Question

Does a non-controlling shareholder have access to any information other than the consolidated financial statements to determine how well the subsidiary is doing? Explain.

Advanced accounting

Answer 1

What is a Non-Controlling Interest?

A non-controlling interest (NCI) is an ownership stake of less than 50% in a corporation, where the position held gives the investor no influence or an insignificant amount of influence on how the company is run. Non-controlling interests are measured at the respective net asset value of entities which have other shareholders than the controlling shareholder. Potential voting rights are not taken into account when measuring an NCI. Another name for this type of investment is minority interest (it’s the same thing as non-controlling interest).

A non-controlling interest is also specifically used in relation to subsidiary companies to refer to the equity interest that is held by outside investors, rather than the parent company.

What is the criteria for Non Controlling Interest?

Non-controlling interest (minority interest) occurs when an ownership stake is insignificant relative to the total  number of outstanding shares. This threshold often means that any stakeholder carrying less than 50% of the outstanding shares classifies as having an NCI. However, sometimes this threshold is lower, as a shareholder may hold only 49% of a company, but be able to exercise a level of influence. As such, the criteria really depends on whether the NCI classification is for accounting purposes or for strategic planning.

For the majority of publicly traded companies, the number of outstanding shares is so large that a normal position cannot influence higher level activity, which is why it is deemed as a non controlling interest. It is generally not until one holds 5-10% of the total oustanding shares that they can push for a seat on the board, or significantly drive changes at the shareholders’ meetings by publicly lobbying for them.

Types of Non Controlling Interest

There are generally two types of non controlling interests:

1. A Direct NCI receives a proportionate share of all equity recorded by the subsidiary — these equity balances include both pre-acquisition and post-acquisition amounts.

2. An Indirect NCI receives a proportionate share of a subsidiary’s post-acquisition equity only.

Calculating Non Controlling Interest

In calculating the NCI share of equity, it is consolidated equity rather than recorded equity on which the NCI 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.

It is important to investors that companies provide transparency regarding non controlling interests, because this will give them a better understanding of the effect of the NCI on a group’s financial position, financial results and cash flows, and therefore also the risks faced by the group. Investors will thus be better informed regarding the actual value of the assets and liabilities of the NCI when it is held by a company, and also the extent to which the assets and liabilities are attributable to the holders of the NCI. 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.