Non non controlling interest

What Is Noncontrolling Interest?

Noncontrolling interest (NCI), often referred to as minority interest, represents the portion of a subsidiary's equity not attributable, directly or indirectly, to the parent company. This concept is fundamental to financial reporting within the broader category of accounting standards, particularly when a parent company consolidates the financial statements of a subsidiary it does not wholly own. Even though the parent holds a controlling interest (typically more than 50% of voting shares), the noncontrolling interest acknowledges the claims of other shareholders on the subsidiary's net assets and net income.

History and Origin

The accounting treatment of noncontrolling interest has evolved significantly over time to enhance the transparency and comparability of financial statements. Historically, noncontrolling interest was often presented as a liability or a mezzanine instrument outside of the main equity section. However, a major shift occurred with the issuance of new accounting standards.

In the United States, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards (SFAS) No. 160, "Noncontrolling Interests in Consolidated Financial Statements," in 2007, which became effective for fiscal years beginning after December 15, 2008. This standard, now largely codified under Accounting Standards Codification (ASC) 810, changed the classification of noncontrolling interest to a separate component within the equity section of the consolidated financial statements. The FASB's objective was to improve the relevance and comparability of information related to business combinations. Under ASC 810-10-20, noncontrolling interest is explicitly defined as the "portion of equity (net assets) in a subsidiary not attributable, directly or indirectly, to a parent."⁹, ¹⁰

Internationally, the International Accounting Standards Board (IASB) also updated its guidance. In 2008, amendments were made to IAS 27, "Consolidated and Separate Financial Statements," addressing noncontrolling interests. Subsequently, in May 2011, the IASB issued IFRS 10, "Consolidated Financial Statements," which replaced IAS 27 for consolidation requirements and solidified the treatment of noncontrolling interest as an equity component.⁶, ⁷, ⁸ This harmonization aimed to provide a more cohesive global approach to financial reporting.

Key Takeaways

• Noncontrolling interest represents the ownership stake in a subsidiary held by parties other than the parent company.
• It is presented as a separate component within the equity section of the consolidated financial statements.
• Noncontrolling interest impacts both the consolidated balance sheet and income statement.
• Changes in the parent's ownership interest in a subsidiary that do not result in a loss of control are accounted for as equity transactions.
• The measurement of noncontrolling interest can involve using either the fair value (full goodwill method) or the proportionate share of net identifiable assets (partial goodwill method under IFRS).

Formula and Calculation

Noncontrolling interest is calculated as the proportionate share of the subsidiary's net income or loss, and its equity, attributable to the minority shareholders.

For the balance sheet at the acquisition date, the noncontrolling interest (NCI) is determined:

For subsequent periods, the noncontrolling interest's share of net income or loss is calculated as:

This amount is then added to the noncontrolling interest balance on the balance sheet, while dividends paid to noncontrolling interest holders reduce the balance.

Interpreting the Noncontrolling Interest

The presence of noncontrolling interest on the consolidated financial statements provides crucial insight into the ownership structure of a corporate group. When analyzing a company, a significant noncontrolling interest balance on the balance sheet indicates that a notable portion of the subsidiary's net assets belongs to outside investors. Similarly, on the income statement, the allocation of net income to noncontrolling interests clearly delineates the earnings that are not attributable to the parent company's shareholders. This distinction allows financial statement users to understand the true proportion of a company's financial results and equity that belongs to the controlling entity.

Hypothetical Example

Assume Parent Co. acquires 80% of Sub Corp. for cash. The remaining 20% of Sub Corp. is held by other investors. On the acquisition date, Sub Corp. has total identifiable net assets with a fair value of $1,000,000.

1. Initial Recognition: Parent Co. will consolidate Sub Corp.'s financial statements. The noncontrolling interest will be recorded as 20% of Sub Corp.'s fair value of net identifiable assets, which is $200,000 ($1,000,000 * 0.20), as a separate line item within the equity section of Parent Co.'s consolidated financial statements.
2. Subsequent Period Earnings: In the following year, Sub Corp. reports a net income of $100,000. On Parent Co.'s consolidated financial statements, 20% of this net income, or $20,000, will be attributed to the noncontrolling interest and presented separately in the income statement. This $20,000 also increases the noncontrolling interest balance on the balance sheet.
3. Dividends: If Sub Corp. declares and pays $50,000 in dividends, the noncontrolling interest holders would receive 20%, or $10,000. This amount would reduce the noncontrolling interest balance on the consolidated balance sheet.

Practical Applications

Noncontrolling interest plays a critical role in various real-world financial scenarios. It is fundamental in business combinations, where a parent company acquires a controlling stake in another entity but does not own 100% of its shares. This commonly occurs in mergers and acquisitions, as well as in the formation of joint ventures where multiple parties hold a share in a combined entity.

Regulators, such as the U.S. Securities and Exchange Commission (SEC), closely scrutinize the accounting and disclosure of noncontrolling interests to ensure transparency and proper classification, especially for complex instruments like redeemable noncontrolling interests. For instance, the SEC staff provides interpretive guidance on how entities should measure and present such interests, impacting how they are reflected on a company's financial statements.⁵ Understanding noncontrolling interest is also vital for financial analysts and investors who need to accurately assess the profitability and financial health of a consolidated group, distinguishing between earnings attributable to the parent company versus those belonging to external shareholders.

Limitations and Criticisms

While the accounting standards for noncontrolling interest aim to provide clarity, their application can present complexities and has faced some criticisms. One challenge lies in determining the appropriate attribution of losses to noncontrolling interests, particularly if such attribution leads to a deficit balance for the noncontrolling interest. Under U.S. GAAP, noncontrolling interest can indeed have a deficit balance.⁴

Another area of complexity involves the measurement of noncontrolling interest at the acquisition date. While U.S. GAAP generally mandates the fair value (full goodwill method), IFRS allows for an election between the full goodwill method and the proportionate share of net identifiable assets (partial goodwill method), leading to potential differences in reported goodwill and overall equity depending on the accounting standards applied.³

Furthermore, the accounting for changes in a parent company's ownership interest in a subsidiary that do not result in a loss of control is treated as an equity transaction. This means no gain or loss is recognized in the income statement from such changes, which some argue might obscure the economic impact of these transactions. The complex nature of some capital structure arrangements, especially those involving redeemable noncontrolling interests or non-cash consideration, can also make the application of accounting guidance challenging.¹, ²

Noncontrolling Interest vs. Controlling Interest

Noncontrolling interest and controlling interest both refer to ownership stakes in a company, but they represent different levels of influence and reporting within consolidated financial statements.

The primary point of confusion often arises because the parent company, holding the controlling interest, fully consolidates the financial results of the subsidiary, even though it does not own 100%. Noncontrolling interest is the accounting mechanism to reflect the portion of the subsidiary's net income and equity that belongs to these outside investors, ensuring that the consolidated financial statements accurately portray the ownership breakdown.

FAQs

Q1: Why is noncontrolling interest shown on the balance sheet if the parent company consolidates 100% of the subsidiary?

Even though the parent company includes all of the subsidiary's assets and liabilities on its consolidated financial statements, it doesn't own 100% of the subsidiary's equity. Noncontrolling interest is a required line item within the equity section to show the portion of the subsidiary's net assets that belongs to the minority shareholders.

Q2: Does noncontrolling interest receive a share of the subsidiary's net income?

Yes, the noncontrolling interest is allocated a proportionate share of the subsidiary's net income or loss. This portion is presented separately on the consolidated financial statements to clearly distinguish earnings attributable to the parent from those attributable to the noncontrolling interest holders.

Q3: What happens to noncontrolling interest if the parent company buys out the remaining shares of a subsidiary?

If the parent company acquires the remaining shares of the subsidiary (making it 100% owned), the noncontrolling interest account will be eliminated from the consolidated balance sheet. The acquisition of additional shares, if control is maintained, is treated as an equity transaction.

Q4: Can noncontrolling interest have a negative balance?

Yes, under U.S. GAAP and IFRS standards, if the subsidiary incurs losses that exceed the noncontrolling interest's share of equity, the noncontrolling interest balance can indeed become negative. This reflects that the minority shareholders are allocated their share of the subsidiary's losses, even if it results in a deficit.