The accounting for noncontrolling interest (NCI) has long been a contentious topic among practitioners.
Prior to 2009, the official guidance that entities used to account for NCI was SFAS No. 141, Business Combinations. However, this guidance was vague and did not directly address how to record NCI within the financial statements.
To improve on this guidance, the FASB issued SFAS No. 141(R), Business Combinations and SFAS No. 160, Noncontrolling Interests in Consolidated Financial Statements.
Even with this improved guidance, there is still a debate on what exactly NCI represents.
Table of Contents
What is Noncontrolling Interest?
Noncontrolling Interest – Prior to 2009
Noncontrolling Interest – 2009 and Onwards
What is Noncontrolling Interest?
The FASB defines NCI as “the portion of equity in a subsidiary not attributable, directly or indirectly, to a parent.”1
NCI is found in the consolidated financial statements of a business entity that holds a controlling stake in a non-wholly owned subsidiary.
Generally, an entity has a controlling stake if it owns more than 50% of the outstanding voting shares of a subsidiary.2
Example 1:
On January 1, 2020, Parent A purchases 70% of the outstanding common stock of Subsidiary Z for $21,000,000. Assume that there is no control premium and that the book value equaled the fair value of Subsidiary Z on the acquisition date. The controlling interest and NCI are allocated as follows:
Noncontrolling Interest – Prior to 2009
In 2001, the FASB passed SFAS No. 141, which remained in effect until 2009, in response to criticism that the prior business combination guidance made it difficult to conduct comparisons across entities.
Initial Measurement of NCI
To initially account for NCI, entities used a proportional valuation method which based the controlling interest on the fair value of the subsidiary and the NCI on the book value of the subsidiary.
Example 2:
Assume that the book value of Subsidiary Z is $24,000,000 on the acquisition date.
Changes in NCI
The value of an entity’s interest in a subsidiary can change due to four primary reasons.3
- The entity purchases additional ownership interests in the subsidiary
- The entity sells some of its ownership interests in the subsidiary
- The subsidiary reacquires some of its ownership interests
- The subsidiary issues additional ownership interests
In accordance with SFAS No. 141, entities recognized a gain or loss on the income statement after a change in controlling interest.
Example 3:
Based off the assumptions in Example 1, Parent A sells 10% of its interest in Subsidiary Z for $4,000,000. The new ownership allocation is as follows:
Parent A records the following entry that hits the income statement:
| Cash | $4,000,000 | |
| Controlling Interest | $3,000,000 | |
| Gain on Sale | $1,000,000 |
Disclosure of NCI
NCI was called minority interest prior to 2009. The name change recognizes the fact that in some cases an entity may hold a minority share of interests in a subsidiary but still have a controlling stake in that subsidiary.4
Entities displayed NCI on the balance sheet as a liability, within equity, or as mezzanine. Mezzanine was an unofficial balance sheet category situated between assets and liabilities.
The differences in classification of NCI was a major issue that the FASB addressed in the new standards that became effective in 2009.
Noncontrolling Interest – 2009 and Onwards
The FASB’s goal upon issuance of SFAS No. 141(R) and SFAS No. 160 was to improve the relevance, comparability, transparency, and representational faithfulness of information that an entity provided about business combinations. These new standards updated the accounting for NCI.
Initial Measurement of NCI
Instead of measuring NCI at the book value of a subsidiary, entities are now required to record NCI at fair value.
Example 4:
Using the assumptions in Example 2, the NCI will be based on the fair value of the subsidiary, not the book value.
When Parent A issues its consolidated statements, Subsidiary Z’s net assets will all be on the balance sheet at their respective fair values.
Changes in NCI
SFAS No. 160 requires changes in ownership to be recognized as equity transactions. This means that no gain or loss will be recognized in the income statement from a change in controlling interest.
Example 5:
Using the same assumptions in Example 3, the controlling interest and NCI of $18,000,000 and $12,000,000 remain unchanged. However, Parent A’s entry to record the sale of controlling interest will be accounted for as an equity transaction:
| Cash | $4,000,000 | |
| Controlling Interest | $3,000,000 | |
| APIC | $1,000,000 |
Disclosure of NCI
After much debate, the FASB decided to classify NCI as part of equity.
The board mandated NCI to be separate from the parent’s equity, so that financial statement users can easily determine the portion of equity attributable to the parent from the portion attributable to the noncontrolling shareholders.
This decision was in opposition to many firms that wanted to retain the practice of reporting NCI within the unofficial mezzanine category. These firms believed that NCI should not be a part of equity because noncontrolling shareholders do not own ownership in the parent company.
However, the board did not want to create an additional official financial statement element, mezzanine, just for the purpose of reporting NCI.
The board ruled out classification of NCI as a liability because it does not meet the traditional definition of a liability. There is no obligation for a parent company to contribute consideration to noncontrolling shareholders.
Carl’s Take
I think the FASB made the correct decision to change the accounting for NCI.
The initial measurement of both the controlling interest and NCI at fair value removes the awkward combination of a subsidiary’s net assets at both carrying value and fair value within the consolidated financial statements.
However, this guidance did not address the issue that consolidated statements contain a mixture of the carrying value of a parent’s net assets and the fair value of a subsidiary’s net assets. This issue is part of a larger debate on whether the FASB should expand the use of fair value accounting.
The change from an income to equity approach to account for changes in NCI removed the ability for managers to “game” the system by purchasing and selling interests at opportune times.
The classification of NCI as equity was the best choice the FASB had since NCI does not meet the definitions of an asset or liability.