Minority interest, also referred to as non-controlling interest (NCI), is the share of ownership in a subsidiary’s equity that is not owned or controlled by the parent corporation. The parent company has a controlling interest of 50 to less than 100 percent in the subsidiary and reports financial results of the subsidiary consolidated with its own financial statements.
For example, suppose that Company A acquires a controlling interest of 75 percent in Company B. The latter retains the remaining 25 percent of the company.
On its financial statements, Company A cannot claim the entire value of Company B without accounting for the 25 percent that belongs to the minority shareholders of Company B. Thus, company A must incorporate the impact of company B’s minority interest on its balance sheet and income statements.
The concept of minority interest is applied only when the ownership share in a subsidiary exceeds 50 but is less than 100 percent. A parent company may want to own less than 100 percent for a number of reasons. First, achieving control of a subsidiary with a smaller than 100 percent capital investment puts less capital at risk of loss. Since control is obtained when the ownership percentage goes above 50 percent, investing 51 percent will guarantee control and will present less risk to capital compared to an investment of 100 percent. Second, it may be hard to acquire all shares in a subsidiary, since some of the existing shareholders may not be willing to part with their stock.
When a controlling interest in a subsidiary is achieved, the consolidated method of accounting for share purchase is used. This method requires that many line items in the financial statements of the parent incorporate financial results of the acquiree, i.e. reflect a fictitious 100 percent ownership of the subsidiary. The parent must, however, maintain separate accounts on the balance sheet and income statement that track the value of the minority interest in the subsidiary, as well as its profit belonging to the minority owners.
The other two methods are the cost method, where the parent owns 20 percent or less in subsidiary’s voting stock, and the equity method, where the percentage of ownership is 21–49 percent. Neither method uses minority interest to report a subsidiary’s share of assets or income anywhere on the parent’s financial statements.
Under U.S. GAAP, the financial accounting treatment of minority interest requires that it be recorded either as a non-current liability or as part of the equity section on a consolidated balance sheet of the parent company to reflect non-controlling shareholders’ claim on assets. Under IFRS, however, it can be reported only in the equity section of the balance sheet. It must be recorded “within equity, but separate from the parent’s equity.” On a consolidated income statement, minority interest is recorded as a share of the minority shareholders’ profit, in compliance with FASB standards.
How to Measure
There are a few basic steps to measuring minority interest. The first step is always to find the book value of the subsidiary as it appears on the subsidiary’s balance sheet. The book value, or the net asset value of a company, is its total assets less the intangible assets (patents, goodwill) and liabilities. You then proceed to multiply the book value by the percentage of the subsidiary owned by the minority shareholders. If we use 25 percent from the example above for the minority share percentage and assume the subsidiary’s net asset value to be $2 million, then our minority interest will equal 25% x $2 million = $500,000. Once the dollar value of minority interest is calculated, we record it on the balance sheet as part of the equity section.
The second step is to compute the net income that belongs to the minority interest owners of the subsidiary. It is simply the subsidiary’s total net income multiplied by the minority interest percentage. Again, using the 25 percent minority interest percentage, and an assumed net income of $1 million, we calculate our minority income as 25% x $1 million = $250,000. 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.
Let’s look at a recent example of an acquisition and apply our calculation of minority interest to it. In August 2015, Berkshire Hathaway Inc. (BRK.A; BRK.B) entered into an agreement to acquire Precision Castparts Corp. (PCP) for $37.2 billion. For the purpose of this exercise, we will assume that the agreement is for a controlling interest of 90 percent in PCP. Below is simplified financial information from PCP’s balance sheet and income statement for the fiscal year ending on March 29, 2015.
|(in millions)||Fiscal Year End March 29, 2015|
|Property, Plant and Equipment, net||2,474|
|Acquired Intangible Assets, net||3,744|
|(in millions)||Fiscal Year Ending March 29, 2015|
|Operating Costs and Expenses||7,466|
Source: Precision Castparts Corp. annual report for fiscal year ending March 29, 2015
We first determine the net asset value of PCP as total assets minus the intangible assets and liabilities, or $19,428 – ($6,661+$3,744) – $8,471 = $552. We then multiply this book value by 100% – 90% = 10%, which is the percentage of PCP owned by minority shareholders, to arrive at the minority interest value of $55.2 million to be reported on BRK’s consolidated balance sheet.
We then proceed to calculate the net income that belongs to PCP’s minority interest owners. We do this by multiplying PCP’s net income of $1,533 by its remaining minority share of 10%, or to arrive at $153.3 million. Again, this figure gets reported on BRK’s consolidated income statement as “net income attributable to the minority interest,” a separate non-operating line item.
Minority interest is important in analyzing prospective investments. It is most often used in calculating the enterprise value of a company and is treated much like the company’s debt and added to the market capitalization to arrive at the company’s enterprise value:
Hence, the main use of the minority interest is in valuation ratios, such as the Enterprise-Value-To-Sales (EV/Sales), Enterprise Multiple (EV/EBITDA), etc. As we already know, the consolidation method of accounting for an investment in a subsidiary requires that 100 percent of the subsidiary’s sales or EBITDA be included on the parent company’s income statement, even in cases when the parent owns less than 100 percent of the subsidiary. For this reason, and to ensure consistency, we need to add minority interest so that the parent does not own back to the Enterprise Value. This ensures that both the numerator and the denominator of the above ratios reflect 100 percent of the subsidiary’s financials, even if the parent owns less than 100 percent of it.
The Bottom Line
Minority interest comes into play when consolidation accounting is applied to report 51 to less than 100 percent investment in a subsidiary. The calculation of minority interest is relatively simple and requires the use of minority shareholders’ percentage ownership of a subsidiary. This measurement is then reported on the parent’s consolidated balance sheet and income statement in accordance with IFRS or U.S. GAAP rules.