If an investing firm owns less than 100% of the voting shares of another firm, a noncontrolling interest will exist. Many companies use the term minority interest to describe the noncontrolling interest in their financial statements. The noncontrolling interest, which may be widely held, is entitled to a pro rata portion of net assets, earnings, and dividends. Recent accounting standards have drastically changed accounting for noncontrolling interests. In the past, an acquisition of less than 100% resulted in only a partial remeasurement of the acquired firm’s assets and liabilities to fair value. For example, in a 70% acquisition, land with a book value of $100 and fair value of $110 would be remeasured and reported at $107 in the consolidated financial statements.
The parent’s interest in the land would be based on fair value, $77 ($110 3 70%), and the noncontrolling interest would be based on book value, $30 ($100 3 30%). Under currentstandards (the acquisition method), the basis for recording the acquisition transaction is the fair value of the acquired firm. Therefore, land is remeasured to its fair value of $110, with a pro rata share allocated to parent and noncontrolling interests. The measurement of noncontrolling interests also extends to goodwill, which puts both controlling and noncontrolling interests at full fair value. However, under IFRS, firms have an option (on a transaction-by-transaction basis) to assign to noncontrolling interests only their pro rata share of differences between fair value and book value of identifiable assets and liabilities, but not goodwill.
Prior to the issuance of the current accounting standards, noncontrolling interests received disclosure on the balance sheet between liabilities and shareholders’ equity (‘‘mezzanine’’ disclosure). Under current accounting standards, noncontrolling interests are a component of shareholders’ equity. To illustrate an acquisition of less than 100%, Exhibit 8.16 presents the separate financial statements at December 31, 2015, of Power Company and its 80%-owned subsidiary, Small Technologies. Two years earlier, on January 1, 2014, Power acquired 80% of the common shares of Small for $3,900 in cash (all amounts in millions). Small’s 2014 net income was $350, but Small paid no dividends in that year. Small’s 2015 income was $450, and it paid $250 dividends on common stock during 2015. Shortly after the date of acquisition, Small common stock traded at a share price that was close to the share price Power paid in the acquisition. Because this condition
The parent’s interest in the land would be based on fair value, $77 ($110 3 70%), and the noncontrolling interest would be based on book value, $30 ($100 3 30%). Under currentstandards (the acquisition method), the basis for recording the acquisition transaction is the fair value of the acquired firm. Therefore, land is remeasured to its fair value of $110, with a pro rata share allocated to parent and noncontrolling interests. The measurement of noncontrolling interests also extends to goodwill, which puts both controlling and noncontrolling interests at full fair value. However, under IFRS, firms have an option (on a transaction-by-transaction basis) to assign to noncontrolling interests only their pro rata share of differences between fair value and book value of identifiable assets and liabilities, but not goodwill.
Prior to the issuance of the current accounting standards, noncontrolling interests received disclosure on the balance sheet between liabilities and shareholders’ equity (‘‘mezzanine’’ disclosure). Under current accounting standards, noncontrolling interests are a component of shareholders’ equity. To illustrate an acquisition of less than 100%, Exhibit 8.16 presents the separate financial statements at December 31, 2015, of Power Company and its 80%-owned subsidiary, Small Technologies. Two years earlier, on January 1, 2014, Power acquired 80% of the common shares of Small for $3,900 in cash (all amounts in millions). Small’s 2014 net income was $350, but Small paid no dividends in that year. Small’s 2015 income was $450, and it paid $250 dividends on common stock during 2015. Shortly after the date of acquisition, Small common stock traded at a share price that was close to the share price Power paid in the acquisition. Because this condition
indicated the lack of a control premium, the fair value of Small Technologies was computed as $4,875 ($3,900 acquisition price 4 80%). Recording the acquisition at $4,875 (the acquisition method based on fair value) rather than $3,900 (the purchase method) causes the noncontrolling interest to reflect fair value as well.
Exhibit 8.17 presents Power’s allocation of Small’s fair value at the date of acquisition, updated through the current balance sheet date, December 31, 2015. One year of excess fair value amortization must be reflected in consolidated net income each year, and the balance sheet amounts have accumulated two years of amortization as of December 31, 2015. For example, patented technologies had a fair value that exceeded Small’s book value by $600. If the estimated life is 20 years, patent amortization expense on a consolidated basis must be increased by $30 in a given year. After two years have passed, the consolidated balance sheet reports the excess fair value at $540.
Exhibit 8.18 traces Power Company’s equity method accounting for Small. Power paid $3,900 at the acquisition date (1/1/14), increased the investment account to recognize its equity in Small’s earnings (percent ownership times Small’s earnings, adjusted for the excess amortizations from Exhibit 8.17), and decreased the investment when it received its share of Small’s dividends. The $320 equity in Small’s earnings for 2015 appears in Power’s own income statement, and the $4,260 investment in Small Technologies appears on Power’s own December 31, 2015 balance sheet. The noncontrolling interest computations follow the same process, yielding a noncontrolling interest in 2015 net income of $80 and a noncontrolling interest in the net assets of Small o $1,065 at December 31, 2015.
Exhibit 8.19 presents the consolidation worksheet at December 31, 2015. The eliminations have been coded to facilitate the explanation. The consolidation process for less than 100% ownership follows the same process as illustrated for 100% ownership, with
Exhibit 8.17 presents Power’s allocation of Small’s fair value at the date of acquisition, updated through the current balance sheet date, December 31, 2015. One year of excess fair value amortization must be reflected in consolidated net income each year, and the balance sheet amounts have accumulated two years of amortization as of December 31, 2015. For example, patented technologies had a fair value that exceeded Small’s book value by $600. If the estimated life is 20 years, patent amortization expense on a consolidated basis must be increased by $30 in a given year. After two years have passed, the consolidated balance sheet reports the excess fair value at $540.
Exhibit 8.18 traces Power Company’s equity method accounting for Small. Power paid $3,900 at the acquisition date (1/1/14), increased the investment account to recognize its equity in Small’s earnings (percent ownership times Small’s earnings, adjusted for the excess amortizations from Exhibit 8.17), and decreased the investment when it received its share of Small’s dividends. The $320 equity in Small’s earnings for 2015 appears in Power’s own income statement, and the $4,260 investment in Small Technologies appears on Power’s own December 31, 2015 balance sheet. The noncontrolling interest computations follow the same process, yielding a noncontrolling interest in 2015 net income of $80 and a noncontrolling interest in the net assets of Small o $1,065 at December 31, 2015.
Exhibit 8.19 presents the consolidation worksheet at December 31, 2015. The eliminations have been coded to facilitate the explanation. The consolidation process for less than 100% ownership follows the same process as illustrated for 100% ownership, with
the addition of recognizing the noncontrolling interest in net income and net assets
computed in Exhibit 8.18. The eliminations are as follows:
A ¼ Elimination of the Investment in Small Technologies account
B ¼ Elimination of Small’s shareholders’ equity accounts
C ¼ Allocation of excess fair value amounts at the date of acquisition to expenses and to the balance
computed in Exhibit 8.18. The eliminations are as follows:
A ¼ Elimination of the Investment in Small Technologies account
B ¼ Elimination of Small’s shareholders’ equity accounts
C ¼ Allocation of excess fair value amounts at the date of acquisition to expenses and to the balance
sheet as computed in Exhibit 8.17
D ¼ Elimination of the Equity in subsidiary earnings account
E ¼ Recognition of an $80 noncontrolling claim on consolidated net income and of
noncontrolling equity of $1,065
The noncontrolling equity interest of $1,065 should be reported as a component of shareholders’ equity. As noted in Chapter 4, if the denominator of the ROA computation includes all assets (as it typically does), the numerator should be calculated before the allocation of consolidated net income to the noncontrolling interest. A tax effect adjustment is not necessary because the noncontrolling interest is in after-tax netincome.
D ¼ Elimination of the Equity in subsidiary earnings account
E ¼ Recognition of an $80 noncontrolling claim on consolidated net income and of
noncontrolling equity of $1,065
The noncontrolling equity interest of $1,065 should be reported as a component of shareholders’ equity. As noted in Chapter 4, if the denominator of the ROA computation includes all assets (as it typically does), the numerator should be calculated before the allocation of consolidated net income to the noncontrolling interest. A tax effect adjustment is not necessary because the noncontrolling interest is in after-tax netincome.
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