Search within this section
Select a section below and enter your search term, or to search all click PwC SEC volume
Favorited Content
SEC 4400 - The significant subsidiary tests
Publication date: 30 Jun 2023
us PwC SEC Volume 4400
[Editor’s note: In May 2020, the SEC adopted amendments to the significant subsidiary tests in S-X 1-02(w). See SEC Release No. 33-10786, Amendments to Financial Disclosures about Acquired and Disposed Businesses (SEC Release 33-10786). The amendments became effective January 1, 2021 subject to the transition provisions (including voluntary early compliance) described in Section II. F. of SEC Release 33-10786.
SEC 4400 contains guidance regarding the application of the significance tests contained in amended S-X 1-02(w)(1) by companies other than business development companies and registered investment companies. Business development companies and registered investment companies should refer to S-X 1-02(w)(2), S-X 6-11 and section II.E of SEC Release 33-10786.
The SEC staff has published extensive interpretive guidance relating to the significance tests and related matters (e.g., in various sections of the SEC Staff’s Financial Reporting Manual). Much of the guidance was issued prior to the adoption of SEC Release 33-10786. Care should be exercised when considering guidance that was issued prior to the adoption of SEC Release 33-10786.]
.1 General
Many SEC reporting requirements are based, at least in part, on the determination of whether a tested entity (e.g., an acquired business) meets the SEC’s definition of a significant subsidiary as applied in the context of the specific rule or form requirement that is calling for the assessment (e.g., S-X 3-05). If the tested entity is considered a significant subsidiary in the context under which the test is being performed, the registrant may be required to provide financial and nonfinancial disclosures, such as summarized financial information, audited and unaudited historical financial statements and/or pro forma financial information. The acquisition of a business (e.g., S-X 3-05) and the acquisition of a real estate operation (e.g., S-X 3-14) are two commonly encountered situations in which the definition of a significant subsidiary is used. Other examples can be found in footnote 23 to SEC Release 33-10786.
[Editor’s note: References in SEC 4400 to “tested subsidiary” should also be read as “tested business” or “tested entity” where appropriate.]
.11 What is the significance threshold used when performing a significant subsidiary test?
The significance threshold specified in S-X 1-02(w)(1) is 10%. However, it is important to note that the various SEC rules and form requirements that make use of the significant subsidiary tests oftentimes specify different thresholds, calculation methods or limitations. Accordingly, the significance assessment should be made in the context of the specific disclosure requirement being assessed. For example, Instruction 4(ii) to Item 2.01 of Form 8-K indicates that the significance assessment relating to the acquisition or disposition of a business should be based on S-X 11-01(b). S-X 11-01(b) specifies a threshold of 20% and also provides additional requirements to be used for performing the significance assessment.
.12 Basis of accounting used to perform significance tests
.121 What basis of accounting should be used to perform significance tests?
A registrant that files its financial statements in accordance with or provides a reconciliation to US GAAP must determine significance using amounts determined under US GAAP (i.e., both the numerator and the denominator of the significance tests will be calculated under US GAAP). This is true even if the financial statements of the tested entity may be presented in accordance with International Financial Reporting Standards as issued by the International Accounting Standards Board (IFRS-IASB) without reconciliation to US GAAP.
A foreign private issuer that files its financial statements in accordance with IFRS-IASB must determine significance using amounts determined under IFRS-IASB (i.e., both the numerator and the denominator of the significance tests will be calculated under IFRS-IASB).
See S-X 1-02(w)(1) and SEC FRM 2015.3.
[Editor’s note: We understand the SEC staff will permit registrants to assess significance for an acquired business based on financial statements of the acquired business that applied the non-public business entity (PBE) guidance in ASC 842-20-30-3 relating to the use of the risk-free discount rate to account for leases if that is the only non-PBE accounting method used in the financial statements. However, if the acquired business is significant, we understand the financial statements presented should follow the requirements applicable to PBEs, as appropriate. See Topic III.E in the highlights of the October 2020 meeting of the CAQ SEC Regulations Committee.]
.122 Can financial statements prepared using Private Company Council alternatives be used for performing significance tests?
Certain private companies may elect to prepare financial statements using US GAAP alternatives as developed by the Private Company Council (“PCC”) and endorsed by the FASB. The SEC staff has indicated that if registrants are required to perform significance tests using US GAAP information, then the tests generally may not be performed using information that applies the accounting alternatives developed by the PCC. Therefore, to comply with requirements of S-X 1-02(w), these financial statements must be adjusted to US GAAP without applying PCC alternatives in order to perform the significance tests. See Topic III.B in the highlights of the March 2014 meeting of the CAQ SEC Regulations Committee.
.2 Investment test
The investment test is set forth in S-X 1-02(w)(1)(i). The investment test is applied differently depending on the purpose for which the test is being performed.
.21 How is the investment test performed for acquisitions (other than a combination of entities or businesses under common control) and dispositions?
For acquisitions (other than a combination of entities or businesses under common control) and dispositions, the investment test is performed by comparing the registrant’s and its 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 (the aggregate worldwide market value).
If the registrant has no aggregate worldwide market value (e.g., in connection with an initial public offering), then the comparison is made to the total assets of the registrant as of the end of the most recently completed fiscal year.
See S-X 1-02(w)(1)(i)(A).
[Editor’s note: The above guidance is based solely on the application of S-X 1-02(w)(1)(i)(A). As noted in SEC 4400.11, it is important to perform the significance assessment in light of the specific provisions of the rule being evaluated. For example, S-X 11-01(b)(4) specifies circumstances under which a registrant, including a real estate investment trust, which conducts a continuous offering over an extended period of time and applies the Item 20.D. Undertakings of Industry Guide 5, would perform the investment test and the asset test (if applicable), using the registrant’s total assets as of the date of acquisition or disposition (except that for acquisitions, total assets would exclude the acquired business) plus the proceeds (net of commissions) in good faith expected to be raised in the registered offering over the next 12 months.]
[Editor’s note: The investment test uses the phrase “investments in and advances to” the tested subsidiary. This means that the numerator of the investment test includes two parts: “investments in” the tested subsidiary and “advances to” the tested subsidiary. The discussion regarding the determination of “investments in” the tested subsidiary is not intended to suggest that the numerator of the investment test excludes “advances to” the tested subsidiary. See footnote 53 to SEC Release 33-10786.]
.211 How is “investments in” the tested subsidiary determined for acquisitions?
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 that is required to be recognized at fair value on the acquisition date by US GAAP or 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 under ASC 323, then the “investments in” the tested subsidiary should include all contingent consideration except that for which the likelihood of payment is remote. See S-X 1-02(w)(1)(i)(A)(1).
[Editor’s note: The above guidance is based solely on the application of S-X 1-02(w)(1)(i)(A)(1). As noted in SEC 4400.11, it is important to perform the significance assessment in light of the specific provisions of the rule being evaluated. For instance, S-X 3-14(b)(2)(ii) requires the “investments in” the tested real estate operation to include any assumed debt secured by the real properties when the investment test is based on the total assets of the registrant and its subsidiaries consolidated.]
[Editor’s note: It is not clear whether the SEC staff’s pre-existing guidance in the Note to SEC FRM 2015.5 (with respect to the investment test calculation in connection with the acquisition of an equity method investment) is still applicable.]
.212 How is “investments in” the tested subsidiary determined for dispositions?
For dispositions, the “investments in” the tested subsidiary is calculated differently depending on whether the comparison is being made to aggregate worldwide market value or total assets when the registrant has no such aggregate worldwide market value.
- If the comparison is being made to aggregate worldwide market value, then the “investments in” the tested subsidiary is the fair value of the consideration received, including contingent consideration, for the disposed subsidiary.
- If the comparison is being made to total assets, then the “investments in” the tested subsidiary is the carrying value of the disposed subsidiary.
.213 How is the aggregate worldwide market value determined for purposes of the investment test?
When determining the aggregate worldwide market value for purposes of the investment test, the registrant should use the average 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. See S-X 1-02(w)(1)(i)(A)(3).
The SEC staff indicated that the aggregate worldwide market value is determined using the market value from a public market, including a foreign market when the company’s common stock is only listed for trading on a non-US exchange. See Topic III.C from the highlights of the June 2023 CAQ SEC Regulations Committee.
[Editor’s note: Aggregate worldwide market value differs from the common equity public float amount used by registrants to determine accelerated filer status. For example, common equity public float excludes common equity held by affiliates.]
.22 How is the investment test performed for combinations between entities or businesses under common control?
For a combination between entities or businesses under common control, the investment test is performed by comparing:
(i) the net book value of the tested subsidiary to the registrant’s consolidated total assets, and
(ii) if applicable, the number of common shares exchanged or to be exchanged to the registrant’s total common shares outstanding at the date the exchange is initiated.
If either comparison meets the relevant threshold, then the tested entity is considered significant under the investment test. See S-X 1-02(w)(1)(i)(B).
.23 How is the investment test performed in cases other than those discussed in SEC 4400.21 and .22?
When performing the investment test in cases other than an acquisition or disposition (e.g., when assessing significance in connection with S-X 3-09 or S-X 4-08(g)), the investment test is performed by comparing the registrant’s and its other subsidiaries’ investments in and advances to the tested subsidiary to the total assets of the registrant and its subsidiaries consolidated as of the end of the most recently completed fiscal year. See S-X 1-02(w)(1)(i)(C).
.3 Asset test
.31 How is the asset test performed?
The asset test is set forth in S-X 1-02(w)(1)(ii). The asset test is performed by comparing the registrant’s and its other subsidiaries’ proportionate share of the tested subsidiary’s consolidated total assets (after intercompany eliminations) to the registrant’s total consolidated assets as of the end of the most recently completed fiscal year.
[Editor’s note: It is not clear whether the SEC staff’s pre-existing guidance in SEC FRM 2015.4 (regarding treatment of ordinary receivables, inventory, and other working capital amounts not acquired) is still applicable.]
.4 Income test
.41 How is the income test performed?
The income test is set forth in S-X 1-02(w)(1)(iii). The income test has two components: the income component and the revenue component.
- The income component of the income test compares 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 to the absolute value of such consolidated income or loss of the registrant for the most recently completed fiscal year (see S-X 1-02(w)(1)(iii)(A)(1)). See SEC 4400.42 and .43 for additional computation guidance.
- The revenue component of the income test compares the registrant’s and its other subsidiaries’ proportionate share of the tested subsidiary’s consolidated total revenue from continuing operations (after intercompany eliminations) to such consolidated total revenue of the registrant for the most recently completed fiscal year (see S-X 1-02(w)(1)(iii)(A)(2)).
The revenue component of the income test 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.
- If the revenue component is not applicable, then the income test is evaluated solely based on the results of the income component (although the averaging method described below would be applicable).
- If both components are applicable, both components must exceed the relevant significance threshold to conclude that the tested subsidiary is significant based on the income test. For example, assume Company X acquires Business A, and the income component yields a result of 45% while the revenue component yields a result of 15%. In this scenario, because the revenue component is less than the 20% threshold established in S-X 3-05(b)(2)(i), Business A is not considered significant due to the income test.
If the revenue component of the income test is not applicable (i.e., 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) then the calculation of the income component of the income test may need to be performed using an averaging method as described in S-X 1-02(w)(1)(iii)(B)(2).
[Editor’s note: The use of averaging is only applicable for purposes of determining the denominator of the income component of the income test. It is not applicable to the numerator (i.e., the tested subsidiary’s income).]
[Editor’s note: It is not clear whether the SEC staff’s historical guidance relating to averaging as described in SEC FRM 2410.5 is still applicable.]
.42 Does the denominator of the income test include a disposed entity that is included as a component of discontinued operations?
The definitions outlined in S-X 1-02(w)(1)(iii) specify that the numerator and denominator in both the income and revenue components are determined using results from continuing operations. Therefore, the denominators in the income test will not include the income/loss or revenue of a disposed business that has been previously reported as a discontinued operation in the historical financial statements. See SEC FRM 2130.3.
.43 How is the denominator of the income component of the income test calculated when the registrant has an equity method investee and non-controlling interests?
The calculation of the denominator of the income component of the income test should begin with the registrant’s consolidated income or loss from continuing operations before income taxes and other items, (e.g., the line item referred to in S-X 5-03(b)(10)), adjusted to:
a) include the registrant’s equity in the income or loss from continuing operations before income taxes attributable to controlling interests of the equity method investee, and
b) exclude the portion of the registrant’s income or loss from continuing operations before income taxes and other items, attributable to any non-controlling interests in the registrant’s consolidated subsidiaries.
As an example, consider the following assumptions for the registrant:
Income before taxes and other items (S-X 5-03(b)(10)) |
$ 1,000 |
Income taxes |
(400) |
Equity in earnings of investees |
300 |
Net income (amounts applicable to controlling and non-controlling interests) |
900 |
Net income applicable to non-controlling interest |
(100) |
Net income applicable to controlling interest |
$800 |
The registrant has two equity-method investees in which it owns 50 percent interests. Investee A has income from continuing operations before income taxes of $800 and net income of $500, and Investee B has income from continuing operations before income taxes of $290 and net income of $100. Investees A and B own 100 percent of each of their subsidiaries (i.e., there are no noncontrolling interests at the investee level). The registrant has two 80 percent owned consolidated subsidiaries. Subsidiary X has income from continuing operations before income taxes of $300 and net income of $200. Subsidiary Y has income from continuing operations before income taxes of $700 and net income of $300.
The registrant would calculate the denominator for the income component of the income test as follows:
Income from continuing operations before income taxes and other items (S-X 5-03(b)(10)) |
$ 1,000 |
Plus - registrant's share (50%) of: Investee A’s income from continuing operations before income taxes Investee B’s income from continuing operations before income taxes |
400 145 |
Less - portion of income before taxes and other items applicable to noncontrolling interest (20%) in registrant's consolidated subsidiaries of: Subsidiary X’s income from continuing operations before income taxes Subsidiary Y’s income from continuing operations before income taxes |
(60) (140) |
$ 1,345 |
See SEC FRM 2410.4.
.44 Income component of the income test for equity method investees
.441 How is the numerator of the income component of the income test determined when testing an equity method investee for significance under S-X 3-09 and S-X 4-08(g)?
The numerator of the income component of the income test is determined from the separate financial statements of the investee determined on a US GAAP basis for a registrant using US GAAP. The starting point is pre-tax income (loss) from continuing operations attributable to controlling interests. The registrant determines its proportionate interest in this pre-tax income from continuing operations and adjusts for basis differences that are considered in preparing the consolidated financial statements. Consideration should be given to ASC 323-10-35-34 and ASC 323-10-35-32A when evaluating the basis differences. See SEC FRM 2410.3.
The numerator is determined based on the period in which the registrant accounted for the entity under the equity method of accounting taking into consideration differences in fiscal year and recording on a lag period as applicable. See SEC 4400.445.
A registrant that prepares its financial statements using IFRS-IASB would follow a conceptually similar methodology.
The numerator of the income component of the income test for an equity-method investee will usually be different from the amount the registrant reflects in its financial statements which is frequently after income taxes. Additionally, other items relating to the investee that would not be reflected in the investee’s financial statements such as impairment charges recorded at the investor level, gains or losses from stock sales by the registrant, dilution gains/losses from stock sales by the investee and preferred dividends paid by the investee are generally not considered in determining the numerator but would remain in the denominator.
Intercompany transactions should not be eliminated when measuring significance of an equity method investee under S-X 3-09 and S-X 4-08(g). See SEC FRM 2410.6.
.442 How are losses that are reported by the registrant or the tested subsidiary considered in the denominator of the income component of the income test under S-X 3-09 or S-X 4-08(g) for an existing equity-method investment?
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, the equity in the income or loss from continuing operations before income taxes (after intercompany eliminations) attributable to controlling interests of the tested subsidiary should be excluded from such income or loss of the registrant and its subsidiaries consolidated for purposes of the computation. The income or loss of the tested subsidiary may only be excluded when measuring significance if the income or loss of the tested subsidiary is included in the registrant’s consolidated income or loss from continuing operations before income taxes. See S-X 1-02(w)(1)(iii)(B)(1).
Example computation of the income component assuming the registrant’s net income includes its equity in the tested subsidiary’s net loss (assume amounts presented represent income and loss attributable to controlling interest):
Registrant’s equity in tested subsidiary’s pre-tax loss from continuing operations |
$(1,000) |
Registrant’s consolidated pre-tax income from continuing operations |
4,500 |
Registrant’s consolidated pre-tax income from continuing operations excluding equity in loss of tested subsidiary |
$ 5,500 |
Significance of tested subsidiary [|($1,000)| divided by $5,500] |
18.2% |
When the registrant’s pre-tax income or loss from continuing operations includes the pre-tax income or loss from continuing operations of multiple subsidiaries which must be tested for significance (e.g., in connection with multiple equity-method investees tested under S-X 3-09), there may be different denominators for purposes of each assessment. For instance, consider an example in which the registrant has pre-tax income from continuing operations, two of the tested subsidiaries have pre-tax losses from continuing operations, and two of the tested subsidiaries have pre-tax income from continuing operations. In this example, there will be three different denominators for the income component of the income test. The denominator for each tested subsidiary with a pre-tax loss from continuing operations will be different and the denominator for the tested subsidiaries with pre-tax income from continuing operations will be the same.
Example calculation of the income component:
Registrant’s consolidated pre-tax income from continuing operations |
$ 5,000 |
Registrant’s equity in pre-tax loss from continuing operations of Subsidiary A |
($ 1,000) |
Registrant’s equity in pre-tax loss from continuing operations of Subsidiary B |
($ 1,200) |
Registrant’s equity in pre-tax income from continuing operations of Subsidiary C |
$ 1,200 |
Registrant’s equity in pre-tax income from continuing operations of Subsidiary D |
$ 100 |
Registrant’s equity in pre-tax loss from continuing operations of Subsidiary A |
($1,000) |
Registrant’s consolidated pre-tax income from continuing operations |
5,000 |
Registrant’s consolidated income from continuing operations before income taxes excluding equity in loss of Subsidiary A |
$6,000 |
Significance of Subsidiary A [|($1,000)| divided by $6,000] |
16.7% |
Registrant’s equity in pre-tax loss from continuing operations of Subsidiary B Registrant’s consolidated pre-tax income from continuing operations |
($1,200) 5,000 |
Registrant’s consolidated income from continuing operations before income taxes excluding equity in loss of Subsidiary B |
$6,200 |
Significance of Subsidiary B [|($1,200)| divided by $6,200] |
19.4% |
Registrant’s equity in pre-tax income from continuing operations of Subsidiary C Registrant’s consolidated pre-tax income from continuing operations |
$1,200 $5,000 |
Significance of Subsidiary C [$1,200 divided by $5,000] |
24.0% |
Registrant’s equity in pre-tax income from continuing operations of Subsidiary D Registrant’s consolidated pre-tax income from continuing operations |
$ 100 $5,000 |
Significance of Subsidiary D [$100 divided by $5,000] |
2.0% |
This example assumes that the averaging concept discussed in SEC 4400.41 is not applicable.
.443 How is the income test for an equity method investee under S-X 3-09 and S-X 4-08(g) calculated when there are changes in ownership during the period (including disposition of the entire investment)?
A change in ownership of an investee may result in the following:
- A decrease in ownership which results in a formerly consolidated subsidiary becoming an equity-method investee;
- A decrease in ownership which results in an investment previously accounted for under the equity method no longer being accounted for under that method;
- An increase in ownership which results in an investment previously accounted for under a method other than the equity method becoming an investment accounted for under the equity method; or
- An increase in ownership which results in an investment previously accounted for under the equity method becoming a consolidated subsidiary.
During years in which such changes occur, the registrant should calculate the income and revenue components of the income test based on the registrant's proportionate share for the period of the fiscal year in which the investee was accounted for by the equity method. As noted in SEC 4400.441, significance is determined based on the separate company financial statements of the equity-method investee. Therefore, any gain or loss arising from the transaction that caused the former subsidiary to become an equity-method investee should be excluded from the numerator of the income component of the income test. See SEC FRM 2410.3.
Any "holding gain or loss" resulting from the remeasurement of a registrant’s previously held equity interest in an investee that is recognized in earnings when the registrant obtains control of an investee in which it held an equity interest immediately before the acquisition date, should be excluded from the numerator of the income component of the income test. See Discussion Document A-3 from the highlights of the April 2008 meeting of the CAQ SEC Regulations Committee.
For example, assume Company X, a calendar year-end SEC registrant, purchased 35 percent of the common stock of Investee A in 2017. Company X accounted for its investment in Investee A using the equity method of accounting. On November 1, 2023, Company X acquired the remaining 65 percent of Investee A's common stock. In connection with the acquisition of the remaining 65 percent of Investee A's common stock, Company X obtained control over Investee A. Accordingly, under ASC 805-10-25-9 through 25-10, Company X remeasured its prior 35 percent equity interest at the acquisition-date fair value and recorded a $10 million holding gain in its statement of comprehensive income for the year ended December 31, 2023.
Company X should exclude the $10 million holding gain from the numerator of the income test for purposes of evaluating whether Investee A was significant under S-X 3-09 and S-X 4-08(g) during the period in which it was accounted for under the equity method (January 1, 2023 through October 31, 2023). However, the holding gain would be included in the denominator of that significance calculation.
[Editor’s note: See SEC FRM 2020.3-.4 for guidance relating to determining significance in connection with “step acquisitions.”]
.444 How is the income component of the income test under S-X 3-09 and S-X 4-08(g) calculated for an investment that is being accounted for using the fair value option in lieu of the equity method?
ASC 825-10 permits a company to account for financial assets, including investments that would otherwise be required to be accounted for under the equity method, at fair value. This is commonly referred to as the fair value option. Under the fair value option, the investment is reflected on the balance sheet at fair value, with changes in fair value between reporting periods reflected in the statement of comprehensive income. The investor would not record its share of investee income or loss in the statement of comprehensive income.
In these circumstances, the numerator for the income component of the income test should be determined as the change in fair value of the relevant instrument(s) during the relevant period as recorded by the registrant in its statement of comprehensive income (see SEC FRM 2435.2). The fair value option (ASC 825-10) must be applied to all of the investor's financial interests in the entity which could include such items as equity, debt, or guarantees. If this method of assessing significance results in an anomalous answer, registrants should contact the SEC staff.
[Editor’s note: At the 2021 AICPA & CIMA Conference on Current SEC and PCAOB Developments, the SEC staff indicated that the revenue component of the income test should be considered when performing the income test under S-X 3-05 (in connection with the acquisition of an investment) and S-X 3-09 and S-X 4-08(g) (for the relevant period that a registrant holds an equity investment that is being accounted for using the fair value option in lieu of the equity method).]
.445 How is the income component of the income test under S-X 3-09 and S-X 4-08(g) calculated for an equity method investee whose results are recorded on a "lag" basis?
The registrant should use the investee's financial results used by the registrant to calculate the registrant's equity in the income or loss of the investee in performing the income component of the income test. See SEC FRM 2410.7.
If a calendar year-end registrant records its equity in the earnings of an equity method investee with a September 30, 2023 year-end on a three-month lag, the numerator of the income component of the income test for the registrant's year ended December 31, 2023 would be based on the registrant’s share of the investee's income for the 12 month period ended September 30, 2023 (i.e., the amount recorded in the registrant's financial statements for the year ended December 31, 2023).
.5 Aggregate significance tests
.51 How are the components of the income test determined when calculating the significance tests for acquisitions of related businesses and related real estate operations?
SEC 4550.213 and SEC 4555.223 discuss the SEC’s requirements relating to the acquisition of related businesses (S-X 3-05(a)(3)) and related real estate operations (S-X 3-14(a)(3)).
The income component of the income test and the revenue component of the income test should each be calculated on a combined basis, as applicable.
See S-X 11-01(b)(3)(ii) for information regarding the financial statements to use for determining significance in connection with the acquisition of related businesses or related real estate operations.
.52 Evaluating aggregate significance of acquired and to be acquired businesses for which financial statements are not (or not yet) required
See SEC 4550.23 (businesses other than real estate operations) and SEC 4555.232 (real estate operations).
.6 Financial information used to determine significance
S-X 1-02(w)(1) sets forth general requirements as to which financial information should be used to perform the various tests of significance. However, as highlighted above, significance tests should be performed in the context of the specific rule that is calling for the assessment.
For instance, S-X 3-05(b)(3) indicates that the significance assessment must be performed in accordance with the requirements of S-X 11-01(b)(3) and (4). S-X 11-01(b)(3) and (4) set forth detailed guidance as to which financial statements should be used to perform the assessments.
See SEC 4550.902 for guidance on which financial statements a registrant should use to evaluate significance for transactions that closed early in its fiscal year.
.9 Frequently asked questions
.901 When determining whether an acquisition or disposition of a business is significant, should a registrant round the results of the significance tests?
The results of the significance tests should not be rounded. For example, assume a registrant acquired a business and is performing a significance test under S-X 3-05. The highest of the three significance tests yielded a result of 20.1%. In this example, the acquired business would be considered significant under S-X 3-05. The results of the test should not be rounded down to 20% to conclude that the acquired business is not significant. See SEC FRM 2015.13.
.902 How is the phrase “after intercompany eliminations” interpreted as it relates to the significance tests?
The SEC staff has indicated that intercompany transactions between the registrant and tested subsidiary should be eliminated in the same way as if the tested subsidiary was consolidated. See SEC FRM 2015.11.
Because an equity method investment is not consolidated, intercompany transactions should not be eliminated when measuring significance of an equity method investee. See SEC FRM 2410.6.
The intercompany elimination procedure may result in asymmetrical adjustments, meaning the elimination adjustments could impact the numerator of the significance calculation, the denominator of the calculation, or both the numerator and the denominator. For example, if an acquirer's total assets include a receivable from the tested subsidiary, then, for purposes of testing significance under S-X 3-05, the acquirer’s total assets would be reduced by the receivable, but no adjustment would be made to the tested subsidiary’s total assets (for that item) because the amount is a liability in the financial statements of the tested subsidiary (i.e., not a part of the tested subsidiary's total assets).
.903 How is the term “material revenue” interpreted when evaluating whether the revenue component of the income test is applicable?
S-X 1-02(w)(1)(iii)(A)(2) provides that the revenue component of the income test does not apply if the registrant or the tested subsidiary did not have material revenue in each of the two most recently completed fiscal years. The SEC did not define the term “material revenue” nor did it provide any interpretive guidance on how to determine if either the registrant or the tested subsidiary had material revenue during the last two years. A registrant should use judgment when considering whether the revenue component of the income test is applicable.
.904 How should the five-year averaging mechanism described in S-X 1-02(w)(1)(iii)(B)(2) be performed for the income component of the income test when the registrant presents successor and predecessor periods?
This is a complex area with little authoritative interpretive guidance. The SEC staff has indicated that registrants that wish to consider averaging when the five-year period includes both successor and predecessor periods should contact the SEC staff for additional guidance.
.905 Should a registrant adjust the denominator of the income component of the income test when the tested subsidiary qualifies to provide abbreviated financial statements described in S-X 3-05(e)?
No. Although certain costs may be excluded from the tested subsidiary’s abbreviated financial statements, the registrant should not adjust the denominator of the test to exclude costs not directly related to revenue producing activities, such as corporate overhead, interest and taxes. See SEC FRM 2065.9.
.906 How should the significance tests be performed when annual financial statements are retrospectively revised?
A registrant may be required to revise its audited annual financial statements, for example, to reflect a discontinued operation or a retrospective change in accounting principle that was appropriately not reflected in the audited financial statements for the most recently completed fiscal year included in its Form 10-K. The SEC staff’s pre-existing guidance with respect to significance calculations in connection with a new or amended registration statement or proxy statement is set forth in SEC FRM 2025.1 (with respect to acquired businesses) and SEC FRM 2410.8 (with respect to equity method investees). The SEC staff’s pre-existing guidance with respect to significance calculations in connection with a subsequent Form 10-K is set forth in SEC FRM 2410.8.
We believe these same principles should be applied when analyzing the requirements of S-X 10-01(b)(1).
[Editor’s note: As a result of applying the guidance in SEC FRM 2410.8 in connection with a subsequent Form 10-K, a previously insignificant investee may become significant as a result of a discontinued operation. Registrants are encouraged to contact the SEC staff with specific facts and circumstances if application of existing rules yields an impractical answer. See Topic III.B from the highlights of the June 2015 meeting of the CAQ SEC Regulations Committee.]
.907 May a registrant consider public offering proceeds received after the most recent pre-acquisition balance sheet date when performing significant tests?
As indicated in SEC FRM 2020.6, the registrant's assets generally may not be increased by the pro forma effect of anticipated public offering proceeds for purposes of significance tests.
[Editor’s note: This differs in connection with a blind pool offering subject to the Item 20.D Undertakings of Industry Guide 5. See S-X 11-01(b)(4) and SEC 4555.6.]
.908 How should the significance tests be performed for business acquisitions or dispositions which take place after the completion of a reverse merger but before the Form 10-K reflecting the transaction is filed?
The SEC staff’s pre-existing guidance is contained in SEC FRM 2025.7 (with respect to a reverse acquisition) and SEC FRM 2025.8 (with respect to a reverse recapitalization of a legal target).
.909 How should significance be calculated when a registrant contributes a business to a joint venture in exchange for an equity interest in the joint venture?
The SEC staff’s pre-existing guidance is contained in SEC FRM 2025.4.
.910 How should the significance tests under S-X 3-05 be performed when a registrant increases its investment in an entity already consolidated?
When a registrant increases its investment in a company that is already reflected as a consolidated subsidiary in the audited financial statements of the registrant for a complete fiscal year, financial statements of the acquired investment are ordinarily not required. However, pro forma financial statements may be required pursuant to S-X 11-01(a)(8) which refers to other transactions for which disclosure of pro forma financial information would be material to investors. See SEC FRM 2020.5.
.911 How should the significance tests be performed when an equity-method investee is consolidated through events other than transactions?
A registrant may obtain control of an entity through events other than transactions, such as the lapse of contractual rights. This is a complex area with little authoritative interpretive guidance. Accordingly, the application of the SEC’s reporting requirements on how to perform the relevant significance tests to this type of fact pattern may need to be discussed in advance with the SEC staff. See Topic 5 of Discussion Document A from the highlights of the April 2008 meeting of the CAQ SEC Regulations Committee.
.912 Can pro forma financial information be used to evaluate significance?
In some cases, yes. See S-X 11-01(b)(3).
.913 How should a registrant determine the numerators in the significance test calculations when 100% of a business is acquired by a registrant’s non-wholly-owned consolidated subsidiary?
The tests used to determine significance should be performed as follows:
- The numerator used for the asset test, the investment test, and the revenue component of the income test should not consider the registrant’s ownership percentage in the non-wholly-owned subsidiary.
- The numerator used for the income component of the income test should consider the registrant’s ownership percentage in the non-wholly-owned subsidiary.
For example, assume a registrant has a 60%-owned consolidated subsidiary, which acquires 100% of a business.
- When performing the asset test, 100% of the acquired business’s assets should generally be included in the numerator (i.e., the 60% ownership of the consolidated subsidiary does not impact the calculation).
- When performing the investment test, 100% of the registrant’s and its other subsidiaries’ investments in the target should generally be included in the numerator (i.e., the 60% ownership of the consolidated subsidiary does not impact the calculation).
- When performing the revenue component of the income test, 100% of the acquired business’s revenue should generally be included in the numerator (i.e., the 60% ownership of the consolidated subsidiary does not impact the calculation).
- When performing the income component of the income test, the registrant’s proportionate interest (i.e., 60%) of the absolute value of the acquired business’s consolidated pre-tax income (loss) from continuing operations attributable to controlling interests should generally be included in the numerator. See SEC 4400.4 for guidance on the use of the absolute value.
See Topic III.D. from the March 2022 CAQ SEC Regulations Committee Meeting Highlights.
PwC. All rights reserved. PwC refers to the US member firm or one of its subsidiaries or affiliates, and may sometimes refer to the PwC network. Each member firm is a separate legal entity. Please see www.pwc.com/structure for further details. This content is for general information purposes only, and should not be used as a substitute for consultation with professional advisors.
Link copied
