AU: Consolidation: non-controlling interest

Consolidation: Non-Controlling Interest

1. What is meant by the term ‘non-controlling interest’ (NCI)?2. Explain whether the NCI is better classified as debt or equity.

NCI is the term used for the ownership interest in a subsidiary other than the parent. It is defined in AASB 10/IFRS 10 Consolidated Financial Statements as:
• The equity in a subsidiary not attributable, directly or indirectly, to a parent.

The non-controlling interest is still regarded as equity of the group. Hence there are effectively two equity parties in the group: the owners of the parent and the NCI. Classification of the NCI as equity affects both the calculation of the NCI as well as how it is disclosed in the consolidated financial statements. Measurement and disclosure of the NCI are mainly determined by AASB 10/IFRS 10 and AASB 101/IAS 1 Presentation of Financial Statements.

2. Explain whether the NCI is better classified as debt or equity.

The non-controlling interest is regarded as equity of the group. Hence there are effectively two equity parties in the group: the owners of the parent and the NCI. Classification of the NCI as equity affects both the calculation of the NCI as well as how it is disclosed in the consolidated financial statements. Measurement and disclosure of the NCI are mainly determined by AASB 10/IFRS 10 and AASB 101/IAS 1 Presentation of Financial Statements.

The main argument for the NCI being classified as equity is that it better fits the definition of equity. The subsidiary has no present obligation in relation to the NCI so the NCI does not meet the definition of a debt/liability.

Some writers argue that NCI should be disclosed separately from equity and liabilities – the “mezzanine” treatment. This argument relates to the utility of financial statements in relation to the parent’s shareholders. It is argued that this form of presentation will provide more relevant information to the parent shareholders.

3. Explain whether the NCI is entitled to a share of subsidiary equity or some other amount.

The NCI, being a part of the equity in the subsidiary, contributes to the equity of the consolidated group and so is entitled to a share of consolidated equity. Nevertheless, the measurement of the NCI share of equity involves firstly allocating to the NCI a part of the subsidiary’s equity proportionate to the ownership interest that it holds in the subsidiary. However, because the subsidiary’s equity is affected by profits or losses made in relation to transactions within the group, the calculation of the NCI is affected by the existence of intragroup transactions.

The NCI is only entitled to the share of the subsidiary’s equity that is reflected in the consolidated equity. In other words, the NCI is entitled to a share of the equity of the subsidiary adjusted for the effects of profits or losses made on intragroup transactions.

4. For what line items in the financial statements is it necessary to provide a break-down into parent entity share and NCI share?

Statement of Profit or Loss and Other Comprehensive Income:
• AASB 101/IAS 1 paragraph 81B: Disclose both NCI and parent share of profit/loss for the period and share of total comprehensive income for the period

Statement of Financial Position:
• AASB 10/IFRS 10 paragraph 22: A parent shall present non-controlling interests in the consolidated statement of financial position within equity, separately from the equity of the owners of the parent.
• AASB 101/IAS 1 paragraph 54 (q) and (r): NCI share of equity, and share capital and reserves attributable to parent.

Statement of Changes in Equity:
• AASB 101/IAS 1 paragraph 106 (a): total comprehensive income for the period, showing that attributable to the parent and that attributable to the NCI.
• In summary, the information that needs to be disclosed for NCI is: - the NCI share of profit after tax - the NCI share of comprehensive income - the NCI share of consolidated equity.

5. Describe the format of the consolidation worksheet prepared in the presence of the NCI.

The consolidation worksheet used for a wholly owned subsidiary is changed to enable the disclosures required where NCI exists in a subsidiary. Figure 29.4 contains a pro‐forma example of such a worksheet. (The assets and liabilities section is not included, as it is not affected by the presence of NCI.) In relation to this worksheet, note the following.

• As in the case of wholly owned subsidiaries, the column on the right of the ‘Adjustments’ column is named ‘Group’. The ‘Adjustments’ column contains the business combination valuation reserve (BCVR) and pre‐acquisition entries and the adjustments for intragroup transactions. Combining these adjustments with the financial statement numbers of both the parent and subsidiary provides the group (consolidated) amounts. Note that the consolidated amounts related to equity include the equity attributable to the owners of the parent and to NCI.

• Two columns (one for debit and one for credit entries) collectively named ‘NCI’ are added to the normal worksheet that was used for wholly owned subsidiaries. These columns record the NCI journal entries prepared in order to transfer the NCI share of each individual consolidated equity account from the consolidated amounts to an account that recognises the NCI share of total consolidated equity. For example, the NCI share of consolidated share capital is transferred from the consolidated share capital amount (by being included on the ‘NCI’ debit column in the ‘Share capital’ line) to the NCI share of total equity (by being on the ‘NCI’ credit column in the new ‘Total equity: NCI’ line described below).

• One more column, named ‘Parent’, is added which contains the parent share of consolidated equity. This share is calculated by adjusting the consolidated amounts related to equity from the ‘Group’ column for the NCI journal entries posted in the ‘NCI’ columns. The adjustments are made according to the general rules of debits and credits. For example, the parent share of consolidated share capital is calculated as the consolidated amount (from the ‘Group’ column) minus the NCI share (from the ‘NCI’ debit column). This is because share capital is a credit account, and the NCI share is going to be subtracted from the consolidated share capital to get to the parent share. In contrast, dividend paid has a debit balance, so the NCI share is extracted from the consolidated amount via the ‘NCI’ credit column to get the parent share.

• Two new lines are added in the worksheet, namely ‘Total equity: parent’ and ‘Total equity: NCI’. These lines contain amounts that show the parent share and the NCI share of total consolidated equity respectively.
- ‘Total equity: parent’ is determined by adding together the amounts in the ‘Parent’ column for all individual equity accounts.
- ‘Total equity: NCI’ is determined by subtracting the sum of the amounts for this line in the ‘NCI’ debit column from the sum of the amounts in the ‘NCI’ credit column. The resulting amount is written in the ‘Parent’ column.
- The sum of the amounts included in these two lines in the ‘Parent’ column equal the total consolidated equity shown in the ‘Group’ column. The disclosures detailed in section 29.2.2 should be able to be read from this worksheet.

6. Why is it necessary to change the format of the worksheet where a NCI exists in the group?7. What is the impact on goodwill of the two methods prescribed by AASB 3/IFRS 3 to measure NCI?

The AASB’s accounting standards, as well as the IFRS, require the disclosure of the equity of the group, as well as the relative proportions of the equity that belongs to the parent’s shareholders and the NCI. The reason the accounting standards ask for separate disclosure of the parent and NCI share of equity is that the owners of the parent want to determine the profitability and the equity of the group that will accrue to them, separate from that belonging to the NCI. As such, disclosure of the NCI is required in the consolidated statement of profit and loss and other comprehensive income, the consolidated statement of changes in equity and the consolidated statement of financial position. The consolidation worksheet used for a wholly owned subsidiary is changed to enable the disclosures required where NCI exists in a subsidiary.

For a wholly owned subsidiary situation, the final column in the worksheet represents the group position which is also the parent’s position, as there is no NCI. Where an NCI exists, having determined the group position, the equity must be divided into parent’s shareholders share and the NCI share. Hence, the worksheet must have additional columns to divide the group’s consolidated equity into the relative shares belonging to the parent’s shareholders and the NCI. This is done by calculating the NCI share and subtracting it from the group equity so that the final column is then the parent entity’s share.

7. What is the impact on goodwill of the two methods prescribed by AASB 3/IFRS 3 to measure NCI?

Paragraph 32 of AASB 3/IFRS 3 Business Combinations states:

The acquirer shall recognise goodwill as of the acquisition date measured as the excess of (a) over (b) below:
(a) the aggregate of:
(i) the consideration transferred measured in accordance with this Standard, which generally requires acquisition‐date fair value (see paragraph 37);
(ii) the amount of any non‐controlling interest in the acquiree measured in accordance with this Standard; and
(iii) in a business combination achieved in stages (see paragraphs 41 and 42), the acquisition date fair value of the acquirer’s previously held equity interests in the acquiree.
(b) the net of the acquisition‐date amounts of the identifiable assets acquired and the liabilities assumed measured in accordance with this Standard.

Therefore, in order to determine the amount of goodwill as part of the acquisition analysis, we need to be aware of the methods prescribed by the standard to measure non‐controlling interest.

Paragraph 19 of AASB 3/IFRS 3 states:

For each business combination, the acquirer shall measure at the acquisition date components of non‐controlling interests in the acquiree that are present ownership interests and entitle their holders to a proportionate share of the entity’s net assets in the event of liquidation at either:
(a) fair value; or
(b) the present ownership instruments’ proportionate share in the recognised amounts of the acquiree’s identifiable net assets.

The choice of each alternative measurement prescribed in paragraph 19 of AASB3/IFRS 3 affects the determination of goodwill and the subsequent consolidation adjustments. Where the first alternative is used, goodwill attributable to both the NCI and the parent is measured. Under the second alternative, only the goodwill attributable to the parent is measured, with no goodwill recognised for NCI. The methods are sometimes referred to as the ‘full goodwill’ and the ‘partial goodwill’ methods (see paragraph BC205 in the Basis for Conclusions on AASB 3/IFRS 3). These terms are used in this chapter. These methods are demonstrated in sections 29.4.1 and 29.4.2.

Under the full goodwill method, the NCI in the subsidiary is measured at fair value. The fair value is determined on the basis of the market prices for shares not acquired by the parent, or, if these are not available, a valuation technique is used. The total goodwill calculated in the acquisition analysis consists of both the goodwill of the subsidiary and a control premium paid by the parent over the fair value of the shares acquired to obtain control over the subsidiary. The goodwill of the subsidiary will be allocated proportionally to the parent and NCI, but the control premium is only attributable to the parent.

Under the partial goodwill method, at acquisition date the NCI is measured at the NCI’s proportionate share of the acquiree’s identifiable assets and liabilities. The NCI therefore does not get a share of any goodwill as goodwill is not an identifiable asset. The only goodwill recognised is that attributable to the parent; hence the term ‘partial’ goodwill. This goodwill (that belongs to the parent) will be calculated as follows.

Goodwill = consideration transferred
                   plus previously acquired investment by parent
                   less parent share of the net fair value of identifiable assets and liabilities of subsidiary.

8. Describe the disadvantages of the two methods prescribed by AASB 3/IFRS 3 to measure NCI for users and preparers of financial information.

It is unusual for the standard setters to allow a choice of methods as this leads to non‐comparability of financial statements between entities. As some entities may use the full goodwill method, while others partial goodwill method when measuring NCI, users of financial information may find it difficult to compare the financial statements of those entities.

Choosing one method over the other results in different outcomes as follows.
1. The reported amounts at acquisition date will be different. The amounts recognised for goodwill and the NCI share of equity would be higher under the full goodwill method.
2. If the goodwill is tested for impairment subsequent to acquisition date, the test is less complex under the full goodwill method. Further, any impairment of goodwill will be recognised for the entire subsidiary under the full goodwill method, but only for the parent’s share of the goodwill under the partial goodwill method.
3. Where a parent acquires some or all of the NCI subsequent to obtaining control, there is a lower negative impact on equity attributable to the parent shareholders under the full goodwill method due to the NCI being recognised at a higher carrying amount.

Ernst & Young (2010) provides a detailed discussion of these outcomes.

When preparing IFRS 3, on which AASB 3 is based, the IASB members could not agree on the use of the fair value measurement for NCI (i.e. the full goodwill method) and so both methods were allowed (see AASB 3/IFRS 3 BC210 and BC213). Some reasons for the disagreement are related to the perceived disadvantages of using the full goodwill method (see AASB 3/IFRS 3 BC213‐214):
• it is more costly to measure the NCI at fair value
• there is not sufficient evidence to assess the marginal benefits of reporting the acquisition‐date fair value of the NCI.

9. If a step approach is used in the calculation of the NCI share of equity, what are the steps involved?

The NCI is entitled to a share of the recorded equity of the subsidiary as measured at the end of the period for which the consolidated financial statements are being prepared. This share is calculated in three steps as follows.

1. Determine the NCI share of equity of the subsidiary at acquisition date.
2. Determine the NCI share of the changes in subsidiary equity between the acquisition date and the beginning of the current period for which the consolidated financial statements are being prepared.
3. Determine the NCI share of the changes in subsidiary equity in the current period.

10. How does the existence of the NCI affect the business combination valuation entries?

The existence of NCI has no effect on the business combination valuation entries other than the one recognising goodwill. If the full goodwill method is used (NCI is measured based on the fair value), the recognition of the subsidiary’s goodwill (i.e. total goodwill excluding the control premium) is made via a BCVR entry. In contrast, where the partial goodwill method is used, goodwill is recognised only in the pre-acquisition entry.

The other BCVR entries, apart from that for goodwill, are not affected because they are prepared in response to the requirement of AASB 3/IFRS 3 Business Combinations to show the identifiable assets and liabilities of the acquiree at fair value at acquisition date. The determination of fair value of those identifiable assets and liabilities is not affected by the parent’s ownership in the subsidiary.

11. How does the existence of the NCI affect the pre-acquisition entries?12. Explain how business combination valuation entries may affect the calculation of NCI in step 2 and step 3.

Normally, the first pre-acquisition entry eliminates the investment account recorded by the parent and the pre-acquisition equity of the subsidiary (including any BCVR for differences between the fair values and the carrying amounts of the subsidiary’s identifiable assets and liabilities at acquisition date plus the goodwill, if any), as well as recognising any gain on bargain purchase. The other pre-acquisition entries in each period after acquisition normally reverse the period’s transfers from pre-acquisition equity.

The existence of the NCI has a few effects on the pre-acquisition entries as follows:
• The subsidiary’s equity eliminated is only the parent’s share; in each period after acquisition the transfers from pre-acquisition equity are only reversed for the parent’s share.
• If the acquisition analysis determines a gain on bargain purchase, the gain on bargain purchase recognised is only that relating to the parent’s share of the equity of the subsidiary.
• If the acquisition analysis determines a goodwill:
- In the full goodwill method, the subsidiary’s goodwill (i.e. total goodwill excluding control premium) is recognised as part of BCVR and eliminated in the pre-acquisition entry, while the control premium part of goodwill is recognised in the pre-acquisition entry.
- In the partial goodwill method, the goodwill determined is recognised in the pre-acquisition entry.

12. Explain how business combination valuation entries may affect the calculation of NCI in step 2 and step 3.

The NCI is entitled to a share of the recorded equity of the subsidiary in the consolidated financial statements as measured at the end of the period for which the consolidated financial statements are being prepared. The recorded equity in the consolidated financial statements is the equity as appearing in the financial statements of the subsidiary, adjusted for the impact of business combination valuation entries, pre-acquisition entries and the elimination entries for the intragroup transactions prepared at the end of the period.

The business combination valuation entries prepared at the end of a period may include:
• Adjustments to income and expenses for the current period as the assets or liabilities undervalued or overvalued at acquisition date are depreciated, sold or settled – those adjustments impact of the reported equity of the subsidiary and affect the current profit that is to be allocated to NCI in the NCI Step 3
• Adjustments to retained earnings for the previous periods as the assets or liabilities undervalued or overvalued at acquisition date were depreciated – those adjustments impact of the reported equity of the subsidiary and affect the retained earnings that is to be allocated to NCI in the NCI Step 2.

As such, before allocating the current profit and the change of retained earnings of the subsidiary to NCI, the impact of the business combination valuation entries on those need to be taken into consideration.

13. What are two events that could occur between the acquisition date and the beginning of the current period that could affect the calculation of the NCI share of retained earnings?

The NCI share of retained earnings is calculated as the NCI share of pre-acquisition retained earnings of the subsidiary (in step 1 of NCI allocation) and the NCI share of changes in retained earnings between the acquisition date and the beginning of the current period (in Step 2 of NCI allocation). The changes in retained earnings between the acquisition date and the beginning of the current period may be caused by:
• Changes in the assets & liabilities recognised via the BCVR entries (e.g. sale of the inventories or prior period’s depreciations of non-current assets on hand in the subsidiary undervalued at the acquisition date): these changes can cause transfers from BCVR to retained earnings or decreases in retained earnings.
• Other transfers involving retained earnings e.g. transfers to/from general reserve or other reserves, prior period profits and dividends.

Other than those events above, prior period’s intragroup transactions originating from the subsidiary that still had unrealised profits/losses at the beginning of the current period will also affect the retained earnings of the subsidiary and therefore the calculation of the NCI share of retained earnings.

14. Explain whether an NCI adjustment needs to be made for all intragroup transactions.

An NCI adjustment does NOT need to be made for all intragroup transactions. An NCI adjustment only needs to be made for intragroup transactions where there is unrealised profit/loss recorded by the subsidiary. Hence, in order for an NCI adjustment to be made, the intragroup transactions must be upstream transactions, i.e. from subsidiary to parent and must have generated profits/losses that are unrealised from the group’s perspective. Examples of such upstream intragroup transactions include:
• Sales of inventories by the subsidiary to the parent for a profit/loss, with some inventories still on hand with the parent at the beginning or at the end of the period.
• Sales of non-current assets by the subsidiary to the parent for a profit/loss, with the assets still on hand with the parent at the beginning or at the end of the period.
• Transfers of inventories to non-current assets or vice-versa by the subsidiary to the parent for a profit/loss, with some of those assets still on hand with the parent at the beginning or at the end of the period.
• Dividends declared or dividends declared and paid by the subsidiary during the period.
In terms of intragroup borrowings and intragroup services, as there are no unrealised profits, there won’t be any NCI adjustment needed.

15. Explain how the adjustment for intragroup transactions affects the calculation of the NCI share of equity.

The NCI does not affect the adjustments for intragroup transactions, as the full effects of each intragroup transaction are eliminated on consolidation, no matter how much is the parent’s ownership interest in the subsidiary. However, where the subsidiary records profits/losses which are unrealised from the group’s perspective, this affects the calculation of the NCI. The NCI is entitled to a share of the equity from the group’s perspective, rather than just a simple share of the subsidiary’s equity. Hence:
• where the subsidiary has recorded unrealised profits/losses in the current profit, the NCI share of the current recorded profit of the group must be adjusted for any of that profit/loss which is unrealised.
• where the subsidiary has recorded unrealised profits/losses in the previous period’s profit, the NCI share of the recorded retained earnings of the group must be adjusted for any of that profit/loss which was unrealised. If these profits/losses are realised in the current period, the NCI share of the recorded current profit of the group must be adjusted for any of that profit/loss which was realised.

Therefore, the adjustments for intragroup transactions affect the calculation of the NCI share of equity in the Step 2 & Step 3 calculations where those intragroup transactions generate unrealised or realised subsidiary’s profits/losses. The net result after those adjustments is then that the NCI gets only a share of realised subsidiary’s equity.

16. Explain how the gain on bargain purchase affects the measurement of the NCI.

In the rare case that a gain on bargain purchase arises as a result of a business combination, such a gain has no effect on the calculation of the NCI share of equity. The gain is made by the parent paying less than the net fair value of the identifiable assets acquired and liabilities assumed of the subsidiary. The NCI receives a share of the net assets of the subsidiary, and has no involvement with the gain on bargain purchase.

17. Identify the disclosures required in relation to the NCI.

The specific disclosure requirements with regards to NCI within the statement of profit or loss and other comprehensive income, statement of changes in equity and statement of financial position are discussed in section 29.2.2 as stipulated in AASB 10/IFRS 10 and AASB 101/IAS 1.

Statement of Profit or Loss and Other Comprehensive Income:
• AASB 101/IAS 1 paragraph 81B: Disclose both NCI and parent share of profit/loss for the period and share of total comprehensive income for the period

Statement of Financial Position:
• AASB 10/IFRS 10 paragraph 22: A parent shall present non-controlling interests in the consolidated statement of financial position within equity, separately from the equity of the owners of the parent.
• AASB 101/IAS 1 paragraph 54 (q) and (r): NCI share of equity, and share capital and reserves attributable to parent.

Statement of Changes in Equity:
• AASB 101/IAS 1 paragraph 106 (a): total comprehensive income for the period, showing that attributable to the parent and that attributable to the NCI.
• In summary, the information that needs to be disclosed for NCI is: - the NCI share of profit after tax
- the NCI share of comprehensive income
- the NCI share of consolidated equity.

AASB 12/IFRS 12 Disclosure of Interests in Other Entities also contains disclosures requirements for subsidiaries in which there are NCI. Paragraph 12 of AASB 12/IFRS 12 states:

An entity shall disclose for each of its subsidiaries that have non‐controlling interests that are material to the reporting entity:
(a) the name of the subsidiary.
(b) the principal place of business (and country of incorporation if different from the principal place of business) of the subsidiary.
(c) the proportion of ownership interests held by non‐controlling interests.
(d) the proportion of voting rights held by non‐controlling interests, if different from the proportion of ownership interests held.
(e) the profit or loss allocated to non‐controlling interests of the subsidiary during the reporting period.
(f) accumulated non‐controlling interests of the subsidiary at the end of the reporting period.
(g) summarised financial information about the subsidiary (see paragraph B10).