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Minority Interest – What’s in the name! This famous adage of Shakespeare does not always hold. Minority Interest is one such exception. As the name suggest,
Minority interest can simply be defined as the value of share, or the interest attributable to the shareholders holding less than 50% of the total number of shares. Shareholders holding less than 50% of the total outstanding number of shares are known as minority shareholders. It is also known as Non-controlling interest.
In this article we take the discussion on Minority Interest in detail –
- What is Minority Interest?
- Financial Reporting
- Minority Interest Example – Consolidation Calculation
What is Minority Interest?
In accounting world minority interest means the ownership in subsidiary company not owned by holding company which is also know as Parent Company. For a Company to be a holding company it must always hold more than 50% of the shares in its subsidiary company.
For example, A & B are the two shareholders of Company Pine-Apple Inc. holding 80% and 20% respectively. In the Balance-sheet of Pine –Apple Inc. Shareholder B will be considered as minority shareholder since it owns less than 50% of total shares and its net worth as on date has to be shown under the separate head as minority interest. Whereas, shareholder A is the majority shareholder of Pine-Apple Inc.
Financial Reporting of Minority Interest
This concept arises only in case when the company prepares two sets of financial statement Viz. Separate set of financial statement and Consolidated Financial statement. It is reported separately only in the consolidated financial statement. Minority interest adjustments occurs when the parent does not own 100% of the subsidiary.
In the consolidated profit and loss account minority interest is that proportion of the results for the year that relate to the minority holdings. It is disclosed on the face of the consolidated profit and loss account under “Profit on ordinary activities after taxation”.
As per IFRS, Minority Interest is shown under the Equity section of consolidated balance sheet whereas US GAAP offers much flexibility for reporting. Under US GAAP, it can be reported under the liabilities or equity section.
checkout the difference between IFRS vs US GAAP
The reason for separate line item with respect to such interest is to give clear picture to the users of financial statement about the various controlling interest in the company. It helps them in making an informed economic decisions and also helps them in making comparisons on the shareholding patterns of different companies. It plays a huge role in analyzing various investments opportunities and calls for its consideration while computing various ratios and analyzing financial statement.
One other reason for separate disclosure is to provide certain protection to minority shareholders as they are in a position of disadvantage. Since, they are hardly involved in the decision making process, there is a need to protect them oppression and mismanagement of conduct of company’s affairs by management.
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Minority Interest Example – Consolidation Calculation
As mentioned earlier, it arises whenever a holding company owns a controlling interest (Less than 100 percent) in a subsidiary company. The claim of shareholders on the net assets of a company are known as minority interest. These minority shareholders like any other shareholders have an equal but proportionate claim on the earnings and assets of the subsidiary.
The consolidated balance sheet comprises of all of the assets and liabilities of a subsidiary. Similarly, the consolidated income statement includes all of the revenues and expenses of a subsidiary. The controlling interest of parent company gives it enough rights to manage all of the net assets of a subsidiary, which justifies the inclusion of 100 percent of subsidiary’s assets, liabilities, revenues, and expenses in the consolidated financial statements. It is important to note here that though parent company includes 100 percent of subsidiary’s assets, liabilities, revenues, and expenses in its consolidated financial statements, it does not have a claim on 100 percent of the net assets or earnings. The consolidated financial statement therefore recognizes the claim of the minority shareholders. Let’s understand the above facts with the help of illustrations.
Let’s assume that H Inc. acquired 80% of equity shares in S Inc. for $ 650,000 in January 2015. On the date of acquisition, the book value of equity was also $ 650,000 (Comprising of equity shares $500,000 and retained earnings $150,000).
|Total||Company H (80 %)||Minority Shareholders (20%)|
|Equity shares||$ 500,000||$ 400,000||$ 100,000|
|Retained earnings||$ 150,000||$ 120.000||$ 30,000|
|Total Equity||$ 650,000||$ 520,000||$ 130,000|
Let’s see how goodwill will be calculated and shown in the consolidated balance sheet of H Inc.
Calculation of Minority Interest
20% of 650,000 = $ 130,000
Calculation of Goodwill
Amount paid for 80% equity in S Inc. $ 650,000
Books value of 80% equity $ 520,000
(650,000 x 80%)
Excess amount paid or Goodwill $ 130,000
Consolidated Balance sheet of H Inc. as on January 2015.
This $ 130,000 will not appear in the separate financial statement of either H or S Inc. Rather, it will appear in the consolidated financial statement of H Inc.
Subsequent recognition of Minority Interest from the date of acquisition
Let’s assume in the above example,
Company S Inc. generated retained earnings of $ 7,000 in three years (January 2015 to January 2018). Subsequent to the date of acquisition S Inc registered a net profit of $ 48,000 in year 4.
Now let’s see how this impact the calculation of minority interest
|Total||Company H||Minority Interest|
|Equity shares||$ 500,000||$ 400,000||$100,000|
|Year 1||$ 150,000||$ 120,000||$ 30,000|
|Increase in earnings over three years||$ 7,000||$ 5,600||$ 1,400|
|Net profit for year 4||$ 48,000||$ 38,400||$ 9,600|
|Total Shareholders’ equity||$ 705,000||$ 564,000||$ 141,000|
In the exhibit 1 above, H Inc. investment value in subsidiary company S was valued at $ 520,000 in year 1. Which was subsequently increased by $7,000 between year 1 and year 3 for its 80% share of Company S earnings. Company S earned $48,000 during year 4.
Similarly, minority interest in company S has increased from $130,000 on January 1 2015 to $ 141,000 on January 2019.
Minority Interest Valuation
Any valuation of company requires forecasting of financial statements for the future on the basis of certain assumptions and parameters. While most of the financial figures has a direct relation with revenue and net profit, but forecasting the minority interest based on the revenue and net profit figures will lead to ambiguous data. Hence, in order to address the above issue analyst have drawn out four common methods or approaches for correct computation.
- Constant growth – This approach is rarely used by the analyst as it assumes there is no growth/decline in performance of the subsidiary.
- Statistical growth – In this approach, analysis is done on the past figures in order to establish certain trend. This model suggest that the subsidiary will grow at a stable rate which is based on past trend. This is known as statistical growth as it uses various forecasting tools of statistics like moving average, time series, regression analysis and etc. This is not used for companies engaged in dynamic growth industries like FMCG and etc. but are used for companies engaged in industries like utilities which experience a constant growth.
- Modeling each subsidiary separately – This involves forecasting each subsidiary individually followed by adding up the individual interest of subsidiary companies to arrive at one consolidated figure. This approach offers flexibility to analyst and results in most accurate computation. But this cannot be adopted in all the circumstances as it leads to time and cost constraints and also this concept is not feasible in cases where there are number of subsidiaries.
The most important thing to remember in case of valuation of minority interest is that its valuation are affected by number of factors, internal and external, applicable to company and the industry in which it operates. All these require careful considerations as its impact will be different for different companies. Also, one has to take into account the applicable laws, bye laws and regulatory regulations.
FAQ’s on Minority Interest
Should such Interest is to be valued on book value basis or market value basis?
Since the balance sheet is prepared on the historical cost basis or the book value basis. It should also be valued on book value basis. Though the debate is ranging on the pros and cons of this approach.
Is minority Interest relevant for ratio analysis?
Yes, absolutely it is important in Ratio Analysis. Any ratio that takes into account capital structure has to take into account the implication of such interest. To name a few important ratios: Debt equity ratio, Return on equity, Capital gearing ratio and return on capital employed are impacted.
Return on equity (ROE) – The numerator should be profit after minority interest while denominator include “shareholder’s equity excluding minority interest”. The above formula will calculate return generated by the parent shareholders.
Net Margin ratio – Revenue in the denominator and numerator should be taken as profit before minority interest/sales.
Whether minority interest is asset or liability?
Liability can be defined as obligation on the company arising out of past events that will result in outflow of resources. For e.g. provision on unpaid bills, employees dues, creditors balances all these denote and will entail the outflow of resources (i.e. cash or its equivalents) in future. Since no cash has to be paid to outsiders on account of such interest hence it cannot be treated as liability.
On the other hand, assets means the something of value to an enterprise on which it has control and will result in receipt of cash or its equivalents in future. Though such interest has value but the company has no control over it. Minority interest represent the non-controlling interest of shareholders. Hence, It is neither an asset nor a liability.
Whether minority interest is part of Debt or Equity?
It is certainly not debt as there is no obligation on the company to repay it. There is no mandatory payments, fixed life and etc. Since minority interest is not payable it cannot be termed as debt. Whereas minority interest does satisfy some preconditions to be construed as equity. Assets of the consolidated balance sheet have some contribution coming from minority interest. As per the generally accepted accounting principles, it is presented as part of shareholders equity in the consolidated balance sheet. And even it is included with shareholder’s equity in all relevant ratios.
Should minority Interest added for computation of enterprise value?
Enterprise value is the company’s total value. Enterprise value is always greater than market capitalization since it also includes the debt. But one pertinent question which lingers on is whether it should be included for computation of enterprise value. Since enterprise value represents total capitalization of a company hence minority interest is always a part of enterprise value.
Minority interest does provides the user of financial statement with useful insights which helps them to analyze and make us informed decision. Degree of influence of minority interest influences the decision making.
- Appointment of directors on the board of directors of company and fixing their compensation.
- Making changes in the articles of association and other important applicable regulatory provisions.
- Registration of company’s shares for initial public offering
- Making changes in the capital structure of the company
This concept has evolved over the time. In the past it has not received a great deal of attention in the accounting literature. It was referred to as a liability, equity, or neither. Even as of today, there is little guidance on treatment and presentation of minority interest. And there is no consensus on any position.
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