1. Overview of the New Rule
Subtopic 3250, In Business Combinations, was revised to include the following paragraph:

m. If a Registrant adopts a new accounting standard as of a different date and/or under a different transition method than a significant acquired business, the Registrant must conform the date and method of adoption of the acquired business to its own in its pro forma financial information. The staff will consider requests for relief from this requirement. (Last updated: 12/1/2017).

2. Example: Applying the New Rule

  • Assume a Registrant early-adopted a new accounting standard (e.g. ASC 606) as of January 1, 2017, and in September 2018 it makes a significant acquisition of an entity that has not early-adopted ASC 606.
  • When the Registrant later files a Form 8-K that includes pro forma financial information for the year ended December 31, 2017 and the six months ending June 30, 2018, the Registrant is required to apply ASC 606 to the acquiree’s financial statements for purposes of conforming the pro forma information to the Registrant’s.

3. Purpose and Benefits of the New Rule

  • This change benefits investors as it requires the acquisition-related pro forma financial information to be prepared on the same basis of accounting as the Registrant, which results in more meaningful disclosure of historical results and brings more value to readers of the Form 8-K.
  • The purpose of pro forma information, in the context of a significant acquisition, is to show readers what the financial statements of the combined entity would have looked like if the acquisition had been part of the Registrant for a full year.
  • The new guidance will result in pro forma presentations that are consistent with the combined entity’s future financial statements, thus providing for enhanced comparability.

4. New Compliance Requirements

  • The new rule creates an additional compliance hurdle for Registrants who make significant acquisitions as they will need to assess a target’s ability to conform its historical accounting to that of the acquirer. Time and expense associated with this process will need to be budgeted for and assessed during due diligence.
  • The time and costs associated with conforming an acquiree’s historical accounting methods to those of a buyer can be substantial as public companies are often required to adopt many of the new accounting pronouncements earlier than private companies and certain accounting pronouncements can only be utilized by private companies. Private companies are provided these benefits to help ease the burden and cost associated with accounting for certain complex areas and adopting new accounting pronouncements.
  • Further, many accounting pronouncements offer different transition methods and timeline options for public companies. As a result, public companies that are potential acquisition targets are also impacted to the extent they have adopted new accounting guidance under different timing or transition methods than that of a potential buyer that is an SEC Registrant.

5. Expected impact on Private Equity (PE) and M&A Markets

  • Strategic sale to a public acquirer is a common exit scenario for many PE-backed companies. PEs often go to great lengths to properly prepare their portfolio companies for exits to: (1) maximize the number of potential buyers, (2) facilitate a timely exit, and (3) ultimately drive the maximum value.
  • PE-backed companies that are: (1) considering a strategic sale to a public acquirer; and (2) believe their sale will qualify as a significant acquisition for the acquirer, will now need to add being prepared to conform their historical financial results as part of their preparation efforts.
  • Being prepared to conform the historical financials includes being ready to adopt and report financial statements in accordance with all new accounting pronouncements applicable to public companies. Notable new accounting pronouncements include ASC 606, Revenue from Contracts with Customers and ASC 842, Leases.
  • Also, to the extent a portfolio company of a PE has opted for Private Company Accounting (e.g. amortizing goodwill instead of testing for impairment), the company should be prepared to conform such accounting to public-company standards. Companies should not underestimate the level of effort required to assess the implications of new accounting standards and to conform the applicable historical periods.

6. Compliance Cost and Effort Will Vary; Exceptions to the Rule

  • The level of cost and effort to apply the new rule will vary by acquisition depending on the extent to which the acquiree’s timing and/or transition methods of adopting any new accounting guidance differ from that of the public company acquirer.
  • This new requirement applies only to significant acquisitions (as defined in Regulation S-X 3.05). Acquisitions that are not deemed significant are not subject to this requirement.