2.3 Non-controlling interests and goodwill
5 min read•august 16, 2024
Business combinations often involve non-controlling interests and . These elements impact how we measure and report a company's financial position after an . Understanding their treatment is crucial for accurate .
Non-controlling interests represent minority shareholders' stake in a subsidiary. Goodwill arises when a company pays more than the fair value of net assets acquired. Both affect profit allocation, equity structure, and impairment testing in consolidated accounts.
Non-controlling Interests in Subsidiaries
Definition and Calculation of Non-controlling Interests
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- Non-controlling interests (NCI) represent the equity in a subsidiary not attributable to the parent company, typically expressed as a percentage of ownership
- Calculate NCI by determining the fair value of the subsidiary's net identifiable assets and multiplying it by the percentage not owned by the parent
- Measure NCI using either the proportionate share method or the full fair value method, as per
- NCI measurement method choice impacts the of goodwill and subsequent consolidation entries
- Present NCI as a separate component of equity in the consolidated statement of financial position
- Account for changes in a parent's ownership interest that do not result in a loss of control as equity transactions
- Adjust the carrying amount of NCI to reflect changes in the relative interests in the subsidiary
- Example: If a parent company owns 80% of a subsidiary with net assets of 200,000 (20% of $1,000,000)
- Example: If the parent increases its ownership to 90%, the NCI would decrease to 1,000,000), with the change accounted for in equity
Accounting for Changes in Non-controlling Interests
- Account for changes in NCI resulting from changes in ownership percentages as equity transactions
- Adjust the carrying amounts of the controlling and non-controlling interests to reflect changes in their relative interests in the subsidiary
- Recognize no gain or loss in profit or loss on partial disposals when control is retained
- Reattribute a proportion of the components of equity (including reserves) between the parent and NCI when their relative ownership interests change
- Example: If a parent sells 10% of its 80% stake in a subsidiary, reduce the parent's interest and increase the NCI, adjusting retained earnings for any difference
- Example: When a parent acquires additional shares from NCI, decrease the NCI and adjust retained earnings or other equity accounts for the difference in consideration paid
Profit Allocation for Parent and Non-controlling Interest
Attribution of Profit or Loss and Other Comprehensive Income
- Attribute profit or loss and each component of other comprehensive income (OCI) to the owners of the parent and to the NCI
- Base the allocation on present ownership interests, disregarding potential voting rights or other derivatives
- Allocate losses applicable to the NCI in a subsidiary that exceed the NCI's interest in the subsidiary's equity against the interests of the parent
- Exception applies when the NCI has a binding obligation to make good the losses
- Include disclosures in the financial statements for the profit or loss and OCI attributed to non-controlling interests
- Example: If a subsidiary generates 75,000 to the parent and $25,000 to NCI
- Example: For a subsidiary with 40,000 to the parent and $10,000 to NCI in the statement of comprehensive income
Handling Excess Losses and Changes in Ownership
- Allocate excess losses against the interests of the parent when NCI's losses exceed their equity interest
- Account for changes in NCI resulting from changes in ownership percentages as equity transactions
- Adjust the carrying amounts of the controlling and non-controlling interests to reflect changes in their relative interests in the subsidiary
- Example: If an NCI has a zero balance and the subsidiary incurs a $30,000 loss, the parent would absorb the entire loss
- Example: When a parent increases its ownership from 70% to 80%, adjust the NCI balance and retained earnings to reflect the new ownership structure
Goodwill and Impairment Testing
Concept and Recognition of Goodwill
- Goodwill represents the excess of the consideration transferred over the net identifiable assets acquired in a business combination
- Recognize goodwill as an intangible asset in the consolidated financial statements
- Do not amortize goodwill, instead subject it to annual impairment testing
- Example: If a company pays 8 million, recognize $2 million as goodwill
- Example: Goodwill might arise from factors such as assembled workforce, customer relationships, or synergies that are not separately identifiable
Impairment Testing Process
- Perform impairment testing for goodwill annually or more frequently if there are indicators of impairment
- Compare the carrying amount of the cash-generating unit (CGU) to which goodwill is allocated with its recoverable amount
- Define the recoverable amount as the higher of the CGU's fair value less costs of disposal and its value in use
- Recognize an impairment loss when the carrying amount of the CGU exceeds its recoverable amount
- Note that impairment losses for goodwill cannot be reversed in subsequent periods, unlike other non-financial assets
- Example: If a CGU with goodwill has a carrying amount of 4.5 million, recognize a $500,000 impairment loss
- Example: Indicators of impairment might include significant adverse changes in the technological, market, economic, or legal environment
Goodwill Measurement in Consolidated Statements
Initial Measurement of Goodwill
- Calculate the initial measurement of goodwill as the difference between the consideration transferred and the fair value of the identifiable net assets acquired
- Include in the consideration transferred the fair value of assets given, liabilities incurred, and equity interests issued by the acquirer
- Measure contingent consideration at fair value at the acquisition date and include it in the consideration transferred
- Example: If a company pays 40 million, recognize $10 million as goodwill
- Example: Contingent consideration might include future payments based on the acquired business meeting certain performance targets
Subsequent Measurement and Allocation
- Perform annual impairment testing for of goodwill rather than amortization
- Allocate goodwill to cash-generating units (CGUs) or groups of CGUs expected to benefit from the synergies of the business combination
- Include the carrying amount of goodwill allocated to a CGU in the carrying amount of the CGU when determining impairment
- Allocate any impairment loss first to reduce the carrying amount of goodwill, with any excess allocated to other assets of the CGU on a pro-rata basis
- Example: Allocate $5 million of goodwill to the European operations CGU if it's expected to benefit most from the acquisition's synergies
- Example: If a CGU with 8 million in other assets has an impairment of 1 million to other assets proportionately
Key Terms to Review (18)
Acquisition: Acquisition refers to the process of obtaining control over another company through the purchase of its assets or shares. This concept is crucial in understanding how companies expand their operations, enter new markets, or enhance their competitive advantage. Acquisitions can impact financial statements significantly, especially in terms of goodwill and non-controlling interests, which arise when the acquiring company does not purchase 100% of the target company's equity.
Acquisition Goodwill: Acquisition goodwill represents the excess amount paid by a company over the fair value of the net identifiable assets acquired during a business combination. This intangible asset arises when a company purchases another company for more than the value of its tangible and identifiable intangible assets, reflecting factors like brand reputation, customer relationships, and employee expertise that contribute to future profitability.
ASC 810: ASC 810 refers to the Accounting Standards Codification Topic 810, which governs the consolidation of financial statements. This standard establishes the criteria for determining when one entity should consolidate another entity's financial statements and outlines the accounting and reporting requirements for consolidated entities. Understanding ASC 810 is essential for recognizing how ownership interests impact financial reporting, including the treatment of non-controlling interests and the implications of changes in ownership interests on consolidation.
Balance Sheet Impact: Balance sheet impact refers to the effect that certain transactions or events have on the financial position of a company as reflected in its balance sheet. This includes how assets, liabilities, and equity are affected by these transactions, ultimately influencing a company's financial health and stability. Understanding balance sheet impact is crucial for assessing the implications of non-controlling interests and goodwill, as well as equity-settled and cash-settled transactions.
Consolidated Financial Statements: Consolidated financial statements are financial reports that present the combined financial position and results of operations of a parent company and its subsidiaries as a single entity. This process provides a comprehensive view of the entire corporate group’s performance, highlighting how well the parent company manages its investments in subsidiaries and ensuring that all stakeholders get a clearer picture of the overall financial health.
Consolidation adjustments: Consolidation adjustments refer to the necessary changes made to the financial statements of a parent company and its subsidiaries to accurately present their combined financial position and performance. These adjustments are essential for eliminating intercompany transactions, aligning accounting policies, and recognizing non-controlling interests and goodwill. They ensure that the consolidated financial statements reflect the economic reality of the entire group as if it were a single entity.
Equity Method: The equity method is an accounting technique used to record the investment in an associate or joint venture. Under this method, the investor recognizes its share of the investee's profits or losses and adjusts the carrying amount of the investment accordingly. This method connects to non-controlling interests and goodwill by reflecting how ownership stakes in other entities can impact financial results and reporting when control is not fully established.
Fair Value Measurement: Fair value measurement refers to the process of determining the price that an asset or liability would sell for in an orderly transaction between market participants at the measurement date. This concept is crucial in ensuring that financial statements reflect a more accurate picture of an entity's financial position, enhancing transparency and comparability among companies' financial reporting.
GAAP: GAAP stands for Generally Accepted Accounting Principles, which are a set of rules and standards that govern the preparation and presentation of financial statements. These principles provide consistency and transparency in financial reporting, ensuring that stakeholders can accurately interpret a company's financial health. GAAP is crucial for ensuring that non-controlling interests and goodwill are reported appropriately, that impairment of financial assets is recognized correctly, and that earnings per share calculations follow standardized methods.
Goodwill: Goodwill is an intangible asset that represents the excess amount paid during a business acquisition over the fair value of the identifiable net assets acquired. This figure reflects the reputation, brand strength, customer relationships, and other unique attributes of a business that contribute to its ongoing profitability. Understanding goodwill is crucial as it plays a significant role in accounting for mergers and acquisitions, impacts consolidated financial statements, is linked to non-controlling interests, and raises important considerations regarding earnings quality.
Goodwill calculation: Goodwill calculation refers to the process of determining the excess value paid for an acquired company over the fair value of its identifiable net assets at the time of acquisition. This intangible asset arises during business combinations, reflecting factors such as brand reputation, customer relationships, and employee loyalty that contribute to a company's earning power beyond its tangible assets. Understanding goodwill calculation is essential for recognizing non-controlling interests and accurately assessing the value of an acquisition.
IFRS 3: IFRS 3 is an International Financial Reporting Standard that provides guidance on accounting for business combinations. It establishes the principles for recognizing and measuring identifiable assets acquired, liabilities assumed, and any non-controlling interest in the acquiree at fair value, as well as determining goodwill or a gain from a bargain purchase. This standard is crucial because it outlines how to effectively consolidate financial statements when one entity acquires another, impacting both the financial position and performance of the combined entity.
Initial Recognition: Initial recognition refers to the process of identifying and recording an asset or liability in the financial statements at the time it is acquired or incurred. This concept establishes the foundational understanding of how entities account for transactions, ensuring that the values assigned reflect the true economic substance of those transactions right from the outset.
Merger: A merger is a business combination in which two or more companies come together to form a single entity, usually to achieve synergies, enhance competitive advantages, or expand market reach. This process often involves the consolidation of assets, liabilities, and ownership structures, leading to changes in the financial reporting of the merged entity, including implications for non-controlling interests and goodwill. As ownership stakes shift, understanding how these factors influence the overall valuation and reporting of the new entity is crucial.
Minority Interest: Minority interest, also known as non-controlling interest, refers to the ownership stake in a subsidiary company that is not held by the parent company. This term is significant in accounting because it reflects the portion of a subsidiary's equity that is not attributable to the parent company, and it plays a crucial role in the consolidation of financial statements. The recognition of minority interest ensures that the financial position and performance of the group are accurately represented, especially when determining goodwill during mergers and acquisitions.
Non-controlling interest: Non-controlling interest refers to the portion of equity ownership in a subsidiary that is not owned by the parent company. This concept is crucial for accurately reflecting the financial position of consolidated entities, as it represents the claims of minority shareholders in a subsidiary. Understanding non-controlling interests helps in evaluating the overall financial health of a business combination and its impact on consolidated financial statements, goodwill, and changes in ownership interests.
Purchase method: The purchase method is an accounting technique used to account for business combinations where one company acquires another. Under this method, the acquiring company records the assets and liabilities of the acquired company at their fair values on the acquisition date, and any excess paid over the fair value of net identifiable assets is recognized as goodwill. This approach is essential for understanding how to report non-controlling interests and the implications of changes in ownership interests.
Subsequent Measurement: Subsequent measurement refers to the process of valuing an asset or liability after its initial recognition on the balance sheet, using a specified measurement basis. This ongoing assessment plays a vital role in financial reporting, as it impacts the representation of financial performance and position over time. Understanding subsequent measurement is essential for grasping how different accounting standards influence the evaluation of various elements, including non-controlling interests, goodwill, financial instruments, leases, and related disclosures.