Learning Outcomes
This article explains how to account for non-controlling interests in consolidated financial statements for CFA Level 2, focusing on recognition, measurement, presentation, and analytical interpretation. It clarifies when control exists and consolidation is required, distinguishes consolidation from the equity method and proportional consolidation, and shows how non‑controlling interests are reported in equity and on the income statement under IFRS and US GAAP. The article explains the acquisition method, the determination of fair value for identifiable net assets, and the calculation of goodwill using both full and partial goodwill approaches. It demonstrates how to compute non‑controlling interests in net assets and profit, and how these amounts flow through the consolidated balance sheet and income statement. It further analyzes how consolidation choices affect leverage, profitability, and return ratios, including ROE, ROA, margins, gearing, and EPS. Throughout, the emphasis is on performing exam‑style calculations, interpreting adjustments, and identifying common traps related to goodwill allocation, NCI measurement, and ratio comparability across firms.
CFA Level 2 Syllabus
For the CFA Level 2 exam, you are expected to understand the accounting and financial reporting effects of intercorporate investments and business combinations, with a focus on the following syllabus points:
- The classification, measurement, and disclosure of investments in financial assets, associates, and business combinations under both IFRS and US GAAP
- The distinction between significant influence and control for purposes of financial statement consolidation
- The methods and impact of non-controlling (minority) interests within consolidated financial statements
- The effects of each accounting method on reported assets, liabilities, income, and key ratios
- How the recognition of non-controlling interests affects financial analysis and comparability across firms
Test Your Knowledge
Attempt these questions before reading this article. If you find some difficult or cannot remember the answers, remember to look more closely at that area during your revision.
- When a parent company acquires less than 100% of a subsidiary, where is the non-controlling interest reported in consolidated financial statements?
- True or False? The equity method and proportional consolidation method treat non-controlling interests identically.
- How does the choice between full goodwill and partial goodwill methods affect reported equity and ratios?
- Briefly explain why consolidated revenues typically exceed the sum reported under the equity method.
Introduction
Business combinations and intercorporate investments are a common feature of corporate strategy and financial reporting. Understanding how investments are classified, consolidated, and presented is essential for accurate financial analysis. For the CFA Level 2 exam, you must be able to account for non-controlling interests, differentiate between significant influence and control, and evaluate the effects of consolidation choices on reported financial performance and ratios. This article covers the key rules, concepts, and exam techniques you need for reporting business combinations and non-controlling interests.
CONSOLIDATION AND NON-CONTROLLING INTERESTS
When a parent acquires control—typically through ownership of more than 50% of the voting shares—consolidated financial statements must be prepared. The consolidated statements combine 100% of the subsidiary’s assets, liabilities, income, and expenses with those of the parent, regardless of the percentage owned.
Key Term: consolidation
The process of combining the financial statements of a parent and its subsidiaries into a single set of statements as if they were a single economic entity.Key Term: non-controlling interest (NCI)
The portion of a subsidiary’s net assets and net income not attributable, directly or indirectly, to the parent company, but to other shareholders.
Non-Controlling Interest Recognition
When the parent does not own 100% of the subsidiary, the portion not owned by the parent—the non-controlling (minority) interest—must be reported. Under both IFRS and US GAAP, non-controlling interest appears as a separate component of equity on the consolidated balance sheet. On the consolidated income statement, it is deducted from the consolidated net income, with the residual net income attributable to the parent.
Acquisition Method and Goodwill
The acquisition method requires the parent to recognize 100% of the fair value of the subsidiary’s identifiable assets and liabilities. If the acquisition price exceeds the parent’s share of net assets, the difference is allocated to goodwill.
Goodwill can be measured using the full goodwill method or the partial goodwill method:
Key Term: full goodwill method
Goodwill is calculated as the excess of the total fair value of the subsidiary (including both parent and NCI shares) over the fair value of identifiable net assets.Key Term: partial goodwill method
Goodwill is measured as the excess of the purchase price over the parent’s share of the fair value of identifiable net assets acquired.
The choice between methods affects the amount of goodwill and the value of non-controlling interest recognized.
Calculation and Presentation
On the consolidated balance sheet, total assets and liabilities include 100% of the subsidiary’s items. Non-controlling interest is shown in equity. On the income statement, the full revenues and expenses are included, followed by a deduction for net income attributable to NCI.
Impact on Ratios and Analysis
Consolidation with non-controlling interests affects reported results and ratios:
- Sales, operating income, and total assets appear higher than under the equity method
- Return on equity may decrease due to the inclusion of minority equity (NCI) in the denominator
- Net profit margin and return on assets are diluted by the inclusion of the subsidiary’s less-than-fully-owned results
Investors and analysts must adjust ratios for NCI to make meaningful peers comparisons.
OTHER ACCOUNTING METHODS
When the investor does not have control, different investment models are used:
- Equity method (significant influence, typically 20–50% ownership): the investor records its proportional share of the associate’s net income and adjusts the investment account accordingly.
- Proportional consolidation (rare, used in joint ventures under some standards): both assets/liabilities and income/expenses are combined in proportion to ownership.
Key Term: equity method
Accounting method used when an investor has significant influence over, but not control of, an investee; the investor records its share of the investee’s net income and adjusts the carrying value of the investment accordingly.Key Term: proportional consolidation
An accounting method in which the investor combines its proportionate share of a joint venture’s assets, liabilities, revenues, and expenses line by line.
CONSOLIDATION: BALANCE SHEET AND INCOME STATEMENT COMPARISON
Under the acquisition method with consolidation, the financial statements differ significantly from those under the equity method:
- Consolidation includes 100% of subsidiary financial data, plus NCI.
- Equity method shows only the investor’s share of net income and an investment asset line.
Revenues, expenses, assets, and liabilities are higher under consolidation. Equity attributable to NCI is separately shown.
Worked Example 1.1
A parent acquires 80% of SubCo for $400,000. SubCo’s identifiable net assets are $450,000. The fair value of the non-controlling interest (20%) is $100,000. Calculate the goodwill and NCI on the consolidated balance sheet using the full goodwill method.
Answer:
- Goodwill (full): ($400,000 + $100,000) – $450,000 = $50,000.
- NCI: $100,000, reported within equity.
- On balance sheet: Assets and liabilities include 100% of SubCo’s, goodwill of $50,000, and NCI of $100,000 in equity.
Worked Example 1.2
Suppose a parent owns 70% of a subsidiary. The subsidiary earns $60,000 net income for the year. What is the NCI share of net income?
Answer:
- NCI share = $60,000 × 30% = $18,000.
- On consolidated statement: $18,000 subtracted as "attributable to non-controlling interest."
Exam Warning
Mixing partial and full goodwill methods is a common exam trap. Under IFRS, either method may be used. Under US GAAP, only full goodwill is permitted. The method selected affects both the amount of goodwill and the reported NCI.
CONSOLIDATION EFFECTS ON FINANCIAL ANALYSIS
Consolidated financial statements with NCI can distort intercompany comparison if not properly adjusted. Key impacts for analysis include:
- Sales, assets, and net income are increased under consolidation versus the equity method.
- Profit margins and return measures may be diluted.
- Gearing ratios (e.g., debt/equity) may differ due to higher equity (including NCI).
- EPS is based only on the parent’s share of earnings.
When benchmarking, adjust ratios to exclude NCI where necessary.
Worked Example 1.3
A parent company consolidates a subsidiary it owns 65% of, with NCI of $300,000. The group’s consolidated net income is $120,000. What is the profit attributable to the parent?
Answer:
- Parent’s share: $120,000 × 65% = $78,000.
- The $42,000 attributable to NCI will be deducted on the income statement, with $78,000 shown as "net income attributable to parent shareholders."
SUMMARY
- The acquisition method combines 100% of subsidiary financials with parent’s, regardless of ownership percentage.
- Non-controlling interest (NCI) is presented as a separate equity component, reflecting the portion of net assets and income not attributable to the parent.
- Full goodwill is allowed under both IFRS and US GAAP; partial goodwill is only permitted under IFRS.
- The presentation impacts key results and financial ratios.
- For analysis and exam purposes, ensure you correctly compute goodwill, NCI, and adjust ratios for NCI inclusion.
Key Point Checklist
This article has covered the following key knowledge points:
- Identify when to apply consolidation for business combinations.
- Explain non-controlling interest and how it appears in group accounts.
- Calculate goodwill using full and partial methods for NCI.
- Differentiate consolidation, equity, and proportional consolidation methods.
- Analyze consolidation effects on financial statements and key ratios.
- Perform ratio adjustments for NCI in consolidated analysis.
Key Terms and Concepts
- consolidation
- non-controlling interest (NCI)
- full goodwill method
- partial goodwill method
- equity method
- proportional consolidation