Historically, a minority interest has been called equity and liability. More recently, it has been referred to as none of these. Despite its name, minority interest has had limited attention in accounting literature.
As such, there is not a great deal of guidance on treating minority interests. In addition, there is no consensus on how minority interests should be reported. When they appear, they are shown in two different places in a company's financial statements.
By reading this article, you'll get through what minority interest includes, its appearance in the balance sheet, examples and much more.
Did You Know?
The statement of consolidated income should have a clear difference between the exact income from the parent organisation and that of the main interest.
Also Read: What is Enterprise Value, and How can You Calculate it?
What is Minority Interest?
In business, minority interest is an ownership position below 50% of the company's voting shares. These investors do not exercise control over the company and do not have much influence over decisions. Their ownership interest is reflected as a non-current liability on the company's balance sheet.
Minority interests in subsidiaries are also included in this category. In many cases, the interest of a minority shareholder in a company can be beneficial for the business. A minority interest is owned by a few shareholders who have less than 50% of a company's total shares.
A partnership partner with a smaller percentage of ownership has a minority interest. Depending on the ownership percentage, a minority investor will have trouble influencing the business's decisions and policies.
However, it is possible to earn a minority interest by working with other investors to gain control of a company. While a minority shareholder may not have the same power as the upper management, they can significantly impact the business's direction.
Understanding Minority Interests
For minority interests financial reporting, financial reporting only occurs when the major company has prepared separate financial statements and consolidated financial records. Minority interest adjustments occur when the major corporation owns less than a 100% share in the minority business.
In the context of the profit and loss account, minor interest is the portion of the consolidated profits and losses that fall from normal activities after taxation. By IFRS rules, the minority stake is classified under equity.
In a balance sheet, minor interest is listed as an item on a separate line. This way, those who read the financial statements can discern the all-controlling interests of the company's parent. Users can make informed decisions by analysing patterns among the smaller companies.
While the major stakeholder--in most instances, the parent company - has the right to vote on policies and procedures. The minority stakeholders typically have no influence or say in how the company operates. Business. This is the reason why it's known as the non-controlling interests.
In certain situations, the minority could have certain rights, such as the right to take part in sales. Some laws permit minority interest holders to have certain audit rights. They may also be able to attend partnership or shareholder meetings.
In the realm of private equity, firms and investors who hold minority interests might be in a position to negotiate control rights. For instance, venture capitalists might seek to negotiate seats as a director on board in return for an investment in a start-up.
In the world of business, corporations list the minority ownership of their balance report. Also, if you want more traffic to reach your business, social media can be a great way. You can read Instagram business tricks in 2023 to know how you can boost engagement in your business.
How to Measure Minority Interest
The minority interest account can be used to calculate the value of the subsidiary that the majority owner does not control. In this example, XYZ Corp. owns 90% of ABC Inc., which means that it has a ₹10 million liability to the minority owner.
The value of the minority ownership portion of the subsidiary is determined by multiplying its book value by the percentage of ownership held by non-controlling interests.
To accurately value a company, you need to understand how minority interest is calculated. Most financial figures have a direct relation to revenue and net profit. Therefore, calculating minority interest by focusing on those numbers can confuse most investors.
The Method
There are a few fundamental ways to determine minor interest. One of the first steps is to calculate the booking amount for the affiliate, as shown on the subsidiary's balance sheet. Book value, also known as the net asset value of a firm, is the total value of its assets, less intangible assets and liabilities.
Then, you multiply book value by the proportion of the subsidiary's share held by minority shareholders. Let's take 25% of the figure above as the minority share percentage and suppose the net asset value of the subsidiary is ₹2 million. Our minority stake will be equal to 25% x ₹2 million = ₹500,000.
After the value of the minority interest has been calculated, the value is recorded on the balance sheet as a part of the equity section. The next step is to determine how many net earnings the minority shareholders in the affiliate own. It is the total net income of the subsidiary multiplied by the percentage of minority interests.
Also, using the 25% minority interest rate and deducting a net loss of ₹1 million, We estimate our minority income at 25% x ₹1,000,000 = ₹250,000. The balance is then reported as an individual non-operating line item on the parent company's income statement. This method assumes no growth in the performance of the subsidiary.
However, this method is not always correct. You can also use the constant growth method. The company's balance sheet that includes a minority interest will show this information in the equity section of the balance sheet.
The balance sheet for a company with a minority interest should be prepared on a book value basis rather than on a historical cost basis. In general, a minority interest should be valued at its fair value. It should be recorded under the section titled "shareholders' equity".
Also Read: Consolidated Balance Sheet and Steps to Prepare it
Minority Interest Example of Calculation
Ajax Corporation owns 25% of the outstanding shares in Dark Horse Corporation. Ajax has reported its initial purchase of Dark Horse, which measures ₹3.7 million. The following calendar year Dark Horse reports ₹500,000 in earnings. Ajax can recognise its portion of this profit, that is, ₹125,000.
Ajax's stake in Dark Horse, therefore, increases to ₹3,825,000. Then, Dark Horse pays Ajax the dividend of ₹25,000. Ajax reports this as a decrease in its stake, which falls to ₹3.8 million. If the subsidiary has a majority ownership in a subsidiary and the parent company holds a majority stake, the subsidiary will recognise the minority stake within its accounts.
Summary of Minority Interest in Enterprise Value
- Bringing minority interest in EV enables the "apples to apples" comparison among EV and various figures like EBIT, EBITDA or Total Sales.
- According to minority interest accounting rules, the issue arises as the parent company is required to disclose 100% of all other data related to its subsidiary companies if it has more than 50% in its affiliate.
- The equity value shown in the consolidated financial statements will always reflect the worth of the stake owned by the parent company in its subsidiary. So if the parent holds 80% of its subsidiary, and the subsidiary is worth ₹1,000, the equity value is 80% of ₹1,000, which is ₹800.
- The parent company does not reflect more than 80% of numbers like the EBITDA, EBIT, or Total Sales. This causes a problem with calculating valuation ratios like EBIT/EV, EV/Total Sales and EV/EBITDA since the numerator only represents 80% of the subsidiary. In comparison, the denominator is 100% of the company.
- Changing the denominator is usually not feasible or practical since companies do not divulge sufficient information. So, we modify the numerator to represent 100% of the subsidiaries.
Conclusion
Minority interest gives investors crucial information when they read the financial statements. It can also help investors understand and make educated investment decisions. The proportion of the controlling stake determines the impact and the voting rights of a minority interest in decisions made by the majority.
In the past, the minor interest concept was referred to as equity, liability or, at times, neither of the two. At present, little information is available regarding how to present and deal with non-controlling interests. Now keep track of your cashflow and manage your incomes and expenses with ease by using the Cashbook app by Khatabook.
