Non-Controlling Interest (NCI)

Non-Controlling Interest: Intercompany Investment Accounting

Companies often invest in the equity of other companies, which are collectively called “intercompany investments”. For intercompany investments, the accounting treatment of such investments depends on the size of the ownership stake.

The proper accounting method varies with the implied ownership post-investment:

1. Investments in Securities → Cost Method (<20% Ownership)
2. Equity Investments → Equity Method (~20-50% Ownership)
3. Majority Stakes → Consolidation Method (>50% Ownership)

The cost (or market) method is used when the acquirer holds minimal control in the equity of the underlying company.

Considering the equity ownership percentage is <20% , these are treated as “passive” financial investments.

If the equity ownership ranges between 20% to 50%, the accounting treatment applied is the equity method, as the stake is classified as an “active” investment with a significant level of influence.

Under the equity method, intercompany investments are recorded at the initial acquisition price on the assets side of the balance sheet (i.e. “Investment in Affiliate” or “Investment in Associate”).

As for the consolidation method, the acquirer – who is often called the “parent company” – holds a meaningful stake in the equity of the subsidiary (exceeding 50% ownership).

However, in these instances, rather than creating a new line item on the balance sheet to account for the new investment asset, the subsidiary’s balance sheet is consolidated with the parent company.

Non-Controlling Interest (NCI): Accounting Method

The appropriate accounting treatment applied for investments with majority ownership is the consolidation method.

The cause for much of the confusion surrounding non-controlling investments is the accounting rule stating that if the parent company owns greater than 50% of the subsidiary, full consolidation is required regardless of the percentage owned.

Therefore, whether the parent company owns 51%, 70%, or 90% of the subsidiary, the degree of consolidation remains unchanged – effectively the treatment is akin to as if the entire subsidiary had been acquired.

To reflect that the acquirer owns less than 100% of the consolidated assets and liabilities, a new equity line item titled “Non-Controlling Interests (NCI)” is created.

Non-Controlling Interest on Income Statement

As for the income statement, the parent company’s I/S will also be consolidated into the subsidiary’s I/S.

Hence, the consolidated net income reflects the share of net income that belongs to the parent common shareholders, as well as the consolidated net income that does not belong to the parent.

In the consolidated income statement, for example, the net income that belongs to the parent (vs. to the non-controlling interest) will be clearly identified and separated.

Minority Interest in Enterprise Value Calculation

Under US GAAP accounting, companies with >50% ownership of another company but below 100% are required to consolidate 100% of the subsidiary’s financials into their own financial statements.

If we’re calculating valuation multiples that use enterprise value (TEV) as the measure of value, the metrics used (e.g. EBIT, EBITDA) include 100% of the financials of the subsidiary.

Logically, for the valuation multiple to be compatible – i.e. no mismatch between the numerator and denominator regarding the represented capital provider groups – the minority interest amount must thus be added back to enterprise value.

Non-Controlling Interest Calculator – Excel Template

Now, we’ll move on to an example consolidation method modeling exercise in which we’ll see a hypothetical scenario where non-controlling interest (NCI) is created.

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Step 1. Model Transaction Assumptions

First, we’ll list out each of the transaction assumptions which will be used in our model.

Transaction Assumptions

• Form of Consideration: All-Cash
• Purchase Price: $120m
• % of Target Acquired: 80.0%
• Target PP&E Write-Up: 50.0%

The form of consideration (i.e. cash, stock, or mixture used to complete the payment) is 100% all-cash.

But remember that the fair market value (FMV) of the target’s shareholders’ equity must reflect 100% of the target’s value, as opposed to just the stake taken by the parent company.

Since the purchase price – i.e. the size of the investment – is assumed to be $120m for an 80% ownership stake in the target company, the implied total equity valuation is $150m.

• Implied Total Equity Valuation: $120m Purchase Price ÷ 80% Ownership Stake = $150m

For the last transaction assumption concerning the PP&E write-up, the target’s PP&E is going to be marked up by 50% to more accurately reflect its fair market value (FMV) on its books.

Step 2. Excess Purchase Price Schedule (Goodwill)

If the purchase price were equal to the book value of equity, the non-controlling interest could be calculated by multiplying the BV of equity by the ownership stake acquired.

In such scenarios, the equation to calculate the NCI is simply the target’s book value of equity × (1 – % of target acquired).

However, the purchase price paid is in excess of the book value in the vast majority of acquisitions, which can be caused from:

• Control Premiums
• Buyer Competition
• Favorable Market Conditions

If a purchase premium is paid, the acquirer is obligated to “mark up” the purchased assets and liabilities to their fair market value (FMV), with any excess purchase price over the value of the net identifiable assets being allocated to goodwill.

Here, the only FMV-related adjustment for the target company is the PP&E write-up of 50%, which we’ll calculate by multiplying the pre-deal PP&E amount by (1 + PP&E write-up %).

• FMV PP&E = $80m × (1 + 50%) = $120m

As for the calculation of goodwill – the asset line item that captures the excess purchase price paid over the value of the net identifiable assets – we must deduct the FMV of net assets from the implied total equity valuation.

• FMV of Net Assets = $100m Book Value of Net Assets + $40m PP&E Write-Up = $140m
• Pro Forma Goodwill = $150m Implied Total Equity Valuation – $140m FMV of Net Assets = $10m

Note that the PP&E write-up refers to the incremental value added onto the existing PP&E balance, rather than a new PP&E balance.

Step 3. Calculation of Deal Adjustments and Non-Controlling Interest

The first deal adjustment is the “Cash & Cash Equivalents” line item, which we’ll link to the $120m purchase price assumption with the sign convention flipped (i.e. the cash outflow for the acquirer in the all-cash deal).

Next, we’ll link the “Goodwill” line item to the $10m in goodwill calculated in the prior section.

As for calculating the “Non-Controlling Interest (NCI)”, we’ll subtract the purchase price from the perspective of the acquirer from the total implied equity valuation.

• Non-Controlling Interest (NCI) = $150m Total Equity Valuation – $120m Purchase Price = $30m

Contrary to a frequent misunderstanding, the non-controlling interests line item contains the value of the equity in the consolidated business held by minority interests (and other third parties) – i.e. the non-controlling interest is the amount of equity in the subsidiary NOT owned by the parent company.

In the final adjustment, the process for calculating the consolidated “Shareholders’ Equity” account consists of adding the acquirer’s shareholders’ equity balance, the target’s FMV shareholders’ equity balance, and the deal adjustments.

• Pro Forma Shareholders’ Equity = $200m + $140m – $140m = $200m

Step 4. Consolidation Method Example Output

With all the required inputs calculated, we’ll copy the post-deal pro forma financials formula for each line item (Column L).

• Pro Forma Consolidated Financials = Pre-Deal Acquirer Financials + FMV Adjusted Target Financials + Deal Adjustments

Once done, we’re left with the post-deal financials of the consolidated entity.

Since the assets and liabilities & shareholders’ equity side of the balance sheet each comes out to $570m, that indicates all necessary adjustments were accounted for and the B/S remains in balance.