Essay: Minority interest is an accounting concept

1. What is a minority interest/non-controlling interest and how is it shown in consolidated financial statements?

A: Jeff Faust said: “Minority interest is an accounting concept that refers to own a company (subsidiary) that is less than 50% of voting shares. Minority interest belongs to minority investors and is showed on the consolidated balance sheet of the parent company to reflect the claim on assets belonging to other, non-controlling shareholders. Also, minority interest is reported on the consolidated income statement as a share profit belonging to minority shareholders.” (Minority Interest on the Balance Sheet) In other words, minority interest refers to the quantity of the minority shareholders in a company’s subsidiaries.

For example, ROSE plc provided to sell 80% of ABC to BILL plc for $100million. That is, ABC is a partially-owned subsidiary of BILL plc. Since subsidiaries are controlled by their parent company, accounting rules allow them to be carried on the parent company’s balance sheet. When BILL bought it 80% stock in ABC, it was able to add the assets of ABC to its balance sheet. However, it doesn’t owned ABC all. ROSE still kept the other 20% of ABC. BILL have to show that some of the assets on its balance sheet belong to ROSE, who has minority interest in ABC. To do this, it will be required to calculate the value of ROSE’s stock in the subsidiary and put it under a liability account which called “Minority Interest”. These are the assets ROSE “owes” ABC.

Joshua Kennon said: “There are several minority partners in lots of subsidiaries may own by one company. The minority interest of all of these partners is added together and reported on the balance sheet.” (Minority Interest on the Balance Sheet)

“Minority interests are part owners of the subsidiary. In such a case, therefore, the parent company does not own all the net assets of the acquired company but does control them.” (Barry Elliott and Jamie Elliott, 2008)

References:

1. http://beginnersinvest.about.com/od/analyzingabalancesheet/a/minority-interest-on-the-balance-sheet.htm
2. http://www.investopedia.com/terms/m/minorityinterest.asp
3. http://www.groco.com/readingroom/bus_dloc_mid.aspx
4. Barry Elliott and Jamie Elliott. (2008). Financial Accounting and Reporting, 12th edition. P540－P541, Ashford Colour Press, London.

2. ‘Disclosure of related party transactions (e.g., transactions involving parent and subsidiaries) in consolidated financial statements provides no useful information’. Discuss this statement.

A: I do agree with this statement. The only information will be provided is the transaction internal the group if these internal transactions show up on the balance sheet. It may not provide any useful information, and may make the balance sheet more confused and unclear. “The reason why those related transactions should be cancelled out is that the group accounts do not double count assets and/or liabilities.”(Barry Elliott and Jamie Elliott, 2008)

“On the one hand, if entries in the parent’s records and the subsidiary’s records are up to date, the same figure will appear as a balance in the current assets of one company and in the current liabilities of the other.” (Barry Elliott and Jamie Elliott, 2008)

“On the other hand, in practice, temporary differences may arise for such items as inventory or cash in transit that are recorded in one company’s book but of which the other company is not yet aware.” (Barry Elliott and Jamie Elliott 2008) In such a case, the records will require reconciling and updating before proceeding. “In a multinational company, this can be an extremely time-consuming exercise. According to the Sanitec International S.A 2004 financial statements, all significant inter-company balance and transaction have been eliminated in consolidation.” (Barry Elliott and Jamie Elliott 2008)

References:

1. Barry Elliott and Jamie Elliott. (2008). Financial Accounting and Reporting, 12th edition. P554－P556, Ashford Colour Press, London.

3. Explain the limitations of consolidated financial statements?

A: Consolidated financial statement is the financial information presentation in which the assets, equity, liabilities, and operating accounts of a firm and its subsidiaries are combined (after eliminating all inter-firm transactions) and shown as belonging to a single reporting entity. But, the consolidated financial statements have some limitations as follows.

1. In accounting rules aspect, in different industries may use different accounting rules. This may cause the consolidated account cannot reflect the real situation of the parent company and its subsidiaries. For example, when a parent company is a car industrial enterprise, and may require account A, but in its subsidiary which a financial company, they may be required account B, when they make the consolidated account, the result may difficult to judge for the same accounting rule, some of the terms may lose their meaning in the consolidated account. This kind of consolidated account is useless for the shareholders, because it is not reflect the real condition of the group. If enterprises use different accounting policies to deal with the same transaction, they would get different financial results.
2. Consolidated financial statements only can reflect the financial position of the whole group, not the individual enterprise, subsidiary, entity and parent company. The number in the consolidated financial statements cannot reflect the each subsidiaries financial position, which one is better or which is worse. This may hard for the shareholders to make the right decisions.
3. If the parent company and its subsidiaries are the abroad group, the consolidated account may become more complicated and take time. For example, the currency in each subsidiary should be exchanged to the uniform currency used by parent company, and finally reflect on the consolidated financial statements. During this process, we need to consider the exchange rate, inflation rate, interest rate and the different financial policy in different countries.
4. “Consolidated financial statement is primarily for owners and creditors of parent, not for non-controlling owners or subsidiary creditors.” (Weygandt, Kieso, and Warfield. 2003) That is, the consolidated financial statement is useless for the subsidiaries’ shareholders to get useful information from consolidated financial statements.
5. “There are some information in financial statements is “estimate”. For example, how accurate is depreciation? How about ‘ days sales outstanding’? There are too many assumptions used in Accounting.” These assumptions make the result not exactly accurate.
6. Some consolidated financial statements have time limitations. “For example, the consolidated balance sheet is supposed to provide a ‘ snapshot’ of business financial condition as of a very specific point in time.” It only can be made at the end of the year. And if shareholders want to know what happened during the year, and that would be impossible to get any useful information from consolidated account. What they got is just the consolidated result of the group.
7. Dennis, Michael C said: “Past financial performance, good or bad, is not necessarily a good predictor of what will happen with a customer in the future.” (The limitations of financial statement analysis, 1995)
8. Dennis, Michael C said: “Without the notes to the financial statements, credit managers cannot get a clear picture of the scope of the credit risk they are considering.”(The limitations of financial statement analysis, 1995)

References:

1. http://www.bylw8.com/Thesis/Accounting_Auditing/Accounting_Theory/0401121312007-1175447317.html
2. http://www.allbusiness.com/accounting-reporting/reports-statements/490273-1.html
3. Weygandt, Kieso, and Warfield. (2003). Fundamentals of Intermediate Accounting, chapter 4.

Answers to question 4:

Note 1 Goodwill

Investment 165000

70% × Common share capital (42000)

70% × General reserve at 1 January 2008 (11200)

70% × Retained earnings at 1 January 2008 (42000)

70% × Revaluation of land (14000)

Goodwill 55800

Impairment loss 10% 5580

Goodwill 50220

Note 2 The Minority Interest

30% × Common share capital 18000

30% × General reserve at 31 December 2008 6300

30% × Retained earnings at 31 December 2008 27000

30% × Revaluation of land 6000

The Minority interest 57300

Note 3 Provision of unrealized profit

The mark -up on the inter-company sales was £9000×1/3 = £3000

Half the goods are still in inventories at the balance sheet date so provide

1/2×£3000 for the unrealized profit = £1500