What is Minority Interest?
Minority Interest is the holding of stake by the investors which is less than 50% of the existing shares or the voting rights in the company and they do not have control over the company through their voting rights thereby having very little role in taking the decisions for the company.
In simple words, Minority interest is the value of a 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 interestNon-controlling InterestIt generally projects curves on the data sets. For example, to forecast population growth, forming a non-linear relationship between time and growth..
In the accounting world, it means ownership in a subsidiary company not owned by a holding company, which is also known as Parent CompanyParent CompanyA holding company is a company that owns the majority voting shares of another company (subsidiary company). This company also generally controls the management of that company, as well as directs the subsidiary's directions and policies.. 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 a minority shareholder since it owns less than 50% of total shares, and its net worthNet WorthThe company's net worth can be calculated using two methods: the first is to subtract total liabilities from total assets, and the second is to add the company's share capital (both equity and preference) as well as reserves and surplus. as on date has to be shown under the separate head as a minority interest. Whereas, shareholder A is the majority shareholderMajority ShareholderA majority shareholder or controlling shareholder is an individual or a corporation that owns the majority of the company's stock (more than 50%) and therefore enjoys more voting power than other shareholders. These shareholders are in a position to influence the company's decisions. of Pine-Apple Inc.
Financial Reporting of Minority Interest
This concept arises only in case when the company prepares two sets of financial statements Viz. A separate set of financial statements and Consolidated Financial StatementsConsolidated Financial StatementsConsolidated Financial Statements are the financial statements of the overall group, which include all three key financial statements – income statement, cash flow statement, and balance sheet – and represent the sum total of its parents and all of its subsidiaries.. It is reported separately only in the consolidated financial statement. Minority interest adjustments occur when the parent does not own 100% of the subsidiary.
In the consolidated profit and loss, account minority interest is the 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 the 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 items with respect to such interest is to give a clear picture to the users of financial statementsUsers Of Financial StatementsFinancial statements prepared by the Companies are used by different categories of individuals and corporates on the basis of their relevancy to the respective parties. The most common users to the financial statements are Management of the Company, Investors, Customers, Competitors, Government and Government Agencies, Employees, Investment Analysts, Lenders, Rating Agency and Suppliers. about the various controlling interest in the company. It helps them in making 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 investment opportunities and calls for its consideration while computing various ratios and analyzing financial statements.
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 the company’s affairs by management.
Minority Interest Example – Consolidation Calculation
As mentioned earlier, it arises whenever a holding company owns a controlling interestControlling InterestA controlling interest is the shareholder's power to speak in the corporate actions or decisions derived from possessing a considerable chunk of the company's voting stock. However, such a stakeholder may or may not hold a significant portion of the company's common stocks. (Less than 100 percent) in a subsidiary company. The claim of shareholders on the net assets of a company is known as a 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 the parent company gives it enough rights to manage all of the net assetsNet AssetsNet Fixed Assets is a financial metric used to calculate the overall value of a firm’s fixed assets. You can calculate it by deducting the total depreciation or liabilities from the total amount paid for all the fixed assets. of a subsidiary, which justifies the inclusion of 100 percent of the subsidiary’s assets, liabilities, revenues, and expenses in the consolidated financial statements. It is important to note here that though the parent company includes 100 percent of the subsidiary’s assets, liabilities, revenues, and expenses in its consolidated financial statements, it does not have a claim on 100 percent of the net assetsNet AssetsThe net asset on the balance sheet is the amount by which your total assets exceed your total liabilities and is calculated by simply adding what you own (assets) and subtract it from whatever you owe (liabilities). It is commonly known as net worth (NW). 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 equityBook Value Of EquityThe book value of equity reflects the fund that belongs to the equity shareholders and is available for distribution to the shareholders. It is computed as the net amount remaining after deducting all of the company's liabilities from its total assets. 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 GoodwillGoodwillIn accounting, goodwill is an intangible asset that is generated when one company purchases another company for a price that is greater than the sum of the company's net identifiable assets at the time of acquisition. It is determined by subtracting the fair value of the company's net identifiable assets from the total purchase price. $ 130,000
Consolidated Balance sheet of H Inc. as of 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 from the date of acquisition
Let’s assume in the above example,
Company S Inc. generated retained earningsRetained EarningsRetained Earnings are defined as the cumulative earnings earned by the company till the date after adjusting for the distribution of the dividend or the other distributions to the investors of the company. It is shown as the part of owner’s equity in the liability side of the balance sheet of the company. of $ 7,000 in three years (January 2015 to January 2018). After the date of acquisition, S Inc registered a net profit of $ 48,000 in year 4.
Now let’s see how this impacts 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 exhibit 1 above, H Inc.’s 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 in January 2019.
Minority Interest Valuation
Any valuation of a company requires forecasting financial statements for the future based on certain assumptions and parameters. While most of the financial figures have 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, analysts have drawn out four common methods or approaches for correct computation.
- Constant growth – Analysts rarely use this approach as it assumes there is no growth/decline in the performance of the subsidiary.
- Statistical growth – In this approach, analysis is done on past figures in order to establish a certain trend. This model suggests that the subsidiary will grow at a stable rate, which is based on past trends. It is known as statistical growth as it uses various forecasting tools of statistics like moving averageMoving AverageMoving Average (MA), commonly used in capital markets, can be defined as a succession of mean that is derived from a successive period of numbers or values and the same would be calculated continually as the new data is available. This can be lagging or trend-following indicator as this would be based on previous numbers., time series, regression analysis and etc. It is not used for companies engaged in dynamic growth industries like FMCG and etc. but are used for companies engaged in industries like utilities that experience constant growth.
- Modeling each subsidiary separately – This involves forecasting each subsidiary individually, followed by adding up the individual interest of subsidiary companiesSubsidiary CompaniesA subsidiary company is controlled by another company, better known as a parent or holding company. The control is exerted through ownership of more than 50% of the voting stock of the subsidiary. Subsidiaries are either set up or acquired by the controlling company. to arrive at one consolidated figure. This approach offers flexibility to analysts and results in the 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 several subsidiaries.
The most important thing to remember in case of valuation of minority interest is that its valuation is affected by several factors, internal and external, applicable to the company and the industry in which it operates. All these require careful considerations as their impact will be different for different companies. Also, one has to take into account the applicable laws, bye-laws, and regulatory regulations.
Since the balance sheetBalance SheetA balance sheet is one of the financial statements of a company that presents the shareholders' equity, liabilities, and assets of the company at a specific point in time. It is based on the accounting equation that states that the sum of the total liabilities and the owner's capital equals the total assets of the company. is prepared on the historical cost basis or the book value basis, it should also be valued on a book value basisValued On A Book Value BasisPrice to Book Value Ratio or P/B Ratio helps to identify stock opportunities in Financial companies, especially banks, and is used with other valuation tools like PE Ratio, PCF, EV/EBITDA. Price to Book Value Ratio = Price Per Share / Book Value Per Share . However, the debate is raging on the pros and cons of this approach.
Yes, absolutely, it is important in Ratio AnalysisRatio AnalysisRatio analysis is the quantitative interpretation of the company's financial performance. It provides valuable information about the organization's profitability, solvency, operational efficiency and liquidity positions as represented by the financial statements.. 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 ratioCapital Gearing RatioCapital Gearing, also called Financial Leverage, is the level of debt that a Company utilizes for obtaining assets. It is determined as the ratio of Total Equity to Total Debt. , and return on capital employed are impacted.
Interpret ROEInterpret ROEReturn on Equity (ROE) represents financial performance of a company. It is calculated as the net income divided by the shareholders equity. ROE signifies the efficiency in which the company is using assets to make profit. – The numerator should be profit after minority interest while the denominator includes “shareholder’s equity excluding minority interest.” The above formula will calculate the return generated by the parent shareholders.
Net Margin ratio – Revenue in the denominator and numerator should be taken as profit before minority interest/sales.
Liability can be defined as an obligation on the company arising out of past events that will result in an outflow of resources. E.g., the provision on unpaid bills, employee dues, creditors balances all these denote and will entail the outflow of resources (i.e., cash or its equivalentsCash Or Its EquivalentsCash and Cash Equivalents are assets that are short-term and highly liquid investments that can be readily converted into cash and have a low risk of price fluctuation. Cash and paper money, US Treasury bills, undeposited receipts, and Money Market funds are its examples. They are normally found as a line item on the top of the balance sheet asset. ) in the future. Since no cash has to be paid to outsiders on account of such interest hence, it cannot be treated as a liability.
On the other hand, assets mean something of value to an enterprise on which it has control and will result in receipt of cashReceipt Of CashA cash receipt is a small document that works as evidence that the amount of cash received during a transaction involves transferring cash or cash equivalent. The original copy of this receipt is given to the customer, while the seller keeps the other copy for accounting purposes. or its equivalents in the future. Though such interest has value, the company has no control over it. It represents the non-controlling interest of shareholders. Hence, It is neither an asset nor a liability.
It is certainly not debt as there is no obligation on the company to repay it. There are no mandatory payments, fixed life, etc. Since minority interest is not payable, it cannot be termed as debt. Whereas, it 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 principlesGenerally Accepted Accounting PrinciplesGenerally accepted accounting principles (GAAP) are the minimum standards and uniform guidelines for the accounting and reporting. These standards prohibit firms from engaging in unethical business activities and enable for a more accurate comparison of financial reports to investors., 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.
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 valueEnterprise ValueEnterprise Value is a measure of a company's total value that spans the entire market rather than just the equity value. It includes all debt and equity-based ownership claims. This value, which is calculated as the market value of debt + market value of equity - cash and cash equivalents, is particularly relevant when valuing a takeover.. Since enterprise value represents the total capitalization of a company, hence it is always a part of enterprise value.
Minority interest does provide the user of financial statements with useful insights, which helps them to analyze and make us informed decisions.
- Appointment of directors on the board of directors of the company and fix their compensation.
- Making changes in the articles of associationArticles Of AssociationArticles of association is a legally binding document that states the corporate rules, regulations, and purpose. It serves as a user's guide for executing the organizational tasks, directors' appointment and recording the financial information. and other important applicable regulatory provisions.
- Registration of the company’s shares for initial public offeringInitial Public OfferingInitial Public Offering (IPO) is when the shares of the private companies are listed for the first time in the stock exchange for public trading and investment. This allows a private company to raise the capital for different purposes.
- Making changes in the capital structure of the company
This concept has evolved over 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 the treatment and presentation of minority interest. And there is no consensus on any position.