Q5.1 The nature of NCI and PI (Section 5.2.1)
In introductory financial accounting, the accounting entity is often a sole trader (or sole proprietorship) that runs a small business such as a hardware store or flower shop. In the financial reports prepared for a sole trader, the interest of the owner in the business is shown in the owner’s equity section of the statement of financial position and is comprised of original capital +/– profit/losses + additional capital contributed – withdrawals.
When the accounting entity is a single entity, the ownership interest extends from a sole proprietor to all of the shareholders in the entity. In the financial reports prepared for a single entity, the interest of the owners (the shareholders) in the entity is shown in the equity section of the statement of financial position and comprises of:
Issued capital 100 Retained earnings 500 Reserves/surplus (e.g. revaluation, general, capital 300 profits)
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Total equity 900
In consolidation accounting, the accounting entity is the group consisting of a parent entity and its subsidiaries and is frequently a corporate combination (i.e., a parent entity and its subsidiary entities).
If the group includes a partly owned subsidiary, then the ownership interests in the group are not limited to the shareholders of a single entity but extend to two distinguishable shareholder groups as follows:
1 The shareholders of the parent entity (PI); and
2 The outside shareholders in the partly owned subsidiary (NCI).
The non-controlling interest is the ownership interest in a partly owned subsidiary held by shareholders other than the parent entity or other subsidiaries that it wholly owns. Whenever the ownership of the group includes outside shareholders, it is necessary to partition the equity of the group for accounting purposes between the ownership interests of the parent entity (PI) and non-controlling interest (NCI).
In the textbook the partitioning of equity is shown on the face of the consolidated statement of financial position as follows.
Extract from consolidated statement of financial position
Consolidated $
Issued capital 80 Retained earnings 425 Reserves/surplus 290 Total equity attributable to equity 795
holders of parent entity
Non-controlling interest 105 Total equity 900
As discussed in the text, the simplest approach to the attribution process is to calculate the amount attributable to the NCI and then determine the PI as the residual amount using the consolidated (or group) total. For example, if the NCI in issued capital is $20 and the consolidated total is $100, then the PI in issued capital must be the residual of $80 (i.e., $100 – $20).
If a group has a parent entity and one partly owned subsidiary, then the group has a NCI with an ownership interest in that partly owned subsidiary. The amount of the NCI must be determined on the equity balances it contributes to the group’s consolidated net assets in the consolidated financial statements rather than the equity balances of the parent entity or the group equity balances.
In the example above, the calculation of the NCI could be explained as follows.
Issued capital
NCI share 20%
Retained earnings NCI share 20%
Reserves/surplus
NCI share 20%
Total contributed equity of subsidiary NCI share 20%
Subsidiary NCI $$
100 375 50 525
20 75 10 105
It should also be noted that the ownership interests of the PI and NCI expressed as percentages must add up to 100%. For example, if the NCI has a 20% ownership interest in a partly owned subsidiary, then the PI must have an 80% ownership interest in that subsidiary.
Q5.3 Relevance of consolidated financial statements to shareholders in the group (Section 5.2.2)
(a) Relevance to the shareholders of the parent entity
It is generally accepted that the consolidated financial statements are primarily of benefit to the shareholders of the parent entity rather than to the non-controlling interest shareholders in the group.
From the perspective of the shareholders of the parent company, the consolidated financial statements will show the net assets under the control of the management of the parent entity and management’s performance in generating earnings from those assets. As shareholders are interested in the amount of dividends that will eventually be paid by the parent entity to them, the parent entity shareholders are interested in the PI in consolidated profit of the group. This amount can be considered as the amount which will eventually flow from subsidiaries to the parent entity as dividends. (Refer to Section 5.2.2 of the text.)
(b) Relevance to non-controlling interest shareholders
From the perspective of non-controlling interests, they have a right to dividends distributed by the entity in which they have an ownership interest (i.e., the partly owned subsidiary). They do not have a claim against the profits and dividends of the parent entity. Nor do they ordinarily have a claim against the assets of any other member of the group. Similarly, the investment of non-controlling interest shareholders has a ‘net asset backing’ based on the subsidiary’s rather than the group’s financial position.
Because the non-controlling interest shareholders in a subsidiary have a primary interest in the performance of the entity in which they hold shares, the subsidiary’s separate financial statements are of primary interest to these shareholders.
The non-controlling interest shareholders may have a secondary interest in the consolidated financial statements to the extent those statements reveal financial information about the expected financial position or performance of the subsidiary itself. For example, the relevance of the consolidated statements to non-controlling interests will be enhanced if the parent entity has taken steps to bind the group of entities together, such as through a mutual guarantee of each other’s debts. On occasions, a strong group will support a weak subsidiary, or alternatively, a strong subsidiary will support a weak group.
Q5.9 Unrealised revenues and expenses and the calculation of NCI (Section 5.4.6)
The financial accounting effects of the management fees, interest on loans and operating leases are included in subsidiary single entity financial statements and is part of its profit for the period. The starting point for a NCI allocation in a subsidiary’s profit for the period is extracted from its single entity financial statements. The recorded profit is then adjusted for any items which affect the subsidiary’s contribution to the group’s consolidated net assets.
Arguments for adjusting the NCI
The argument for adjusting the NCI is based on the proposition that the NCI in current period profit is an allocation of the profit of the subsidiary which includes the effects of transactions within the group. It could be argued that a subsidiary that provides management services, rental property or loans to another member of the group has contributed to the group. In an economic sense, the subsidiary’s activities may have allowed the group to avoid the potential higher costs of acquiring these services from other external parties. Alternatively, the parent entity would not have generated profit had it not been for the supporting activities of the subsidiary.
Arguments against adjusting the NCI
The argument for not adjusting the NCI is based on the entity concept which requires NCI to be calculated on the consolidated equity a subsidiary contributes to the consolidated financial statements of a group. Accordingly, if the adjusting consolidation journal entries are for intragroup transactions which only affect the consolidated income statement and do not affect the consolidated net assets of the group, then in theory there will not be any ‘unrealised’ revenues and expenses that relate to, say, management fees, interest or rents because the services have been consumed within the group and they should be ignored in the NCI allocation. This argument is explored further in Section 5.4.6 in the text.
Suppose the consolidated profit for the current reporting period is $20million. The NCI have a 40% interest in a partly owned subsidiary which made a profit for the period of $15million from the rent of an office property to the parent entity. The allocation of the consolidated profit under both approaches of adjusting and not adjusting the NCI for the unrealised rent revenue is as follows:
NCI adjusted for rent PI NCI Cons. $m $m $m Net profit 20 – 20
The NCI is calculated as follows:
NCI adjusted for
NCI not adjusted for rent PI NCI Cons. $m $m $m 14 6 20
NCI not adjusted for
Recorded profit of sub 15 Less Unrealised revenue (15) Contributed profit –
NCI share 40% –
In this extreme example, it is arguably not true and fair to show that NCI amounting to $6million when the subsidiary has not engaged in any external transactions that have generated revenues to the group.
Conclusion
As stated in the text (Section 5.4.6), the adjustment of a subsidiary’s profit for the NCI allocation is limited to unrealised profits from sale of assets and inter-entity dividends.
This conclusion is based on the net assets effect in the consolidated financial statements of the adjusting consolidation journal entries for intra-entity transactions. Consolidation adjustments for some intragroup transactions may affect consolidated net assets. For example, where the borrowing entity within the group may recognise interest expense on an accrual basis and lending entity may recognise interest income on a cash receipts basis. In this case the revenue and expense from the group’s perspective would be recognised in different accounting periods.
Q5.10 Impairment losses (Section 5.4.7)
The technique used to calculate and allocate impairment losses in a partly controlled subsidiary depends upon the accounting policy adopted for the recognition of NCI at the date of acquisition. AASB 136 Impairment of Assets Appendix C, which is integral to the provisions of AASB 136, is the authority that provides preparers of financial statement guidance for this issue. If the 100% goodwill method is adopted, the goodwill on acquisition already includes the non-controlling shareholders’ interest in goodwill and, as directed by AASB 136.C6, any related impairment losses are split between PI and NCI on the same basis as the partly controlled entity’s profit or loss is allocated between the PI and NCI.
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