New rules that change the way companies account for minority interests in their financial statements will have a small — yet measurable — effect on reported income and debt ratios, says a new study. And some industries and individual companies will see significant changes, according to the report, issued by Georgia Tech’s Financial Analysis Lab.
A minority interest is the portion of a controlled subsidiary that is owned by someone other than the parent company. Because the parent is deemed to control the subsidiary, it must consolidate the subsidiary’s financial statements into its own.
The new rules — FAS 160 (Noncontrolling Interests in Consolidated Financial Statements) and FAS 141(R) (Business Combinations) — go into effect for fiscal years beginning after December 15, 2008. FAS 160 will require companies that currently record minority interests in the mezzanine section of the balance sheet (sort of limbo between liabilities and equity) to record them as stockholders’ equity instead. Meanwhile, FAS 141(R) will require minority interests to be measured at fair value on the date of acquisition, instead of being carried at historical cost on the books of the buyer.
The practical effect of the fair-value change, according to study authors Charles Mulford and Erin Quinn, is that for most acquisitions, minority interest in equity will be represented by a larger value. In turn, that bumped-up value will drive up shareholders’ equity. The report does not calculate the fair-value effect because the researchers used reported minority interest values from 2006 and 2007, and did not have the data necessary to revalue them at fair value.
However, the researchers did record the effects of FAS 160. Indeed, Mulford explains that by moving minority interests out of the mezzanine section, a company will get an immediate hike in equity, making measures of leverage look better. In other words, the increase in equity will make the balance sheet appear lighter — as if the company can afford to take on more debt because it has more equity and therefore more net worth, says the accounting professor.
The study examines the financial statements of 876 public companies, 506 of them listed on the New York Stock Exchange. The authors underscore four major findings, two related to the size of minority interest on the balance sheet and income statement, and the other two focused on changes to ratios that are likely to appear in debt covenants.
If FAS 160 had been in effect, shareholders’ equity for the group would have increased 2 percent on average, though 10 percent of the companies would have seen an increase of more than 25 percent. Income from continuing operations would have been increased by 3 percent overall, with 12 percent of the companies experiencing, again, more than a 25 percent increase.
The industry most affected by the inclusion of minority interest in shareholders’ equity is the financial-services sector: of the 228 companies in that sector, 35 reported an increase of more than 25 percent. The energy sector was the next-most affected, with 18 of the 68 companies covered registering a bump of more than 25 percent.