14.3 Non-controlling (Minority) Interest Accounting
5 min read•july 30, 2024
accounting is a crucial part of . It deals with the portion of a subsidiary's equity not owned by the parent company, affecting how income, equity, and other financial elements are reported.
Understanding non-controlling interest is key to grasping the full picture of a company's financial position. It impacts various aspects of financial reporting, from balance sheets to income statements, and plays a significant role in financial analysis and decision-making.
Non-controlling interest in consolidated statements
Definition and role
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- Non-controlling interest (NCI), also known as , represents the portion of a subsidiary's equity not owned by the parent company
- NCI arises when the parent company owns less than 100% of the subsidiary's outstanding shares
- In consolidated financial statements, NCI is reported as a separate component of equity, distinct from the equity attributable to the parent company's shareholders
- The presence of NCI affects the allocation of a subsidiary's net income, comprehensive income, and equity between the parent company and the non-controlling shareholders
Reporting in consolidated statements
- On the consolidated balance sheet, NCI is reported as a separate component of equity, typically between liabilities and equity attributable to the parent company's shareholders
- The consolidated income statement includes a separate line item for the to NCI, which is deducted from the consolidated net income to arrive at the net income attributable to the parent company
- The consolidated statement of changes in equity presents the changes in NCI during the reporting period, including the allocation of net income, dividends paid to non-controlling shareholders, and any transactions between the parent company and NCI
- When analyzing consolidated financial statements, it is important to consider the impact of NCI on key financial ratios, such as return on equity and earnings per share, as these ratios may differ from those of the parent company on a standalone basis
Calculating non-controlling interest
Calculating NCI in subsidiary equity
- NCI in the equity of a subsidiary is calculated by multiplying the subsidiary's total equity by the percentage of ownership held by non-controlling shareholders
- The subsidiary's total equity includes common stock, additional paid-in capital, retained earnings, and accumulated other comprehensive income (if applicable)
- When calculating NCI, it is essential to consider any preferred stock issued by the subsidiary, as it may have different rights and preferences compared to common stock
- Example: If a subsidiary has total equity of 1,000,000 x 20% = $200,000
Factors to consider
- The calculation of NCI should take into account any changes in the subsidiary's equity during the reporting period, such as the issuance of new shares, share repurchases, or dividend distributions
- If the subsidiary has multiple classes of stock with different rights and preferences, the calculation of NCI should be adjusted accordingly to reflect the economic interests of non-controlling shareholders
- In some cases, the parent company may have a contractual arrangement with non-controlling shareholders that affects the allocation of the subsidiary's equity (put options or forward contracts)
Allocating consolidated net income
Allocation process
- Consolidated net income must be allocated between the parent company and NCI based on their respective ownership percentages in the subsidiary
- The allocation of consolidated net income to NCI is calculated by multiplying the subsidiary's net income by the percentage of ownership held by non-controlling shareholders
- The remaining portion of the subsidiary's net income is allocated to the parent company and is included in the consolidated retained earnings
- If the subsidiary has any items of other comprehensive income (OCI), the allocation of OCI between the parent company and NCI follows the same approach as the allocation of net income
Examples
- If a subsidiary reports net income of $100,000 and the parent company owns 80% of its outstanding shares, the allocation of net income would be:
- NCI: 20,000
- Parent company: 80,000
- If the subsidiary also reports OCI of $50,000, the allocation of OCI would be:
- NCI: 10,000
- Parent company: 40,000
Journal entries for non-controlling interest
Acquisition of subsidiary
- When a parent company acquires less than 100% of a subsidiary's outstanding shares, the transaction is recorded using the acquisition method
- The journal entry to record the acquisition includes debiting the subsidiary's identifiable assets and goodwill (if any), crediting the subsidiary's liabilities, and crediting NCI for the portion of the subsidiary's equity attributable to non-controlling shareholders
- Example: If the parent company acquires 80% of a subsidiary's outstanding shares for 900,000, the journal entry would be:
- Debit: Identifiable net assets $900,000
- Debit: Goodwill $100,000
- Credit: Cash $800,000
- Credit: NCI $200,000
Subsequent transactions with NCI
- Subsequent transactions between the parent company and NCI, such as the sale of additional shares to non-controlling shareholders or the purchase of shares from non-controlling shareholders, are recorded as equity transactions
- Journal entries for NCI transactions may involve adjustments to additional paid-in capital, NCI, and any gain or loss on the transaction, which is recognized directly in equity
- Example: If the parent company sells an additional 10% of the subsidiary's outstanding shares to non-controlling shareholders for 110,000, the journal entry would be:
- Debit: Cash $120,000
- Credit: NCI $110,000
- Credit: Additional paid-in capital $10,000
Impact of non-controlling interest
Financial statement presentation
- The presence of NCI affects various aspects of consolidated financial statements, including the balance sheet, income statement, and statement of changes in equity
- NCI is reported as a separate component of equity on the consolidated balance sheet, distinguishing it from the equity attributable to the parent company's shareholders
- The consolidated income statement includes a separate line item for the allocation of net income to NCI, which is deducted from the consolidated net income to arrive at the net income attributable to the parent company
- The consolidated statement of changes in equity presents the changes in NCI during the reporting period, including the allocation of net income, dividends paid to non-controlling shareholders, and any transactions between the parent company and NCI
Financial ratios and analysis
- When analyzing consolidated financial statements, it is important to consider the impact of NCI on key financial ratios, such as return on equity (ROE) and earnings per share (EPS)
- ROE calculated based on the consolidated financial statements may differ from the parent company's standalone ROE, as the consolidated ROE takes into account the profit attributable to both the parent company and NCI
- EPS calculated based on the consolidated financial statements reflects the earnings attributable to the parent company's shareholders, excluding the portion of net income allocated to NCI
- Analysts and investors should be aware of the presence of NCI when comparing the financial performance of companies with different ownership structures in their subsidiaries
Key Terms to Review (16)
Allocation of net income: Allocation of net income refers to the process of distributing a company's earnings among its shareholders, including both controlling and non-controlling interests. This allocation is significant as it impacts how profits are recognized and reported in the financial statements, especially when a company has subsidiaries with minority shareholders. Understanding this allocation is crucial for accurately assessing the financial performance and equity positions of both parent companies and their subsidiaries.
ASC 810: ASC 810 is the Accounting Standards Codification that provides guidance on consolidations and the reporting of non-controlling interests in financial statements. It establishes the principles for determining whether an entity must consolidate a variable interest entity (VIE) and how to account for ownership interests that are not wholly owned, ensuring that financial statements reflect the true financial position of a company and its subsidiaries.
Balance Sheet Presentation: Balance sheet presentation refers to the way assets, liabilities, and equity are organized and displayed on a balance sheet. This structure not only provides a clear snapshot of a company's financial position at a specific point in time but also helps users understand how different components relate to one another, especially when considering aspects like non-controlling interests. The clarity and consistency of this presentation are crucial for accurate financial analysis and decision-making.
Consolidated financial statements: Consolidated financial statements are comprehensive financial reports that aggregate the financial position and results of operations of a parent company and its subsidiaries into a single set of statements. This provides a holistic view of the entire economic entity, eliminating intercompany transactions to avoid double counting and ensuring that stakeholders understand the overall financial health of the group as a whole.
Cost method: The cost method is an accounting approach used to record investments at their original purchase price, without adjusting for market value fluctuations. This method allows companies to recognize the initial costs associated with acquiring assets or investments and is particularly relevant in the context of stock repurchases, changes in accounting principles, non-controlling interests, and intercompany transactions.
Disclosure of Ownership Interests: Disclosure of ownership interests refers to the requirement for companies to report and provide transparent information about the ownership stakes held by shareholders, particularly those who hold significant or controlling interests. This concept is vital for understanding the implications of ownership on corporate governance and financial reporting, especially in the context of accounting for non-controlling interests and ensuring that financial statements reflect a true and fair view of the company's structure.
Equity method: The equity method is an accounting technique used to record investments in associated companies where the investor has significant influence, typically defined as owning 20% to 50% of the voting stock. This method allows the investor to recognize their share of the investee's profits and losses, impacting the investor's balance sheet and income statement directly.
Fair Value Measurement: Fair value measurement is the process of determining the estimated worth of an asset or liability based on current market conditions, rather than historical cost. This approach reflects how much an entity would receive or pay in an orderly transaction between market participants at the measurement date, ensuring that financial statements provide more relevant and timely information about an entity's financial position.
Financial Statement Notes: Financial statement notes provide additional information and context to the numbers presented in the financial statements. They are crucial for understanding the accounting policies, assumptions, and other details that can affect the interpretation of financial results, including specific issues like impairment of investments, goodwill recognition, and non-controlling interest accounting.
IFRS 10: IFRS 10 is an International Financial Reporting Standard that outlines the requirements for the preparation of consolidated financial statements. It establishes principles for the presentation and preparation of consolidated financial statements when an entity controls one or more other entities, thereby ensuring transparency and comparability across financial reports.
Impairment testing: Impairment testing is the process of evaluating whether an asset's carrying amount exceeds its recoverable amount, leading to a potential write-down in financial statements. This assessment is crucial for ensuring that assets are not overstated and reflects a company's actual financial position. It connects to the broader concepts of fair value reporting, goodwill recognition, and the treatment of non-controlling interests by determining how these elements can be affected when assets lose value.
Joint Ventures: A joint venture is a business arrangement in which two or more parties agree to combine their resources and share risks to accomplish a specific project or goal. This collaboration allows companies to pool expertise, reduce costs, and share profits, while also maintaining their separate legal identities. Joint ventures often arise in strategic partnerships, particularly in complex projects or when entering new markets, where combining strengths can lead to better outcomes for all involved.
Minority interest: Minority interest, also known as non-controlling interest, refers to the portion of equity ownership in a subsidiary not attributable to the parent company. This interest arises when a parent company owns less than 100% of a subsidiary and allows for the recognition of other shareholders' claims on the subsidiary's net assets and profits. Understanding minority interest is essential for accurately presenting consolidated financial statements and reflects the economic reality of ownership stakes in multi-entity corporations.
Non-controlling interest: Non-controlling interest refers to the ownership stake in a subsidiary company that is not owned by the parent company. This concept is crucial in accounting for business combinations, as it reflects the portion of equity in a subsidiary that is not attributable to the parent company. It affects the consolidation of financial statements, where the parent company must report the non-controlling interest as a separate line item in its equity section, showcasing the interests of minority shareholders.
Partially Owned Subsidiaries: Partially owned subsidiaries are companies where the parent company holds a significant but less than controlling interest, typically between 20% and 50% of the subsidiary's equity. This relationship implies that while the parent has substantial influence over the subsidiary's operations and decisions, it does not have full control. The accounting treatment for these subsidiaries must reflect their non-controlling interests in financial statements, emphasizing the need for transparency regarding ownership stakes and profit sharing.
Purchase price allocation: Purchase price allocation refers to the process of assigning the total purchase price of an acquired company to its identifiable assets and liabilities at fair value. This is crucial for understanding the financial implications of a business acquisition and is key in determining the amount of goodwill and other intangible assets that may arise in the transaction.