, among other things.

• Technical Line, How to apply the amended S-X Rule 3-14 to real estate acquisitions — This publication

explains when a registrant is in the scope of this specialized industry guidance, how to measure

significance when acquiring a real estate operation and what financial information is required.

1 Overview

Pro forma financial information | 2

1.3 Other considerations

Reading our publication is not a substitute for reading Article 11 or the applicable form instructions that

require pro formas. Registrants should also consider the following resources that describe SEC staff

views about complying with Article 11. Since the SEC staff had not yet updated its guidance to reflect

the most recent amendments

to Article 11, registrants should confirm the relevance of the guidance

referred to below.

• The Financial Reporting Manual (FRM) provides views on financial reporting matters from the

Division of Corporation Finance’s Office of Chief Accountant.

The SEC staff’s interpretations and

guidance about pro forma financial information are included in Topic 3 of the FRM.

• The highlights of meetings the Center for Audit Quality (CAQ) SEC Regulations Committee holds

periodically with the SEC staff describe the staff’s views on emerging financial reporting issues

relating to SEC rules and regulations. The highlights can be found on the CAQ’s website.

• Staff Accounting Bulletins (SABs) provide the SEC staff’s views on accounting-related disclosure

practices. They reflect the interpretations and policies followed by the SEC’s Division of Corporation

Finance and the Office of the Chief Accountant and are codified in the Codification of Staff Accounting

Bulletins. There are only a limited number of SABs (e.g., SAB Topics 1.B.2 and 1.B.3) that address

pro forma financial information under the legacy rules.

1.3.1 ASC 805 pro forma requirements

Accounting Standards Codification (ASC) 805-10-50-2(h) requires an entity to disclose certain pro forma

information in the footnotes to its financial statements when the entity has completed a material business

combination. ASC 805, Business Combinations, requires pro forma revenue and earnings to be disclosed

as if the business combination had occurred at the beginning of the prior annual period when comparative

financial statements are presented. Entities also must provide a narrative description of the nature and

amount of material nonrecurring adjustments.

The preparation of ASC 805 pro forma adjustments is generally consistent with the preparation of

adjustments required under Article 11, but the disclosures under ASC 805 are substantially less detailed.

Many registrants, nevertheless, will continue to apply the principles in Article 11 to prepare their ASC 805

pro forma disclosures because ASC 805 does not provide guidance on how entities should calculate the

items that must be disclosed (pro forma revenue and earnings). For example, see section 4.4.1.1,

Nonrecurring items, for details.

It is also important to note that registrants determining whether to include ASC 805 pro forma information

in the footnotes to their financial statements evaluate whether the information is material, while registrants

determining whether to present Article 11 pro formas evaluate whether the acquired business exceeds a

significance threshold (see section 2.2.2). As a result, a registrant may need to make supplemental pro

forma disclosures under ASC 805, even when Article 11 pro formas are not required.

The SEC most recently amended the rules with SEC Release 33-10786, Amendments to Financial Disclosures about Acquired and

Disposed Businesses, which was effective 1 January 2021 for calendar year-end companies. The amended rules (reflected herein)

changed the significance tests used to determine whether registrants need to file audited financial statements of an acquired

business and related pro formas, the periods the financial statements must cover, and the form and content of the pro formas,

among other things.

The FRM can be found at http://www.sec.gov/divisions/corpfin/cffinancialreportingmanual.shtml.

The CAQ SEC Regulations Committee highlights can be found on the CAQ website at https://www.thecaq.org/sec-regulations-

committee-highlights.

1 Overview

Pro forma financial information | 3

Refer to our Financial reporting developments (FRD) publication, Business combinations, for more

information about the pro forma requirements in ASC 805.

1.3.2 Pro forma financial information in non-SEC offering documents

Registrants may include pro formas in offering documents other than registration statements under the

Securities Act of 1933 (Securities Act) or Exchange Act of 1934 (Exchange Act). Financial statements

and other information (including pro formas) included in these offering documents (e.g., exempt offering

memoranda for Rule 144A offerings) are not subject to SEC form instructions or the requirements of

Regulation S-X. Instead, third-party broker-dealers or financial intermediaries associated with the

offering determine what information should be provided. Therefore, the requirements of Article 11 of

Regulation S-X discussed in this publication do not have to be followed in non-SEC offering documents.

However, the principles in Article 11 and the discussions in this publication may provide a helpful

framework for preparing pro formas in non-SEC offering documents.

Pro forma financial information | 1

2 Events requiring pro forma financial

information

2.1 Overview

This section describes the events and circumstances in which Article 11 pro formas should be presented

in filings with the SEC.

Excerpt from SEC rules and regulations

Regulation S-X, Article 11 Pro forma financial information

Rule 11-01, Presentation requirements

(a) Pro forma financial information must be filed when any of the following conditions exist:

(1) During the most recent fiscal year or subsequent interim period for which a balance sheet

is required by Regulation S-X Rule 3-01, a significant business acquisition has occurred

(for purposes of this section, this encompasses the acquisition of an interest in a business

accounted for by the equity method);

(2) After the date of the most recent balance sheet filed pursuant to Regulation S-X Rule 3-01,

consummation of a significant business acquisition or a combination of entities under

common control has occurred or is probable;

(3) Securities being registered by the registrant are to be offered to the security holders of a

significant business to be acquired or the proceeds from the offered securities will be applied

directly or indirectly to the purchase of a specific significant business;

(4) The disposition of a significant portion of a business either by sale, abandonment or

distribution to shareholders by means of a spin-off, split-up or split-off has occurred or is

probable and such disposition is not fully reflected in the financial statements of the

registrant included in the filing;

(5) Reserved;

(6) Pro forma financial information required by Regulation S-K Item 914 is required to be

provided in connection with a roll-up transaction as defined in Regulation S-K Item 901(c);

(7) The registrant previously was a part of another entity and such presentation is necessary to

reflect operations and financial position of the registrant as an autonomous entity; or

(8) Consummation of other transactions has occurred or is probable for which disclosure of

pro forma financial information would be material to investors.

Companies must present Article 11 pro formas when certain transactions occur or become probable, including:

• Significant acquisitions of businesses, including equity method investments, those that meet the

definition of a real estate operation and a combination of entities under common control (refer to

section 5.1, Business combinations, section 5.2, Acquisition of equity method investments, and

section 5.5.1, Reorganization of entities under common control, for further discussion)

2 Events requiring pro forma financial information

Pro forma financial information | 2

• Significant disposals of businesses, including real estate operations (refer to section 5.3, Disposals,

for further discussion)

• Spin-offs (refer to section 5.4, Spin-off transactions, for further discussion)

• Roll-up transactions (refer to section 6.3, Roll-up transactions, for further discussion)

• Any other transaction that has occurred or is probable for which disclosure of pro formas would be

material to investors

Materiality for this purpose depends on the facts and circumstances of the event or transaction and can

also include the following:

• Repayment or refinancing of debt (refer to section 5.1.4, Debt, for further discussion)

• Emergence from bankruptcy (refer to section 5.5.2, Emergence from bankruptcy, for further discussion)

• Receipt and application of offering proceeds (refer to section 5.5.3, Use of proceeds in securities

offerings, for further discussion)

• Declaring dividends after the most recent balance sheet date (refer to section 6.1.1, Planned

distributions not reflected in the historical balance sheet, and section 6.1.2, Distribution in excess of

earnings, for further discussion)

• Changes in tax status, such as converting a subchapter S corporation or partnership to a C

corporation (refer to section 6.1.3, Changes in tax status, for further discussion)

• Changes in capitalization at or prior to closing of an IPO (refer to section 6.1.4, Other changes in

capitalization, for further discussion)

2.2 Significant business acquisitions and disposals

Article 11 pro formas are required if a significant acquisition of a business or real estate operation,

including equity method investments, has occurred in the latest fiscal year or subsequent interim period or

is probable. Significant acquisitions include any transaction or event that results in the registrant obtaining

control (e.g., consolidation by contract) as well as the acquisition of a significant equity method investment.

Article 11 pro formas are also required if a disposal of a significant business (including disposition of a

significant equity method investment) or real estate operation by sale, abandonment or distribution to

shareholders has occurred or is probable.

The requirements to provide pro formas are triggered when an acquisition or disposal is more than 20%

significant to a registrant. See section 2.2.2 for details of how significance is measured. Because a

transaction involving a business that also meets the definition of a real estate operation is treated

differently under Regulation S-X than one involving a business that doesn’t meet the definition of a real

estate operation, this type of transaction is discussed separately below. See also our Technical Line,

How to apply the amended S-X Rule 3-14 to real estate acquisitions.

In general, whenever audited historical financial statements of an acquired business or real estate

operation are required, Article 11 pro formas also must be presented. Article 11 pro formas also may be

necessary if an acquired business or real estate operation of the registrant consummated a significant

acquisition of its own during the year (i.e., a second-tier acquisition) if that information would be material

for investors to understand the registrant or vote on a transaction.

2 Events requiring pro forma financial information

Pro forma financial information | 3

Generally, the SEC staff considers presenting separate financial statements of an acquired business or

real estate operation without accompanying pro formas to be misleading. Likewise, pro formas are not

required to be presented for an acquisition if separate financial statements are not required in the filing,

except in certain cases involving individually insignificant acquisitions that are significant in the

aggregate. See sections 2.2.2.3 and 2.2.2.6 for more about these situations.

2.2.1 Definition of a business

To determine whether S-X Article 11 applies, a registrant must first determine whether the assets and

liabilities it is acquiring or disposing of meet the SEC’s definition of a business in S-X Rule 11-01(d).

Under Rule 11-01(d), the general principle for identifying a business is that there must be continuity of the

revenue-producing activity before and after the transaction, and the pre-acquisition financial information

about the acquired or disposed business is, therefore, material to an understanding of the registrant’s

operations after the transaction. There is a presumption that a separate entity, subsidiary, division or

working interest in an oil and gas property is a business. S-X Rule 11-01(a)(1) also defines as a business an

investment accounted for using the equity method (including when the fair value option has been elected).

Other components of a selling entity, such as a product line, may also be considered a business for SEC

reporting purposes. When evaluating whether such a component is a business, registrants must consider

the criteria in S-X Rule 11-01(d). However, these attributes are not all-inclusive.

Excerpt from SEC rules and regulations

Regulation S-X, Article 11 Pro forma financial information

Rule 11-01, Presentation requirements

(d) For purposes of this rule, the term business should be evaluated in light of the facts and

circumstances involved and whether there is sufficient continuity of the acquired entity’s operations

prior to and after the transactions so that disclosure of prior financial information is material to an

understanding of future operations. A presumption exists that a separate entity, a subsidiary, or a

division is a business. However, a lesser component of an entity may also constitute a business.

Among the facts and circumstances which should be considered in evaluating whether an

acquisition of a lesser component of an entity constitutes a business are the following:

(1) Whether the nature of the revenue-producing activity of the component will remain generally

the same as before the transaction; or

(2) Whether any of the following attributes remain with the component after the transaction:

(i) Physical facilities,

(ii) Employee base,

(iii) Market distribution system,

(iv) Sales force,

(v) Customer base,

(vi) Operating rights,

(vii) Production techniques, or

(viii) Trade names.

2 Events requiring pro forma financial information

Pro forma financial information | 4

The SEC staff has emphasized that the analysis of whether a set of assets and liabilities constitutes a

business focuses primarily on the continuity of operations before and after the transaction. Therefore,

registrants must use judgment to evaluate the above criteria among other facts and circumstances.

Illustration 1-1 — Definition of a business in an acquisition

Registrant A is acquiring certain assets related to Product X from Company B. No employees will move

from Company B to Registrant A, and the transaction involves only the internally generated intangible

assets (e.g., brand name, manufacturing know-how) and inventory related to Product X. Product X is

not a separate entity, subsidiary or division of Company B. After the acquisition, Registrant A will sell

Product X to Company B’s customers.

Because the nature of the revenue-producing activity associated with Product X will remain the same

after the acquisition and multiple attributes listed in S-X Article 11 will remain with Product X,

Registrant A concludes that the transaction involves a business.

If a registrant believes that it may be able to overcome the presumption that a separate entity, subsidiary,

division or working interest in an oil and gas property is a business or is uncertain whether the criteria in

S-X Rule 11-01(d) have been met, we recommend that the registrant contact the SEC staff to discuss

whether a business has, in fact, been acquired. When the answer is unclear, it may also be helpful to

consider whether the information conveyed in Rule 3-05 financial statements would be useful to investors.

The SEC’s definition of a business differs from the US GAAP definition in ASC 805; therefore, it is possible

to reach a different conclusion about whether a business has been acquired under Article 11 and ASC 805.

2.2.1.1 Definition of a real estate operation

Rule 3-14 of Regulation S-X, Special instructions for financial statements of real estate operations acquired

or to be acquired, requires registrants to present the audited financial statements and Article 11 pro formas

of significant consummated and probable acquisitions of real estate operations. In addition, Article 11

requires pro formas when a registrant disposes of a significant real estate operation.

A real estate operation is a business that generates substantially all of its revenues through the leasing of

real property. A registrant must evaluate a property’s rental history in order to determine whether it meets

the definition. The SEC staff has said that it is not necessary to provide financial statements or pro formas

for an acquired property that has less than three months of history (including newly constructed properties

or previously owner-occupied properties) or a rental property that will be demolished and replaced with

a new rental property, regardless of its rental history. The definition of a real estate operation also

encompasses an investment in a real estate operation accounted for using the equity method.

Please refer to our Technical Line, How to apply the amended S-X Rule 3-14 to real estate acquisitions,

for further explanations of what constitutes a real estate operation, how to measure significance and

what financial information is required when a registrant acquires a significant real estate operation.

2.2.2 Measuring significance

Significance is expressed as a percentage using the asset test, the investment test and the income test

applicable to the transaction as described in S-X Rule 1-02(w). The results of the tests cannot be rounded,

and the registrant uses the highest result of the three tests to determine its reporting requirements.

More details about how the tests should be applied are included in Article 11 and Rules 3-05 and 3-14 for

acquisitions of businesses and real estate operations, respectively.

2 Events requiring pro forma financial information

Pro forma financial information | 5

Excerpt from SEC rules and regulations

Regulation S-X, Article 1 Application of Regulation S-X

Rule 1-02, Definitions of terms used in Regulation S-X

(w) Significant subsidiary.

(1) The term significant subsidiary means a subsidiary, including its subsidiaries, which meets any

of the conditions in paragraphs (w)(1)(i), (ii), or (iii) of this section; however if the registrant is

a registered investment company or a business development company, the tested subsidiary

meets any of the conditions in paragraph (w)(2) of this section instead of any of the conditions

in paragraph (w)(1) of this section. A registrant that files its financial statements in accordance

with or provides a reconciliation to US GAAP must use amounts determined under US GAAP.

A foreign private issuer that files its financial statements in accordance with International

Financial Reporting Standards as issued by the International Accounting Standards Board

(IFRS-IASB) must use amounts determined under IFRS-IASB.

(i) Investment test.

(A) For acquisitions, other than those described in paragraph (B), and dispositions this

test is met when the registrant’s and its other subsidiaries’ investments in and

advances to the tested subsidiary exceed 10 percent

of the aggregate worldwide

market value of the registrant’s voting and non-voting common equity, or if the

registrant has no such aggregate worldwide market value the total assets of the

registrant and its subsidiaries consolidated as of the end of the most recently

completed fiscal year.

(1) For acquisitions, the “investments in” the tested subsidiary is the consideration

transferred, adjusted to exclude the registrant’s and its other subsidiaries’

proportionate interest in the carrying value of assets transferred by the registrant

and its subsidiaries consolidated to the tested subsidiary that will remain with the

combined entity after the acquisition. It must include the fair value of contingent

consideration if required to be recognized at fair value by the registrant at the

acquisition date under US GAAP or IFRS-IASB, as applicable; however if recognition

at fair value is not required, it must include all contingent consideration, except

contingent consideration for which the likelihood of payment is remote.

(2) For dispositions, the “investments in” the tested subsidiary is the fair value of the

consideration, including contingent consideration, for the disposed subsidiary

when comparing to the aggregate worldwide market value of the registrant’s

voting and non-voting common equity, or, when the registrant has no such

aggregate worldwide market value, the carrying value of the disposed subsidiary

when comparing to total assets of the registrant.

(3) When determining the aggregate worldwide market value of the registrant’s

voting and non-voting common equity, use the average of such aggregate

worldwide market value calculated daily for the last five trading days of the

registrant’s most recently completed month ending prior to the earlier of the

registrant’s announcement date or agreement date of the acquisition or disposition.

(B) For a combination between entities or businesses under common control, this test is

met when either the net book value of the tested subsidiary exceeds 10 percent of

the registrant’s and its subsidiaries’ consolidated total assets or the number of

common shares exchanged or to be exchanged by the registrant exceeds 10 percent

of its total common shares outstanding at the date the combination is initiated.

2 Events requiring pro forma financial information

Pro forma financial information | 6

investments in and advances to the tested subsidiary exceed 10 percent of the total

assets of the registrant and its subsidiaries consolidated as of the end of the most

recently completed fiscal year.

(ii) Asset test. This test is met when the registrant’s and its other subsidiaries’ proportionate

share of the tested subsidiary’s consolidated total assets (after intercompany eliminations)

exceeds 10 percent

of such total assets of the registrant and its subsidiaries consolidated

as of the end of the most recently completed fiscal year.

(iii) Income test.

(A) This test is met when:

(1) The absolute value of the registrant’s and its other subsidiaries’ equity in the tested

subsidiary’s consolidated income or loss from continuing operations before income

taxes (after intercompany eliminations) attributable to the controlling interests

exceeds 10 percent of the absolute value of such income or loss of the registrant

and its subsidiaries consolidated for the most recently completed fiscal year; and

(2) The registrant’s and its other subsidiaries’ proportionate share of the tested

subsidiary’s consolidated total revenue from continuing operations (after

intercompany eliminations) exceeds 10 percent of such total revenue of the

registrant and its subsidiaries consolidated for the most recently completed fiscal

year. This component does not apply if either the registrant and its subsidiaries

consolidated or the tested subsidiary did not have material revenue in each of the

two most recently completed fiscal years.

(B) When determining the income component in paragraph (w)(1)(iii)(A)(1) of this section:

(1) If a net loss from continuing operations before income taxes (after intercompany

eliminations) attributable to the controlling interest has been incurred by either

the registrant and its subsidiaries consolidated or the tested subsidiary, but not

both, exclude the equity in the income or loss from continuing operations before

income taxes (after intercompany eliminations) of the tested subsidiary

attributable to the controlling interest from such income or loss of the registrant

and its subsidiaries consolidated for purposes of the computation;

(2) Compute the test using the average described in this paragraph (w)(1)(iii)(B)(2)

if the revenue component in paragraph (w)(1)(iii)(A)(2) of this section does not

apply and the absolute value of the registrant’s and its subsidiaries’ consolidated

income or loss from continuing operations before income taxes (after intercompany

eliminations) attributable to the controlling interests for the most recent fiscal

year is at least 10 percent lower than the average of the absolute value of such

amounts for each of its last five fiscal years; and

(3) Entities reporting losses must not be aggregated with entities reporting income where

the test involves combined entities, as in the case of determining whether summarized

financial data must be presented or whether the aggregate impact specified in S-X

Rules 3-05(b)(2)(iv) and 3-14(b)(2)(i)(C) is met, except when determining whether

related businesses meet this test for purposes of Rules 3-05 and 8-04.

(2) [Omitted from this publication]

__________________________

The significant subsidiary tests in Regulation S-X Rule 1-02(w) are referenced in several SEC rules and regulations and the

threshold to determine significance may vary from one rule to another. For example, under Regulation S-X Rule 3-05 and for

Article 11, an acquired business is significant when the results of any of the three significance tests (i.e., asset, investment

and income) exceeds 20%.

2 Events requiring pro forma financial information

Pro forma financial information | 7

2.2.2.1 Significant business acquisitions

In most cases, the significance tests described below are performed using amounts that appear in the

registrant’s most recent annual pre-acquisition audited financial statements filed with the SEC and amounts

in the financial statements of the acquired business for the same fiscal year. The financial statements of

the acquired business do not need to be audited to be used in the significance test. The following

summarizes each of the three significance tests.

• Asset test — Significance is measured by comparing the registrant’s proportionate share of the

acquired business’s total assets (after intercompany eliminations) to its consolidated total assets.

• Investment test — Significance is measured by comparing the registrant’s investments in and advances

to the acquired business (i.e., consideration transferred, typically consistent with US GAAP) to the

aggregate worldwide market value of the registrant’s voting and non-voting common equity (WWMV),

or the registrant’s total assets if WWMV is not available (i.e., when common equity is not publicly

traded, as is the case for a company conducting an IPO).

• Income test — Significance is measured using the lower result of the following two components unless

either the registrant or the acquired business did not have material revenue during each of their past

two years, in which case only the income component is used:

• Income component — This component compares the registrant’s proportionate share of the

acquired business’s pretax income or loss from continuing operations, net of amounts attributable

to any noncontrolling interest, to that of the registrant.

• Revenue component — This component compares the registrant’s proportionate share of the

acquired business’s most recent annual consolidated revenue from continuing operations to that

of the registrant.

Refer to our Technical Line, Applying the SEC’s requirements for significant acquired businesses

(updated April 2023), for further discussions (including examples) about measuring significance for

business acquisitions.

2.2.2.2 Related businesses

Generally, each business acquired or to be acquired is evaluated individually. However, a group of related

businesses must be treated as a single acquisition. Businesses are considered related if they are under

common control or management, the acquisition of one business is conditional on the acquisition of each

other business, or each acquisition is conditioned on a single common event.

To perform the tests for the group as a whole, a registrant must aggregate the amounts for each business,

and the highest result represents the significance of the group. That is, if the significance of the group

exceeds 20% for at least one test, Rule 3-05 financial statements and pro formas are required for each of

the related businesses, even if the significance of one or more of them is 20% or less for all three tests.

Companies should include related acquisitions that have occurred in the period after the latest audited

fiscal year end and, for registration statements, include related acquisitions that are probable.

While the related businesses must be combined for purposes of determining significance, the financial

statements of the related businesses, if required, may be presented on a combined basis only if they are

under common control or common management as specified in ASC 810, Consolidation.

2 Events requiring pro forma financial information

Pro forma financial information | 8

2.2.2.3 Business acquisitions that are individually insignificant

Registrants must also consider the aggregate significance of acquisitions that do not individually trigger a

requirement to include Rule 3-05 financial statements and pro formas in a registration statement or

proxy statement. Significance is calculated as if the acquisitions were a single acquisition and include:

• Acquisitions consummated after the registrant’s most recent audited balance sheet date that are

20% or less significant

• Probable acquisitions that are 50% or less significant

• Completed acquisitions that are more than 20% but not more than 50% significant for which Rule 3-05

financial statements and pro formas are not yet required because the filing or effective date of a

registration statement (or mailing date of a proxy) falls within 74 days of consummation

If the aggregate significance of these acquisitions exceeds 50% for any of the three tests, the rules

require a registrant to include in a registration or proxy statement pro formas that depict the aggregate

effect of all individually insignificant acquisitions in all material respects. Rule 3-05 financial statements

(covering the most recent fiscal year and interim period) for any of these acquisitions that exceed 20%

must also be included.

Refer to our Technical Line, Applying the SEC’s requirements for significant acquired businesses

(updated April 2023), for further discussion and examples of how to calculate aggregate significance of

individually insignificant acquisitions.

2.2.2.4 Significant business disposals

Significance for business disposals is calculated using the three tests specified for disposals in S-X 1-

02(w)(1). These tests are consistent with the tests used for acquired businesses, except the numerator

of the investment test is the fair value of the consideration received, including contingent consideration.

If a registrant does not have WWMV, the denominator would be the registrant’s total assets and the

numerator should be the carrying value of the portion of business disposed.

When a disposal is achieved in the form of a spin-off transaction, a registrant performs the investment

test by comparing the carrying value of the disposed business to the total assets of the registrant (even if

the registrant has WWMV).

The SEC staff has said that the numerator for the income test is calculated based on the income

statement effects that would be removed from the registrant’s income statement during the tested

period, similar to the requirements for presenting discontinued operations under ASC 205- 20-45, and

not on pretax income on a carve-out basis using the principles of SAB Topic 1.B.1.

The denominator of the income test should not include the results of the business that is disposed of if it

already has been reported as a discontinued operation because S-X Rule 1-02(w) specifies that the

denominator must equal the registrant’s pretax income or loss from continuing operations.

Refer to section 3.1 for additional considerations related to Form 8-K when reporting disposals.

2.2.2.5 Acquisitions of significant real estate operations

Significance for acquisitions of real estate operations is determined using the investment test used for

acquisitions of a business. However, the numerator must include any debt secured by the property that is

assumed by the registrant when WWMV is not available and total assets are used as the denominator.

2 Events requiring pro forma financial information

Pro forma financial information | 9

Related real estate operations are treated the same way as related businesses. Special tests can be used

when a registrant conducts a “blind pool” offering or enters into a transaction to form a real estate

investment trust. Refer to our Technical Line, How to apply the amended S-X Rule 3-14 to real estate

acquisitions, for further discussion.

2.2.2.6 Acquisition of individually insignificant real estate operations

When filing a registration statement or proxy statement, a registrant must also calculate the aggregate

significance of acquisitions that do not individually trigger a requirement to include Rule 3-14 financial

statements and pro formas. The real estate operations are identified in the same way that individually

insignificant businesses are, as described in section 2.2.2.3.

If the aggregate significance of these acquisitions exceeds 50% for any of the three tests, a registrant is

required to include in a registration statement or proxy statement pro formas that depict the aggregate

impact of all individually insignificant acquisitions in all material respects. Rule 3-14 financial statements

for any of these acquisitions that exceed 20% significance must also be included.

If the registrant acquires both businesses subject to Rule 3-05 and real estate operations subject to

Rule 3-14, the registrant must use the significance tests that apply to each type of transaction. When

aggregating significance, the registrant must include both the businesses and the real estate operations.

Please refer to our Technical Line, How to apply the amended S-X Rule 3-14 to real estate acquisitions,

for further discussion.

2.2.2.7 Exchange transactions

In an exchange transaction, the registrant and another party contribute businesses to a joint venture in

exchange for an equity interest. To determine whether pro forma financial information is required, the

registrant should measure the significance of the business being disposed of (i.e., contributed by the

registrant) and separately measure the significance of the business being acquired (i.e., contributed by the

other party). The significance of the business being acquired should be calculated based only on the

portion of the business being acquired, and the significance of the business being disposed of should be

calculated based only on the portion of the business being disposed of.

Refer to our Technical Line, Applying the SEC’s requirements for significant acquired businesses

(updated April 2023), for further discussion and an example of how to calculate significance of an

exchange transaction.

2.3 Spin-off of a portion of an entity

Article 11 pro forma information is necessary to reflect the operations and financial position of a

registrant that was previously part of another entity as a standalone entity after a transaction commonly

referred to as a spin-off. In this case, the historical financial statements typically do not reflect the

operations of the ongoing entity. The pro forma balance sheet should include pro forma adjustments to

remove assets and liabilities that are not part of the spin-off. In addition, the effects of major distribution

agreements, cost-sharing or management agreements, and compensation or benefit plans should be

reflected if they qualify as autonomous entity adjustments. Refer to section 4.4.2 for further discussion.

Pro forma financial information | 10

3 Forms requiring pro forma financial

information

Generally, pro forma financial information is required in Form 8-K, registration statements, and proxy

statements for significant acquisitions and disposals. Pro formas for other transactions are generally

required only in registration statements and proxy statements. Periodic reporting Forms 10-K and 10-Q

do not require Article 11 pro formas.

3.1 Form 8-K

Form 8-K requires pro forma financial information under Article 11 or Rule 8-05 of Regulation S-X for

smaller reporting companies for acquisitions and disposals

of significant businesses and real estate

operations, including significant equity method investments. These transactions must be reported under

Item 2.01 of Form 8-K within four business days of completion of the transaction. For counting purposes,

day one is the first business day after the day on which the transaction occurred.

If a registrant is unable to provide the required pro formas for a significant acquisition when the Item 2.01

Form 8-K is filed (e.g., because audited financial statements of the acquired business are not available),

an automatic extension of 71 calendar days is available (Form 8-K Item 9.01(a)(3)). However, the

registrant must state in the initial Form 8-K that it will file them within 71 days. If either of these due

dates occurs on a weekend or a holiday, the registrant can file on the next business day.

The 71-day extension allowed by Item 9.01(a)(3) of Form 8-K is not available for disposals because

separate audited financial statements are not required. That is, the pro formas reflecting the disposal must

be provided within four business days of its completion.

While each significant acquisition or disposal triggers separate disclosure under Item 2.01 of Form 8-K and

the filing of pro formas under Item 9.01 of Form 8-K, companies typically provide cumulative pro formas

when they make subsequent significant acquisitions or disposals in the same year. The SEC staff

encourages this presentation because it provides more comprehensive disclosure.

For example, consider a registrant that completes a significant acquisition during the first quarter of its

current fiscal year and reports timely pro forma and historical financial statements for that acquisition

under Item 9.01 of Form 8-K within the 71-day grace period. If the registrant completes another significant

acquisition in the third quarter of the same fiscal year, the instructions in Item 9.01(b) of Form 8-K would

only require the registrant to file pro formas reflecting the second acquisition. However, the registrant

may decide to include both transactions in the pro forma information filed in the second Form 8-K to

provide more comprehensive disclosure.

A registrant that reflects both acquisitions in such cumulative pro formas should refer to section 4.6.1,

Pro formas involving multiple transactions.

While the discussion herein refers to significant dispositions of a business, the Form 8-K instructions also require disclosure

under Item 2.01 for a significant asset disposition (greater than 10% significance) that doesn't meet the definition of a business.

However, in this instance the registrant is only required to provide the disclosures (e.g., a brief description of the assets involved)

as required under Item 2.01 Form 8-K, but it is not required to file Article 11 pro formas.

3 Forms requiring pro forma financial information

Pro forma financial information | 11

General Instruction A of Form 8-K allows a registrant to skip filing an Item 9.01 Form 8-K containing

Rule 3-05 financial statements and pro formas if the registrant already included the information in a

registration statement, and the information in the Form 8-K would be “substantially the same” as what

is presented in that registration statement. This instruction generally allows a registrant to skip filing

an Item 9.01 Form 8-K if the Rule 3-05 financial statements and pro formas it would need to provide in

the Form 8-K would need only one additional interim quarter based on the financial statement age

requirements. However, a registrant will need to file an Item 9.01 Form 8-K if it previously filed third-

quarter financial information and pro formas of an acquired business and the Form 8-K requires audited

financial statements and pro formas for the latest annual period.

3.1.1 Exchange transaction

As discussed in section 2.2.2.7, a registrant may need to report both the acquisition of the equity

method investment and the disposal of the business(es) it contributed in an exchange transaction. In

these cases, the registrant may be unable to present a pro forma income statement depicting the joint

venture formation at the time of the initial Form 8-K filing because the financial statements of the

business(es) contributed by the other party are not available.

If that’s the case, the SEC staff will not object to the registrant filing complete pro forma information

depicting the effects of the exchange of interests (i.e., its disposal of the business(es) it contributed and

its acquisition of the equity interest in the joint venture) at the time that the audited financial statements

of the business contributed by the other party are filed (within the 71-calendar-day extension) if the initial

Form 8-K reporting the transaction includes a description of the effects of the disposal and quantifies

those effects, if practicable.

3.2 Registration statements and proxy statements

Article 11 pro forma financial information must be provided in registration statements and certain proxy

statements when a significant transaction or event listed in section 2.1 is probable or has occurred during

the latest annual period or in the period since the latest annual balance sheet on file. However, the

requirements and due dates are different from those for Form 8-K as discussed above, and a registrant

may need to provide disclosures about additional acquired businesses.

A registrant can omit pro formas from registration statements and certain proxy statements when, under

S-X Rules 3-05 and 3-14, it can also omit the separate financial statements of an acquired business or

real estate operation that has been included in the registrant’s audited results for at least nine months.

Acquisitions that exceed 40% significance must be reflected in the registrant’s audited results for a full

fiscal year before being omitted.

If the registrant has multiple significant transactions (or multiple acquisitions that are individually

insignificant but significant in the aggregate), such transactions may all need to be included in the pro

formas in a registration or proxy statement. Accordingly, the pro formas required in registration or proxy

statements may include more transactions than those filed by the registrant in its most recent Form 8-K

reporting a significant transaction.

Furthermore, some registrants voluntarily include insignificant transactions that they are not required to

reflect in the pro formas in a registration or proxy statement to illustrate more fully the consequences of

recent transactions. A registrant that elects to reflect such transactions needs to consider whether the

pro forma financial information would be misleading if it excludes other individually insignificant transactions.

3 Forms requiring pro forma financial information

Pro forma financial information | 12

Registration statements

The following table outlines the pro forma requirements applicable to significant transactions in the most

common domestic registration statements:

Illustration 3-1: Domestic registration statement requirements for pro forma financial

information

Registration

statement

Pro forma financial information required?

Form Item

Form S-1

Yes — pro forma disclosures must be provided, when applicable.

Item 11(e)

Form S-3

Yes — registrants may choose to:

• Include pro forma information in the Form S-3 prospectus

• Incorporate pro forma information by reference into the

Form S-3 prospectus from:

(1) Recent Exchange Act filing, such as Form 8-K

(2) Proxy or information statement

(3) Previously filed prospectus

Item 11(b)(i)

Form S-4

Yes — pro forma disclosures relating to the transaction must

be included in the prospectus.

Item 5

Form S-4

The registrant and/or the company being acquired may have

to present pro forma information unrelated to the transaction

for which securities are being registered in the Form S-4.

Item 10(b) and

Item 12(c)

Form S-8

No — pro forma disclosures are not required.

N/A

Form S-11

Yes — pro forma disclosures must be provided in the

prospectus, when applicable.

Item 27

Form 10

Yes — pro forma disclosures must be provided, when applicable.

Item 13

Proxy statements

A proxy statement filed on Schedule 14A may require Article 11 pro forma information in Item 13 when

it is used to solicit a shareholder vote to:

• Authorize or issue additional securities under Item 11 of Schedule 14A (e.g., securities to be issued

for cash in a public offering)

• Modify or exchange outstanding securities under Item 12 of Schedule 14A

An emerging growth company (EGC) is permitted to omit pro forma financial information otherwise required by Article 11 of

Regulation S-X from the registration statement for its IPO on Form S-1 or Form F-1 if the EGC reasonably believes that the pro

forma information will not be required at the time of the offering. An EGC’s IPO registration statement may not omit interim pro

forma information that will become part of the pro forma financial information for a longer period required to be included at the

time of offering. See the SEC staff’s FRM Section 10220.5.

Such unrelated pro forma information must be presented with, but clearly distinguished from, the pro forma information relating

to the transaction. See section 4.6.1 for additional discussion and an example about how to present multiple transactions.

3 Forms requiring pro forma financial information

Pro forma financial information | 13

Pro forma financial information may be omitted if it is “not material to the exercise of prudent judgment.”

For example, Item 13 of Schedule 14A presumes pro forma information would be material to the decision

to authorize or issue a material amount of senior securities. However, the information usually is not

material if shareholders are being asked to authorize or issue common stock (except in an exchange,

merger, consolidation, acquisition or similar transaction); authorize preferred stock that the registrant

has no specific plans to issue; or authorize preferred stock to be issued for cash at fair value.

Pro forma information may be required in Item 14 of Schedule 14A if shareholders are voting on any

transaction involving:

• The merger or consolidation of the registrant into or with any other company or of any other

company into or with the registrant

• The acquisition by the registrant of securities of another company

• The acquisition by the registrant of any other business or of the assets of another business

• The sale or other transfer of all or any substantial part of the assets of the registrant

• The liquidation or dissolution of the registrant

The requirements for pro forma information (for the registrant and/or acquiree) in these circumstances

under Item 14 are similar to the requirements in a Form S-4 filing, which are shown in the table above.

Shelf registration statements

Rule 3-05 financial statements and pro formas for a completed or probable acquisition of a business or

real estate operation that is more than 50% significant must always be included in a registration

statement, including a new or amended shelf registration statement, unless the results of the acquired

business have been included in a registrant’s post-acquisition audited financial statements for the full

12 months as described above. Further, if the significance of a completed acquisition exceeds 50%, a

registrant is required to file Rule 3-05 financial statements and pro forma financial information before

completing an offering from its existing shelf registration statement.

However, before conducting a shelf offering, a registrant must also consider whether a completed

acquisition of a business or real estate operation that is 50% or less significant, for which financial statements

and pro formas have not been filed, represents a “fundamental change” as defined by Rule 512 of

Regulation S-K. Probable acquisitions must also be considered. If the completed or probable acquisition

represents a fundamental change, the financial statements and pro formas must be filed before the

registrant conducts the offering. While such acquisitions are rarely determined to be a fundamental

change, the determination is a legal matter that a registrant should discuss with its legal counsel.

3.3 Foreign private issuer forms

A foreign private issuer (FPI) is not required to file Form 8-K. Rather, Form 6-K is available for FPIs to

furnish certain information to the SEC that is (1) made public or is required to be made public pursuant to

the laws of the FPI’s country of domicile or under which the FPI is incorporated, (2) filed with and made

public by a stock exchange on which the FPI’s securities are traded or (3) distributed to the FPI’s security

holders. Depending on the local law and stock exchange requirements, this information may include certain

financial information about acquisitions or disposals. However, Form 6-K does not include an item analogous

to Item 2.01 of Form 8-K.

Pro forma financial information must be provided in or incorporated by reference into FPI registration

statements (i.e., F-1, F-3, F-4, registration statements on Form 20-F) consistent with the respective

requirements above for domestic registration statements. Similar to domestic registrants, FPIs are not

required to provide pro forma financial information in annual reports on Form 20-F.

Pro forma financial information | 14

4 Preparation of pro forma financial

information

4.1 General form and content

Excerpt from SEC rules and regulations

Regulation S-X, Article 11 Pro Forma Financial Information

Rule 11-02(a), Preparation requirements, Form and content

(1) Pro forma financial information must consist of a pro forma condensed balance sheet, pro forma

condensed statements of comprehensive income, and accompanying explanatory notes. In

certain circumstances (i.e., where a limited number of pro forma adjustments are required and

those adjustments are easily understood), a narrative description of the pro forma effects of the

transaction may be disclosed in lieu of the statements described in this paragraph (a)(1).

(2) The pro forma financial information must be accompanied by an introductory paragraph which

briefly sets forth a description of (i) each transaction for which pro forma effects is being given,

(ii) the entities involved, (iii) the periods for which the pro forma financial information is presented,

and (iv) an explanation of what the pro forma presentation shows.

(3) The pro forma condensed financial information need only include major captions (i.e., the

numbered captions) prescribed by the applicable sections of Regulation S-X. Where any major

balance sheet caption is less than 10 percent of total assets, the caption may be combined with

others. When any major statement of comprehensive income caption is less than 15 percent of

average net income attributable to the registrant for the most recent three fiscal years, the caption

may be combined with others. In calculating average net income attributable to the registrant,

loss years should be excluded unless losses were incurred in each of the most recent three years,

in which case the average loss must be used for purposes of this test. Notwithstanding these

tests, de minimis amounts need not be shown separately.

(4) Pro forma statements will ordinarily be in columnar form showing condensed historical

statements, pro forma adjustments, and the pro forma results.

(5) The pro forma condensed statement of comprehensive income must disclose income (loss) from

continuing operations and income or loss from continuing operations attributable to the

controlling interest.

Article 11 pro formas generally consist of an introductory section, pro forma condensed balance sheet,

pro forma condensed statements of comprehensive income and explanatory notes. Pro forma statements of

cash flows or shareholders’ equity are not required. While Article 11 uses the term “pro forma statement

of comprehensive income,” pro forma financial information is not required for other comprehensive

income (OCI),

so Article 11 effectively requires the equivalent of an income statement through income

(loss) from continuing operations. Accordingly, we have used the term “income statement” throughout this

publication to refer to the statement of comprehensive income required under Article 11.

The statement of comprehensive income usually includes all components of net income and OCI. OCI includes all nonowner changes in

equity that are included in comprehensive income but excluded from net income (e.g., unrealized gains/losses on available-for-

sale securities, foreign currency translation adjustments, gains/losses associated with pension or other post-retirement benefits).

4 Preparation of pro forma financial information

Pro forma financial information | 15

The pro forma financial statements are presented in columnar form with separate columns depicting the

historical financial information of the registrant, the historical financial information of the businesses that

have been acquired or disposed of (if applicable), the pro forma adjustments (as described in section 4.4)

and a total or combined column.

The requirements of Article 11 apply to all registrants, although smaller reporting companies can

condense the information in accordance with Regulation S-X 8-03(a).

4.2 Required statements and periods presented

A registrant’s pro formas typically include the most recent condensed balance sheet and condensed

income statement for its most recent annual and year-to-date interim period. These statements must

include the captions required by Article 5 of Regulation S-X but can be condensed as described below.

De minimis amounts do not need to be shown separately.

The age of the pro forma balance sheet and income statements are determined at the earlier of the filing

or due date of the initial Item 2.01 Form 8-K for a significant acquisition or disposal and at the filing and

effective date of a registration statement (or mailing date of a proxy statement) for all transactions.

Excerpt from SEC rules and regulations

Regulation S-X, Article 11 Pro forma financial information

Rule 11-02(c), Preparation requirements, Periods to be presented

(1) A pro forma condensed balance sheet as of the end of the most recent period for which a

consolidated balance sheet of the registrant is required by Regulation S-X Rule 3-01 must be filed

unless the transaction is already reflected in such balance sheet.

(2) (i) Pro forma condensed statements of comprehensive income must be filed for only the most

recent fiscal year, except as noted in paragraph (c)(2)(ii) of this section, and for the period

from the most recent fiscal year end to the most recent interim date for which a balance

sheet is required. A pro forma condensed statement of comprehensive income may be filed

for the corresponding interim period of the preceding fiscal year. A pro forma condensed

statement of comprehensive income must not be filed when the historical statement of

comprehensive income reflects the transaction for the entire period.

(ii) For transactions required to be accounted for under US GAAP or, as applicable, IFRS-IASB by

retrospectively revising the historical statements of comprehensive income (e.g., combination

of entities under common control and discontinued operations), pro forma statements of

comprehensive income must be filed for all periods for which historical financial statements of

the registrant are required. Retrospective revisions stemming from the registrant’s adoption of

a new accounting principle must not be reflected in pro forma statements of comprehensive

income until they are depicted in the registrant’s historical financial statements.

(3) Pro forma condensed statements of comprehensive income must be presented using the

registrant’s fiscal year end. If the most recent fiscal year end of any other entity involved in the

transaction differs from the registrant’s most recent fiscal year end by more than one fiscal

quarter, the other entity’s statements of comprehensive income must be brought up to within one

fiscal quarter of the registrant’s most recent fiscal year end, if practicable. This updating could be

accomplished by adding subsequent interim period results to the most recent fiscal year end

information and deducting the comparable preceding year interim period results. Disclosure must

be made of the periods combined and of the sales or revenues and income for any periods which

were excluded from or included more than once in the condensed pro forma statements of

comprehensive income (e.g., an interim period that is included both as part of the fiscal year and

the subsequent interim period).

4 Preparation of pro forma financial information

Pro forma financial information | 16

Instruction 1 to paragraph (c)(3) In circumstances where different fiscal year ends exist,

Regulation S-X Rule 3-12 may require a registrant to include in the pro forma financial information

an acquired or to be acquired foreign business historical period that would be more current than

the periods included in the required historical financial statements of the foreign business.

(4) Whenever unusual events enter into the determination of the results shown for the most recently

completed fiscal year, the effect of such unusual events should be disclosed and consideration

should be given to presenting a pro forma condensed statements of comprehensive income for

the most recent twelve-month period in addition to those required in paragraph (c)(2)(i) of this

section if the most recent twelve-month period is more representative of normal operations.

4.2.1 Pro forma condensed balance sheet

A registrant must include a pro forma condensed balance sheet as of the end of the most recent annual or

interim period filed or required to be filed by S-X Rule 3-01. If financial statements for the registrant’s most

recently completed annual or interim period are not yet required or included in the filing, the pro forma

financial information would be as of the most recent balance sheet included in the filing.

Generally, the historical balance sheet of an acquired business included in a pro forma presentation should

be as of the same date unless the business has a different fiscal year end (refer to section 4.2.4, Combining

entities with different fiscal years).

If the transaction is already reflected in the registrant’s latest balance sheet included in the filing, a

pro forma balance sheet is not required. For example, a pro forma balance sheet reflecting a significant

acquisition or disposal that closed during the first quarter is not required when a registrant incorporates

its first-quarter Form 10-Q by reference into a registration statement.

The pro forma balance sheet can be condensed by combining items that are less than 10% of total assets

with others.

4.2.2 Pro forma condensed income statement

Pro forma income statements are required for the registrant’s most recent fiscal year and any subsequent

year-to-date interim period filed or required to be filed by S-X Rule 3-02. Generally, the historical income

statements of an acquired business should be for the same periods, unless the business has a different

fiscal year end, in which case specific rules apply (refer to section 4.2.4, Combining entities with different

fiscal years).

An income statement for the corresponding interim period of the preceding fiscal year is optional. Once

the transaction has been reflected in a registrant’s results for an entire period required to be presented

in the pro formas, that period is not required and should not be presented. In addition, as discussed in

section 3.2, a registrant is able to omit the pro formas related to an acquisition if it can omit the separate

financial statements required by S-X Rules 3-05 or 3-14.

S-X Rule 11-02(c)(2) prohibits a registrant from presenting more than one annual period of pro forma

results of operations unless one of the transactions described in section 4.2.2.1 below is involved.

Registrants present the pro forma income statements through income (loss) from continuing operations

attributable to the registrant. Discontinued operations would not be shown in the condensed historical

financial statements used as the starting point for the pro forma presentation. Registrants can also elect

to present an allocation of the income or loss to noncontrolling interests.

4 Preparation of pro forma financial information

Pro forma financial information | 17

In addition, any income statement caption that is less than 15% of average net income attributable to the

registrant for the most recent three fiscal years can be combined with others. When calculating average net

income attributable to the registrant, a registrant excludes losses, unless it incurred losses in each of the

most recent three years, in which case the average loss recorded in those years is used.

A registrant also must disclose, on the face of the pro forma income statement, basic and diluted

earnings per share (EPS) from continuing operations attributable to the registrant and the number of

shares used in the computation, on both a historical and pro forma basis, giving effect only to the

transaction accounting adjustments and autonomous entity adjustments discussed in more detail below.

The weighted average number of shares outstanding during the period should be adjusted to give effect

to any shares that have been or will be issued to consummate the transaction as if the shares were

outstanding as of the beginning of the period presented. The potential dilutive effect of any convertible

securities issued or to be issued as part of the transaction should also be considered.

4.2.2.1 Pro forma income statement required for all fiscal years presented

As noted above, a registrant is prohibited from presenting more than one annual period in its pro forma

income statements unless the transaction requiring the pro formas is accounted for as:

• A reorganization of entities under common control (ASC 805, Business Combinations)

• Discontinued operations (ASC 205, Presentation of Financial Statements) not yet reflected in the

historical financial statements

In these cases, pro forma income statements must include all annual historical financial statement

periods presented in a registrant’s filing.

Common control transactions include a transfer of net assets or an exchange of equity interests between

entities under common control. An example would be the contribution of a business by a parent company

to its consolidated subsidiary that reports separately as a registrant. In this example, the subsidiary

would account for the receipt of the business as a common control transaction. See our FRD publication,

Business combinations, for more information about accounting for common control transactions.

If a transaction that will be accounted for as a reorganization of entities under common control occurs

after the date of the registrant’s latest balance sheet included in a registration statement or proxy

statement and post-transaction financial statements reflecting the reorganization have not been issued,

pro forma income statements included in the registration statement or proxy statement are required for

each fiscal year (and any subsequent interim period, as applicable) for which the registrant’s historical

financial statements are presented in the filing and in which the entities were under common control.

Refer to section 5.5.1 for a discussion of the pro forma adjustments and presentation of EPS when there

is a reorganization of entities under common control.

A new registration or proxy statement filed before any financial statements of a registrant reflecting

discontinued operations must include pro forma income statements for all fiscal years for which financial

statements are presented and any subsequent interim period, as applicable. Likewise, a Form 8-K reporting

a significant disposal that has occurred, and that has not yet been but ultimately will be reflected in the

registrant’s historical annual financial statements as a discontinued operation, also needs to include pro forma

income statements for all fiscal years included in the registrant’s prior-year annual report. Refer to our FRD

publication, Discontinued operations, for the criteria that must be met for reporting discontinued operations.

4.2.2.2 Pro forma information reflects common control (or discontinued operations) and other

transactions

The SEC staff believes that the periods for which pro forma income statements should be presented generally

should be based on the transaction that triggers the pro forma reporting requirements.

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As discussed in section 4.2.2.1, pro forma income statements are required for all fiscal years for which

financial statements are required if the purpose of the pro formas is to reflect a common control

transaction or discontinued operation. In these cases, the common control transaction or discontinued

operation would be considered the “primary” or “triggering” transaction for the pro formas.

All other transactions, regardless of whether they are related to the primary transaction (e.g., new financing

to fund the common control transaction, a shared-services arrangement) or unrelated to the primary

transaction (e.g., an unrelated significant acquisition), should be reflected in the pro forma income statements

only for the most recent annual and subsequent interim period, as applicable. Thus, the pro forma income

statements for the earlier annual periods would only contain adjustments for the common control transaction

or discontinued operation. That is, the pro forma combined column of the earlier annual periods should

match the recasted income statements for the respective periods that the registrant expects to file in its

next annual report.

Sometimes, pro formas may be voluntarily included for a common control transaction or a discontinued

operation when the transaction is not significant or when it is being included as an additional transaction

in pro forma financial information filed on Form 8-K (or in a proxy or registration statement) for an

unrelated transaction, which separately “triggered” the pro forma requirements. In these circumstances,

pro forma income statements would be presented only for the latest annual and subsequent interim

period, as applicable, as required for the triggering transaction, rather than all periods.

For example, a registrant may be required to provide pro formas in a merger proxy to reflect a proposed

business acquisition when it has also had an insignificant discontinued operation transaction that has not

yet been reflected in its historical financial statements. Pro forma income information is required only for

the latest annual and subsequent interim period, if any, even if the discontinued operation is reflected in

those period(s). Nonetheless, the SEC staff has said that the registrant may choose to also include pro

forma income statements for the earlier annual periods reflecting only the discontinued operation.

4.2.2.3 Historical results include unusual events

S-X 11-02(c)(4) requires registrants to disclose unusual events that affect the operating results

presented for the most recently completed fiscal year.

Registrants should also consider presenting an

additional pro forma income statement for the most recent 12-month period (e.g., trailing 12 months) if

it is more representative of normal operations. However, the effects of the unusual events should not be

eliminated from the pro forma presentation. In certain circumstances, registrants may determine that it

is more appropriate to present a financial forecast in lieu of a pro forma income statement. For further

discussion, refer to section 6.2, Financial forecasts.

4.2.3 Filing of a Form 10-Q or Form 10-K during the Form 8-K extension period

As discussed previously, the age of the pro forma financial statements to be included in a Form 8-K is

determined at the earlier of the filing or due date of the initial Item 2.01 Form 8-K related to a significant

acquisition. A registrant that files a Form 10-Q or Form 10-K after the initial Form 8-K has been filed and

before the end of the 71-day grace period is not required to file pro forma financial information through

the end of that fiscal quarter or fiscal year. When the registrant amends the Form 8-K to file pro forma

information, it can provide that information through the date of either (1) the latest financial statements

filed or required to be filed before the initial Form 8-K, or (2) the interim or annual financial statements

filed before the amended Form 8-K.

Although not specified in the rules, in practice this requirement also is applicable to any interim pro forma income statements required.

4 Preparation of pro forma financial information

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If the registrant chooses the second option, and the pro forma reporting period includes the acquistion date,

the registrant should avoid any doublecounting of the acquiree’s operating results in the pro forma income

statement. This could be accomplished by using only the acquiree stub period that ended on the acquisition

date. Furthermore, when a registrant chooses the second option, it will not be required to present a pro

forma balance sheet if the transaction is already reflected in the latest balance sheet filed with the SEC.

4.2.4 Combining entities with different fiscal years

The pro forma income statement must be presented based on the fiscal year of the registrant. If the

registrant and an acquired business have different fiscal year ends, the following special rules apply:

• If the difference between the acquired business’s year end and registrant’s year end is one quarter or

less, the registrant generally combines its annual income statement with that of the acquired

business for the same fiscal year. That is, the historical financial information of the acquired business

is not required to be adjusted when presenting in the pro formas.

• If the difference between the acquired business’s year end and the registrant’s year end is more than

one quarter, the registrant should use an income statement of the acquired business for a 12-month

period that ends within one quarter of the registrant’s year end. This is accomplished by adding

subsequent interim-period results to the latest fiscal year-end information and subtracting interim-

period financial information of the comparable period in the preceding year.

Similarly, if an interim period is required, the length of the periods presented for the registrant and the

acquired business should be the same, and the periods must end not more than one quarter apart. If

required, the acquired business’s balance sheet should be dated at the end of its latest income statement

period included in the presentation (either annual or interim).

The periods that are being combined for both the fiscal-year and interim-period pro forma income

statements must be disclosed. In addition, revenue and income must be disclosed for any periods

excluded from the historical results of the acquired business or included more than once (e.g., the same

months are included in both the annual and interim income statements presented in the pro formas).

Illustration 4-1: Excluding interim periods or including them twice

Registrant A acquires Company B on 15 September 20X1. Registrant A’s fiscal year ends on

31 December, and Company B’s ends on 31 July. Company B is 30% significant to Registrant A.

Registrant A must file a Form 8-K that includes pro forma income statements for the year ended

31 December 20X0 and the six months ended 30 June 20X1.

Registrant A has the following options for the historical periods of Company B to include in the pro

forma income statements (assuming the periods used align with Company B’s fiscal quarters):

Annual period:

Option 1: 12 months ended 31 October 20X0

Option 2: 12 months ended 31 January 20X1

Interim period:

Option 1: Six months ended 30 April 20X1

Option 2: Six months ended 31 July 20X1

Revenue and income must be disclosed for the quarter ended 31 January 20X1 if the quarter is

excluded from the presentation (i.e., Registrant A uses Company B’s results for the annual period

ended 31 October 20X0 and the six months ended 31 July 20X1), or included twice (i.e., Registrant A

uses the annual period ended 31 January 20X1 and the six months ended 30 April 20X1).

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4.2.5 Changes in fiscal year end

Rules 13a-10 and 15d-10 of the Exchange Act provide the SEC’s reporting and filing requirements when

a registrant changes its fiscal year end or a successor issuer has a different fiscal year end than its

predecessor. These rules designate as the “transition period” the short period between the end of the

registrant’s most recent fiscal year and the opening date of its newly selected fiscal year (e.g., a change in

fiscal year from 31 December to 30 September would result in a nine-month transition period). Similarly,

the reports required by Rules 13a-10 and 15d-10 are designated “transition reports.” Our publication, SEC

annual reports — Form 10-K, includes more information on transition reports covering the transition period.

Pursuant to S-X Rule 3-06, a transition period of nine months or more is considered to approximate a full

year. If a pro forma condensed income statement is required in the year after a registrant has changed

its fiscal year end and has filed a transition report on Form 10-K for a period of nine months or more, the

registrant can satisfy that requirement by providing a pro forma condensed income statement for the

transition period. In this case, the historical financial information of the acquiree would be presented for

the same number of months as the registrant’s transition period.

When the transition period is less than nine months, a pro forma condensed income statement that

satisfies the requirement for one year may include either:

• A pro forma income statement for a nine- to 12-month period ending on the registrant’s new fiscal year

end using a combination of the transition period and earlier periods to satisfy the nine- to 12-month

requirement in S-X Rule 3-06 (accompanied by the year-to-date interim period subsequent to the

transition period, as applicable)

• A pro forma income statement for the registrant’s previous full fiscal year, along with pro forma

income statement(s) for the subsequent transition period and any year-to-date interim period

subsequent to the transition period

The periods of the registrant and an acquired business are subject to the one-quarter rule (i.e., the acquired

business’s period end should not be more than one quarter apart from the registrant’s period end). In

addition, the length of the income statement period of an acquired business should be consistent with that

of the registrant (i.e., the length of the period presented for the registrant and acquiree should match). The

respective periods being combined should be disclosed.

Illustration 4-2: Change in fiscal year end

A registrant changed its fiscal year from 30 April 20X2 to 31 December 20X2 and filed a transition report

on Form 10-K for the eight-month period ended 31 December 20X2. The registrant acquired Company B

on 31 July 20X3. Company B is a calendar-year company and is 25% significant to the registrant under S-X

Rule 3-05. The registrant is required to file an Item 9.01 Form 8-K to include Rule 3-05 financial

statements of Company B and pro forma financial information of the combined entity. The registrant has

the following options for its pro forma income statement(s) required to satisfy the one-year requirement:

Option 1: Using the registrant’s new fiscal year

Registrant (12 months)

Company B

Transition period

5/1/20X2 to 12/31/20X2

1/1/20X2 to 12/31/20X2

Plus

Last four-month of old fiscal year

1/1/20X2 to 4/30/20X2

Because the transition period is only eight months, under this option, the period from 1 January to

30 April 20X2 is added to the transition period to comply with S-X Rule 3-06. Using this option, the

length of the periods in the pro forma presentation for the Registrant and Company B match and end

within one quarter by using the historical income statement of Company B for its fiscal year 20X2.

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Option 2: Using the registrant’s old fiscal year

Registrant

Company B

Transition period

5/1/20X2 to 12/31/20X2

Preceding 12-month period

5/1/20X1 to 4/30/20X2

5/1/20X1 to 12/31/20X1

(i.e., registrant’s old fiscal year)

plus

1/1/20X2 to 4/30/20X2*

Under this option, the pro forma presentation includes both the transition period (aligned to the same

period for Company B) and the Registrant’s preceding 12-month period (aligned to a 12-month period

for Company B that ends within one quarter*).

* The 12-month period of Company B could also be (1) the 12-month period ended 31 March 20X2 (i.e., the end of its first fiscal

quarter), in which case the period end dates would be within one quarter, but Company B’s results for April 20X2 would be

omitted from the pro forma presentation, or (2) the 12-month period of Company B ended 30 June 20X2, in which case the

period end dates would be within one quarter, but Company B’s results for May and June 20X2 would be included in the pro

forma income statements for both the transition period and the preceding 12-month period. If either of these alternatives are

used, the additional disclosures described in section 4.2.4 must be provided.

4.2.6 Narrative disclosure only

In limited cases when there are only a few adjustments that are easy to understand, a registrant can

provide a narrative description of the pro forma effects of the transaction instead of Article 11 pro formas.

Illustration 4-3: Narrative disclosure only example

On 1 February 20X4, a registrant acquired the remaining 40% noncontrolling interest in a subsidiary

that it already consolidated. Because the acquisition of the noncontrolling interest is significant to

the registrant (i.e., greater than 20% significant based on the tests specified in Rule 1-02(w) of

Regulation S-X), the registrant is required to include pro forma information on the acquisition of the

additional interest in a Form 8-K by 16 April 20X4.

There are only two adjustments necessary and they are easy to understand. The registrant only needs

to reclassify the noncontrolling interest within equity in the balance sheet and the income attributable

to noncontrolling interest holders in the income statement.

The registrant might provide the following narrative disclosures related to the pro forma

financial information in lieu of pro forma financial statements:

Narrative description of the pro forma effects of the transaction

On 1 February 20X4, the Company acquired the remaining 40% noncontrolling interest in XYZ Inc.,

which is a consolidated subsidiary of the Company, for $100 million in cash.

If the transaction had occurred on 31 December 20X3, the pro forma balance sheet would have reflected

an adjustment to reduce cash by $100 million and total shareholders’ equity by $100 million (of which

$90 million would reduce the carrying amount of the noncontrolling interest as of 31 December 20X3 and

$10 million would reduce additional paid-in capital). As of 31 December 20X3, pro forma total assets

and shareholders’ equity would have been $385 million and $220 million, respectively. If the transaction

had occurred on 1 January 20X3, the pro forma income statement would have been adjusted to

reclassify the net income of $25 million attributable to noncontrolling interests to net income

attributable to controlling interests. Pro forma net income attributable to controlling interests would

have been $70 million for the year ended 31 December 20X4. Pro forma basic and diluted EPS would

have increased $0.25 per share to $0.70 per share.

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Pro forma financial information | 22

4.3 Updating pro formas

The age of pro formas included in a registration statement is based on the age of the registrant’s

financial statements required by S-X Rule 3-12 (or S-X 8-08 for smaller reporting companies) at the date

the registration statement is filed as well as when it becomes effective.

When amending an existing registration statement (i.e., post-effective amendment) or filing a new one,

a registrant may need to update previously filed pro forma information (e.g., filed on Form 8-K). The pro

forma income statements must be kept current in new or amended registration statements until the

registrant is able to omit the historical financial statements of the acquired business required by Rule 3-05

from the registration statement. The pro forma balance sheet must also be updated until the transaction

is reflected in the registrant’s latest balance sheet filed with the SEC.

For registration statements, an FPI would follow the financial statement age requirements in Item 8 of

Form 20-F (i.e., Items 8.A.4 and 8.A.5).

Illustration 4-4: Updating pro formas in a registration statement

Registrant A acquires Company B on 1 June 20X1. Company B is 25% significant to Registrant A,

and both are calendar year-end companies. Registrant A files a Form 8-K that includes the financial

statements of Company B for the year ended 31 December 20X0 and the interim period ended

31 March 20X1. The Form 8-K also includes pro formas for the same periods.

Registrant A files a new registration statement on 1 December 20X1 that incorporates by reference

the Form 8-K and Registrant A’s Form 10-Q as of 30 September 20X1. Registrant A must update the

pro formas in the registration statement through 30 September 20X1 to correspond with its latest

interim period that is incorporated by reference.

As a result, the pre-acquisition interim results of Company B included in the pro formas would be

updated in the registration statement to cover the stub period from 1 January 20X1 through 1 June

20X1 (i.e., the date of the acquisition). Registrant A should not file a pro forma balance sheet as of

30 September 20X1 because Company B is already consolidated in its Form 10-Q that is incorporated

by reference.

The updated pro forma income statement would be required for any new or amended registration

statement filed before Registrant A’s annual audited financial statements for fiscal year 20X2 are filed

with the SEC.

This contrasts with the updating requirements for Rule 3-05 financial statements because there is no

requirement to update those for Company B in the registration statement since Company B’s latest

interim financial statements before the acquisition (i.e., 31 March 20X1) have already been filed

under Item 9.01 of Form 8-K and are incorporated by reference.

However, Company B’s Rule 3-05 financial statements would have to be included or incorporated by

reference into every new or amended registration statement filed by Registrant A until the registrant

files its annual report for 20X2 (i.e., once Company B has been included Registrant A’s audited results

for nine months). However, Company B’s pre-acquisition balance sheet may be omitted once

Registrant A files its annual report for 20X1 reflecting the acquisition.

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4.4 Pro forma adjustments

A registrant makes transaction accounting adjustments to show how a transaction would have affected

the historical financial information of the registrant. Autonomous entity adjustments are used to show

what a new registrant that was part of another entity would have looked like as a standalone entity

(e.g., in a spin-off transaction). A registrant can also elect to present management’s adjustments that

provide supplemental forward-looking information.

4.4.1 Transaction accounting adjustments

Excerpt from SEC rules and regulations

Regulation S-X, Article 11 Pro Forma Financial Information

Rule 11-02(a), Preparation requirements, Form and content

(6) The pro forma condensed balance sheet and pro forma condensed statements of comprehensive

income must include, and be limited to, the following pro forma adjustments, except as noted in

paragraph (a)(7) of this section:

(i) Transaction Accounting Adjustments.

(A) Adjustments that depict in the pro forma condensed balance sheet the accounting for

the transaction required by US Generally Accepted Accounting Principles (US GAAP) or,

as applicable, International Financial Reporting Standards as issued by the International

Accounting Standards Board (IFRS-IASB). Calculate pro forma adjustments using the

measurement date and method prescribed by the applicable accounting standards. For a

probable transaction, calculate pro forma adjustments using, and disclose, the most

recent practicable date prior to the effective date (for registration statements), qualification

date (for Regulation A offering statements), or the mail date (for proxy statements).

(B) Adjustments that depict in the pro forma condensed statements of comprehensive

income the effects of the pro forma balance sheet adjustments in paragraph (a)(6)(i)(A)

of this section assuming those adjustments were made as of the beginning of the fiscal

year presented. Such adjustments must be made whether or not the pro forma balance

sheet is presented pursuant to paragraph (c)(1) of this section. If the condition in

Rule 11-01(a) that is met does not have a balance sheet effect, then depict the

accounting for the transaction required by US GAAP or IFRS-IASB, as applicable.

Transaction accounting adjustments are defined as those that:

• Depict in the pro forma balance sheet the accounting for the transaction required by US GAAP or IFRS-IASB

• Depict in the pro forma income statements the effects of the pro forma balance sheet adjustments,

assuming those adjustments were made as of the beginning of the fiscal year presented

In an acquisition, transaction accounting adjustments should reflect the recognition of the identifiable

assets acquired and liabilities assumed as prescribed by ASC 805 (i.e., the purchase price allocation).

The effects of the purchase price allocation on the registrant’s results after the acquisition

(e.g., amortization of acquired intangible assets) should also be reflected as of the beginning of the fiscal

year presented and reflected through any interim period, as applicable.

Additionally, some provisions in an acquisition agreement may require transaction accounting

adjustments beyond those related to the purchase price allocation. For example, a registrant might

record compensation expense after the acquisition because it was required by the agreement to modify

certain stock-based awards. Another example might be when a registrant records a tax benefit

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Pro forma financial information | 24

immediately after the acquisition because it can use the acquired deferred tax liabilities to reduce its

deferred tax valuation allowance. The SEC staff has also said that accounting for transaction costs

related to a business combination should be included.

In a disposal, transaction accounting adjustments should reflect the consideration received and the removal

of the assets, liabilities and operations that are disposed of. The registrant would not present a line item

for discontinued operations, even if the disposal qualifies as a discontinued operation (see section 4.2.2).

We believe most other items related to acquisition and disposal transactions should be evaluated under

S-X 11-01(a)(8) to determine whether they are separate material transactions. Under this rule, a registrant

presents pro forma financial information for “an event or transaction that has occurred or is probable

for which disclosure of pro forma financial information would be material to investors” (e.g., obtaining

financing to fund an acquisition, repaying debt with proceeds from a disposal). The illustrations in section 5

identify related transactions that are separately evaluated under S-X 11-01(a)(8).

Identifying items as separate material transactions under Article 11 triggers additional disclosure requirements.

Specifically, each transaction must be described in the introductory section, and the adjustments related

to such transactions must be shown separately (i.e., separate columns). See also the discussion below

about the disclosures required in the introductory section and the required columnar presentation.

We believe companies should focus primarily on making sure all material aspects of a business combination

or disposal are reflected in the pro forma combined amounts and that the pro forma financial information is

understandable. Accordingly, we believe that a registrant could present the separate material transactions

in a single column unless combining the transactions would mislead investors.

The income tax effects of the transaction accounting adjustments should also be reflected (as a separate

adjustment) and calculated based on the statutory rate in effect during the periods for which the pro

forma income statement is being presented. If taxes are calculated using a rate other than the statutory

rate in effect or if there are unusual effects of other aspects of tax accounting (e.g., loss carryforwards),

the registrant should provide an explanation in a note to the pro forma financial information.

The adjustments reflected in the pro forma balance sheet will not necessarily reconcile with the

adjustments in the pro forma income statement, because the pro forma balance sheet assumes the

transaction occurred on the balance sheet date, while the pro forma income statement assumes the

transaction occurred at the beginning of the fiscal year presented.

For example, if the pro forma income statement reflects amortization expense for intangible assets recorded

as part of the purchase price allocation transaction adjustments, a corresponding adjustment to accumulated

amortization would not be appropriate because the pro forma balance sheet assumes the transaction

occurred on that date. See further discussion of this difference in section 5.1.5, Intangible assets.

4.4.1.1 Nonrecurring items

A registrant should make transaction accounting adjustments for nonrecurring items (i.e., revenues,

expenses, gains and losses that will not recur in the income of the registrant beyond 12 months after the

acquisition) and the related tax effects in the pro forma income statement. The SEC staff has said that

transaction accounting adjustments for nonrecurring items should be made to the annual period because

the acquisition is assumed to occur at the beginning of that period, and these items are typically

expenses that are recognized in the historical results of the registrant shortly after the acquisition.

In addition, the explanatory notes to the pro forma presentation must identify any nonrecurring items

and the related tax effects.

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4.4.2 Autonomous entity adjustments

Excerpt from SEC rules and regulations

Regulation S-X, Article 11 Pro Forma Financial Information

Rule 11-02(a), Preparation requirements, Form and content

(6) (ii) Autonomous Entity Adjustments. Adjustments that depict the registrant as an autonomous

entity if the condition in Rule 11-01(a)(7) is met. Autonomous Entity Adjustments must be

presented in a separate column from Transaction Accounting Adjustments.

Autonomous entity adjustments are only needed when a registrant was previously part of another entity and

investors need to see what the registrant would have looked like as a standalone entity. These adjustments

are typically required in connection with a public company’s spin-off of a portion of its business to its

shareholders that will report as a separate public company. In these cases, a formal agreement between

the parent and the business being spun off is often established that sets forth the terms of administrative

services that the parent will continue to provide to the new registrant. Adjustments may be necessary

because the separate financial statements of the business being spun off may include allocations of the

parent’s historical expenses that do not reflect what the business will incur on a standalone basis (e.g., under

an administrative services agreement). Such transactions would not qualify as transaction accounting

adjustments and must be shown separately as autonomous entity adjustments.

We believe that adjustments beyond those necessary to address the allocations described above should

generally be considered management’s adjustments. An example would be additional costs that the

newly separated company expects to incur as a public company.

Further, the SEC staff has said that when a registrant prepares pro formas for a spin-off transaction, it

should carefully differentiate between autonomous entity adjustments, which are required, and

management adjustments (see section 4.4.3 for further discussion), which are not required and can only

appear in the explanatory notes.

Changes in the spun-off entity’s costs that are evidenced by agreements (such as new lease arrangements

or transaction service arrangements) can be reflected as autonomous entity adjustments. Such changes

that are not evidenced by agreements should be evaluated carefully when determining whether to include

them as autonomous entity adjustments. Alternatively, such changes may be synergies or dis-synergies

reflected as management’s adjustments.

4.4.3 Management’s adjustments

Excerpt from SEC rules and regulations

Regulation S-X, Article 11 Pro Forma Financial Information

Rule 11-02(a), Preparation requirements, Form and content

(7) Management’s Adjustments. Adjustments depicting synergies and dis-synergies of the

acquisitions and dispositions for which pro forma effect is being given may, in the registrant’s

discretion, be presented if in its management’s opinion, such adjustments would enhance an

understanding of the pro forma effects of the transaction and the following conditions are met:

(i) Basis for Management’s Adjustments

(A) There is a reasonable basis for each such adjustment.

(B) The adjustments are limited to the effect of such synergies and dis-synergies on the historical

financial statements that form the basis for the pro forma statement of comprehensive

income as if the synergies and dis-synergies existed as of the beginning of the fiscal year

presented. If such adjustments reduce expenses, the reduction must not exceed the

amount of the related expense historically incurred during the pro forma period presented.

4 Preparation of pro forma financial information

Pro forma financial information | 26

the opinion of management, necessary to a fair statement of the pro forma financial

information presented and a statement to that effect is disclosed. When synergies are

presented, any related dis-synergies must also be presented.

(ii) Form of Presentation.

(A) If presented, Management’s Adjustments must be presented in the explanatory notes to

the pro forma financial information in the form of reconciliations of pro forma net

income from continuing operations attributable to the controlling interest and the

related pro forma earnings per share data specified in paragraph (a)(9) of this section

to such amounts after giving effect to Management’s Adjustments.

(B) Management’s Adjustments included or incorporated by reference into a registration

statement, proxy statement, Regulation A offering statement, or Form 8-K should be as

of the most recent practicable date prior to the effective date, mail date, qualification

date, or filing date as applicable, which may require that they be updated if previously

provided in a Form 8-K that is appropriately incorporated by reference.

shares, reflect the change within Management’s Adjustments in accordance with US

GAAP or IFRS-IASB, as applicable, as if the common stock or potential common stock

were outstanding as of the beginning of the period presented.

(D) The explanatory notes must also include disclosure of the basis for and material

limitations of each Management’s Adjustment, including any material assumptions or

uncertainties of such adjustment, an explanation of the method of the calculation of the

adjustment, if material, and the estimated time frame for achieving the synergies and

dis-synergies of such adjustment.

Instruction to paragraph (a)(7). Any forward-looking information supplied is expressly

covered by the safe harbor rules under Rule 175 under the Securities Act and Rule 3b-6

under the Exchange Act.

4.4.3.1 Identifying and quantifying the adjustments

Registrants have the option, but are not required, to present adjustments that include forward-looking

information (i.e., synergies and related costs) related to a transaction, if management believes that such

adjustments would enhance readers’ understanding of the pro forma effects of the transaction.

Management must have a reasonable basis for each adjustment, and all adjustments “necessary to a fair

statement of the pro forma information presented” must be included (e.g., when synergies are

presented, related dis-synergies must also be presented). In addition, a registrant must state in its

disclosure that all such adjustments are included.

If management’s adjustments reduce expenses reflected in the historical financial statements

(e.g., compensation expense due to employee terminations), the reductions are limited to the amount of

the related expenses that were incurred. That is, management’s adjustment to reduce compensation

expense for an employee expected to be terminated cannot exceed the amount recorded in the period

for that employee. Any costs to achieve the savings (e.g., severance payments for terminated

employees) also must be included to the extent necessary for a fair presentation.

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4.4.3.2 Disclosures about each adjustment

Management’s adjustments can only appear in the explanatory notes to the pro formas, and the total

effect is reconciled to pro forma net income from continuing operations attributable to the registrant and

the related pro forma EPS.

The explanatory notes must also include all of the following information for each adjustment:

• The basis for the adjustment and any material limitations

• Material assumptions and uncertainties

• An explanation of the method of the calculation

• The estimated time frame for achieving the synergies and realizing the related inefficiencies

4.4.3.3 Updating the disclosures

Management’s adjustments should be determined as of the most recent practicable date before the filing

date of a Form 8-K or the filing and effective date of a registration statement. This is similar to the

obligation to update the transaction accounting adjustments for a probable acquisition.

4.4.3.4 Disclosing management’s adjustments elsewhere in a filing

If a registrant presents management’s adjustments outside of the pro forma presentation in a filing

(e.g., MD&A), it must also disclose the amounts to which they are reconciled (i.e., pro forma net income

from continuing operations attributable to the registrant and the related pro forma EPS). The registrant

must also provide a cross-reference to the reconciliation in the explanatory notes.

4.5 Other content requirements

4.5.1 Introductory section

The introductory section should briefly describe each transaction reflected in the pro formas (including

any transactions considered material under S-X 11-01(a)(8)), the entities involved, the periods covered by

the pro formas and an explanation of what the pro forma presentation shows (including the date on which

the transaction was assumed to occur). It also frequently highlights the inherent limitations of the pro

formas. For example, it often states that the pro forma financial information may not reflect the financial

condition or operating results of a combined or reorganized entity or may not be useful in predicting its

future condition and operating results.

Illustration 4-5: Example of introductory section

The following unaudited pro forma condensed combined financial statements are based on our

historical consolidated financial statements and Company B’s historical consolidated financial

statements as adjusted to give effect to the 20 August 20X4 acquisition of Company B. The unaudited

pro forma condensed combined statements of operations for the six months ended 30 June 20X4

and the 12 months ended 31 December 20X3 give effect to the acquisition as if it had occurred on

1 January 20X3. The unaudited pro forma condensed combined balance sheet as of 30 June 20X4

gives effect to the acquisition of Company B as if it had occurred on that day.

The transaction accounting adjustments for the acquisition consist of those necessary to account for

the acquisition. Separately, the Company will issue approximately $72.5 million in 4.5% fixed-rate debt

with debt issuance cost of $2.5 million, a portion of which will be used to fund the acquisition. The

adjustments related to the issuance of this debt are shown in a separate column as “other transaction

accounting adjustments.”

4 Preparation of pro forma financial information

Pro forma financial information | 28

The pro forma combined financial statements do not necessarily reflect what the combined company’s

financial condition or results of operations would have been had the acquisition and the related financing

occurred on the dates indicated. They also may not be useful in predicting the future financial condition

and results of operations of the combined company. Our actual financial condition and results of operations

may differ significantly from the pro forma amounts reflected herein due to a variety of factors.

4.5.2 Columnar presentation

The pro forma balance sheet and income statement(s) must include a separate column for the historical

financial information of the registrant and, if applicable, historical information of other entities involved

in a transaction such as an acquired business. The transaction accounting adjustments should also be

shown as a separate column in both statements in addition to the combined total. Transaction accounting

adjustments for any related transactions considered material under S-X 11-01(a)(8) will require the

inclusion of at least one additional adjustment column (see section 4.4.1 for further discussion).

When applicable, autonomous entity adjustments must also be shown separately.

In general, pro forma adjustments, as presented in the respective columns, should be clearly presented

to allow the reader to easily understand the nature and amount of each adjustment. That is, adjustments

can either be presented on a standalone basis (i.e., without netting against other adjustments) or by

providing the details of the components of the net adjustment in the notes to the pro forma financial

information. In both cases, the adjustments should include references to notes that sufficiently disclose

the assumptions and/or other relevant information for the adjustment (see further discussion in 4.5.3).

The following illustration shows this columnar presentation for the most recent fiscal year of a registrant

that acquired a business (Company X):

Illustration 4-6: Presentation example

Unaudited Pro Forma Condensed Combined Statements of Operations

Year Ended 31 December 20X3

(In thousands, except per-share information)

Registrant

historical

Company X

historical

Transaction

accounting

adjustments

Notes

Other

transaction

accounting

adjustments

Notes

Pro forma

combined

Revenue

$ 146,300

$ 63,000

—

$ 209,300

Costs of revenue, exclusive of

depreciation and amortization

84,900

28,900

—

113,800

Depreciation and amortization

expense

14,800

9,100

2,400

(a)

26,300

Selling, general and

administrative expense

33,000

21,900

—

54,900

Operating income

13,600

3,100

(2,400)

14,300

Interest income (expense)

1,600

—

(3,400)

(c)

(1,800)

Income before income taxes

15,200

3,100

(2,400)

(3,400)

12,500

Income tax provision (benefit)

4,500

1,100

(504)

(b)

(714)

(d)

4,382

Net income

$ 10,700

$ 2,000

$ (1,896)

(2,686)

$ 8,118

Basic and diluted earnings

per share

$ 1.09

$ 0.83

Weighted average shares

9,800

See accompanying notes to the Unaudited Pro Forma Condensed Combined Financial Information

4 Preparation of pro forma financial information

Pro forma financial information | 29

4.5.3 Explanatory notes

Excerpt from SEC rules and regulations

Regulation S-X, Article 11 Pro forma financial information

Rule 11-02(a), Preparation requirements, Form and content

(11) The accompanying explanatory notes must disclose:

(i) Revenues, expenses, gains and losses and related tax effects which will not recur in the

income of the registrant beyond 12 months after the transaction.

(ii) For Transaction Accounting Adjustments:

(A) A table showing the total consideration transferred or received including its

components and how they were measured. If total consideration includes contingent

consideration, describe the arrangement(s), the basis for determining the amount of

payment(s) or receipt(s), and an estimate of the range of outcomes (undiscounted) or,

if a range cannot be estimated, that fact and the reasons why; and

(B) The following information when the accounting is incomplete: a prominent statement to

this effect; the items for which the accounting depicted is incomplete; a description of

the information that the registrant requires, including, if material, the uncertainties

affecting the pro forma financial information and the possible consequences of their

resolution; an indication of when the accounting is expected to be finalized; and other

available information that will enable a reader to understand the magnitude of any

potential adjustments to the measurements depicted.

(iii) For each Autonomous Entity Adjustment, a description of the adjustment (including the

material uncertainties), the material assumptions, the calculation of the adjustment, and

additional qualitative information about the Autonomous Entity Adjustments, if any,

necessary to give a fair and balanced presentation of the pro forma financial information.

Generally, each adjustment shown in the pro forma balance sheet and income statement(s) should be

accompanied by an explanatory note that clearly explains its basis and any assumptions used in calculating it.

Additional disclosures are required when any accounting for a transaction is incomplete, and there are

specific disclosures required about the consideration paid or received in acquisition and disposal transactions.

In addition, nonrecurring items (see section 4.4.1.1) should be disclosed in the explanatory notes. The

illustrations in section 5, Pro forma adjustment illustrations, show explanatory note disclosures for

common adjustments made in a variety of transactions requiring Article 11 pro formas.

In addition, the effect of any unusual events on the results of operations for the most recent fiscal year

(see section 4.2.2.3) can be disclosed as part of the explanatory notes.

Further, in some transactions, such as an acquisition of a financial institution, certain acquired assets may

be valued at a significant discount compared to the historical cost of the acquired business. When such

discounts can result in a significant effect on earnings (losses) in periods immediately subsequent to the

acquisition that will be progressively eliminated over a relatively short period, the registrant must disclose

the effect of the discounts on reported results of operations for each of the next five years in the

explanatory notes in accordance with S-X 11-02(b).

4 Preparation of pro forma financial information

Pro forma financial information | 30

4.6 Specific or unique circumstances

4.6.1 Pro formas involving multiple transactions

Excerpt from SEC rules and regulations

Regulation S-X, Article 11 Pro Forma Financial Information

Rule 11-02(b), Preparation requirements, Implementation guidance

(4) Multiple transactions.

(i) When consummation of more than one transaction has occurred, or is probable, the pro

forma financial information must present in separate columns each transaction for which pro

forma presentation is required by Regulation S-X Rule 11-01.

(ii) If the pro forma financial information is presented in a proxy or information statement for

purposes of obtaining shareholder approval of one of the transactions, the effects of that

transaction must be clearly set forth.

As discussed in section 4.4.1, a registrant may need to separately evaluate certain transactions that are

related to, for example, an acquisition to determine whether they require separate disclosure under S-X

Rule 11-01(a)(8). There are also situations where multiple separate transactions requiring pro formas

have occurred during a fiscal year or will be probable (e.g., two or more business acquisitions). Generally,

these transactions should be presented in the same pro forma presentation but with separate columns

showing the effects of each.

In some circumstances, a registrant may be required to present pro formas for both a previous

transaction and a proposed transaction in a merger proxy statement or registration statement. In this

case, the pro forma information should have separate columns for the proposed transaction subject to

the merger proxy or registration statement and for the previous transaction. The presentation should

also include a subtotal column that shows the effects of the previous transaction and serves as the

starting point for the proposed transaction.

If the merger proxy or registration statement incorporates by reference pro formas reflecting the

previous transaction (e.g., from a previously filed Form 8-K), the registrant may carry forward the pro

forma information as the starting point when presenting the pro formas for the proposed transaction.

See Item 5 of Form S-4 and Item 14(b)(11) of Schedule 14A.

In these cases, along with appropriate labeling of the pro forma columns, it’s important that the

introductory section provide sufficient disclosure about the nature of the multiple transactions reflected

and how those transactions are reflected in the pro formas.

Illustration 4-7: Multiple unrelated transactions, with one requiring shareholder approval

On 1 May 20X4, Registrant presents pro forma financial information as of and for the year ended

31 December 20X3 in a proxy statement to obtain shareholder approval for the acquisition of Acquiree A.

The pro forma financial information also reflects a separate transaction for the completed acquisition

of Acquiree B that required separate financial statements under Rule 3-05 of Regulation S-X and was

previously reported on Form 8-K in 20X4.

The pro forma financial information should be presented on a disaggregated basis because

shareholders are asked to vote on the proposed acquisition of Acquiree A.

4 Preparation of pro forma financial information

Pro forma financial information | 31

Combined pro forma presentation

• The following shows an example of the separate columns that could be presented in one set of pro

forma financial information that disaggregates the individual transactions:

Unaudited Pro Forma Condensed Combined Balance Sheet [Statement of Operations]

Registrant

historical

financial

statements

Acquiree B

historical

financial

statements

Transaction

accounting

adjustments

(acquisition of

Acquiree B)

Pro forma

financial

information

(adjusted for

acquisition of

Acquiree B)

Acquiree A

historical

financial

statements

Transaction

accounting

adjustments

(acquisition of

Acquiree A)

Pro forma

results

(combined)

Pro forma financial information incorporating pro forma results from the Form 8-K

• Conversely, Registrant may incorporate by reference pro forma financial information from the

Form 8-K. In this case, the pro forma financial information presented for the proposed acquisition

of Acquiree A would carry forward the Registrant’s pro forma results adjusted for the acquisition

of Acquiree B as shown:

Unaudited Pro Forma Condensed Combined Balance Sheet [Statement of Operations]

Registrant pro forma

financial information

(adjusted for acquisition

of Acquiree B)

Acquiree A

historical financial

statements

Transaction

accounting

adjustments

(acquisition of

Acquiree A)

Pro forma results

(combined)

4.6.2 Transactions with range of possible results

Excerpt from SEC rules and regulations

Regulation S-X, Article 11 Pro Forma Financial Information

Rule 11-02(a), Preparation requirements, Form and content

(10) If the transaction is structured in such a manner that significantly different results may occur,

provide additional pro forma presentations which give effect to the range of possible results.

A registrant may need more than one pro forma presentation if a proposed transaction may have

significantly different results. The additional results may be equally important, depending on the facts

and circumstances.

For example, more than one pro forma presentation may be necessary to reflect different assumptions

about the number of securities sold in a minimum/maximum transaction (e.g., the transaction will not

close unless a minimum number of securities is sold), a range of possible redemption scenarios in

transactions involving the acquisition of a target company by a special purpose acquisition company or to

reflect variability in the purchase price for a proposed acquisition. Additional pro formas may include:

• An additional pro forma balance sheet if the minimum or maximum outcome only affects the balance

sheet

• Footnote-only disclosure about the outcomes and effects in the pro forma financial information if the

minimum or maximum outcome does not have a pervasive effect on the financial statements

• Multiple sets of full pro formas, particularly if the varying outcomes would affect the accounting for

the transaction

4 Preparation of pro forma financial information

Pro forma financial information | 32

Illustration 4-8: Multiple pro forma presentations

A registrant is conducting a tender offer for any or all of the common stock of a target company in

exchange for its common stock. The registrant determines that the possible outcomes include the

acquisition of anywhere from 20% to 100% of the common stock of the target company. Since the

maximum number of shares acquired in the tender offer would result in consolidation by the

registrant, while the minimum number of shares acquired would result in the application of the equity

method of accounting, the registrant would present separate pro forma financial information to depict

the minimum and maximum outcomes.

• The following shows an example of the separate columns that could be used to present the

minimum and maximum outcomes in both the pro forma balance sheet and income statements:

Unaudited Pro Forma Condensed Combined Balance Sheet [Statements of Operations]

Assuming 100% of shares acquired

Assuming 20% of shares acquired

Registrant

historical

financial

statements

Company A

historical

financial

statements

Transaction

accounting

adjustments

(acquisition of

Company A)

Pro forma

results

(combined)

Transaction

accounting

adjustments

(equity method

investment in

Company A)

Pro forma results

(combined)

If there is only one variable that may produce different outcomes that do not have a pervasive effect on

the pro forma financial information, a sensitivity analysis for a change in the variable may be disclosed

in the notes of the pro forma financial information instead of presenting multiple sets of pro forma

financial information. See Illustration 5-1 for an example of a sensitivity analysis disclosure related to a

business combination.

When multiple pro forma financial statements are presented for a range of results, the introductory

paragraph required by Article 11 would need to provide adequate disclosure of the ranges presented.

4.6.3 Cross-border business combinations

As previously discussed, the age of pro forma financial information is based on the age of financial

statements the registrant is required to file. Therefore, an FPI that acquires a US target would determine

the age of the pro formas based on the financial statement age requirements in Item 8 of Form 20-F

(i.e., Items 8.A.4 and 8.A.5). Alternatively, a US domestic registrant that acquires a foreign target

(e.g., foreign businesses and foreign private issuers) would determine the age of the pro formas based on

the latest financial statements the registrant is required to file.

When a US registrant provides Rule 3-05 financial statements of an acquired or to-be-acquired business

that qualifies as a foreign business (as defined in 1-02(l) of Regulation S-X), the registrant can rely on the

age requirements in Item 8 of Form 20-F rather than the age requirements for a US target.

If a business

acquired is not a foreign business but would qualify as a foreign private issuer (as defined in Regulation C,

Rule 405 and Exchange Act Rule 3b-4) if it were a registrant, the age requirements in Item 8 of Form 20-F

do not apply, but the registrant can contact the SEC staff to ask for permission to rely on them.

Similarly, an FPI may also rely on the age requirements in Item 8 of Form 20-F when providing Rule 3-05 financial statements of

an acquired or to-be-acquired business that qualifies as a foreign business (as defined in 1-02(l) of Regulation S-X).

4 Preparation of pro forma financial information

Pro forma financial information | 33

When a registrant acquires a foreign target that can use Item 8 of Form 20-F age requirements, the interim

Rule 3-05 financial statements may only need to cover the first six months of the year.

These financial

statements may not align with a registrant’s financial statements that have been filed or are required to

be filed. Additionally, the pro formas that the registrant (i.e., acquirer) will be required to provide may

have a more current date than that of Rule 3-05 financial statements required for a foreign target.

For example, assume that on 15 June 20X1, a registrant acquires a foreign business that is significant at

the 25% level under S-X Rule 3-05 and files the audited financial statements of the calendar year-end

foreign target as of and for the year ended 31 December 20X0 in an Item 9.01 Form 8-K. Although

interim financial statements are not required in the Rule 3-05 financial statements, the pro formas in the

Form 8-K must include the three months ended 31 March 20X1 based on the most recent financial

statements of the registrant.

Likewise, when an FPI acquires a US domestic target company, the Rule 3-05 financial statements of the

domestic target company may be required for periods that are more current than the financial statements

of the FPI. In these circumstances, the age of the pro formas would still be based on the FPI’s latest financial

statements included in the filing.

As discussed in section 4.2.4, the pro forma rules allow for a difference of up to one quarter between the

fiscal year end of the registrant and the fiscal year end of the target. If there is a difference of more than

one quarter, the target’s historical financial information in the pro formas will need to be updated to a

period ending within one quarter of the registrant’s year end.

See Item 8.A.5 of Form 20-F when determining the requirement to include interim financial statements. Local stock exchanges

may require a company to publish interim financial information that covers a more current period than the information required

by SEC rules. If that’s the case, the registrant must include the more current financial information in the filing with the SEC.

Pro forma financial information | 34

5 Pro forma adjustment illustrations

This section provides examples of transaction accounting adjustments, autonomous entity adjustments

and management’s adjustments that may be presented to give effect to certain events and circumstances

described in section 2. Each illustration in this section shows only the adjustments contemplated by the

respective example.

5.1 Business combinations

This section describes common transaction accounting adjustments that may be required to give effect

to the acquisition of a business that is accounted for as a business combination under ASC 805. The

illustrations below include transaction accounting adjustments for the acquisition as well as other

transaction accounting adjustments for material transactions under S-X 11-01(a)(8).

See our FRD publication, Business combinations, for additional discussion about the accounting

described below and accounting for asset acquisitions.

5.1.1 Calculation of purchase price

As noted above (section 4.5.3), the explanatory notes must include a table showing how the total purchase

price was calculated. The table should include the value of any noncash consideration (e.g., stock).

When calculating the value of stock to be issued in a probable acquisition, registrants should use a stock

price as of the most recent practicable date before the filing date or effective date of a registration

statement. In addition, the explanatory notes to the pro forma balance sheet should disclose the date used

and include a sensitivity analysis for the range of possible outcomes based on reasonably likely increases

and decreases in the stock price.

The following illustration shows the pro forma disclosures a registrant might provide for an estimated

purchase price for a probable acquisition in a registration statement filed on 17 August 20X5.

Illustration 5-1: Schedule and disclosures of estimated purchase price calculation

Notes to Unaudited Pro Forma Condensed Combined Financial Information

Note 2 Estimated purchase price consideration

Estimated consideration of approximately $250.8 million is based on the Company’s closing share

price of $28.35 on 31 July 20X5. The value of purchase price consideration will change based on

fluctuations in the share price of the Company’s common stock and the number of common shares of

Target XYZ outstanding on the closing date.

5 Pro forma adjustment illustrations

Pro forma financial information | 35

The following table summarizes the components of the estimated consideration (in thousands except

per-share information and the exchange ratio):

Estimated Target XYZ shares outstanding*

5,650

Cash consideration (per Target XYZ share)

$ 11.50

Estimated cash portion of purchase price

$ 64,975

Estimated Target XYZ shares outstanding*

5,650

Exchange ratio

1.16

Total Company common shares issued

6,554

Company’s share price**

$ 28.35

Equity portion of purchase price

$ 185,806

Total estimated consideration to be paid

$ 250,781

* Represents Target XYZ’s outstanding shares as of 30 June 20X5.

** Represents the Company’s share price as of 31 July 20X5.

The equity portion of the purchase price will depend on the market price of the Company’s common

shares when the acquisition is consummated. The Company believes that a 10% fluctuation in the

market price of its common stock is reasonably possible based on historical volatility, and the potential

effect on purchase price would be:

Company’s

share price

Purchase price

(equity portion)

As presented

$ 28.35

$ 185,806

10% increase

31.19

204,419

10% decrease

25.52

167,258

5.1.2 Contingent consideration

ASC 805 requires a registrant to recognize the fair value of contingent consideration as of the acquisition date

as part of the consideration transferred in exchange for an acquired business. The explanatory notes must

describe the arrangement, the basis for determining the amount of payments and an undiscounted estimate

of the range of outcomes. If a range cannot be estimated, that fact and the reasons why must be disclosed.

Contingent consideration classified as a liability in a registrant’s balance sheet is remeasured at fair value

through net income at the end of each reporting period. However, if the pro formas filed after consummation

of an acquisition must be updated for a more recent period, no adjustment should be made to reflect

changes in the fair value of contingent consideration, because those changes would be recognized by the

registrant in its historical post-acquisition results.

5.1.3 Preliminary purchase price allocation

Registrants often have to present pro formas before the purchase price allocation is finalized. When this

happens, a prominent statement of that fact must be disclosed in the explanatory notes along with all of

the following:

• The items for which the accounting is incomplete

• A description of the information that the registrant needs, including, if material, the uncertainties

affecting the pro formas and the possible consequences of their resolution

5 Pro forma adjustment illustrations

Pro forma financial information | 36

• An indication of when the accounting is expected to be finalized

• Other available information that will enable a reader to understand the magnitude of any potential

future adjustments to the accounting

The preliminary purchase price reflected in the pro formas should include the best information available

to management at the time of the filing and the disclosures should discuss the potential changes in the

purchase price allocation. There is no obligation to update the pro formas at a future date when the

allocation is finalized.

The following example shows pro forma disclosures a registrant might provide to explain the preliminary

nature of an acquirer’s purchase price allocation.

Illustration 5-2: Disclosure of preliminary purchase price allocation

Notes to Unaudited Pro Forma Condensed Combined Financial Information

Note 2 Estimated consideration and preliminary purchase price allocation

The Company has performed a preliminary valuation analysis of the fair market value of ABC Company’s

assets to be acquired and liabilities to be assumed. Using the total consideration for the acquisition, the

Company has estimated the allocations to such assets and liabilities. The following table summarizes

the allocation of the preliminary purchase price as of the transaction’s closing date, 25 August 20X5

(in thousands):

Assets acquired*

$ 59,118

Identifiable intangible assets

104,640

Goodwill

171,923

Liabilities assumed*

(83,008)

Total estimated consideration

$ 252,673

* Individual assets and liabilities acquired have been condensed for purposes of this illustration.

This preliminary purchase price allocation has been used to prepare the transaction accounting

adjustments in the pro forma balance sheet and income statement. The final purchase price allocation

will be determined when the Company has completed the detailed valuations and necessary calculations

as described in more detail in the explanatory notes below. The final allocation is expected to be

completed when the Company files its report on Form 10-Q for the quarter ended 30 September 20X5

and could differ materially from the preliminary allocation used in the transaction accounting

adjustments. The final allocation may include (1) changes in fair values of property, plant and

equipment; (2) changes in allocations to intangible assets, such as trade names, technology and

customer relationships, as well as goodwill; and (3) other changes to assets and liabilities.

5.1.4 Debt

5.1.4.1 Acquired business’s debt assumed by the registrant

If a registrant assumes an acquired business’s debt, the registrant would include transaction accounting

adjustments for the acquisition to measure the debt at fair value and amortize the remeasurement

adjustment over the remaining life of the debt.

Additional financing transactions entered into to pay for the acquisition or refinance debt issued by the

acquired business would be considered other transaction accounting adjustments and are described in

more detail below.

5 Pro forma adjustment illustrations

Pro forma financial information | 37

5.1.4.2 Additional debt financing

If additional financing is necessary to complete an acquisition, other transaction accounting adjustments

must be presented separately from the transaction accounting adjustments for the acquisition if the

financing transactions are considered material. These adjustments should reflect the interest expense

associated with the financing and any debt issuance costs and related amortization. The details of the

transactions should be disclosed in the explanatory notes. Registrants may need to make certain

assumptions about interest rates to make these adjustments to the pro forma income statements.

Interest expense adjustments for fixed-rate debt generally should reflect the rate in effect at the time a

financing commitment was obtained or an estimated interest rate based on the index used at the time of,

or reasonably close to, the filing date. Registrants should not use the rate that could have been obtained

at the beginning of the year when the transaction was assumed to have occurred.

For variable-rate financing, the other transaction accounting adjustment should be calculated using a

current interest rate (e.g., based on the index at the time of, or reasonably close to, the filing date), and

the registrant should disclose the effect on pro forma net income of a 1/8 of a percentage point change

in interest rates.

5.1.4.3 Obtaining new debt and refinancing acquiree debt to complete acquisition

A registrant may obtain financing to pay for an acquisition and simultaneously refinance the existing debt

of an acquired business.

Illustration 5-3: Additional debt financing and refinancing debt of the acquired business

When its acquisition of Target XYZ closes, Registrant A will issue approximately $72.5 million in 4.5%

fixed-rate debt with debt issuance cost of $2.5 million, a portion of which will be used to fund the

acquisition for approximately $62.5 million. Registrant A also will extinguish Target XYZ’s existing

debt of approximately $7.3 million, which includes a prepayment penalty. Registrant A will not legally

assume Target XYZ’s outstanding debt.

The registrant might present the following pro forma disclosures, assuming that changes in debt, debt

issuance costs and interest expense are the only transaction accounting adjustments (in thousands):

Unaudited Pro Forma Condensed Combined Financial Information

As of and for the six months ended 30 June 20X5

Registrant

historical

Target XYZ

(Acquiree)

historical

Other

transaction

accounting

adjustments

Notes

Pro forma

combined

Debt *

$ 51,104

$ 7,300

$ 62,700

(a)

$ 121,104

Interest expense

1,939

$ 188

1,568

(b)

3,695

For the year ended 31 December 20X4

Interest expense

4,240

—

3,513

(b)

7,753

* Short- and long-term debt have been combined, and unamortized debt issuance costs have been netted against debt balances

in this line item.

SEC staff’s Financial Reporting Manual Section 3260.

5 Pro forma adjustment illustrations

Pro forma financial information | 38

Notes to Unaudited Pro Forma Condensed Combined Financial Information

(a) The net increase to debt reflects the new debt of $72.5 million incurred to finance the acquisition

of Target XYZ, less $2.5 million of debt issuance costs. XYZ’s outstanding debt of $7.3 million is

also extinguished upon consummation of the acquisition.

Decrease for extinguishment of XYZ’s existing debt

(7,300)

Increase for issuance of new debt

70,000

Other transaction accounting adjustment to debt

62,700

(b) Represents the net increase to interest expense resulting from interest on the new debt to finance

the acquisition of Target XYZ and the amortization of related debt issuance costs, offset by the

historical interest expense recorded related to XYZ’s existing debt, as follows:

Six-months ended

30 June 20X5

Year ended

31 December 20X4

Elimination of interest expense and

amortization of debt issuance costs —

outstanding XYZ’s debt

$ (188)

$ –

Interest expense on new 4.5% debt

1,631

3,263

Amortization of new debt issuance costs

125

250

Other transaction accounting adjustments to

interest expense

$ 1,568

$ 3,513

5.1.4.4 Bridge loan financing

If long-term financing is needed but not in place when an acquisition is consummated, a registrant may use a

short-term bridge loan to pay for the acquisition. Such financing, if material, should be reflected in the pro

forma balance sheet and income statements as other transaction accounting adjustments to interest

expense (including any amortization of debt issuance cost). These loans typically are replaced with

permanent financing at or before the end of their term, and the short-term and permanent financing

together mean that the interest expense and amortization of debt issuance costs do not need to be

identified as a nonrecurring item.

Illustration 5-4: Bridge loan financing

Registrant A obtained short-term bridge financing of $63 million, with debt issuance costs of $2.52

million, just before the closing date of 24 August 20X5. The interest on this loan is based on a one-

month benchmark rate (e.g., Secured Overnight Financing Rate) plus certain margins. ABC Corp

(acquired business) had no debt outstanding as of the acquisition date.

Registrant A might provide the following pro forma disclosures, assuming that changes in short-term debt,

debt issuance costs and interest expense are the only transaction accounting adjustments (in thousands):

Unaudited Pro Forma Condensed Combined Financial Information

As of and for the six months ended 30 June 20X5

Registrant

historical

ABC Corp

historical

Other

transaction

accounting

adjustments

Notes

Pro forma combined

Short-term debt*

$ –

$ 60,480

(a)

$ 60,480

Interest expense

18,775

–

1,978

(b)

20,753

5 Pro forma adjustment illustrations

Pro forma financial information | 39

For the year ended 31 December 20X4

Interest expense

37,750

–

3,956

(b)

$ 41,706

* The offsetting balance sheet accounts to this increase to debt will generally comprise the various assets and liabilities being

acquired. Those accounts have not been included in this example.

Notes to Unaudited Pro Forma Condensed Combined Financial Information

(a) Adjustment represents a $63 million bridge loan to finance the cash consideration portion of total

consideration, less $2.52 million in debt issuance costs incurred to obtain the bridge loan

financing. This obligation is classified as current debt based on its term of one year. The Company

expects to replace this loan with long-term financing at or before maturity.

(b) The adjustment to record interest expense assumes the bridge loan was obtained on 1 January

20X4 and was outstanding for the entire year ended 31 December 20X4 and six months ended

30 June 20X5. The interest rate assumed for purposes of preparing this pro forma financial

information is 2.28%. This rate is the one-month benchmark rate of 0.28% on 24 August 20X5, plus

the margins specified in the bridge facility agreement.

The following adjustments have been recorded to Interest Expense:

Six months ended

30 June 20X5

Year ended

31 December 20X4

Estimated interest expense on bridge loan facility

$ 718

$ 1,436

Amortization of debt issuance costs associated

with bridge facility

1,260

2,520

Other transaction accounting adjustments to

interest expense

$ 1,978

$ 3,956

A 1/8 of a percentage point increase or decrease in the benchmark rate would result in a change

in interest expense of approximately $0.05 million for the six months ended 30 June 20X5 and

approximately $0.1 million for the year ended 31 December 20X4.

Although the term of the bridge loan is less than one year in this example, it is assumed that the bridge

loan will be replaced by permanent financing. As a result, the income statement effects of the bridge

loan’s interest expense and the amortization of debt issuance costs are reflected in the entire pro forma

period presented, and this item is not identified as nonrecurring.

5.1.5 Intangible assets

The transaction accounting adjustments should reflect the estimated fair value of identified intangible assets

acquired based on the estimated purchase price allocation. The pro forma income statement also should be

adjusted to reflect the amortization of those intangible assets. In addition, goodwill should be adjusted to

eliminate any goodwill recorded by the acquired business and to reflect the goodwill in the preliminary

purchase price allocation. The SEC staff previously expressed a view that impairment charges recognized in

the acquired business’s historical income statements should not be eliminated. However, we have observed

diversity in practice and the SEC staff has not always objected to registrants removing impairment charges.

In each of the pro forma income statement periods, the individual fair values as of the actual or assumed

acquisition date are used to calculate the pro forma amortization for those periods as if the acquisition

had occurred as of the beginning of the earliest period presented. And it may be necessary to provide

sensitivity ranges to state the variability in amortization expense if the fair value estimates for the

intangible assets are preliminary.

The expected useful lives of material intangible assets acquired should be disclosed in the explanatory

notes. If the identified intangible assets are not amortized on a straight-line basis, the effect on operating

results for the five years after the acquisition should be disclosed if it’s material.

5 Pro forma adjustment illustrations

Pro forma financial information | 40

Illustration 5-5: Intangible assets and amortization expense

Registrant A has preliminarily identified and valued approximately $104.6 million in intangible assets

acquired in its acquisition of ABC Corp as of 24 August 20X5 (the closing date of the acquisition and

date of the purchase price allocation). They include trade names, customer relationships and technology.

Registrant A might provide the following pro forma disclosures, assuming that changes in its

intangible assets, goodwill and amortization expense are the only transaction accounting adjustments

affecting these line items (in thousands):

Unaudited Pro Forma Condensed Combined Financial Information

As of and for the six months ended 30 June 20X5

Registrant

historical

ABC Corp

historical

Transaction

accounting

adjustments

Notes

Pro forma

combined

Intangible assets*

$ —

$ 26,625

$ 78,015

(a)

$ 104,640

Goodwill*

281,000

25,460

146,463

(b)

452,923

Amortization expense

—

2,219

4,061

(a)

6,280

For the year ended 31 December 20X4

Amortization expense

—

4,438

8,123

(a)

12,561

* The offsetting entries for this adjustment to intangible assets and goodwill would be the other accounts adjusted to reflect the

purchase price allocation for the acquisition. Those accounts are not presented here.

Notes to Unaudited Pro Forma Condensed Combined Financial Information

(a) Reflects the adjustment of historical intangible assets acquired by the Company to their estimated

fair values. As part of the preliminary valuation analysis, the Company identified intangible assets,

including technology, trade names and customer relationships. The fair value of identifiable

intangible assets is determined primarily using the “income approach,” which requires a forecast of

all of the expected future cash flows. Since all information required to perform a detailed

valuation analysis of ABC Corp’s intangible assets could not be obtained as of the date of this filing,

for purposes of these unaudited pro forma condensed combined financial statements, the Company

used certain assumptions based on publicly available transaction data for the industry.

The following table summarizes the estimated fair values of ABC Corp’s identifiable intangible

assets and their estimated useful lives and uses a straight-line method of amortization:

Estimated

fair value

Estimated

useful life in

years

Annual 20X4

amortization

expense

Six months

ended

30 June 20X5

amortization

expense

Technology

67,500

6,750

3,375

Trade names

28,300

4,043

2,021

Customer relationships

8,840

1,768

884

$ 104,640

12,561

6,280

Historical amortization expense

(4,438)

(2,219)

Transaction accounting

adjustments to amortization

$ 8,123

$ 4,061

5 Pro forma adjustment illustrations

Pro forma financial information | 41

These preliminary estimates of fair value and estimated useful lives will likely differ from final

amounts the Company will calculate after completing a detailed valuation analysis, and the

difference could have a material effect on the accompanying unaudited pro forma condensed

combined financial statements. A 10% change in the valuation of intangible assets would cause a

corresponding increase or decrease in the balance of goodwill and annual amortization expense of

approximately $1.3 million, assuming an overall weighted average useful life of 8.3 years.

(b) Reflects adjustment to remove ABC Corp’s historical goodwill of $25.5 million and record goodwill

resulting from the acquisition of $171.9 million.

It’s important to note the difference in the assumed timing of the acquisition that should be used for the

income statement versus the balance sheet in this example. For the balance sheet adjustment, the intangible

assets are reflected at their estimated fair value of $104.6 million as of 30 June 20X5. No adjustment is

made to catch up or reflect accumulated depreciation as of 30 June 20X5 as if the acquisition had occurred

as of the beginning of the earliest annual period, 1 January 20X4.

In each of the income statement periods, the fair value of each intangible asset as of the actual or

assumed purchase date is used to calculate the pro forma amortization for those periods as if the

acquisition had occurred as of the beginning of the earliest period presented. The intangible assets’ fair

values should not be recalculated as if the acquisition had occurred as of the beginning of the earliest

income statement period presented.

5.1.6 Long-lived tangible assets

The disclosure considerations for transaction accounting adjustments related to acquired tangible assets

are very similar in nature to those discussed above for intangible assets.

Transaction accounting adjustments should be made to reflect the adjustment of an acquired business’s

long-lived tangible assets (e.g., property, plant and equipment (PP&E)) to fair value based on the

estimated purchase price allocation. The pro forma income statement also should be adjusted to reflect

depreciation expense based on that estimated fair value. The expected useful lives of material PP&E

acquired should be disclosed in an explanatory note.

Sensitivity ranges to address potential variability in depreciation expense may be necessary if the fair

value used for PP&E is preliminary. In practice, registrants sometimes use the acquired business’s

carrying values because the registrant may not know the fair value when the pro formas are prepared. In

this situation, the registrant shouldn’t state that the carrying value approximates fair value unless it has a

sufficient basis for that statement. Instead, the registrant should indicate that it has not yet determined

the fair value of PP&E acquired and is using the carrying value.

5.1.7 Transaction costs

A registrant typically incurs various acquisition-related costs in connection with a business combination.

Under ASC 805, costs related to the transaction (e.g., costs of services of lawyers, investment bankers,

accountants) are not part of the allocation of the consideration transferred. These costs are expensed in

the periods in which costs are incurred and the services are received. However, as noted above, the SEC

staff has stated that adjustments related to transaction costs are part of the transaction accounting

adjustments for the acquisition rather than for separate material transactions.

Whether a registrant makes transaction accounting adjustments for a business combination’s transaction

costs generally depends on whether the transaction costs are recognized in the historical income

statement. The SEC staff has indicated that, when either the registrant or the acquiree incurred and

recorded transaction costs in the historical financial statements, there should not be a pro forma

5 Pro forma adjustment illustrations

Pro forma financial information | 42

adjustment to remove them. Alternatively, if a registrant incurred transaction expenses after the

historical periods (or is expected to incur such expenses), the registrant is required to include a pro

forma adjustment in the latest annual period presented. However, the registrant should not make a pro

forma adjustment to add transaction costs incurred by the acquiree after the historical period.

Illustration 5-6: Transaction costs not yet recognized in the historical financial statements

Registrant A incurred $2.5 million of transaction costs related to a business combination, and this

amount is recognized in its historical financial statements for the six-month period ended 30 June 20X5.

In addition, Registrant A incurred an additional $1 million of transaction costs in the month ended

31 July 20X5 that it has not yet paid.

Because the initial $2.5 million of transaction costs are already reflected in Registrant A’s historical

income statement, no adjustment is necessary for that amount. However, a transaction accounting

adjustment should be made in the annual period ended 31 December 20X4 to recognize the additional

$1 million of transaction costs that have been incurred by the registrant.

The registrant might provide the following pro forma disclosures, assuming that the effect of transaction

costs is the only transaction accounting adjustment affecting these line items (in thousands):

Unaudited Pro Forma Condensed Combined Financial Information

As of 30 June 20X5

Registrant

historical

XYZ

Company

historical

Transaction

accounting

adjustments

Notes

Pro forma

combined

Accrued liabilities

$ 3,000

$ 500

$ 1,000

(a)

$ 4,500

For the year ended 31 December 20X4

General and administrative

expenses

25,000

2,000

1,000

(a)

28,000

Notes to Unaudited Pro Forma Condensed Combined Financial Information

(a) Represents the accrual of additional transaction costs incurred by Registrant A subsequent to 30

June 20X5. The remaining transaction costs of $2.5 million are included in the historical income

statement of the Company for the six months ended 30 June 20X5. These costs will not affect the

Company’s income statement beyond 12 months after the acquisition date.

5.1.8 Gains and losses attributable to the acquisition

An acquirer may incur certain gains or losses in connection with an acquisition. Certain items, such as

bargain purchase gains and gains/losses recognized for acquisitions achieved in stages, may be part of

the purchase price allocation and included as transaction accounting adjustments for the acquisition.

Other gains or losses may be recognized as part of other transaction adjustments, if the underlying

transactions are material under S-X Rule 11-01(a)(8). These might include gains/losses recognized from

the settlement or termination of preexisting relationships before or upon completion of an acquisition

(e.g., settlement of a contractual relationship, such as a lease between an acquirer and acquiree or a

noncontractual relationship, such as an ongoing lawsuit between those same parties).

5 Pro forma adjustment illustrations

Pro forma financial information | 43

5.1.9 Inventory valuation

Acquired inventory balances are recognized in a business combination at fair value under ASC 820, Fair

Value Measurement. Accordingly, the transaction accounting adjustments should be used to step up the

pro forma balance sheet to reflect the fair value consistent with the purchase price allocation and to

reflect in the pro forma income statement the amortization of the step-up based on how long it will take to

sell the inventory.

The following illustration shows a disclosure that a registrant might provide for a transaction accounting

adjustment to inventory in the pro forma balance sheet to reflect the fair value adjustment based on the

purchase price allocation.

Illustration 5-7: Inventory valuation adjustment

Notes to Unaudited Pro Forma Condensed Combined Financial Information

(a) The adjustment steps up the pro forma balance sheet for Target XYZ’s finished goods and work-in-

process inventory to a fair value of approximately $9 million. The calculation of fair value is

preliminary and subject to change. The fair value was determined based on the estimated selling

price of the inventory, less the remaining manufacturing and selling costs and a normal profit

margin on those manufacturing and selling efforts. The pro forma income statement for the year

ended 31 December 20X4 is also adjusted to increase cost of sales by the same amount as the

inventory that is expected to be sold within one year of the acquisition date.

5.1.10 In-process research and development

Under ASC 805, acquired in-process research and development (IPR&D) assets cannot be written off

upon acquisition. Instead, acquired IPR&D assets are required to be measured at their acquisition-date

fair value and considered indefinite-lived intangible assets until the completion or abandonment of the

associated R&D efforts.

Acquired IPR&D assets may include projects for which the acquired business incurred R&D expenses in its

pre-acquisition historical financial statements. The SEC staff has said that a registrant should not

eliminate the R&D expense recognized in the acquired business’s historical financial statements.

5.1.11 Deferred tax asset valuation allowances

A business combination may result in changes to the valuation allowance recorded on either the registrant’s

or the acquired business’s deferred tax assets.

For example, a registrant that has previously recorded a valuation allowance on its deferred tax assets

may reverse that allowance because it can use the deferred tax liabilities assumed in a business

combination to offset the reversal of its preexisting deferred tax assets. Changes in the acquirer’s

valuation allowance that result from a business combination should be recognized in the acquirer’s deferred

income tax expense (benefit) during the reporting period that includes the business combination. On the

other hand, changes to the acquired business’s valuation allowance are accounted for as part of the

allocation of the purchase price.

SEC staff’s Financial Reporting Manual Section 3250.1.g.

5 Pro forma adjustment illustrations

Pro forma financial information | 44

The registrant should consider the effects of the business combination on its or the acquired business’s

previously recorded valuation allowances and determine whether transaction accounting adjustments for

the acquisition related to changes to the valuation allowances are necessary. Such adjustments may include:

• A reduction of the registrant’s or acquired entity’s valuation allowance in the pro forma balance sheet

• The impact of a reduction of the valuation allowance on the registrant’s deferred tax assets as a

result of the acquisition in the pro forma income statement (with disclosure that the income tax

benefit adjustment related to the reduction of its valuation allowance is nonrecurring)

• An adjustment to the pro forma income statement to reflect the effect of the transaction on the

combined entity’s pro forma income tax provision or benefit (e.g., the income tax benefit related to

the registrant’s or acquired entity’s historical pretax losses that previously could not be recognized

due to the need for a valuation allowance)

After a business combination, the combined entity could have an effective tax rate that differs from the

registrant’s historical tax rate. The registrant would need to consider whether its historical tax rate

should be revised when calculating the pro forma effects of the business combination.

Illustration 5-8: Change in registrant’s valuation allowance

After considering all available evidence, Registrant A, a calendar-year registrant, concluded that a

valuation allowance of $30,000 was required for the full amount of its deferred tax assets as of

31 December 20X4.

On 1 March 20X5, Registrant A acquired ABC Company, and the acquisition resulted in a deferred tax

liability balance of $60,000 related primarily to acquired intangible assets that it will amortize for

financial reporting purposes. After the acquisition, Registrant A will file a consolidated tax return that

will include ABC Company. The registrant concluded that the deferred tax liabilities related to the ABC

acquisition were sufficient to realize its preexisting deferred tax assets. Accordingly, Registrant A

recorded a tax benefit of $30,000 related to the reversal of its valuation allowance in the period the

acquisition occurred.

Registrant A might provide the following pro forma disclosures related to the ABC acquisition,

assuming that changes in the registrant’s valuation allowance are the only transaction accounting

adjustments affecting these line items:

Unaudited Pro Forma Condensed Combined Financial Information

As of and for the year ended 31 December 20X4

Registrant

historical

ABC

Company

historical

Transaction

accounting

adjustments

Notes

Pro forma

combined

Deferred income tax

assets (liabilities)

$ –

$ 20,000

$ (50,000)

(a)

$ (30,000)

(Loss) income before

income taxes

(10,000)

15,000

5,000

Income tax (benefit)

provision

–

3,750

(30,000)

(a)

(28,750)

(2,500)

(b)

Net (loss) income

$ (10,000)

$ 11,250

$ 32,500

$ 33,750

5 Pro forma adjustment illustrations

Pro forma financial information | 45

Notes to Unaudited Pro Forma Condensed Combined Financial Information

(a) This adjustment reflects (1) the purchase accounting adjustments to the acquired business’s

historical deferred tax asset of $20,000 to the deferred tax liability balance of $60,000 (a net

change of $80,000), and (2) the elimination of the Company’s deferred tax asset valuation

allowance of $30,000. This results in a net deferred tax liability balance of $30,000 for the pro

forma combined entity. Because ABC Company will be included in the Company’s consolidated tax

return following the acquisition, the Company has determined that the deferred tax liabilities

related to the acquisition provide sufficient taxable income to realize the Company’s deferred tax

assets of $30,000. The income tax benefit of $30,000 related to the reduction in the Company’s

valuation allowance is also reflected in the pro forma income statement as a nonrecurring adjustment

to income from continuing operations.

(b) As explained in Note (a), the acquisition of ABC Company will result in the reversal of the

Company’s valuation allowance. As a result, the combined entity would have benefited from the

Company’s historical pretax losses in the pro forma period presented. This transaction accounting

adjustment reflects the income tax expense related to the combined pro forma pretax income

during the year ended 31 December 20X4, based on the statutory tax rate of 25% and calculated

as follows.

Pro forma combined income before income taxes

$ 5,000

Statutory tax rate

25%

Pro forma combined income tax provision

1,250

Historical combined income tax provision

3,750

Transaction accounting adjustment

(2,500)

5.1.12 Compensation arrangements

In connection with business combinations, acquired businesses’ compensation arrangements are

often settled or exchanged for new arrangements. These arrangements may include management

contracts, severance agreements, share-based awards or benefit plan arrangements. In general, the

effects of settlements and exchanges resulting from preexisting contractual provisions or that are

required by the merger agreement should be reflected in the transaction accounting adjustments for

the acquisition. Otherwise, settlements and exchanges should be evaluated as separate transactions

under S-X 11-01(a)(8).

5.1.12.1 Change-in-control provisions

Change-in-control provisions in employment or compensation agreements may cause the acceleration of

share-based awards or one-time cash payments upon consummation of an acquisition. Compensation

charges resulting from these provisions may be included in the acquired business’s pre-acquisition or

acquirer’s post-acquisition financial statements, depending on the facts and circumstances.

For example, if the preexisting terms of the acquired business’ share-based awards contained a change-

in-control provision that automatically accelerated all unvested awards immediately upon consummation

of the acquisition, the resulting compensation charges would be recognized in the acquired business’s

pre-acquisition financial statements. If the charges are not yet recognized in the periods presented in the

pro formas, the registrant should not make transaction accounting adjustments for the additional

compensation charges that incurred by the acquiree after the historical period. But, if a change-in-

5 Pro forma adjustment illustrations

Pro forma financial information | 46

control provision is added to an acquired business’ share-based awards in contemplation of the business

combination, the registrant generally would expense the cost in its financial statements following the

acquisition,

and it should evaluate the new provision as a separate transaction under S-X 11-01(a)(8).

The SEC staff has said that a registrant generally should not make transaction accounting adjustments to

remove any historical compensation expense of the acquired entity.

Illustration 5-9: Change-in-control provisions

Double-trigger arrangements

In connection with a registrant’s acquisition of Target XYZ, certain executive officers of Target XYZ

are expected to receive severance and other separation benefits related to existing employment

agreements with double-trigger provisions. The provision is triggered if both of the following events

occur: a change-in-control and a termination or reduction in the responsibilities of the executives. The

registrant decided to terminate these executives immediately following the business combination, so

both conditions were met. Because the registrant elected to terminate the executives, the post-

combination compensation expense that it will recognize should be reflected as other transaction

accounting adjustments.

Share-based compensation awards

Target XYZ also decided to modify its share-based awards to include a change-in-control provision in

contemplation of its acquisition by the registrant. To ease the transition for Target XYZ’s employees,

the registrant agreed to the modification to these awards as part of its negotiations. As a result, the

registrant will recognize a compensation charge immediately after the business combination that should be

reflected in other transaction accounting adjustments.

The registrant concluded that both of the above matters were material under S-X 11-01(a)(8) and

might make the following pro forma disclosures:

Notes to Unaudited Pro Forma Condensed Combined Financial Information

(a) The Company expects to record a one-time post-combination expense of $5 million consisting of

severance and other separation benefits in connection with the termination of certain executive

officers of Target XYZ. The executives’ employment agreements included double-trigger

provisions that require us to provide these benefits upon a change in control and termination. The

amount is accrued in the pro forma condensed balance sheet and reflected as an expense in the

pro forma condensed statement of operations for the year ended 31 December 20X4.

(b) The Company expects to record a one-time post-combination compensation expense of $7 million

related to the decision to accelerate the unvested share-based awards of Target XYZ in

contemplation of the merger. This amount is reflected in the pro forma condensed statement of

operations for the year ended 31 December 20X4 and as a reduction to retained earnings in the

pro forma condensed balance sheet.

A modification to share-based payment awards that adds a change-in-control provision in contemplation of a business combination

requires a careful analysis of all of the facts and circumstances related to the terms of the acquired business’s awards. In general,

we believe such a modification that is initiated by the acquirer or is subject to the approval of the acquirer is primarily for the

benefit of the combined entity and, therefore, should be accounted for as a separate transaction (i.e., as post-combination

compensation cost).

5 Pro forma adjustment illustrations

Pro forma financial information | 47

5.1.12.2 New or replacement compensation agreements

Generally, new compensation contracts (including replacement agreements) with employees of the

acquired business that are stipulated in the merger agreement would require transaction accounting

adjustments for the acquisition. Otherwise, the new contracts should be evaluated under S-X 11-01(a)(8).

Replacement awards to employees of the acquired business with post-acquisition vesting (i.e., relating to

future services) are recognized by the registant in the post-acquistion period. Any incremental post

acquistion expense (i.e., in excess of that recorded in the historical financial statements of the acquiree)

should be recognized as an adjustment to the pro forma income statement. Additionally, one-time

incremental post-acqusition expense should also be recognized as an adjustment to the pro forma

balance sheet.

Illustration 5-10: New compensation arrangements

While negotiating an acquisition of Target XYZ, the registrant decided to execute new compensation

arrangements with five key executives of Target XYZ who will continue as employees of the registrant.

These compensation agreements were not contemplated in the merger agreement and result in

annual salary increases and one-time bonuses (cash as well as fully vested restricted stock units).

The registrant also decided to issue new share-based awards to the employees of Target XYZ that replace

their unvested Target XYZ stock-based awards. The replacement share-based awards vest over post-

combination service periods that range from two to three years.

The registrant concluded that these new compensation arrangements were material under S-X 11-

01(a)(8) and might make the following pro forma disclosures:

Notes to Unaudited Pro Forma Condensed Combined Financial Information

(a) This adjustment reflects new compensation arrangements executed with five key executives in

connection with the business combination, resulting in a $2.5 million increase in the annual

compensation for these executives from their previous compensation. In addition, this adjustment

includes $1 million in bonuses and $2 million for the value of restricted stock units granted to

these executives, which were payable and fully vested upon closing of the business combination.

(b) The adjustment for share-based awards represents the difference between Target XYZ’s historical

share-based compensation expense and the estimated share-based compensation expense related

to replacement awards issued to continuing employees as part of the acquisition. The fair value of

the replacement share-based awards, including stock options and restricted stock units, will be

recognized ratably over post-combination service periods ranging from two to three years.

5.1.13 Accounting policies and financial statement presentation

Conforming the accounting policies of the acquired business to those of the registrant are considered

transaction accounting adjustments for the acquisition (e.g., when the entities use different methods for

inventory accounting, when the registrant has already adopted a new accounting principle that the

acquired business has not). In addition, the registrant may need to reclassify balance sheet and income

statement items to conform the historical financial statement presentation of the acquired business to

its own. These are also related to the acquisition, and the following illustration shows examples of

these adjustments.

5 Pro forma adjustment illustrations

Pro forma financial information | 48

Illustration 5-11: Conforming accounting policies and classification

Unaudited Pro Forma Condensed Combined Financial Information

For the year ended 31 December 20X4

Registrant

historical

Target XYZ

historical

Transaction

accounting

adjustments

Notes

Pro forma

combined

Revenues

$ 120,500

$ 48,000

$ —

$ 168,500

Cost of revenues

63,000

24,500

(3,000)

2,500

3(a)

4(a)

87,000

Selling and administrative

expenses

11,500

10,000

(2,500)

4(a)

19,000

Notes to Unaudited Pro Forma Condensed Combined Financial Information

Note 3 Accounting policy adjustments

(a) The Company defers certain direct and incremental costs for delivered products prior to the

recognition of revenue. Because Target XYZ has an accounting policy to expense these costs as

incurred, this transaction accounting adjustment reflects the net change in the amount of deferred

costs during the period to conform Target XYZ’s accounting policy to that of the Company.

Note 4 Reclassification adjustments

Certain reclassifications have been made to the historical presentation of Target XYZ to conform to

the financial statement presentation of the Company, as follows:

(a) The Company recognizes all shipping and handling costs in cost of revenue, while Target XYZ

recognizes these costs in selling and administrative expenses. Therefore, this adjustment

conforms the presentation of shipping and handling costs to the Company’s presentation.

We believe that registrants can combine the reclassification adjustments with the transaction accounting

adjustments for the acquisition as shown above or show them in a separate column, provided the

disclosure is clear and understandable.

When the registrant adopts a new accounting principle, the effects on the pro formas are considered

transaction accounting adjustments for the acquisition. A registrant is prohibited from adopting a new

accounting principle in the pro forma presentation until it has filed financial statements reflecting the

adoption. Instead, the potential effects of the recently issued accounting standard should be described in

the explanatory notes in accordance with SAB Topic 11.M.

The following illustration shows how a registrant would reflect the adoption of a new accounting principle

in two different situations:

Illustration 5-12: Adoption of new accounting principles

Example 1: New accounting principle not yet reflected in interim financial statements

In April 20X5, Registrant A, a calendar-year registrant, completes a significant business acquisition of

Target XYZ for which pro formas on Form 8-K are required for the fiscal year ended 31 December

20X4. The registrant adopted a new accounting principle on 1 January 20X5 that will require

retrospective application, but the registrant has not yet filed its first quarter 20X5 financial

statements reflecting the new accounting principle.

5 Pro forma adjustment illustrations

Pro forma financial information | 49

Analysis:

Registrant A is not allowed to make transaction accounting adjustments to reflect the pro forma

effects of the new accounting principle for the year ended 31 December 20X4. However, the

registrant should make adjustments to conform the other accounting policies of Target XYZ to its own

policies. In addition, the registrant should include or reference in the explanatory notes the disclosures

required by SAB Topic 11.M.

Example 2: New accounting principle reflected in interim financial statements

In June 20X5, Registrant B, a calendar-year registrant, completes a significant business acquisition of

Target ABC. The registrant will file pro formas on Form 8-K for the fiscal year ended 31 December

20X4 and the interim period ended 31 March 20X5. The registrant adopted a new accounting principle

on 1 January 20X5 that requires retrospective application. The new accounting principle is reflected

in Registrant B’s first quarter 20X5 financial statements, but it has not yet revised its financial

statements for prior annual periods. The annual and interim financial statements of Target ABC do not

reflect the adoption of this new accounting principle.

Analysis:

Because Target ABC has not reflected the new accounting principle in its interim financial statements,

Registrant B should include transaction accounting adjustments for the acquisition to conform Target

ABC’s interim period to the registrant’s policy.

Assuming that the accounting principles of Registrant B and Target ABC are consistent for the year

ended 31 December 20X4, the registrant would not make any transaction accounting adjustments to

reflect the new accounting principle in that period because it has not yet reissued historical financial

statements for the annual period reflecting the accounting change. In that case, the explanatory notes

should clearly explain how the annual and interim periods are different due to the new accounting principle.

An acquired business does not always have to adopt a new accounting standard adopted by the registrant

in its Rule 3-05 financial statements. However, as shown in the illustrations above, the analysis is

different for pro formas, and it can be challenging to alter the existing adoption plans of an acquired

business.

We recommend that a registrant contact the SEC staff and seek relief from this requirement if adopting a

new principle solely for the purpose of a pro forma presentation would require significant resources

and/or could compromise the timing of the transaction.

5.1.14 Business combinations involving foreign entities

5.1.14.1 Basis of accounting

The pro formas should generally reflect the basis of accounting used by the registrant. When a domestic

registrant acquires a business that applies a different basis of accounting, transaction accounting

adjustments for the acquisition are required to convert the acquired business’s historical financial

statements to the registrant’s basis of accounting.

Consider the following examples:

• A US domestic registrant acquires a foreign business whose historical financial statements are presented

on a comprehensive basis other than US GAAP. While the registrant may not be required to reconcile the

acquiree’s financial statements to US GAAP (e.g., if they are presented under IFRS as issued by the IASB

or local home country GAAP and the acquisition is less than 30% significant), the registrant must

reflect adjustments to convert the acquiree’s financial statements to US GAAP in the pro forma

financial information.

5 Pro forma adjustment illustrations

Pro forma financial information | 50

• An FPI that presents its financial statements under IFRS as issued by the IASB acquires a US business

whose financial statements are prepared under US GAAP. The FPI must convert the acquired

business’s financial statements to IFRS in the pro forma financial information.

• An FPI that presents its financial statements under local home country GAAP with a reconciliation to

US GAAP acquires a foreign business that also presents its financial statements under local home

country GAAP. The pro forma financial information of the registrant and the acquired business

should be reconciled to US GAAP (in a manner consistent with Item 17 of Form 20-F). However, the

SEC staff generally has not objected if the FPI elects to present the pro forma financial information

directly in US GAAP.

In addition, if a registrant acquires another company in a transaction accounted for as a reverse acquisition,

the post-acquisition financial statements will generally be those of the legal acquiree, and the acquiree’s

basis of accounting will become the basis of accounting for the registrant. For example, in a reverse

merger, a foreign private issuer (i.e., registrant and legal acquirer) that reports under IFRS-IASB may

acquire a US target (i.e., accounting acquirer and legal acquiree) that reports under US GAAP. In these

situations, we have seen the SEC staff accept pro forma financial information that applies the basis of

accounting of the legal acquiree (accounting acquirer) instead of the registrant.

We believe that registrants can combine the adjustments that give effect to the conversion of the

acquired foreign business’s balance sheet and income statement to US GAAP (or the registrant’s basis of

accounting) with the remaining transaction accounting adjustments for an acquisition or show them in a

separate column, provided the disclosure is clear and understandable.

5.1.14.2 Foreign currency adjustments

S-X Rule 3-20, Currency for financial statements for foreign private issuers, allows an FPI to prepare its

financial statements in the currency it believes is appropriate, but the rule does not address financial

statements of acquired businesses. The SEC staff allows these financial statements to be prepared either in

the same currency as the registrant or in the currency that normally is used for preparation of such

entities’ financial statements.

However, all the columns in the pro formas should be presented using the reporting currency of the

registrant. A method consistent with ASC 830 generally should be used to translate currencies. The pro

forma presentation should disclose the basis for the conversion either in narrative form or in a schedule

in the explanatory notes.

Illustration 5-13: Basis of accounting and foreign currency adjustments

On 1 March 20X5, a US calendar-year registrant acquires Target XYZ, a UK entity that qualifies as a

foreign business. Target XYZ has prepared its financial statements in accordance with IFRS as issued

by the IASB (and accordingly a reconciliation to US GAAP is not required in its historical financial

statements presented to comply with S-X Rule 3-05). In addition, Target XYZ presents its financial

statements using British pounds sterling as its reporting currency.

However, in the pro forma financial information, the registrant must make transaction accounting

adjustments to translate the target’s financial information to its reporting currency of US dollars and

to convert the target’s financial information to US GAAP.

SEC staff’s Financial Reporting Manual Section 6360.2.

5 Pro forma adjustment illustrations

Pro forma financial information | 51

The following example is an acceptable presentation of the registrant’s pro forma financial information

related to the foreign business acquisition. In this example, the registrant elects to present the adjustments

to conform accounting policies with the remaining transaction accounting adjustments for the acquisition.

Note that the illustration only reflects the adjustments and disclosures related to one financial

statement line item:

Unaudited Pro Forma Condensed Combined Financial Information

For the year ended 31 December 20X4

Registrant

historical

Target XYZ

historical

IFRS (in £)

Target XYZ

historical

IFRS

(in USD)

Transaction

accounting

adjustments

Pro forma

combined

Income tax

(benefit) provision

$ 140,000

£ 50,000

$ 77,500

$ 8,000

(3a)

$ 225,500

Notes to Unaudited Pro Forma Condensed Combined Financial Information

Note 3 Foreign currency and US GAAP conversion adjustments

The historical financial information of Target XYZ was prepared in accordance with IFRS-IASB and

presented in British pounds sterling. The historical financial information was translated from British

pounds sterling to US dollars using the following historical exchange rates:

$ / £

Average exchange rate for year ended 31 December 20X4 (statement of operations)

1.55

Period end exchange rate as of 31 December 20X4 (balance sheet)

1.65

In addition, the following transaction accounting adjustments convert Target XYZ’s financial

information from IFRS-IASB to US GAAP and align Target XYZ’s accounting policies with those applied

by the Company.

(a) This adjustment reflects an additional income tax provision of $8,000 related to IFRS to US GAAP

differences for uncertain tax positions. Target XYZ’s uncertain tax positions were determined

using an expected value or probability-weighted average approach under IFRS instead of a

cumulative probability model under US GAAP.

5.1.15 Regulatory effects of a business combination

The SEC staff has said that regulatory effects of a transaction should be evaluated under Regulation S-X

Rule 11-01(a)(8) and included in the presentation, if material. Examples include deposit fee caps and

additional regulatory costs following the merger of two banks.

A registrant or its target may also expect to dispose of certain operations to gain approval for the business

combination from one or more regulatory agencies. If the disposal is probable and material at the time

the pro formas are filed, it should be reflected as part of the other transaction adjustments. If uncertainties

remain about which operations may be disposed of, the registrant should disclose the uncertainties and

the possible consequences of their resolution. We believe that a registrant should consider the status of

its discussions with regulatory agencies, potential disposals identified in regulatory approval orders and

its past experience to assess whether an expected disposal should be reflected in the pro formas.

5 Pro forma adjustment illustrations

Pro forma financial information | 52

Pro formas for a significant business disposal (i.e., one that exceeds 20% significance) should be filed

under Item 2.01 of Form 8-K when the disposal occurs.

Illustration 5-14: Disposal in connection with a business combination

A telecommunications registrant has entered into an agreement to acquire XYZ Company. In order to

obtain regulatory approval from the Federal Communications Commission (FCC), the registrant proposed

a plan to dispose of a material portion of its business within one year of the consummation of the XYZ

acquisition. The FCC has approved the registrant’s plan by the time pro forma financial information is required

in a merger proxy statement. Accordingly, the registrant should make other transaction accounting adjustments

to eliminate the assets, liabilities and operations that will be disposed of to obtain regulatory approval.

If the FCC had not approved the registrant’s plan when the pro forma information was filed, the

registrant would have additionally disclosed the uncertainty and the reasonably possible effects of

resolving it in the explanatory notes to the pro forma financial information.

5.1.16 Management’s adjustments

The following example illustrates disclosures that a registrant may provide as management’s adjustments

if management believes that such adjustments would enhance readers’ understanding of the pro forma

effects of a business combination and has a reasonable basis for each adjustment.

Illustration 5-15: Management’s adjustments

On 10 August 20X9, Registrant A acquired XYZ Company and intends to achieve cost savings after

the acquisition by leveraging its existing marketing infrastructure to sell the products of the combined

company. Within one year after the acquisition, Registrant A plans to eliminate approximately 100

positions from XYZ’s marketing organization.

Registrant A is filing pro formas along with Rule 3-05 financial statements for XYZ on Form 8-K and

might make the following pro forma disclosures:

Notes to Unaudited Pro Forma Condensed Combined Financial Information

Note X. Management’s adjustments

The tables below show the expected cost savings related to the Company’s plans to leverage its existing

marketing infrastructure to sell the products of the combined company after the acquisition. Within

one year after the acquisition, the Company plans to eliminate approximately 100 positions from XYZ’s

marketing organization to achieve an annual pretax savings of approximately $10 million. The affected

employees will receive termination benefits aggregating approximately $3 million. The terminations

are presented below as if they had occurred on 1 January 20X8, and the statutory tax rate is 25%.

The adjustments shown below include those that management deemed necessary for a fair statement

of the pro forma information presented. The adjustments include forward-looking information that is

subject to the safe harbor protections of the Securities Exchange Act of 1934, and actual results could

differ materially from what is presented below as efforts to integrate XYZ’s operations into the

Company’s progress.

5 Pro forma adjustment illustrations

Pro forma financial information | 53

For the six months ended 30 June 20X9

Net income

Basic and

diluted

earnings per

Weighted

average

Pro forma combined*

$ 28,207

$ 2.77

10,200

Management’s adjustments

Cost savings

5,000

Tax effect

(1,250)

Pro forma combined after

management’s adjustments

31,957

3.13

10,200

* As shown in pro forma income statement on page X-1.

For the year ended 31 December 20X8

Net income

Basic and

diluted

earnings per

Weighted

average

Pro forma combined*

$ 57,824

$ 5.67

10,200

Management’s adjustments

Cost savings

10,000

Severance

(3,000)

Tax effect

(1,750)

Pro forma combined net income after

management’s adjustments

63,074

6.18

10,200

* As shown in pro forma income statement on page X-2.

5.2 Acquisition of equity method investments

Acquiring an interest in a business accounted for under the equity method will trigger the requirement to

provide Article 11 pro formas if the investment exceeds the significance threshold for a business acquisition.

While separate historical financial statements of the investee would be included in the registrant’s filing as

required by Rule 3-05 of Regulation S-X, a separate column presenting the historical results of the investee in

the pro formas is not necessary. Instead, a company may include an adjustment to the pro forma income

statement based on its pro rata share of the investee’s historical earnings adjusted for any basis differences.

The computation of the pro rata share of the equity earnings should be disclosed in the notes to the pro formas.

A registrant may elect the fair value option to account for the equity method investment under ASC 825.

The SEC staff has said that full pro formas are not required in that situation (similar to the acquisition of

financial assets). However, the SEC staff expects the registrant to explain how the application of the fair

value option for the equity method investment will affect the results of operations and the balance sheet

in future periods.

SEC staff’s Financial Reporting Manual Section 3110.1.

5 Pro forma adjustment illustrations

Pro forma financial information | 54

Illustration 5-16: Acquisition of an equity method investment

A calendar-year registrant acquires a 49% equity interest in Target on 2 June 20X5.

The registrant might provide the following pro forma financial information and disclosures related to

the acquisition (in millions):

Unaudited Pro Forma Condensed Consolidated Financial Information

As of and for the six months ended 31 March 20X5

Registrant

historical

Transaction

accounting

adjustments

Notes

Pro forma

combined

Cash and equivalents

$ 1,400

$ (500)

(a)

$ 900

Investment in

unconsolidated affiliates

500

(a)

535

Equity in earnings of

unconsolidated affiliates

—

(b)

For the year ended 31 December 20X4

Equity in earnings of

unconsolidated affiliates

—

(b)

Notes to Unaudited Pro Forma Condensed Combined Financial Information

(a) The use of funds for the acquisition of the 49% interest in Target consists of consideration of

$495 million and $5 million of acquisition costs.

(b) This adjustment reflects 49% of Target’s net income of $20.4 million and $51.1 million for the

three months ended 31 March 20X5 and the year ended 31 December 20X5, respectively.

5.3 Disposals

The following example illustrates how a registrant might reflect transaction accounting adjustments in

the pro forma balance sheet and income statement when there is a significant disposal that does not

meet the criteria for a discontinued operation:

Illustration 5-17: Disposal

ABC Co., a calendar-year registrant, completed the sale of its digital business to XYZ Co. on 25 August

20X5 and is filing pro formas for this significant disposal in a Form 8-K. The consideration received by

ABC Co. at closing consisted of $40 million in cash.

The registrant might make the following transaction accounting adjustments and the related

disclosures in the pro forma financial information (in millions):

Unaudited Pro Forma Condensed Combined Statement of Operations

For the six months ended 30 June 20X5

Registrant

historical

Transaction

accounting

adjustments

Notes

Pro forma

Revenue

$ 250

$ (50)

(a)

$ 200

Cost of goods sold

150

(10)

(a)

140

Operating and administrative expense

(30)

(b)

Provision for income taxes

(4)

(d)

5 Pro forma adjustment illustrations

Pro forma financial information | 55

For the year ended 31 December 20X4

Registrant

historical

Transaction

accounting

adjustments

Notes

Pro forma

Revenue

$ 550

$ (150)

(a)

$ 400

Cost of goods sold

350

(30)

(a)

320

Operating and administrative expense

150

(60)

(b)

Gain on disposal

–

(c)

Provision for income taxes

(8)

(d)

(EPS information not included in illustration)

Unaudited Pro Forma Condensed Combined Balance Sheet

As of 30 June 20X5

Registrant

historical

Transaction

accounting

adjustments

Notes

Pro forma

ASSETS

Cash and equivalents

$ 1,350

$ 40

(e)

$ 1,390

Receivables

300

(50)

(f)

250

Inventories

2,220

(450)

(f)

1,770

Property, plant and equipment

7,700

(560)

(f)

7,140

11,570

(1,020)

10,550

LIABILITIES

Accounts Payable and accruals

3,010

(940)

(f)

2,070

Long-term debt

2,300

–

2,300

Deferred income taxes

1,257

(100)

(f)

1,157

6,567

(1,040)

5,527

EQUITY

Common shares

—

Additional paid-in capital

2,000

—

2,000

Retained earnings

3,000

(c)

3,020

Total liabilities and equity

11,570

(1,020)

10,550

Notes to Unaudited Pro Forma Condensed Combined Financial Information

(a) This adjustment reflects the elimination of revenues and cost of goods sold of the digital business.

(b) This adjustment reflects the elimination of operating and administrative expenses of the digital

business.

No adjustment has been made to the sale proceeds to give effect to any potential post-closing

adjustments under the terms of the asset purchase agreement.

(d) This adjustment represents the estimated income tax effect of the pro-forma adjustments. The tax

effect of the pro-forma adjustments was calculated using the historical statutory rates in effect for

the periods presented.

(e) This adjustment represents the receipt of cash consideration at the closing of the transaction.

(f) These adjustments reflect the elimination of assets and liabilities attributable to the digital business.

[Management’s adjustments for any additional cost savings expected as a result of the disposal are excluded from

this illustration]

5 Pro forma adjustment illustrations

Pro forma financial information | 56

In connection with business dispositions, transaction accounting adjustments giving effect to the

disposition of a business should not decrease historically incurred compensation expense for employees

who were not, or will not be, transferred or terminated as of the disposition date.

5.4 Spin-off transactions

The following example illustrates disclosures about autonomous entity adjustments that may be provided

by a newly spun-off registrant that was part of another entity.

Illustration 5-18: Autonomous entity adjustment

ParentCo, a calendar-year-end registrant, plans to spin off its subsidiary into a new public company

(SpinCo) on 1 March 20X5. The historical financial information of SpinCo is taken from its carve-out

financial statements that included $2 million of selling, general and administrative (SG&A) expenses

allocated from ParentCo for providing certain administrative services to SpinCo. In connection with the

spin-off transaction, SpinCo and ParentCo will enter into a transition service agreement (TSA) in

conjunction with the closing of the transaction, under which SpinCo will pay ParentCo a flat fee of $3

million per year to perform the administrative services for two years following the transaction.

SpinCo might provide the following pro forma disclosures in its Exchange Act registration statement

filed on a Form 10 (in thousands):

Unaudited Pro Forma Condensed Combined Financial Information

For the year ended 31 December 20X4

Registrant

historical

Autonomous entity

adjustments

Notes

Pro forma

combined

SG&A expenses

2,000

1,000

(a)

3,000

Notes to Unaudited Pro Forma Condensed Combined Financial Information

(a) SpinCo’s historical SG&A expenses for the year ended 31 December 20X4 included $2 million

allocated from ParentCo for certain administrative services. In connection with the spin-off

transaction, SpinCo will enter into a TSA and pay $3 million per year for two years post-transaction.

The pro forma income statement is adjusted to reflect the expensing of the additional $1 million

that will be paid annually to ParentCo for two years under the TSA.

5.5 Other transactions

5.5.1 Reorganization of entities under common control

Under ASC 805, when an entity transfers assets or liabilities to an entity with which it is under common

control, the receiving entity recognizes the assets and liabilities at the carrying amounts in the transferring

entity’s financial statements on the transfer date. The use of these carrying amounts is required even if

the fair value of the transferred assets or liabilities is determinable. As a result, the pro forma balance

sheet for a common control transaction primarily includes adjustments to capital accounts.

As discussed in section 4.2.2.1, pro forma condensed income statements are required for all historical

financial statement periods presented in a registrant’s filing when the pro forma information reflects a

reorganization of entities under common control. If the consideration consists of equity (e.g., common

stock), there generally would be adjustments to the weighted average shares outstanding for the

issuance of shares that would affect the computation of EPS. If the consideration is cash, the excess of

the carrying amount of the transferred assets and liabilities should be treated as a dividend in the pro

forma balance sheet. Revenues and expenses of the entities (after eliminating intercompany transactions)

are combined for all periods presented during which they were under common control.

5 Pro forma adjustment illustrations

Pro forma financial information | 57

Illustration 5-19: Reorganization of entities under common control

A private equity firm enters into a transaction to reorganize and merge two companies it controls,

ABC Co. and XYZ Co. Under the agreement, ABC Co. is the surviving entity, and all of the outstanding

interests in XYZ Co. are exchanged for 1 million shares of ABC Co. common stock. The following

unaudited pro forma combined balance sheet and statement of operations were derived from

historical financial statements of ABC Co. and XYZ Co. (in thousands, except share amounts).

Unaudited Pro Forma Condensed Combined Financial Information

As of and for the year ended 31 December 20X4

ABC Co.

historical

XYZ Co.

historical

Transaction

accounting

adjustments

Notes

Other

transaction

accounting

adjustments

Notes

Pro forma

combined

Common Stock,

$.05 par value

$ 155

$ 150

$ (100)

(a)

—

$ 205

Additional Paid in

Capital

22,300

5,800

100

(a)

—

28,200

Accumulated

deficit

(3,900)

(5,200)

—

(9,100)

Total liabilities

and shareholders’

deficit

18,555

750

—

19,305

Net income

$ 1,620

$ 500

—

$ 160

(b)

$ 2,280

Net income per

common share

(basic and diluted)

$ 0.52

$ 0.17

$ 0.56

Weighted average

shares outstanding

(basic and diluted)

3,100,000

3,000,000

(2,000,000)

(a)

4,100,000

[Only one year shown for illustration purposes]

Notes to Unaudited Pro Forma Condensed Combined Financial Information

(a) Represents an adjustment to increase the common stock of the surviving entity by the par value of the

1 million shares issued in connection with the transaction and to eliminate the par value of the common

stock of XYZ Co. acquired, as well as to increase additional paid-in capital for the net difference.

(b) In connection with the transaction, a new management services agreement was entered into by

the combined entity that replaces separate agreements that each entity had with a third party

for certain management services. This arrangement is separate from the reorganization and

shown as another transaction adjustment. This represents adjustments to reduce selling, general

and administrative expenses to give effect to cost savings under the terms of the new agreement,

net of the related income tax effect.

5.5.2 Emergence from bankruptcy

Pro forma financial information in connection with a company’s emergence from bankruptcy may be

required under S-X Rule 11-01(a)(8) because it’s material to investors. Transaction accounting adjustments

would likely need to reflect fair value adjustments for assets and liabilities if the criteria for fresh start

accounting under ASC 852, Reorganizations, are met. Examples of other transaction accounting

5 Pro forma adjustment illustrations

Pro forma financial information | 58

adjustments may include giving effect to a reorganization plan filed with and confirmed by a bankruptcy

court showing adjustments for allowed claims, exit financing facilities and the recapitalization of a

company emerging from bankruptcy.

Illustration 5-20: Emergence from bankruptcy

ABC Co. provided the following pro forma financial information to give effect to its reorganization plan

confirmed by a US Bankruptcy Court on 25 March 20X5 (in millions). The plan provides for the

payment of allowed claims, exit financing and recapitalization through the cancellation of the

company’s existing stock and issuance of new common stock. For purposes of the illustration, ABC Co.

has met the criteria for fresh start accounting under ASC 852.

Unaudited Pro Forma Condensed Consolidated Balance Sheet

As of 31 December 20X4

Registrant

historical

Transaction

accounting

adjustments –

claims

settlements

and financing

Transaction

accounting

adjustments —

fresh start

and other

Pro forma

combined

Cash and cash

equivalents

$ 600

$ (100)

(a)

$ —

$ 1,050

550

(b)

Accounts receivable,

net

450

—

450

Inventories

2,000

—

200

(d)

2,200

Property and

equipment, net

2,500

—

500

(d)

3,000

Intangible assets, net

1,500

—

400

(d)

1,900

Goodwill

4,000

—

350

(d)

4,350

Other assets

1,200

—

1,200

Total assets

12,250

450

1,450

14,150

Accounts payable

500

—

500

Notes payable

1,600

—

1,700

(d)

3,300

Accrued liabilities

800

—

100

(d)

900

Long-term debt /

Exit financing

2,000

550

(b)

—

2,550

Other liabilities

1,300

—

1,300

Liabilities subject to

compromise

9,300

(9,300)

(a)

—

Total Liabilities

15,500

(8,750)

1,800

8,550

Common Stock

600

800

(c)

(600)

(e)

800

Additional Paid-in

Capital

2,150

4,800

(c)

(2,150)

(e)

4,800

Retained earnings

(deficit)

(6,000)

3,600

(a)

2,400

(e)

—

Total equity (deficit)

(3,250)

9,200

(350)

5,600

Total liabilities and

equity (deficit)

12,250

450

1,450

14,150

5 Pro forma adjustment illustrations

Pro forma financial information | 59

Unaudited Pro Forma Condensed Consolidated Statement of Operations

For the year ended 31 December 20X4

Registrant

historical

Transaction

accounting

adjustments —

claims

settlements

and financing

Transaction

accounting

adjustments —

fresh start

and other

Pro forma

combined

Interest expense

—

(f)

—

[All other financial statement line items excluded for purposes of illustration]

Notes to Unaudited Pro Forma Condensed Combined Financial Information

(a) As part of the plan of reorganization, the bankruptcy court approved the settlement of certain

allowed claims, reported as liabilities subject to compromise (LSTC) in our historical condensed

consolidated balance sheet. The LSTC were satisfied by paying $100 in cash and issuing new

common stock in the reorganized entity. As a result, a gain of $3,600 [$9,300 — ($100 + $800 +

$4,800)] was recognized on the settlement of LSTC.

(b) This adjustment reflects the drawdown on a senior secured term loan. The loan and cash proceeds are

reflected net of other financing costs. The loan is classified as a long-term liability based on its terms.

(d) Represents adjustments to assets and liabilities as a result of the application of the guidance in

ASC 805.

(e) These adjustments reflect the elimination of pre-emergence from bankruptcy common stock and

other capital accounts and to reset retained earnings to zero.

(f) The Bankruptcy Court had issued a stay order relating to our debt agreements during the bankruptcy

process resulting in no interest expense being recorded in our statement of operations in accordance

with ASC 852. This adjustment reflects interest expense on new exit financing based on contractual

interest rates and commitment fees specified and amortization of original issue discount.

5.5.3 Use of proceeds in securities offerings

Under Item 504 of Regulation S-K, the registrant must disclose in the registration statement how it

intends to use the net proceeds from its offering of securities and how much of the proceeds it intends to

use for each purpose. If the registrant has no current plan for the proceeds (or for a significant portion of

the proceeds), it must state this and discuss the principal reasons for the offering.

Registrants may reflect in the pro formas the receipt or application of offering proceeds reflecting one of

the following amounts: (1) up to the amount of a firm commitment from an underwriter, (2) up to the

minimum amount in a best-efforts minimum/maximum offering or (3) the offering amount in a best-

efforts all-or-none offering. Pro forma financial information also may reflect the receipt or application of

offering proceeds in certain savings and loan conversions. In addition, the application of proceeds should

be limited to the transactions or events reflected in the pro forma financial information presented

(e.g., business acquisition and debt repayment), but should not include proceeds used for working

capital-related expenditures.

5 Pro forma adjustment illustrations

Pro forma financial information | 60

In capitalization tables, registrants also can (1) present both the minimum and the maximum amounts in

a minimum/maximum offering and (2) include the proceeds to the extent exercise of outstanding warrants

in a securities offering or a rights offering is likely due to the current share price.

Illustration 5-21: Use of proceeds

In this example, the registrant does not have a specific corporate purpose for the proceeds in a firm

commitment offering. The registrant might make the following disclosures:

Use of proceeds:

We estimate that the net proceeds from this offering of shares of our common stock will be

approximately $139.2 million, based on an assumed public offering price of $39 per share, which is

the last reported sale price of our common stock on the NASDAQ Global Market on 15 April 20X4,

after deducting underwriting discounts and commissions and estimated offering expenses payable by us.

[The underwriters’ option to purchase additional shares from the company and a sensitivity analysis in

the assumed public offering price are excluded for this illustration]

We intend to use the net proceeds from this offering for general corporate purposes.

Capitalization:

The table below sets forth our long-term debt and capitalization as of 31 December 20X4, as follows

(in thousands except per-share information):

• On an actual basis as of 31 December 20X4

• On an as adjusted basis to reflect our receipt of net proceeds from the sale of 3,800,000 shares of

common stock in the offering at the assumed public offering price of $39 per share after

deducting underwriting discounts and commissions payable by us.

As of 31 December 20X4

Actual

As adjusted

Long-term debt

$ 1,000,000

Stockholders’ equity

Common stock, par value $0.001 per share; 200,000 shares

authorized; 22,170 shares issued and outstanding, actual and

25,970 shares issued and outstanding, as adjusted

Additional paid-in capital

258,400

397,596

Accumulated other comprehensive loss

(7)

Accumulated deficit

(117,409)

Total stockholders’ equity

141,006

280,210

Total capitalization

1,141,006

1,280,210

Pro forma financial information | 61

6 Other pro forma considerations

6.1 IPO considerations

As discussed earlier, Article 11 of Regulation S-X requires pro forma financial information for events or

transactions that are material to investors. Historically, the SEC staff has required companies to present

the additional pro forma disclosures described below in or alongside the historical financial statements in

their IPO registration statements. However, Rule 11-02(a)(12) states that registrants cannot present pro

forma financial information on the face of their historical financial statements or in the accompanying notes,

except when such presentation is required by US GAAP or IFRS–IASB, as applicable.

As a result, we believe registrants should continue to determine whether additional pro forma

information is material and evaluate the appropriate location for such disclosures.

6.1.1 Planned distributions not reflected in the historical balance sheet

Excerpt from SEC staff interpretations

Codification of Staff Accounting Bulletins

Topic 1.B.3, Other matters

Question: What is the staff’s position with respect to dividends declared by the subsidiary subsequent

to the balance sheet date?

Interpretive Response: The staff believes that such dividends either be given retroactive effect in the

balance sheet with appropriate footnote disclosure, or reflected in a pro forma balance sheet. In

addition, when the dividends are to be paid from the proceeds of the offering, the staff believes it is

appropriate to include pro forma per share data (for the latest year and interim period only) giving

effect to the number of shares whose proceeds were to be used to pay the dividend. A similar

presentation is appropriate when dividends exceed earnings in the current year, even though the

stated use of proceeds is other than for the payment of dividends. In these situations, pro forma per

share data should give effect to the increase in the number of shares which, when multiplied by the

offering price, would be sufficient to replace the capital in excess of earnings being withdrawn.

In accordance with SAB Topic 1.B.3, pro forma disclosures may be required when dividends are declared

or a distribution to prior owners, promoters and/or parents is planned after the date of the latest balance

sheet presented. The SEC staff believes that dividends declared by a subsidiary after the balance sheet

date should be reflected in a pro forma balance sheet in the IPO filing.

If a planned distribution is not

reflected in the latest balance sheet but would be significant relative to the reported equity, a pro forma

balance sheet reflecting accrual of the subsequent distribution (but not giving effect to the offering

proceeds) should be presented in the filing, regardless of whether the distribution has been declared or is

to be paid from proceeds.

SEC staff’s Financial Reporting Manual Section 3420.

6 Other pro forma considerations

Pro forma financial information | 62

6.1.2 Distributions in excess of earnings

The SEC staff also provided its views in SAB Topic 1.B.3 about the presentation of pro forma EPS when

dividends paid or planned exceed current earnings. It is important for registrants to consider the

applicability of this guidance when calculating pro forma EPS, even when the use of proceeds in the

capitalization table of a registration statement does not include payment of such dividends. The pro

forma presentation requirements of this SAB Topic apply to dividends paid at or prior to closing of an IPO

that are greater than the current year’s earnings. The SEC staff assumes that offering proceeds will be

used to replenish capital used to pay dividends within 12 months of the offering if those dividends exceed

earnings during the prior 12 months.

The purpose of considering these dividends in pro forma EPS is to include the effect of common shares

for which a registrant would have to raise proceeds to pay the portion of dividends exceeding current

year’s net income, which has been interpreted to mean the most recent 12 months. The shares that are

assumed issued are added to historical shares outstanding in the denominator of the pro forma EPS

calculation. The number of shares added to historical shares outstanding in the denominator should not

exceed the total number of shares issued in the offering.

In these cases, pro forma EPS should be presented only for the most recent annual and interim periods.

The following illustration is an example pro forma EPS calculation that includes the effect of additional

shares whose proceeds were assumed to be used to fund dividends.

Illustration 6-1: Pro forma EPS — dividends in excess of current-year earnings

Company A is planning an IPO of its common stock. Prior to its IPO, Company A had 100,000 shares

of common stock outstanding. Company A will sell 800,000 shares in the IPO for $6.25 per share.

Proceeds will total $5 million before underwriting discounts and other expenses. Company A’s net

income for the previous 12 months was $1 million.

Scenario 1:

Company A will use the proceeds from its IPO together with the funds provided by a bank line of credit

to pay a $3.5 million dividend to its shareholders at the time of closing.

In this scenario, the dividend of $3.5 million exceeds the most recent year’s net income of $1 million

but is not greater than total offering proceeds of $5 million. The dividend exceeds current-year

earnings by $2.5 million ($3.5 million dividend, less $1 million net income), which is deemed to be paid

from the offering proceeds. Because this excess does not exceed total offering proceeds, only a

portion of the total 800,000 IPO shares would be added to the historical 100,000 shares in the pro

forma EPS denominator. That is, because Company A would have to issue 400,000 shares to raise

$2.5 million to pay the dividend ($2.5 million, divided by the offering price per share of $6.25), the

pro forma EPS denominator would be calculated as follows:

Preexisting (historical) weighted average shares outstanding

100,000

IPO shares required to fund dividend in excess of earnings

400,000

Pro forma shares

500,000

6 Other pro forma considerations

Pro forma financial information | 63

Scenario 2:

Company A will use the proceeds from its IPO together with the funds provided by a bank line of credit

to pay a $15 million dividend to existing shareholders at the time of closing.

In this scenario, the dividend that Company A will pay shareholders at the closing date of the IPO

($15 million) exceeds Company A’s net income for the previous 12 months ($1 million). Therefore, a

portion of the dividend is deemed paid from the proceeds of the IPO. Since the amount of the dividend

in excess of Company A’s net income for the previous 12 months ($14 million) exceeds the gross

proceeds of the IPO ($5 million), Company A should include all 800,000 of the shares offered in the

IPO in the denominator of the pro forma EPS calculation. Therefore, the pro forma EPS denominator

would be calculated as follows:

Preexisting (historical) weighted average shares outstanding

100,000

Total IPO shares

800,000

Pro forma shares

900,000

To present a transparent picture for investors, the numerator of the pro forma EPS computation in

Scenario 2 also should be adjusted to reflect the additional interest expense (net of tax) assumed

incurred to finance the portion of the dividend that exceeds both the gross proceeds from the equity

offering and the previous 12 months’ earnings ($9 million in this example: $15 million dividend less

$1 million in earnings and $5 million in IPO proceeds).

6.1.3 Changes in tax status

Many private companies are organized as nontaxable entities (e.g., S corporations, limited-liability

corporations, partnerships) to minimize the tax burden on the equity owners. However, prior to

consummation of an IPO, these companies often convert to C corporations, which are taxable entities. In

these cases, the SEC staff expects IPO registrants to present pro forma income tax and pro forma EPS.

Pro forma income tax should be calculated using statutory tax rates that were in effect in prior periods.

Presentation is generally limited to the most recent annual and interim period included in the IPO registration

statement. However, if the pro forma adjustments relate to only income taxes (i.e., the IPO registration

statement does not include any other pro forma information for other events or transactions), the SEC

staff encourages registrants to present pro forma income tax and pro forma EPS for all periods included

in the historical financial statements.

If a registrant elects to present pro forma information for all periods, as noted above, pro forma income

tax and EPS measures should continue to be presented in SEC filings made after the IPO.

SAB Topic 4B states that undistributed earnings of a former Subchapter S corporation or partnership should

be reclassified to paid-in capital in the pro forma financial statements. We have seen the staff request that

companies reclassify accumulated losses in a similar manner; however, we believe that any portion of

losses that would result in paid-in capital becoming negative should not be reclassified. This presentation

assumes a constructive distribution to (contribution by) the owners or partners followed by a capital

contribution (distribution).

Subchapter S corporations or partnerships that pay distributions to promoter/owners at the closing or

effective date with proceeds of the offering (rather than out of current earnings) should consider the

pro forma EPS presentation described in section 6.1.2 above.

SEC staff’s Financial Reporting Manual Section 3410.

6 Other pro forma considerations

Pro forma financial information | 64

6.1.4 Other changes in capitalization

Pro forma financial information may be required if reorganizations, unusual asset exchanges, debt

restructurings, debt refinancing or other changes in capitalization (e.g., redeemable preferred stock,

debt convertible to common stock) occur at the effective date or the close of an offering, including an

IPO. Generally, the historical balance sheet and statement of operations (including EPS) should not be

revised to reflect modifications of the terms of outstanding securities that become effective after the

latest balance sheet date, although pro forma data may be necessary to reflect these transactions.

If terms of outstanding equity securities will change after the latest balance sheet date and the new

terms result in a material change to equity, or if redemption of a material amount of equity securities will

occur in conjunction with the offering, the filing should include a pro forma balance sheet (excluding

effects of offering proceeds) that gives effect to the change in capitalization.

If the conversion of outstanding securities or other changes in capitalization will occur after the latest

balance sheet date and the conversion or change would materially affect EPS (excluding effects of the

offering), pro forma EPS for the latest year and interim period also should be presented giving effect to

the conversion or other changes in capitalization.

The SEC staff has said that when convertible securities will automatically convert to common stock upon

an IPO, the number of shares used to compute pro forma EPS should include the number of common

shares into which the securities will convert as if they were outstanding as of the beginning of the most

recently completed fiscal year presented in the Article 11 pro forma financial statements, regardless of

when the convertible instrument was issued. This pro forma EPS calculation should give effect only to the

assumed conversion of outstanding securities and not the offering. Pro forma EPS reflecting the

assumed conversions should be included in the registration statement in addition to historical EPS.

6.1.5 Example — disclosure of pro forma financial information in an IPO

Illustration 6-2: Pro forma financial information in an IPO filing

Company A has decided to conduct an IPO of its common stock and expects to file its Form S-1

registration statement on 1 April 20X5. The key facts include:

• Before the IPO, Company A has 1 million shares of issued and outstanding common stock in

addition to outstanding preferred stock that is convertible into 1 million shares of common stock

upon an IPO.

• Company A expects to sell 8 million shares in the IPO for $15 per share. The offering will yield

total proceeds of $120 million before underwriting discounts and other expenses.

• On 6 January 20X5, Company A declared and paid a dividend of $55 million to its shareholders

from cash on hand.

• Company A’s net income for the previous 12 months was $10 million. Accordingly, $45 million of

IPO proceeds (or 3 million shares) must be assumed to fund the dividend.

Company A might provide the following pro forma disclosure to reflect changes in capitalization in

connection with the IPO.

6 Other pro forma considerations

Pro forma financial information | 65

Notes to Unaudited Pro Forma Condensed Combined Financial Information

Note 2 Pro forma Balance Sheet and Net Income Per Share

The unaudited pro forma balance sheet and pro forma basic and diluted net income per share reflect:

(1) the accrual of the $55 million dividend that was declared and paid on 6 January 20X5 and (2) the

expected conversion of all outstanding preferred shares with a historical value of $10 million to

1 million common shares in connection with the IPO.

The dividend payment in January 20X5 was made in contemplation of the IPO offering. Pro forma net

income per share gives effect to 3 million additional common shares issued in the IPO that would be

necessary to fund the excess of the dividend payment over the current-period earnings of $10 million.

The additional common shares were calculated assuming an initial public offering price of $15.00 per

share (the midpoint of the IPO range).

The following table sets forth the computation of pro forma basic and diluted earnings per share for

the year ended 31 December 20X4:

Net income to common shareholders

$ 9,000

Transaction accounting adjustment to remove preferred dividends

1,000

Net income used to compute pro forma net earnings per share

$ 10,000

Basic and diluted weighted average common shares outstanding

1,000

Transaction accounting adjustment to reflect conversion of preferred

1,000

Transaction accounting adjustment to reflect common shares sold in the

IPO to fund dividend payments in excess of current earnings

3,000

Basic and diluted weighted average common shares outstanding

used in computing pro forma net earnings per share

5,000

Pro forma net earnings per common share, basic and diluted

$ 2.00

6.2 Financial forecasts

Excerpt from SEC Rules and Regulations

Regulation S-X, Article 11 Pro Forma Financial Information

Rule 11-03, Presentation of financial forecast

(a) A financial forecast may be filed in lieu of the pro forma condensed statements of comprehensive

income required by Regulation S-X Rule 11-02(a)(1).

1. The financial forecast shall cover a period of at least 12 months from the latest of (i) the

most recent balance sheet included in the filing or (ii) the consummation date or estimated

consummation date of the transaction.

2. The forecasted statement of comprehensive income shall be presented in the same degree

of detail as the pro forma condensed statement of comprehensive income required by

Regulation S-X Rule 11-02(a)(3).

3. Assumptions particularly relevant to the transaction and effects thereof should be clearly

set forth.

6 Other pro forma considerations

Pro forma financial information | 66

4. Historical condensed financial information of the registrant and the business acquired or to

be acquired, if any, shall be presented for at least a recent 12 month period in parallel

columns with the financial forecast.

(b) Such financial forecast shall be presented in accordance with the guidelines established by the

American Institute of Certified Public Accountants.

(d) This section does not permit the filing of a financial forecast in lieu of pro forma information

required by US GAAP or IFRS–IASB.

A financial forecast presents a company’s expected results of operations, based on the conditions

management expects to exist and the actions it expects to take. It may be expressed in specific monetary

amounts as a single-point estimate or as a range. A financial forecast differs from a financial projection,

which presents prospective financial information based on one or more hypothetical assumptions and

may be used to evaluate the outcome of different courses of action.

Rule 11-03 of Regulation S-X permits companies to present a financial forecast in lieu of a pro forma

condensed income statement. Electing this option does not eliminate the requirements to present a pro

forma balance sheet. In the SEC staff’s view, the pro forma balance sheet is necessary to reflect the

effect of the transaction on the financial position of the registrant. In addition, companies cannot

substitute financial forecasts for pro forma disclosures required under US GAAP (e.g., pro forma

disclosures required by ASC 805, Business Combinations).

In practice, very few forecasts are filed in lieu of pro forma income statements, likely due to concerns

about additional legal liability. However, a forecast may be more relevant than a pro forma condensed

income statement in certain situations, as illustrated below.

Illustration 6-3: Forecast in lieu of pro forma income statement

A registrant acquires a significant oil and gas property from ABC Company on 31 March 20X5 that requires

audited financial statements under Rule 3-05 of Regulation S-X for the year ended 31 December 20X4. The

property represents only a portion of the assets of ABC Company and is not a segment, division or separate

legal subsidiary of ABC Company. In addition, it would be impracticable to prepare full financial statements

of the oil and gas property because ABC Company did not maintain distinct and separate accounts of

the property. Therefore, the registrant determines that it is appropriate to provide abbreviated financial

statements of the oil and gas property (e.g., statements of revenue and direct expenses and statements

of assets acquired and liabilities assumed) to satisfy the Rule 3-05 requirements.

When preparing the pro forma financial information for the significant acquisition of the gas and oil

property for the year ended 31 December 20X4, the registrant determines that a forecast about post-

acquisition results of operations would be more meaningful than a pro forma statement of operations.

The historical abbreviated financial statements of the acquired property are not indicative of the

financial condition or results of operations going forward because they omit various operating

expenses. If the forecast complies with the requirements of Rule 11-03 of Regulation S-X, the registrant

may omit a pro forma income statement but would continue to provide a pro forma balance sheet as of

31 December 20X4. The forecast must cover at least the 12 months ending 31 March 20X6.

6 Other pro forma considerations

Pro forma financial information | 67

6.2.1 Presentation and disclosure requirements

Forecasts must follow presentation guidelines issued in the American Institute of Certified Public Accountant’s

Guide for Prospective Financial Statements and S-X Rule 11-03 and comply with the guidelines for projections

in S-K Item 10, including the following:

• The financial forecast must cover a period of at least 12 months from the later of the latest balance

sheet included in the filing or the actual or planned consummation date of the transaction.

• The financial forecast should be presented in the same level of detail as would be required for a pro

forma condensed income statement, substituting forecasted EPS for pro forma EPS.

• The determination and effects of assumptions should be reasonable and clearly disclosed.

Assumptions must be supported by persuasive evidence (e.g., historical operating results, internal

analyses, market surveys, other third-party reports).

• Historical information of the registrant and business to be acquired (if applicable) should be

presented for a recent 12-month period in parallel columns with the forecast.

6.3 Roll-up transactions

Excerpt from SEC rules and regulations

Regulation S-K, Subpart 900 — Roll-Up Transactions

Item 914, Pro forma financial statements; selected financial data

(a) In addition to the information required by Item 301 of Regulation S-K, Selected Financial Data,

and Item 302 of Regulation S-K, Supplementary Financial Information, for each partnership

proposed to be included in a roll-up transaction provide: Ratio of earnings to fixed charges,

cash

and cash equivalents, total assets at book value, total assets at the value assigned for purposes of

the roll-up transaction (if applicable), total liabilities, general and limited partners’ equity, net

increase (decrease) in cash and cash equivalents, net cash provided by operating activities,

distributions; and per unit data for net income (loss), book value, value assigned for purposes of

the roll-up transaction (if applicable), and distributions (separately identifying distributions that

represent a return of capital). This information should be provided for the same period(s) for

which Selected Financial Data and Supplementary Financial Information are required to be

provided. Additional or other information should be provided if material to an understanding of

each partnership proposed to be included in a roll-up transaction.

(b) Provide pro forma financial information (including oil and gas reserves and cash flow disclosure,

if appropriate), assuming:

(1) All partnerships participate in the roll-up transaction; and

(2) Participation in a roll-up transaction of those partnerships that on a combined basis have

the lowest combined net cash provided by operating activities for the last fiscal year of

such partnerships, provided participation by such partnerships satisfies all conditions to

consummation of the roll-up transaction. If the combination of all partnerships proposed to be

included in a roll-up transaction results in such lowest combined net cash provided by operating

activities, this shall be noted and no separate pro forma financial statements are required.

As part of its Disclosure Update and Simplification rule, which became effective 5 November 2018, the SEC amended various items in

Regulation S-K to eliminate the requirement for registrants to present the ratio of earnings to fixed charges in SEC filings. However,

the rule did not eliminate the disclosure requirement to present the ratio of earnings to fixed charges from Item 914 of Regulation S-K.

We believe that this was unintentional, and the ratio of earnings to fixed charges would not be required under Item 914.

6 Other pro forma considerations

Pro forma financial information | 68

of the roll-up transaction on the successor’s:

(1) Balance sheet as of the later of the end of the most recent fiscal year or the latest interim period;

(2) Statement of income (with separate line items to reflect income (loss) excluding and

including the roll-up expenses and payments), earnings per share amounts, and ratio of

earnings to fixed charges for the most recent fiscal year and the latest interim period;

(3) Statement of cash flows for the most recent fiscal year and the latest interim period; and

(4) Book value per share as of the later of the end of the most recent fiscal year or the latest

interim period.

A roll-up transaction involves the combination or reorganization of one or more partnerships, directly or

indirectly, in which some or all of the investors in any of the partnerships will receive new securities or

securities in another entity. However, not all combination or reorganization transactions involving

partnership interests will be subject to these roll-up disclosure requirements, and careful consideration

and analysis should be performed when considering whether a transaction meets the definition of a roll-

up transaction under Item 901(c) of Regulation S-K.

A registrant must disclose the following pro forma financial information showing the effect of a proposed

roll-up transaction on the successor entity:

• Balance sheet as of the later of the end of the most recent fiscal year or latest interim period

• Statements of income for the most recent fiscal year and the latest interim period with separate line

items to reflect income (loss), excluding and including roll-up expenses and payments and earnings-

per-share amounts

• Statement of cash flows for the most recent fiscal year and the latest interim period

• Book value per share as of the later of the end of the most recent fiscal year or the latest interim period

• Pro forma oil and gas reserve data, if applicable

This information should be prepared assuming (1) all partnerships participate and (2) participation is

limited only to those partnerships with the lowest combined net cash provided by operating activities for

the last fiscal year of such partnerships, which would still satisfy the minimum participation requirements

specified in the proposed transaction.

6.4 Tender offers

Excerpt from SEC Rules and Regulations

Regulation S-K, Subpart 1000 — Mergers and Acquisitions (Regulation M-A)

Item 1010, Financial statements

(b) Pro forma information. If material, furnish pro forma information disclosing the effect of the

transaction on:

(1) The company’s balance sheet as of the date of the most recent balance sheet presented

under paragraph (a) of this section;

(2) The company’s statement of comprehensive income and earnings per share for the most recent

fiscal year and the latest interim period provided under paragraph (a)(2) of this section; and

(3) The company’s book value per share as of the date of the most recent balance sheet

presented under paragraph (a) of this section.

6 Other pro forma considerations

Pro forma financial information | 69

Tender offers are offers to buy shares directly from security holders. Tenders may be made by either the

issuer of the securities or by another party. In a tender offer, the offeror may offer cash, securities or a

combination of cash and securities. If the consideration consists wholly of or partly of registered securities,

the offeror generally has to register them under the Securities Act of 1933, and the financial statement

requirements of Form S-4 or F-4 should be followed, unless an exemption from registration is available.

The primary document used to file tender offers is Schedule TO under the Exchange Act. Regulation M-A

provides disclosure requirements that apply to a tender offer on Schedule TO. Item 1010(b) of

Regulation M-A requires pro forma information, if material, disclosing the following effects of the

transaction:

• The effect on the company’s most recent balance sheet

• The effect on the company’s statement of income and EPS for the most recent fiscal year and the latest

interim period

• The effect on the company’s book value per share as of the date of the most recent balance sheet

A registrant may need more than one pro forma presentation giving effect to the range of possible

results if a proposed transaction may have significantly different outcomes. See section 4.6.2 for further

discussion when a tender offer may involve a range of possible outcomes.

6.5 Pro forma MD&A

When a registrant acquires a significant business or applies pushdown accounting, it should consider

whether to include a supplemental discussion in MD&A based on pro forma financial information. When

determining whether such a discussion is necessary, the registrant should consider all the facts and

circumstances of the transaction, the nature of the transaction accounting adjustments to be made and

how meaningful such a discussion would be.

For example, if the application of pushdown accounting in historical financial statements results in

separate predecessor and successor periods, the historical financial statements may not be comparable.

As a result, the registrant may determine that a discussion based on pro forma financial information

would be meaningful to investors.

If a pro forma MD&A discussion is deemed appropriate, the registrant should clearly disclose why

management believes the presentation is meaningful, how the presentation was derived and whether

there are any risks or limitations associated with the presentation (e.g., the results might not necessarily

be indicative of future results). A registrant does not need to include the entire pro forma presentation

required by Article 11 when providing supplemental MD&A. The presentation of MD&A based upon the

pro forma results should supplement and not replace a discussion based upon the historical results as

required by Item 303 of Regulation S-K.

The SEC staff believes that the pro forma discussion should be based on pro forma information prepared

in a manner consistent with Article 11 of Regulation S-X unless another presentation (e.g., ASC 805

disclosures) is more appropriate based on the facts and circumstances. The SEC staff has said that it

would not be appropriate to merely combine the pre- and post-transaction results without reflecting all

relevant pro forma adjustments required by Article 11.

Further, if a pro forma MD&A discussion is

included, it should not be presented with greater prominence than the discussion of the historical

financial statements required by Item 303 of Regulation S-K.

SEC staff’s Financial Reporting Manual Section 9220.8.

6 Other pro forma considerations

Pro forma financial information | 70

6.6 Pro forma effects on non-GAAP financial measures of performance or liquidity

The use of non-GAAP financial measures in SEC filings must comply with Item 10(e) of Regulation S-K.

When a company presents a non-GAAP financial measure in an SEC filing, it must (1) present, with equal

or greater prominence, the most directly comparable financial measure calculated and presented in

accordance with GAAP and (2) reconcile the non-GAAP financial measure, by schedule or other clearly

understandable format, to the most directly comparable GAAP measure.

Non-GAAP financial measures should not be presented on the face of any pro forma financial information

required to be disclosed under Article 11 of Regulation S-X, and we believe pro forma adjustments to

non-GAAP measures should exclude management’s adjustments.

The following is an example of non-GAAP measures used in pro forma financial information:

Illustration 6-4: Pro forma non-GAAP measures

A company includes the following pro forma non-GAAP measures in connection with an acquisition

after the unaudited pro forma balance sheet, statement of operations and related notes.

[The illustration below excludes the narrative disclosure required by Regulation S-K Item 10(e).]

A reconciliation of pro forma earnings before interest, taxes, depreciation and amortization (EBITDA)

to pro forma Net Income (loss) determined in accordance with GAAP is provided below (in millions):

Pro forma

combined

Net Income (loss)

$ 227

Interest expense, net

240

Provision (benefit) for income taxes

142

Depreciation and amortization

424

EBITDA

1,033

Pro forma financial information | 71

7 Auditor involvement

The SEC does not require pro forma financial information to be audited or reported on by an independent

registered public accounting firm. However, auditors may perform procedures over pro forma financial

information at the request of third parties or to comply with professional auditing standards.

When SEC filings, other than a Securities Act filing, include or incorporate by reference audited financial

statements and an auditor’s opinion, the auditor must consider the guidance in Public Company Accounting

Oversight Board (PCAOB) Auditing Standard (AS) 2710, Other Information in Documents Containing

Audited Financial Statements. This guidance requires auditors to read pro forma financial information

(and any other information) included in a filing, if applicable, and consider whether such information or

the manner of its presentation is inconsistent with the audited financial statements. Any actions taken by

the auditor will depend on facts and circumstances and the significance of the inconsistency.

The auditor’s responsibilities with respect to Securities Act filings that include or incorporate by reference

audited financial statements and an auditor’s opinion are addressed in PCAOB AS 6101, Letters for

Underwriters and Certain Other Requesting Parties (PCAOB AS 6101) (discussed in section 7.1 below), and

PCAOB AS 4101, Responsibilities Regarding Filings Under Federal Securities Statutes (PCAOB AS 4101).

PCAOB AS 4101 requires an auditor who issues a consent in a Securities Act registration statement to

read the entire prospectus and other pertinent parts of the registration statement (including any pro

forma financial information included), in part to make sure that the auditor’s name isn’t used in a way

that indicates his or her responsibility is greater than intended (e.g., the experts section doesn’t imply

that the financial statements were prepared by the auditor).

7.1 Comfort letters

An underwriter or other requesting party may request that an auditor comment in a comfort letter on pro

forma financial information included in a registration statement, prospectus supplement or offering

memorandum. PCAOB AS 6101 provides guidance about the level of assurance that auditors may

provide (e.g., negative assurance, procedures performed and findings obtained) on pro forma financial

information. Certain criteria must be met before an auditor can provide negative assurance on pro forma

financial information as it relates to compliance with Article 11 and the proper application of the pro

forma adjustments. If such criteria aren’t met, auditors generally can still report on the procedures

performed and findings obtained in their comfort letter.

7.2 Reporting on pro forma financial information

In certain circumstances, a party to a transaction may request that an auditor report on pro forma

financial information. Reporting on pro forma financial information is an attestation engagement covered

by Statement on Standards for Attestation Engagements, Reporting on Pro Forma Financial Information

(AT 401). Under AT 401, auditor’s reports for general distribution are limited to (1) assurance based on

an examination and (2) negative assurance based on a review.

When an auditor reports on an examination or a review of pro forma financial information, the auditor’s

assurances relate to whether (1) management’s assumptions provide a reasonable basis for presenting

the significant effects of the transaction or event reflected in the pro forma financial information, (2) the

pro forma adjustments give appropriate effect to those assumptions and (3) the resulting pro forma

amounts reflect the proper application of those adjustments to the historical amounts.

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