In the Schweser Notes (Book 2, pp 79):
“In the case wehre the parent owns less than 100% of the subsidiary, it is necessary to create a concontrolling (minority) interest account for the proportionate share of the subsidiary’s net assets that are not owned by the parent.”
It seems counter-intuitive that I would have to add the proportion of the company that the parent doesn’t own in its financial statements. Can anybody explain the rationale for doing this?
Hi. Consider the following scenario. Parent Co. buys 100% of the shares in a business which has the following asset and liabilities (stated at fair values):
The fair value of the net assets of the newly acquired subsidiary is therefore 12 (10 +4 - 2)
If the purchase price is set at 12 (equal to the fair value of the net assets of the subsidiary) then no goodwill arises on the transaction and the acquisition is reflected in the consolidated financial statements of the group (which now includes the new subsidiary) as:
GROUP ASSETS: property: up by 10 (from the subsidiary) trade receivables: up by 4 (from the subsidiary) cash: down by 12 (the purchase price paid by the group to the subsidiary’s previous owners)
GROUP LIABILITIES: trade payables: up by 2 (from the subsidiary)
Please note that the net change in group assets (10 + 4 - 12 = 2) is equal to the increase in group liabiliities, meaning that the post-acquisition balance sheet balances 
Now consider the same data but assume that Parent Co. buys just 75 % of the shares in the other business and pays 75% of the previously identified price, i.e. 9 (75% x 12).
In the consolidated balance sheet, the assets and liabilities of the newly acquired business would be included at 100% of their fair values, so we would see:
GROUP ASSETS: property: up by 10 (from the subsidiary) trade receivables: up by 4 (from the subsidiary) cash: down by 9 (the purchase price paid by the group to the subsidiary’s previous owners, who now become minority shareholders)
GROUP LIABILITIES: trade liabtrade payables: up by 2 (from the subsidiary)
Please note that the net change in group assets (10 + 4 - 9 = 5) is NOT equal to the increase in group liabiliities. The difference, 3, is equal to the share of the subsidiary’s net assets that are not owned by the parent (25% of 12, which was composed of property 10 PLUS trade receivables 4 LESS trade payables of 2).
In order for the post-acquisition group balance sheet to balance we need to stick this missing 3 in EQUITY as non-controlling or minority interest.
You should realise that the appearance of this item is the direct consequence of the subsidiary’s assets and liabilities being shown in the conslidated balance sheet at 100% of their values even when the parent company owns less than 100% of the shares (and therefore pays an appropriately lower acquisition/purchase price). The assumption is - even at 75% I control the subsidiary, so I also exercise control over 100% of that subsidiary’s assets and liablities and therefore show them at full values in the group financial statements. If that is the case, the balance sheet simply would not balance without the addition of the minority interest line.
I hope this rather lentghy explanation proves helpful.
Wojtek in that second example if you paid 12 for 75% of the company the difference in the result would be only cash -12, goodwill +3, and minority interest would still be 3 ?
Yes, goodwill would still be 3. Great write-up Wojtek, I had no idea the Polish were such kind people.
LOL!
Also, Wojtek is so handsome in that LinkedIn profile picture. Combine benevolence with hot looks and you have a winner on your hands.
oh guys
elcoelhon, as Babbabooey confirmed, under your scenario we would still get minority interest of 3 and goodwill of 3 as well.
However, note that the Level curriculum requires you to know two different approaches to computing goodwill (full and partial method) which give different results for goodwill and the level of minority interest as well.
Without additional data about the actual fair value of the non-controlling interest, we would need to measure it as was done in the scenario, i.e. at the minority’s share of the subsidiary’s net assets (partial goodwill method) - 25% x 12 = 3.
Very Nice explanation Wojtek! i was having a lot of issues to understand why we must have minority interest, now it seems so simple! thanks.
Super helpful! Thank you.