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Rule 1-02(w) is used to determine whether a tested subsidiary is deemed significant for the purposes of various SEC rules and form requirements. The significance tests set forth in Rule 1-02(w) are commonly referred to as the investment test, the asset test, and the income test.
The new rules amend the investment and income tests and are intended to result in more meaningful determinations of whether a subsidiary or an acquired or disposed business is significant. No change was made to the asset test.
Investment test
Under amended Rule 1-02(w)(1)(i)(A), when the investment test is performed in connection with an acquisition (other than a combination of entities or businesses under common control) or disposition, the registrant will compare its and its other subsidiaries’ investments in and advances to the tested subsidiary to the aggregate worldwide market value of the registrant’s voting and non-voting common equity (aggregate worldwide market value). For purposes of this test, aggregate worldwide market value is the average for the last five trading days of the registrant’s most recently completed month prior to the earlier of the registrant’s announcement date or agreement date of the acquisition or disposition. Aggregate worldwide market value differs from the common equity public float amount used by registrants to determine accelerated filer status. For example, public float excludes common equity held by affiliates.
If the registrant does not have an aggregate worldwide market value, such as in an initial public offering or when the registrant’s stock is not publicly traded, then the “investments in and advances to” the tested subsidiary will be compared to the registrant’s consolidated total assets as of the end of the most recently completed fiscal year. The comparison to the registrant’s consolidated total assets as of the end of the most recently completed fiscal year is also used when the investment test is being performed for purposes other than an acquisition or disposition, such as when testing the significance of equity method investees under Rules 3-09 and 4-08(g).
  • Acquisitions - the “investments in” the tested subsidiary is based on the consideration transferred and includes the fair value of contingent consideration that is required to be recognized at fair value on the acquisition date by US GAAP or IFRS as issued by the IASB (IFRS-IASB), as applicable. If recognition of contingent consideration at fair value is not required, such as in an acquisition of an equity method investment, then the “investments in” the tested subsidiary should include all contingent consideration except that for which the likelihood of payment is remote.
  • 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. When the registrant does not have an aggregate worldwide market value, the “investments in” the tested subsidiary is the carrying value of the disposed subsidiary.
Income test
Under amended Rule 1-02(w)(1)(iii)(A), the income test includes a revenue component (in addition to an income component) in order to reduce the instances in which a registrant with marginal or break-even income will have a tested subsidiary deemed significant.
The revenue component of the income test compares a registrant’s and its other subsidiaries’ proportionate share of the tested subsidiary’s consolidated total revenues from continuing operations (after intercompany eliminations) to the comparable consolidated total revenues of the registrant for the most recently completed fiscal year. The revenue component, however, 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.
In connection with an acquisition, the registrant would use the lower of the revenue component or the income component when evaluating the income test condition for purposes of determining how many years of financial statements are required under Rule 3-05.
The amended rules also clarify and simplify areas such as income averaging and the use of absolute values, when applicable.
Use of pro forma financial information to measure significance
The determination of whether an acquired or to be acquired business is significant is based on the provisions of amended Rule 11-01(b)(3) and (4), as applicable. Those provisions are also used to determine whether a completed or probable disposition of a business is significant.
Amended Rule 11-01(b)(3) permits registrants to measure significance using pro forma amounts that depict significant business acquisitions and dispositions consummated after the latest fiscal year end for which the registrant’s financial statements are required to be filed when the following conditions are met:
  • the registrant has filed audited financial statements required by Rule 3-05 for any such acquired business; and
  • the registrant has filed the pro forma financial information required by Article 11 for any such acquired or disposed business.

The pro forma amounts used may only give effect to significant acquired or disposed businesses and transaction accounting adjustments, as described below.
If a registrant uses pro forma financial information to determine the significance of an acquisition or disposition, it must continue to do so until its next annual report is filed.

2For ease of reference, we have used the term tested subsidiary throughout when referring to a tested business.

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