Minority Interest

16th May 2021 1 By indiafreenotes

In accounting, minority interest (or non-controlling interest) is the portion of a subsidiary corporation’s stock that is not owned by the parent corporation. The magnitude of the minority interest in the subsidiary company is generally less than 50% of outstanding shares, or the corporation would generally cease to be a subsidiary of the parent.

It is, however, possible (such as through special voting rights) for a controlling interest requiring consolidation to be achieved without exceeding 50% ownership, depending on the accounting standards being employed. Minority interest belongs to other investors and is reported on the consolidated balance sheet of the owning company to reflect the claim on assets belonging to other, non-controlling shareholders. Also, minority interest is reported on the consolidated income statement as a share of profit belonging to minority shareholders.

The reporting of ‘minority interest’ is a consequence of the requirement by accounting standards to ‘fully’ consolidate partly owned subsidiaries. Full consolidation, as opposed to partial consolidation, results in financial statements that are constructed as if the parent corporation fully owns these partly owned subsidiaries; except for two line items that reflect partial ownership of subsidiaries: net income to common shareholders and common equity. The two minority interest line items are the net difference between what would have been the common equity and net income to common, if all subsidiaries were fully owned, and the actual ownership of the group. All the other line items in the financial statements assume a fictitious 100% ownership.

Some investors have expressed concern that the minority interest line items cause significant uncertainty for the assessment of value, leverage and liquidity. A key concern of investors is that they cannot be sure what part of the reported cash position is owned by a 100% subsidiary and what part is owned by a 51% subsidiary.

Companies and investors with a minority stake in the private equity environment can negotiate ownership rights. Venture capitalists, for example, might seek to obtain a seat on the board of directors in return for his investment in a company.

A company reports minority interests in the business sector on the balance sheet. In addition to being represented on the balance sheet, minority interest is listed as a share of the income belonging to minority equity holders on the consolidated revenue statement.

Accounting treatment

Under the International Financial Reporting Standards, the non-controlling interest is reported in accordance with IFRS 5 and is shown at the very bottom of the Equity section on the consolidated balance sheet and subsequently on the statement of changes in equity. Under US GAAP minority interest can be reported either in the liabilities section, the equity section or, preceding changes to acceptable accounting standards, the mezzanine section of the balance sheet. The mezzanine section is located between liabilities and equity. FASB FAS 160 and FAS 141r significantly alter the way a parent company accounts for non-controlling interest (NCI) in a subsidiary. It is no longer acceptable to report minority interest in the mezzanine section of the balance sheet.

Valuation of Minority Interest

Valuation of a company needs proper forecasting of financial statements to understand future trends using certain parameters and assumptions. Nearly all the figures used in forecasting are directly related to net profit and revenue. Unfortunately, making forecasts based on these two parameters can generate data subject to multiple interpretations. Thus, to deal with the issue, analysts developed four methods that can be used to carry out accurate computations.

  1. Numerical Growth

In the numerical growth method, previous figures are analyzed to ascertain existing trends. The model predicts the growth of a subsidiary at a uniform rate based on past trends.  Also called statistical growth, numerical growth uses a number of important tools to forecast trends, such as time series analysis, moving averages, and regression-based analysis. However, the analysis method is not applicable to companies experiencing dynamic growth such as FMCG.

  1. Constant Growth

The constant growth method is seldom used because the assumption is that there is hardly any decline or growth in the performance of a minor company.

  1. Ratio Analysis in Minority Interest

One of the questions many people ask is whether minority interest is relevant when it comes to ratio analysis. The short answer is yes, it is very relevant. Why? Well, any financial ratio that involves investment structures should take into consideration the implication of a minority stake. Some of the ratios that are affected include return on equity, debt-to-equity ratio, and capital gearing ratio.

  1. Modeling Subsidiaries Individually

This analysis method evaluates each subsidiary on its own and then adds up the individual interests of each minor company to achieve a consolidated value. This method is much more flexible, and the results are very accurate. Unfortunately, it does not work in all cases because it results in cost and time constraints. In addition, it won’t work where there are very many subsidiaries to evaluate.

One important thing to remember is that when it comes to the valuation of minority interest, there are many factors to consider, both external and internal, that are applicable to a company and its industry of operation. The factors need careful assessment as their impact is different for each company.