What is a Non-Controlling Interest?
A non-controlling interest (NCI) is an ownership stake of less than 50% in a corporation, where the position held gives the investor little influence or an insufficient amount of influence to determine how the company is run. Non-controlling interests are measured at the respective net asset value of entities that include other shareholders than the controlling shareholder. Potential voting rights are taken into account when measuring an NCI. Another name for such a type of investment is minority interest.
A non controlling interest is also specifically used in relation to subsidiary companies to refer to the equity interest that is held by outside investors, rather than the parent company.
Criteria for a Non Controlling Interest
A non-controlling interest (minority interest) occurs when an ownership stake is less than 50% of the outstanding shares. However, sometimes the threshold is lower, as a shareholder may hold only 49% of a company, but is able to exercise a greater level of influence. As such, the criteria really depends on whether the NCI classification is for accounting purposes or for strategic planning.
For the majority of publicly traded companies, the number of outstanding shares is so large that a normal position cannot influence higher-level activity, which is why it is deemed as a non controlling interest. It is generally not until one holds 5%-10% of the total outstanding shares that they can push for a seat on the board, or significantly drive changes at shareholders’ meetings by publicly lobbying for them.
Types of Non Controlling Interest
There are generally two types of non controlling interests:
A Direct NCI receives a proportionate share of all equity recorded by the subsidiary – the equity balances include both pre-acquisition and post-acquisition amounts.
An Indirect NCI receives a proportionate share of a subsidiary’s post-acquisition equity only.
Calculating Share of Equity
In calculating the NCI share of equity, it is consolidated equity rather than recorded equity on which the NCI is calculated. Hence, in calculating both the DNCI and INCI share of equity, adjustments must be made to eliminate any unrealized profits or losses arising from transactions within the group.
It is important to investors that companies provide transparency regarding non controlling interests, because it will give them a better understanding of the effect of the NCI on a group’s financial position, financial results, and cash flows, and also the risks faced by the group. Investors will then be better positioned to form their own opinion regarding the effect of an NCI on the various ratios and items in the financial statements.
Accounting Treatment of Non Controlling Interest
A parent with controlling interest implements the consolidated method of accounting. The parent company combines 100% of the assets and incomes from the subsidiary to its financial statements. The percentage of the parent’s ownership of the subsidiary’s equity does not matter.
However, to keep track of the value owned by the non-controlling shareholders, the parent company needs to report separate non controlling interest lines on its balance sheet and income statement.
Companies owning less than 50% of the subsidiary implement either the cost method (20% or less) or the equity method (above 20% and below 50%). Neither of the methods reports non controlling interest.
Video Explanation of Non Controlling Interest
Watch this short video to quickly understand the main concepts covered in this guide, including what non controlling interest is, the criteria, and types of non controlling interest.
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