Question

What is noncontrolling interest? How is it classified on the balance sheet of a parent company? Locate a company that has consolidated financial statements, and discuss the noncontrolling interest of that company.

Answer 1

Sollution:-1)What is noncontrolling interest:-A non-controlling interest, also known as a minority interest, is an ownership position wherein a shareholder owns less than 50% of outstanding shares and has no control over decisions.

2)As a result, minority interest shareholders have no individual control over corporate decisions or votes by themselves.

3)In calculating the NCI share of equity, it is consolidated equity rather than recorded equity on which the NC is calculated. Hence, in calculating both the DNCI and INCI share of equity, adjustments must be made to eliminate any unrealized profits or losses arising from transactions within the group.

4)It is important to investors that companies provide transparency regarding non controlling interests, because it will give them a better understanding of the effect of the NCI on a group’s financial position, financial results, and cash flows, and also the risks faced by the group. Investors will then be better positioned to form their own opinion regarding the effect of an NCI on the various ratios and items in the financial statements.

5)The parent company reports the financial results of the subsidiary company in its consolidated balance sheet to present a claim on assets by minority shareholders or in its consolidated income statement as a percentage of profits belonging to minority shareholders. Minority interest shareholders have less influence on a firm’s management and policies, and restricted voting rights, but they offer significant growth for the firm with their experience and capital.

6)Let’s look at an example.

Assume that a parent company buys 80% of XYZ firm and that a non-controlling interest company buys the remaining 20% of the new subsidiary, XYZ. The subsidiary’s assets and liabilities on the balance sheet are adjusted to fair market value, and those values are used on the consolidated financial statements. If the parent and a non-controlling interest pay more than the fair value of the net assets, the excess is posted to a goodwill account in the consolidated financial statements.

Goodwill is an additional expense incurred to buy a company for more than the fair market value, and goodwill is amortized into an expense account over time after an impairment test. This is done under the purchase acquisition accounting method approved by the Financial Accounting Standards Board (FASB).

7)Calculation of non controlling interest:-When a company acquires another company, it compares sum the fair value of purchase consideration it pays plus the fair value of the non-controlling interest with the fair value of net identifiable asset of the subsidiary to arrive at goodwill or any bargain purchase.

Formula

Non-controlling interest on balance sheet equals the proportionate share of the non-controlling shareholders in the fair value of the net assets of subsidiary at the acquisition date plus the proportionate share of non-controlling shareholders in retained earnings since acquisition less their proportionate share in dividends.

NCI in fair value of subsidiary’s net assets at acquisition date	P × FV
Add: NCI share in opening retained earnings	P × RE
Less: cumulative proportionate amortization of fair value differential	P × FVD
Add: net income attributable to NCI	P × SI
Less: dividends paid to non-controlling shareholders	P × D
Non-controlling interest at the date of consolidation	NCI

Alternatively, it can be calculated by starting with proportionate share of the subsidiary’s net asset at the start of the consolidation period plus any unamortized fair value adjustments plus net income attributable to non-controlling shareholders during the period less their proportionate share of dividends.

NCI share of opening net assets of subsidiary	P × NA
Add: NCI share of unamortized fair value differential	P × FVD
Add: net income attributable to NCI	P × SI
Less: dividends paid to non-controlling shareholders	P × D
Non-controlling interest at the date of consolidation	NCI

Where P is the proportionate ownership of minority shareholders. FV is the fair value of net identifiable assets of the subsidiary at acquisition date, RE is opening retained earnings of the subsidiary, FVD is the accumulated amortization of fair value differential, UFVD is the unamortized fair value differential, SI is subsidiary income, NA is the book value of net assets at the start of the consolidation period, D is total dividends declared during the period.

Example

Let’s consider a very simple example. Company A acquired 75% stake in Company B for $50 million when the fair value and book value of net assets of Company B were $40 million and $35 million respectively. The non-controlling interest at acquisition date is $10 million (=25% of $40 million). It can be calculated as the sum of proportionate share in net assets i.e. $8.75 million (=25% of $35 million) plus proportionate share in net fair value differential i.e. $1.25 million (=25% of $5 million).

During the first year of acquisition, Company B earned net income of $8 million, but no dividends are paid. If the fair value differential is amortized over 5 years equally, the value of non-controlling interest at the end of first year since acquisition can be worked out as follows:

NCI in fair value of subsidiary’s net assets at acquisition date	25% × $40 million
Add: NCI share in opening retained earnings since acquisition	25% × 0
Less: NCI share of any cumulative fair value amortization	25% × $10 million × 1/10
Add: net income attributable to NCI	25% × $8 million
Less: dividends paid to non-controlling shareholders	0
Equals non-controlling interest at the date of consolidation	$11.75 million