A robust market for mergers and acquisitions along with brief rules on pro forma financial reporting have made it challenging for companies to properly comply with those reporting requirements. 

“The rules are pretty brief and somewhat principles-based, but with some strict criteria to consider in whether pro forma adjustments are appropriate,” says Steven Jacobs, an assurance partner at EY. “There’s a lot of judgment in applying the criteria and probably somewhat of an evolution in how staff at the Securities and Exchange Commission and others think about applying the criteria, so there’s some diversity in practice.”

Pro forma reporting is required under accounting standards when an entity completes a material business transaction to give investors some perspective on how a company’s financial statements are affected by the transaction. Companies typically must provide pro forma information in combination with any significant business acquisition or disposition, when acquiring significant real estate operations, or when engaging in roll-up or spin-off transactions.

Accounting standards do not specify how entities should calculate pro forma revenue and earnings, but Article 11 of Regulation S-X describes requirements that SEC registrants are expected to follow in presenting pro forma financial information, according to an EY guide meant to help companies apply the rules. Investors tune in to pro forma reporting because it helps them understand the impact of significant transactions, says Jacobs. “It’s an important tool that communicates what investors can expect from a transaction going forward and how a transaction may have impacted financials in an earlier period, to help give comparability,” he says.

Even as the SEC considers changes to the disclosure requirements, SEC guidance today gives companies criteria to determine what constitutes an appropriate pro forma adjustment, and that tends to present many of the challenges to pro forma reporting, says Jacobs. SEC guidance says adjustments are appropriate when they help illuminate events that are directly attributable to the transaction, when they are expected to have a continuing impact on the company, and when they are factually supportable.

Adjustments to the income statement are usually of greatest interest to investors, says Jacobs. “Companies often would like to show everything they think might happen as a result of a merger and make sure they are giving investors every possible scenario, but pro forma somewhat limits that to provide some more reliability behind the numbers,” says Jacobs. “More forward-looking disclosures can be presented outside the pro forma financials or in the notes but not within the pro forma income statement.”

EY says its guide addresses when companies must present Article 11 pro forma financial information in SEC filings, which SEC forms require Article 11 pro forma financial information, SEC staff expectations and interpretations, auditors’ involvement, and more.