Financial statement presentation

Excerpt from Accounting Standards Codification

Business Combinations — Reverse Acquisitions Other Presentation Matters

805-40-45-1

Consolidated financial statements prepared following a reverse acquisition are issued under the name of the legal parent (accounting acquiree) but described in the notes as a continuation of the financial statements of the legal subsidiary (accounting acquirer), with one adjustment, which is to retroactively adjust the accounting acquirer’s legal capital to reflect the legal capital of the accounting acquiree.

That adjustment is required to reflect the capital of the legal parent (the accounting acquiree).

Comparative information presented in those consolidated financial statements also is retroactively adjusted to reflect the legal capital of the legal parent (accounting acquiree).

805-40-45-2

Because the consolidated financial statements represent the continuation of the financial statements of the legal subsidiary except for its capital structure, the consolidated financial statements reflect all of the following:

a. The assets and liabilities of the legal subsidiary (the accounting acquirer) recognized and measured at their precombination carrying amounts.

b. The assets and liabilities of the legal parent (the accounting acquiree) recognized and measured in accordance with the guidance in this Topic applicable to business combinations.

c. The retained earnings and other equity balances of the legal subsidiary (accounting acquirer) before the business combination.

d. The amount recognized as issued equity interests in the consolidated financial statements determined by adding the issued equity interest of the legal subsidiary (the accounting acquirer) outstanding immediately before the business combination to the fair value of the legal parent (accounting acquiree) determined in accordance with the guidance in this Topic applicable to business combinations. However, the equity structure (i.e., the number and type of equity interests issued) reflects the equity structure of the legal parent (the accounting acquiree), including the equity interests the legal parent issued to effect the combination. Accordingly, the equity structure of the legal subsidiary (the accounting acquirer) is restated using the exchange ratio established in the acquisition agreement to reflect the number of shares of the legal parent (the accounting acquiree) issued in the reverse acquisition.

e. The noncontrolling interest’s proportionate share of the legal subsidiary’s (accounting acquirer’s) precombination carrying amounts of retained earnings and other equity interests as discussed in paragraphs 805-40-25-2 and 805-40-30-3 and illustrated in Example 1, Case B (see paragraph 805-40-55-18).

In a business combination, the fair value (with limited exceptions) of the assets acquired and liabilities assumed are recognized by the acquirer on the acquisition date. That guidance also applies to the accounting for a reverse acquisition. From an accounting perspective, the financial statements of the combined entity represent a continuation of the financial statements of the accounting acquirer/legal acquiree. As such, the historical cost bases of assets and liabilities of the acquiring entity (the accounting acquirer/legal acquiree) are maintained in the consolidated financial statements of the merged company and the assets and liabilities of the acquired entity (the legal acquirer) are accounted for under the acquisition method. Results of operations of the acquired entity (the legal acquirer) are included in the financial statements of the combined company only from the acquisition date.

Stockholders’ equity of the accounting acquirer is presented as the equity of the combined company as follows:

Capital Stock: The historical capital stock account of the accounting acquirer immediately prior to the reverse acquisition is carried forward. However, the balance is adjusted to reflect the par value of the outstanding stock of the legal acquirer, including the number of shares issued in the business

combination as the legal acquirer is the surviving legal entity. Any necessary, corresponding offset is added to the additional paid-in capital account.

Additional paid-in capital (APIC): The historical APIC account of the accounting acquirer immediately prior to the acquisition is carried forward and is increased to reflect the additional fair value of the legal acquirer less the par value of the shares held by the legal acquirer’s preacquisition shareholders.

Retained Earnings: Retained earnings of the accounting acquirer are carried forward after the acquisition.

Prior Period Presentation: For periods prior to the business combination, shareholders’ equity of the combined enterprise is presented based on the historical equity of the accounting acquirer prior to the merger retroactively restated to reflect the number of shares received in the business

combination.

3.2.2.2.4.1 Earnings per share (EPS)

Excerpt from Accounting Standards Codification

Business Combinations — Reverse Acquisitions Other Presentation Matters

805-40-45-3

As noted in (d) in the preceding paragraph, the equity structure in the consolidated financial statements following a reverse acquisition reflects the equity structure of the legal acquirer (the accounting

acquiree), including the equity interests issued by the legal acquirer to effect the business combination.

805-40-45-4

In calculating the weighted-average number of common shares outstanding (the denominator of the earnings-per-share [EPS] calculation) during the period in which the reverse acquisition occurs:

a. The number of common shares outstanding from the beginning of that period to the acquisition date shall be computed on the basis of the weighted-average number of common shares of the legal acquiree (accounting acquirer) outstanding during the period multiplied by the exchange ratio established in the merger agreement.

b. The number of common shares outstanding from the acquisition date to the end of that period shall be the actual number of common shares of the legal acquirer (the accounting acquiree) outstanding during that period.

805-40-45-5

The basic EPS for each comparative period before the acquisition date presented in the consolidated financial statements following a reverse acquisition shall be calculated by dividing (a) by (b):

a. The income of the legal acquiree attributable to common shareholders in each of those periods b. The legal acquiree’s historical weighted average number of common shares outstanding

multiplied by the exchange ratio established in the acquisition agreement.

As discussed above, EPS for periods prior to the acquisition date for a reverse acquisition is restated. The retroactive restatement is based on the same number of weighted-average shares outstanding that the accounting acquirer presents as outstanding in each historic period pursuant to the guidance in the preceding section. The denominator of the historical, restated EPS calculation is adjusted by multiplying (or possibly dividing) the weighted-average shares used in each historically reported EPS calculation by the agreed-upon exchange ratio. For reverse acquisitions that result in accounting acquirer

noncontrolling interest as described in section 3.2.2.2.3, the historical EPS would not consider any noncontrolling shares that remained outstanding but, rather, would be presented in the same manner as if all the shares of the accounting acquirer were exchanged.

Illustration 3-5: Reverse acquisition accounting⁹

Balance sheets of Legal Acquirer and Accounting Acquirer just prior to a reverse acquisition are as follows:

Legal Acquirer

(Accounting Acquiree) Accounting Acquirer (Legal Acquiree)

Net current assets $ 20,000 $ 50,000

Common shares outstanding 100 500

Capital stock (par value) $ 10 $ 100

APIC 990 4,900

Retained earnings 19,000 45,000

Total shareholders’ equity $ 20,000 $ 50,000

Legal Acquirer is a public company with a fair value of $1,000 per share (total fair value of $100,000).

Accounting Acquirer is a public company with a fair value of $800 per share (total fair value of $400,000).

Legal Acquirer issues 400 shares of common stock to acquire all of the outstanding 500 common shares of Accounting Acquirer. After the consummation of the transaction, former Accounting Acquirer shareholders will own 80% of the combined entity. All factors (i.e., the criteria discussed in ASC 805-10-55-11 through 55-15) indicate that for accounting purposes, Accounting Acquirer is the acquiring entity. As such, under the acquisition method, the assets acquired and liabilities assumed from Legal Acquirer will be recognized at 100% of their fair values (with limited exceptions) and consolidated with the historical carrying values of Accounting Acquirer’s net assets.

At the acquisition date, the fair value of the consideration transferred is determined based on the number of shares Accounting Acquirer would have had to issue to the shareholders of Legal Acquirer for the ownership ratio in the combined entity to be the same. If Accounting Acquirer issued 125 shares to the shareholders of Legal Acquirer, the shareholders of Legal Acquirer would own 125 shares out of a total of 625 shares (20%), which is the same ratio the shareholders of Legal Acquirer own after the reverse acquisition. As such, the fair value of the consideration transferred is $100,000 (125 shares x

$800 per share), which is also the fair value of Legal Acquirer (100 shares x $1,000 per share).

9 Note that ASC 805-40-55-3 through 55-23 also include a comprehensive example of the accounting for a reverse acquisition.

For purposes of simplicity, this example assumes that Legal Acquirer has no identifiable intangible assets and that the fair value of its net current assets equals $20,000 (the historical cost basis of the net current assets). As such, the fair value assigned to Legal Acquirer’s net assets is as follows:

Fair value of consideration transferred $ 100,000 Fair value of net current assets (20,000)

Goodwill $ 80,000

The accounting required to effect the reverse acquisition is summarized below:

Accounting

After the reverse acquisition, there are 500 shares outstanding (100 initially outstanding plus 400 issued in the business combination) of Legal Acquirer at a par value of $0.10, or $50. As such, Accounting Acquirer reduces its historical capital stock account to reflect the par value of Legal Acquirer’s outstanding capital stock.

Historical Capital Accounts and Earnings per Share

Assume that the reverse acquisition was completed on 30 June 20X8. For the six month period from 1 January 20X8 through 30 June 20X8 (the “Pre-acquisition Period), Accounting Acquirer (Legal Acquiree) had net income of $1,000 and for the six month period from 1 July 20X8 through 31 December 20X8 (the “Post-acquisition Period), the combined entity had net income of $1,000. In the Pre-acquisition Period, Accounting Acquirer had 300 shares outstanding for three months and 500 shares outstanding for three months, resulting in weighted-average shares outstanding of Accounting Acquirer prior to the reverse acquisition of 400 shares [(300 shares x (3 months/6 months)) plus (500 shares x (3 months/6 months))]. In the Post Acquisition Period, Legal Acquirer had no changes to the number of outstanding shares.

The combined entity’s EPS for 20X8 is $4.88 (net income of $2,000/410 weighted-average shares).

The weighted-average shares are calculated as follows:

Accounting Acquirer weighted-average shares 400 shares

Exchange ratio x 0.8

Accounting Acquirer pre-acquisition Period weighted average shares 320 shares

x 6/12 160 shares Legal Acquirer post-Acquisition Period weighted average shares 500 shares

x 6/12 250 shares

Total weighted-average shares 410 shares

In Accounting Acquirer’s 31 December 20X7 statement of financial position (presented comparatively in the 31 December 20X8 financial statements), its capital accounts will reflect 240 outstanding shares (300 shares outstanding as of 31 December 20X7 multiplied by the exchange ratio of 0.8).

Illustration 3-6: Reverse acquisition accounting with noncontrolling interest

Assume the same facts as in Illustration 3-5, except that instead of purchasing all of Accounting Acquirer’s outstanding common stock, Legal Acquirer purchases only 80% or 400 shares of Accounting Acquirer, leaving a legal minority interest in Accounting Acquirer of 100 shares outstanding. To acquire the 400 shares of Accounting Acquirer, Legal Acquirer issues 320 shares, which results in the former shareholders of Accounting Acquirer owning 76% of the merged entity.

At the acquisition date, the fair value of the consideration transferred is the same as Illustration 3-5.

This is determined based on the number of shares Accounting Acquirer would have had to issue to the shareholders of Legal Acquirer for the ownership ratio in the combined entity to be the same. This calculation ignores the noncontrolling interest because they have an interest only in Accounting Acquirer and not the combined entity. Ignoring the noncontrolling interests (100 shares), if

Accounting Acquirer issued 125 shares to Legal Acquirer, the shareholders of Legal Acquirer would own 125 shares out of a total of 525 shares (24%), which is the same ratio the shareholders of Legal Acquirer own after the reverse acquisition. As such, the fair value of the consideration transferred is

$100,000 (125 shares x $800 per share), which is also the fair value of Legal Acquirer (100 shares x

$1,000 per share). The fact that the noncontrolling interest remains in the accounting acquirer after the business combination should not affect the determination of the consideration transferred.

The accounting required to effect Accounting Acquirer’s reverse acquisition is summarized below:

Accounting Acquirer Historical

Value Legal Acquirer Fair Value

Reverse Acquisition

Equity Adjustments

Consolidated Accounting

Acquirer

Net current assets $ 50,000 $ 20,000 $ 70,000

Goodwill − 80,000 80,000

Total assets $ 50,00 0 $100,000 $ 150,00 0

Noncontrolling interest $ − $ − 10,000 $ 10,000

Capital stock 100 − (58) 42

APIC 4,900 100,000 (9,942) 94,958

Retained earnings 45,000 − 4 5,0 00

Total liabilities and

shareholders’ equity $ 50,000 $ 100,00 0 $ 150, 000

The noncontrolling interest is measured at the historical carrying value of Accounting Acquirer’s remaining outstanding shares (100 x ($50,000/500 shares) or $10,000) with the corresponding offsetting entry reducing the combined entity’s APIC. Further, as the number of shares issued by Legal Acquirer is less than if all Accounting Acquirer’s shareholders participated in the exchange, the

adjusted capital stock account is lower than in Illustration 3-5.

The calculation of the pre-acquisition period weighted-average shares for EPS purposes would be as described in the preceding illustration. The calculation of post-acquisition shares will exclude the shares characterized as noncontrolling interest in Accounting Acquirer. Accordingly, The weighted-average shares are calculated as follows:

Accounting Acquirer weighted-average shares 400 shares

Exchange ratio x 0.8

Pre-acquisition Period weighted average shares 320 shares

x 6/12 160 shares Post-Acquisition Period weighted average shares 420 shares

x 6/12 210 shares

Total weighted-average shares 370 shares

The earnings attributable to the noncontrolling interest would be deducted from the consolidated net income for the year and divided by 370 to derive basic EPS.