Conversely, if the market value is below book value, it could suggest overpayment for assets or asset impairment. This section explains the key concepts and calculations involved in determining minority interest ownership using the income statement approach. Any differential between the consideration paid and net assets acquired is accounted for as goodwill or gain on bargain purchase. When calculating a company’s enterprise value (EV), it is important to consider how minority interest is treated. Minority interest refers to the portion of a subsidiary that is not owned by the parent company.
Minority interest refers to the portion of a subsidiary’s equity that is not owned by the parent company. For example, if Company A acquires 80% of Company B, Company A has an 80% controlling interest while the remaining 20% is held by minority shareholders. These minority shareholders have https://turbo-tax.org/ an ownership stake and rights to a proportionate share of Company B’s net income and net assets. Minority interest, also referred to as non-controlling interest (NCI), is the share of equity ownership in a subsidiary’s equity that is not owned or controlled by the parent corporation.
- For example, if Company A acquires 80% of Company B, Company A has an 80% controlling interest while the remaining 20% is held by minority shareholders.
- The full consolidation method combines the financial statements of a parent company and its subsidiaries, treating them as a single economic entity.
- Hence, minority shareholders have a little say in a company’s decision-making, and they cannot exert control over the company through voting.
- Failure to account for minority interest can undermine the accuracy of valuation multiples like EV/EBITDA.
- This may come about as not every type of share issued by a company has voting rights.
The calculation is quite straightforward, as the number reflected as NCI on the financial statements is the percentage of the minority ownership. In summary, properly accounting for minority interest provides an accurate view of the parent corporation’s consolidated financial position and performance. Understanding how minority interest fits on the financial statements is an important aspect of financial analysis. When calculating enterprise value (EV) for the parent company, the minority interest is normally added to the market capitalization.
Comprehensive Calculation of Minority Interest
Here the company will list the parent and subsidiaries’ equity as separate line items. Since minority interest sits below debt and above common equity on the balance sheet, it is essentially treated as a “quasi-equity” claim on the company’s value. Therefore, minority interest must be added to the market capitalization to arrive at a company’s total enterprise value. So on the balance sheet, minority interest sits below liabilities, but above equity belonging to the parent company’s shareholders. Thus, whether XYZ owns 50.1% or 100% of ABC, the financial statements of XYZ will show 100% of the assets and liabilities of ABC and 100% of the Sales, Revenue, Costs, Profits/Loss, etc. of ABC.
Finally, minority shareholders of one company are usually majority shareholders in another company. If one were to have a larger stake in a company and use the consolidation method without having a clear distinction between the other minority shareholders, then revenue and assets would undoubtedly be overstated. There is an ongoing debate around whether minority interest should be considered part of the parent company’s shareholders’ equity. In summary, properly accounting for minority interest provides a clearer picture of economic reality and a more accurate view of financial positions/performance for consolidated businesses. Understanding how to calculate, record, and interpret minority interest is critical for corporate financial reporting.
Noncontrolling Interests in Valuation: Equity Value and Enterprise Value
Under the equity method, the company records the initial cost or purchase price on the asset side of the balance sheet. Active minority interests, which hover between 21% to 49%, include minority shareholders who can materially influence the company. Companies need to account for the financial performance of these subsidiaries.
Even though a subsidiary might not have majority ownership voting rights, the subsidiary does have some rights, including audit rights. But many don’t rise to 100%, and how companies account for the smaller ownership levels impacts the value. My Accounting Course is a world-class educational resource developed by experts to simplify accounting, finance, & investment analysis topics, so students and professionals can learn and propel their careers. Get instant access to lessons taught by experienced private equity pros and bulge bracket investment bankers including financial statement modeling, DCF, M&A, LBO, Comps and Excel Modeling.
Minority interest belongs to other investors and is reported on the consolidated balance sheet of the owning company to reflect the claim on assets belonging to other, non-controlling shareholders. Also, minority interest is reported on the consolidated income statement as a share of profit belonging to minority shareholders. A minority interest, also called a non-controlling interest (NCI), is the percentage of a subsidiary accounting for minority interest owned by shareholders other than the parent company. Majority interests typically represent over 50% of the company’s equity, while minority interests typically range between 20% and 30%. The interests in subsidiaries are listed in the equity section of the consolidated balance sheet of parent companies. It is also reported on the consolidated income statement as a share of profits belonging to minority shareholders.
There are laws that also entitle minority interest holders to certain audit rights. PwC refers to the US member firm or one of its subsidiaries or affiliates, and may sometimes refer to the PwC network. This content is for general information purposes only, and should not be used as a substitute for consultation with professional advisors. Buffett first purchased shares of GEICO in 1951, continuing to buy shares until buying the entire company in 1996. The difference between GAAP and IFRS accounting continues to close, but differences remain.
The equity method provides a more accurate picture of the investing company’s income and financial position when it can influence the investee company’s policies and operations. It goes beyond just reporting dividends received and requires recognizing a proportional share of income/losses. When a business has a minority interest in another entity and it has substantial influence over that entity, the business accounts for its ownership share using the equity method. Under the equity method, the initial investment is subsequently adjusted for dividends received (which reduces the investment) and a proportional share of the investee’s earnings (which increases the investment). When a business has a minority interest in another entity and it has no substantial influence over that entity, the business accounts for its ownership share using the cost method.
Active minority interests—owning 21% to 49%—are when a minority shareholder can materially influence the company where it holds a minority interest. Unlike passive interests, dividends received and a percentage of income are recorded for those with active minority interests. A subsidiary with minority shareholders must also provide its separate financial statements. The above noncontrolling interests represent the minority shareholders’ equity interest from Kraft Heinz and others that Berkshire owns less than 50% of those companies.
It is used when one company has a significant hold over the investee, with investor ownership ranging from 20%-50%. That said, it is important to remember that due to their NCI, they do not have the final say in any corporate decision unless they have over 50% of the voting ability or counted votes in their favor. This section provides examples and case studies to illustrate concepts around minority interest in finance.
Note that the reporting of consolidated revenue and expenses implies that the parent company exerts control over the subsidiary company during the entire 12-month period of the fiscal year. Now, with a better understanding of NCI, let’s look at what it entails in accounting terms. In accounting, NCI is used to understand a company’s ownership structure better and helps to reflect a company’s financial performance better. The founders, Larry Page and Sergey Brin may only have ~12% of total shares outstanding, but they have ~51% of all voting shares, resulting in them effectively having full reign of all company decisions.
The problem with this second method lies in the fact that companies are only required to supply one consolidated Financial Statement and do not provide separate financial statements of all their subsidiaries. The threshold for applying the full consolidation method is typically ownership of over 50% of a subsidiary’s voting shares. This indicates the parent has effective control over the subsidiary’s operations and policies.
Transactions with NCI: How is the purchase or disposal of equity in a subsidiary accounted for?
This ensures that both the numerator and the denominator of the above ratios reflect 100% of the subsidiary’s financials, even if the parent owns less than 100% of it. We then proceed to calculate the net income that belongs to XYZ’s minority interest owners. We do this by multiplying XYZ’s net income of $2,121 by its remaining minority share of 10%, to arrive at $212.1 million. Again, this figure gets reported on ABC’s consolidated income statement as “net income attributable to the minority interest,” a separate non-operating line item. This amount is then recorded as a separate non-operating line item, such as “net income attributable to the minority interest,” on the consolidated income statement of the parent company.