New Reporting Standards for Noncontrolling Interests
Benefits Include Greater Comparability and Conceptual Consistency

By Vincent C. Brenner, Vincent C. Brenner, Jr., and Monica Jeancola

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JULY 2008 - FASB and the International Accounting Standards Board (IASB) have been working together to promote international convergence of accounting standards. In 2001, FASB’s Statement of Financial Accounting Standards (SFAS) 141, Business Combinations, changed the method of accounting for business acquisitions by adopting the acquisition (purchase) method and eliminating the pooling of interests as an alternative. In specific areas in accounting for business acquisitions, however, convergence was not achieved. As a result, in December 2007 FASB issued a revised standard, SFAS 141(R), Business Combinations, and SFAS 160, Noncontrolling Interests in Consolidated Financial Statements. The new standards significantly affect how consolidated financial statements are prepared when a noncontrolling interest is present.

CPAs should be acquainted with the differences in accounting for the consolidation of an acquisition of a less-than-100%-ownership interest in a subsidiary under SFASs 141 and 141(R). An example of accounting for a typical business combination transaction is discussed below, along with SFAS 160 and its additional required disclosures related to noncontrolling interests. Other important issues that the revised standards raise, such as contingent consideration, bargain purchases, and transition issues, are beyond the scope of this article, but readers should acquaint themselves with those issues, nonetheless.

Reporting Partial Ownership Under the Acquisition Method

When a company acquires all of the equity of another company, it records all of the assets and liabilities at their full fair value. An issue arises when less than 100% ownership is acquired. Basically, three views have existed regarding how the acquired company could be recognized:

  • Economic unit view. Under this approach, the business entity acquired is viewed as a total, indivisible entity, and 100% of its assets, liabilities, and income are reported in consolidated statements. Assets and liabilities are reported at their fair value on the date of acquisition. The noncontrolling interest’s share of these is also separately reported in the financial statements.
  • Proportional view. This approach views the acquired entity as divisible, and only the percentage of equity acquired is used to recognize the portion of assets, liabilities, and income to be reported. Thus, if 90% of the equity was acquired, only 90% of assets, liabilities, and income would be reported. Under this approach, the noncontrolling interest’s share of the entity does not need to be reported, because none of its share (e.g., of assets or liabilities) is recognized.
  • Parent company view. Under this approach, all of the acquired company’s assets, liabilities, and income are reported. However, adjustments to fair value are made only for the portion acquired by the parent. Noncontrolling interest is reported at book value, with no adjustments to market value.

Exhibit 1 summarizes the reporting under the three methods. From a conceptual standpoint, the economic unit and proportional views are more logically consistent than the parent company view. In addition, they are consistent throughout the reporting process. The economic view reports all assets and liabilities at their full fair value, reports the noncontrolling interest at fair value, and records any additional depreciation or amortization based on full fair value. The proportional method reports the percentage ownership of assets and liabilities at fair value, including adjustments for depreciation and amortization. Under this method, a noncontrolling interest is not reported.

The parent company view is not conceptually consistent. The approach reports all of the asset and liability book values, but makes market adjustments only for the portion acquired by the parent; none are made for the noncontrolling interest’s share. This partial adjustment is also reflected in the recognition of additional depreciation and amortization. The noncontrolling interest’s share is reported at book value, not fair value.

Existing GAAP

Current GAAP calls for the parent company method, which has been used for many years and was continued under SFAS 141. SFAS 141(R) will eliminate the parent company approach and adopt the economic unit method.

When consolidated financial statements are to be prepared, a consolidation worksheet is used to adjust the amounts reported on the parent’s and subsidiary’s books to reflect the appropriate amounts for the consolidated statements. These worksheet entries eliminate the parent’s investment account against the subsidiary’s equity accounts (to eliminate double-counting), recognize unrecorded assets, and revalue the subsidiary’s assets and liabilities to fair value. Exhibit 2 presents comparable consolidation worksheet entries under SFASs 141 and 141(R). The illustration assumes that the parent, in its books, records its investment account under the equity method.

The first entry eliminates the subsidiary’s beginning retained earnings and other equity account balances against the parent’s investment account (for its share), and it establishes a noncontrolling interest account for the remainder. The consolidated statements will reflect the subsidiary’s assets and liabilities, which are also reflected in the parent’s investment account. Eliminating the investment account eliminates the double-counting. This entry is the same in the revised standard.

The second entry recognizes the subsidiary’s unrecorded assets and liabilities, revalues items to fair value, and recognizes any goodwill. Under SFAS 141, asset and liability values are adjusted to fair value only for the parent’s percentage of ownership. These values are also used to recognize goodwill, which means that total goodwill is not recognized. Under the revised standard, adjustments to fair value are for the full amount, including the portion belonging to the noncontrolling interest. The full amount of subsidiary goodwill is also recognized.

The third entry adjusts the subsidiary’s depreciation and amortization to reflect the new asset and liability values. Under SFAS 141, this is for the revaluation based on only the parent’s share of ownership, while SFAS 141(R) recognizes additional expense based on full revaluation to fair value.

Next, the revised subsidiary net income (after the additional depreciation from the third entry) is offset against the parent’s investment account and the noncontrolling interest account for their respective shares. This entry eliminates double-counting of the subsidiary’s income because the consolidated statements will contain the subsidiary’s revenues and expenses. The amounts eliminated under the SFAS 141 and 141 (R) differ because the revised standard recognizes full fair value revaluations and related depreciation, not just the parent’s share of them.

Finally, the subsidiary’s dividends, if any, are eliminated against both the parent’s investment account and the noncontrolling interest accounts for their respective ownership amounts. The consolidated statements should reflect only the parent’s dividends. This entry will be the same under both approaches.

Example

Assume the following information regarding the subsidiary as of the date of acquisition, January 1, 2XXX:

 
Book value
Fair value
Difference
Nondepreciable assets $300,000 $370,000 $ 70,000
Depreciable assets $600,000 $800,000 $ 200,000
Liabilities $100,000 $100,000  
Common stock, no par   $700,000  
Retained earnings   $100,000  

Additional assumptions:

  • The difference in valuation of nondepreciable assets is due to the fair value of land exceeding its book value.
  • Depreciable assets have an average remaining life of 10 years.
  • The subsidiary’s net income for the year was $80,000, and it paid dividends of $10,000.
  • The parent purchased 80% of the subsidiary for $950,000, and there were no unrecorded assets or liabilities.
  • The market value of net identifiable assets on the acquisition date is $1,187,500.

Goodwill to be recognized. Goodwill is the excess of the purchase price over the fair value of identifiable net assets. Under SFAS 141, the fair value is considered to be only the parent’s share; under SFAS 141(R), the full fair value is recognized. Note that SFAS 141(R) makes some exceptions to fair value. These exceptions relate to areas where other standards require a different valuation. These areas are: 1) assets held for sale, 2) deferred tax assets and liabilities, 3) operating leases, and 4) employee benefit plans. As a result, the SFAS 141(R) total valuation may not equal the total value implied by the parent’s purchase price.

Given the illustration data and assumptions from above,
the calculation of goodwill under SFASs 141 and 141(R) is as follows:

SFAS 141

Parent’s purchase price                                                 $ 950,000
Book value of equity acquired:
    80% of common stock + retained earnings =
    80% of ($700,000 + $100,000)                               $ 640,000
Excess                                                                          $ 310,000

Adjust assets to fair value for parent’s share:

Nondepreciable: 80% of $70,000 = $ 56,000
Depreciable: 80% of $200,000 = $160,000                  $ 216,000
Goodwill                                                                       $ 94,000

SFAS 141(R)

Fair value of total net assets acquired                           $1,187,500
Fair value of subsidiary’s identifiable net assets:
(assets – liabilities)
$370,000 + $800,000 – $100,000                             $1,070,000
Goodwill                                                                     $ 117,500

In this example, asset and liability valuations are greater under SFAS 141(R) because they reflect full fair value, which also results in recognition of the full amount of goodwill.

Under SFAS 141(R), the amount of goodwill must then be allocated to the controlling and noncontrolling interests. The allocation process first assigns the parent its goodwill, and any remaining amount is attributed to the noncontrolling interest:

Fair value of parent’s 80% interest (purchase price) $950,000

Less: Parent’s share of fair value of identifiable
net assets 80% of $1,070,000                                   $856,000
Parent’s share of goodwill                                          $ 94,000
Total goodwill                                                           $117,500
Less: Parent’s share                                                  $ 94,000
Noncontrolling interest’s share                                   $ 23,500

Elimination Entries

Exhibit 3 illustrates the consolidation worksheet elimination entries under the existing and the revised standards. The first entry eliminates the subsidiary’s beginning equity against the parent’s investment account and establishes the noncontrolling interest account. This entry is the same under both standards.

The second entry under SFAS 141 revalues the assets for the parent’s share of the difference between book value and fair value and also recognizes the goodwill calculated above. The second entry under SFAS 141(R) revalues the assets for the full difference between book value and fair value and also recognizes the entity’s full goodwill.

The third entry records additional subsidiary depreciation based on depreciable asset revaluations: SFAS 141 ($160,000) and SFAS 141(R) ($200,000). These additional amounts are depreciated over the 10-year average remaining life of the assets.

The fourth entry eliminates the subsidiary’s adjusted net income against the parent’s investment account and the noncontrolling interest account in their respective share. Because only the parent’s share of the difference between book value and fair value is recognized under SFAS 141, the parent’s share of income is adjusted for additional depreciation, but the noncontrolling interest’s share is not adjusted. The parent’s share is 80% of the $80,000 reported subsidiary income, less the $16,000 additional depreciation. The noncontrolling interest’s share is its percentage of the subsidiary’s reported income, without adjustments for additional depreciation. Under SFAS 141(R), the full asset adjustment is made, resulting in additional depreciation of $20,000, and the adjusted net income of $60,000 ($80,000 – $20,000) is offset against the parent’s investment and the noncontrolling interest for their respective ownership percentages.

The last entry eliminates the subsidiary’s declared dividends of $10,000 against the parent’s investment account and the noncontrolling interest account for their respective shares.

Noncontrolling Interest

After the adjustments and eliminations, the noncontrolling interest under the two standards is shown in Exhibit 4.

The amount is larger under SFAS 141(R) because it includes full fair value adjustments. The difference between the two ($73,500) is equal to the noncontrolling interest’s share of the asset revaluation ($77,500), less its share of the additional depreciation [($200,000 ÷ 10 years) x 20% = $4,000]. The total amounts involved and the distribution between parent and noncontrolling interests are summarized in Exhibit 5.

Under the new standards, the noncontrolling interest must now be reported as part of equity rather than in the mezzanine between liabilities and equity. It is shown as the last item in the equity section.

Disclosure Requirements

SFAS 160 requires the following additional disclosures:

  • In the financial statements, the portion of consolidated net income and comprehensive income attributable to both the parent and the noncontrolling interest.
  • The amounts attributable to the noncontrolling interest for each of the following, if relevant—
  • income from continuing operations;
    • discontinued operations;
    • n extraordinary items; and
    • n components of other comprehensive income.
  • A reconciliation of the annual change in reported amounts of noncontrolling interest, including separate disclosure of the following—
    • consolidated net income attributable to noncontrolling interest;
    • investments by and distributions to noncontrolling interest; and
    • each component of comprehensive income.
  • A footnote schedule showing the effects of transactions with the noncontrolling interest on the equity attributable to the noncontrolling interest.

The standards will generally be applied retrospectively, including the disclosure requirements.

Benefits of the New Method and Approach

SFAS 141(R), effective for periods beginning on or after December 15, 2008, represents a conceptually more consistent method of consolidation and improves financial reporting by reflecting the economic unit concept. The method reflects FASB’s recent emphasis on the balance sheet rather than its traditional emphasis on the income statement. The new method recognizes all assets and liabilities of the acquired company and values them at full fair value. Generally, this will result in higher consolidated assets and noncontrolling interests. The new approach will better reflect the investment made by the parent, enhance financial statement comparability between companies, and provide more complete and relevant financial information. SFAS 160, also effective for periods beginning on or after December 15, 2008, specifies that noncontrolling interests are to be reported as part of equity and also provides enhanced related disclosures.


Vincent C. Brenner, PhD, CPA, is the Beights Professor of Accounting at Stetson University, DeLand, Fla.
Vincent C. Brenner, Jr., CPA, is managing partner of Breakwater Consulting, North Palm Beach, Fla.
Monica Jeancola, CPA,
is an instructor, also at Stetson University.

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 



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