Financial Consolidation: Dealing with Minority Interest

Minority interests, also known as noncontrolling interests, have different meanings according to the two main accounting conventions, GAAP and IFRS. By understanding where a not insignificant portion of revenue and cash flow comes from, investors can make more well-informed decisions and better quantify their risk. If the acquirer does want to modify a target’s stakes in other companies, it might do so after the deal closes and it can evaluate the target’s performance in more detail. It’s best to use the market value when adding the Noncontrolling Interests, but if you cannot find it, the book value is fine – especially if the NCIs are small. So, if Parent Co. owns 70% of Sub Co., the Noncontrolling Interest on its Balance Sheet represents the 30% it does not own. The constant growth method is seldom used because the assumption is that there is hardly any decline or growth in the performance of the subsidiary company.

The value of minority holdings should be added to EV to reflect total business operations included in metrics like EBITDA. This captures the appropriate value of assets generating cash flow, regardless of subsidiary ownership structure. When there is a minority interest in a subsidiary, the parent company that owns a majority stake in the subsidiary recognizes the minority interest in its financial statements.

  1. This contrasts with the partial consolidation method, which only consolidates subsidiaries based on the parent’s percentage of ownership.
  2. For example, venture capitalists may negotiate for a seat on the board of directors in exchange for their investment.
  3. The percentage of income credited to the minority interest adds to the balance sheet’s investment account, increasing the equity share in the company.
  4. Only equity-classified instruments that are not owned by the parent are noncontrolling interests.

Therefore, when calculating enterprise value, an analyst needs to add the non-controlling interest to market cap. This is because enterprise value is often used in valuation multiples like EV/EBITDA. Bottom line, include non-controlling interest when calculating enterprise value. Non-controlling interest typically occurs when one company owns greater than 50% of another company but not 100%.

Why is Minority Interest added to Enterprise Value?

After this initial step, you can model the combined financial statements by assuming that Parent Co. continues to own 70% of Sub Co. It changes only if Parent Co.’s ownership falls below 50%, in which case the equity method of accounting applies. Over 1.8 million professionals use CFI to learn accounting, financial analysis, modeling and more.

Factors Influencing Minority Interest

To reflect that the ownership remains less than 100% of the consolidated assets and liabilities, accountants create a new line item titled minority interests or noncontrolling interests. The accounting treatment for companies with ownership levels above 50% remains the same, regardless of the percentage. For example, if the company owns 50%, 65%, or 75%, the degree of consolidation remains unchanged. The minority or noncontrolling interests represent the amount owned by the minority shareholders. We can find the part of a minority interest on the company’s balance sheet under the equity section.

Noncontrolling interests

Minority stakeholders don’t have much say or influence in the company’s direction, thus the term, noncontrolling interests or NCIs. One can also see that it’s not necessary to have a controlling accounting for minority interest interest/be a majority stakeholder to be able to achieve superior returns. Trust in a company’s management and existing moat works wonders and is practiced by the great Warren Buffett himself.

accounting treatment of non-controlling interest

Some of the most famous real-world examples of NCI would be Berkshire Hathaway’s stakes in prominent public companies such as American Express (~20%), The Coca-Cola Company (~9%), and Apple (~5%). International Financial Reporting Standards (IFRS), which are set by the International Accounting Standards Board (IASB), contain similar guidance around minority interest reporting. In the United States, reporting of minority interest is governed by Generally Accepted Accounting Principles (GAAP) issued by the Financial Accounting Standards Board (FASB). In projection models, you tend to make simple assumptions for the NCI line items, such as fixed-percentage growth rates for their Net Income and Dividends. In real life, most companies show a single line item for the Dividends, but we prefer to show Parent Co.’s Dividends separately from Sub Co.’s Dividends for clarity and ease of modeling.

CFI is the official global provider of the Financial Modeling and Valuation Analyst (FMVA)® certification, designed to transform anyone into a world-class financial analyst. Best practice is to use multiple valuation methods to triangulate on a reasonable fair value estimate for the minority interest. The choice depends on the purpose of the valuation and standards being followed. Calculating minority interest can be confusing for many accountants and financial analysts. For example, suppose that Company A acquires a controlling interest of 75% in Company B. The latter retains the remaining 25% of the company.

Similarly, for minority shareholders, if their NCIs are not accounted for properly under the equity or cost methods, their revenues and profits may similarly be overstated. When companies invest in each other, the accounting treatment of such investments depends on the size of the ownership stake. In this case, $20,000 of Subsidiary B’s net income would be allocated to the minority shareholders on the consolidated financial statements. The remaining $80,000 would accrue to the Parent Company as the majority owner. Minority interest, also known as non-controlling interest, refers to the portion of a subsidiary’s equity that is not owned by the parent company.

In the United States, Deloitte refers to one or more of the US member firms of DTTL, their related entities that operate using the “Deloitte” name in the United States and their respective affiliates. Certain services may not be available to attest clients under the rules and regulations of public accounting. Companies seeking a hostile takeover of another company, seek to acquire a controlling interest in the target company by acquiring enough shares.

It arises when a parent company owns a controlling interest, usually defined as owning more than 50% of the voting shares, but not 100% of the subsidiary. Specifically, it represents the claims on assets and earnings by the non-controlling shareholders of the subsidiary. Valuing a company requires financial statements to better forecast future trends around profits and cash flows.

In addition, on the consolidated statement of changes in equity, Company XYZ reports the equity changes that took place within the fiscal year. After the sale of subsidiary shares to minority shareholders and the relevant deduction of net income as well as the distribution of dividends the total balance on December 31 is $3.1 million. This is more with regard to consolidated financial statements, where there will be a line item for NCI.