Chapter 11: Non-controlling interest

Non-controlling interest is defined as “the equity in a subsidiary not attributable, directly or indirectly, to a parent” . Non- controlling interest arises only where an acquirer acquires less than 100% of an acquiree – a partial acquisition.

Measurement of non-controlling interests

Non-controlling interests in the acquiree, that are present ownership interests and entitle their holders to a proportionate share of the entity’s net assets in the event of liquidation, can be measured in a business combination in one of two ways. The choice is available on a businesscombination-by-business-combination basis. Such non-controlling interest can be measured at either:

• fair value (the ‘fair value method’); or
• the present ownership interests’ proportionate share of the acquiree’s net identifiable assets (the ‘proportionate share method’).

All other components of non-controlling interest (NCI), including those that are not present ownership interests (for example, warrants), are measured at fair value, unless another measurement basis is required by IFRS. For example, equity-settled share-based payments are future ownership interests that are required to be measured in accordance with IFRS 2.

Determining the fair value of the NCI in transactions where not all of the outstanding ownership interests are acquired might present certain challenges to acquirers. The consideration transferred for the controlling interest on a per-share basis might be an indication of the fair value of the NCI in most, but not all, circumstances. An acquirer might be able to measure the acquisition date fair value of the NCI based on a quoted price in an active market for the equity shares not held by the acquirer. Where a quoted price for the equity shares is not available, the fair value of the NCI is established through other valuation techniques and methods.

Determining the impact of control on the non-controlling interest

The price paid for the controlling interest will generally represent the fair value of the consideration transferred on a control basis. The fair value on a per-share basis for the acquirer’s interest and the NCI might differ. The main difference might be a premium or discount in the per-share fair value. Market participants could take into account a control premium in the per-share fair value of the acquirer’s interest in the acquiree or, conversely, a discount for lack of control in the per-share fair value of the NCI, when pricing the NCI. The discount for lack of control is also referred to as a non-controlling interest discount.

Measurement of non-controlling interest

Where the non-controlling interest is measured at fair value, it is recognised at an amount that includes the non-controlling interest’s goodwill. Goodwill is the residual of the elements of a business combination.

Therefore, where non-controlling interest is measured at fair value, goodwill includes the non-controlling interest’s share as well as the parent’s share. Where the non-controlling interest is measured at its proportionate share of the acquiree’s net identifiable assets, total goodwill does not include any amount related to the non-controlling interest. These two bases are illustrated in the following diagram:

An entity might consider the following points when it decides whether or not to measure non-controlling interest (NCI) at fair value:

Notes:

* Assuming that the consideration paid for the purchase of the NCI is greater than its carrying amount.

** The frequency of goodwill impairments is not affected by how NCI is measured, only the amount, because goodwill is grossed up for impairment testing purposes when NCI is measured at the proportionate share of net assets. The amount charged to the parent entity’s share of income is the same – the additional amount charged, where NCI is measured at fair value, will be included in the amount of profit or loss allocated to the NCI on the income statement.

Measurement of non-controlling interest in a business combination including preference shares

Entity B has issued 1,000 common shares and 100 preference shares (nominal value of C1 per preference share). The preference shares are appropriately classified within equity. The preference shares give their holders a right to a preferential dividend in priority to the payment of any dividend to the holders of common shares. On liquidation of entity B, the holders of the preference shares are entitled to receive C1 per share in priority to the holders of the common shares. The holders of the preference shares do not have any further rights on liquidation. Entity A acquires 800 common shares of entity B, resulting in entity A controlling entity B. The acquisition-date fair value of a preference share is CU1.2 per share. How should entity A measure the non-controlling interest including preference shares?

Analysis

Entity A can choose to measure the non-controlling interest that relates to the 200 common shares either at fair value or at the proportionate share of entity B’s identifiable net assets. The non-controlling interest, including preference shares, that relates to entity B’s preference shares should be measured at fair value. The preference shares do not entitle their holders to a proportionate share of entity B’s net assets in the event of liquidation. Entity A must measure the preference shares at their acquisition-date fair value of CU120 (100 preference shares × CU1.2 per share).

Impact of control on the measurement of noncontrolling interest

A control premium generally represents the amount paid by a new controlling shareholder for the benefit of controlling the acquiree’s assets and cash flows. The elements of control derived by an acquirer can be categorised as:-

(i) benefits derived from potential synergies that result from combining the acquirer’s assets with the acquiree’s assets, and

(ii) the acquirer’s ability to control the acquiree’s operating, financial or corporate governance characteristics. Synergies will often benefit the acquiree, including the noncontrolling interest (NCI).

However, the NCI shareholders will not benefit from the synergies that benefit the acquirer, because the controlling shareholder might not decide to distribute dividends or might control the profits of the acquiree. Entities should assess whether the consideration transferred includes a control premium and whether part or all of the control premium should extend to the NCI. To derive a non-controlling interest value from a controlling interest value, consideration of a non-controlling (minority interest) discount might be necessary.

Entities should not mechanically apply a non-controlling discount to a controlling interest without considering whether the facts and circumstances related to the transaction indicate that a difference exists between the controlling and non-controlling values. When the existence of a control premium is being assessed, it is helpful to understand how the negotiations between the acquiree and acquirer evolved – for example, if multiple bidders were involved in the negotiations, the factors that were included in determining the amount of consideration transferred. Additionally, understanding the significant issues that were subject to the negotiations, and how they were eventually resolved, will provide valuable insight into determining the existence of a control premium.

Calls and puts related to non-controlling interest

The acquirer might have the right to purchase the non-controlling interest (that is, a call right), or the NCI holder might have the right to sell its interest (that is, a put right) to the acquirer. These rights to purchase or sell the NCI might be at a fixed or variable price, or at fair value, and might be exercisable on a fixed date or at any time in the future.

The existence of these rights impacts

• whether separate assets or liabilities should be recognised for these rights,
• the recognition or derecognition of any NCI, and
• the amount of profit or loss recognised in the financial statements. The amount of goodwill might be affected by puts and calls where they are written as part of a business combination and the NCI is measured using the proportionate share method.

Non-controlling interest in a reverse acquisition

In some reverse acquisitions, some of the legal subsidiary’s owners do not exchange their equity instruments for the legal parent’s equity instruments. Those owners are treated as NCIs in the consolidated financial statements prepared after the reverse acquisition, even though the legal subsidiary is treated as the acquirer. The legal subsidiary’s owners that do not exchange their equity instruments for the legal parent’s equity instruments have an interest only in the legal subsidiary’s results and net assets, and not in the combined entity’s results and net assets.

The NCI reflects the NCIs’ proportionate interest in the precombination carrying amounts of the legal subsidiary’s net assets.

Choice of measurement at the acquisition date for components of non-controlling interests that are present ownership interests

IFRS 3 states that the choice of measurement basis is available for each business combination. The Basis for Conclusions reiterates that this choice is available on a transaction-by-transaction basis. [IFRS 3:BC216] IAS 8 requires that when specific guidance is available in another Standard, that guidance overrides the requirements of IAS 8:13 to select and apply accounting policies consistently for similar transactions, other events or conditions. There is no requirement within IFRS 3 to measure components of NCIs that are present ownership interests on a consistent basis for similar types of business combinations and, therefore, an entity has a free choice between the two options for each transaction undertaken.

The Board decided to restrict the scope of the measurement choice available under IFRS 3:19 because of concerns that allowing components of NCIs other than those that are present ownership interests to be measured by reference to the net assets of the acquiree might result in inappropriate measurement of those components in some circumstances. Without this restriction, if the acquirer chose to measure an NCI at its proportionate share of the acquiree’s identifiable net assets, the acquirer might have measured some equity instruments at nil. In the Board’s view, this would result in not recognising economic interests that other parties have in the acquiree.

Measuring non-controlling interests at the acquisition date — goodwill recognised in a subsidiary

When measuring components of NCIs that are present ownership interests at the proportionate share of the acquiree’s identifiable net assets, an entity should not take into account any goodwill recognised in the acquiree’s own financial statements. The NCI is calculated as the proportionate share of the acquiree’s identifiable assets and liabilities that satisfy the recognition criteria at the acquisition date. Any pre-existing goodwill recognised in the acquiree’s financial statements is ignored because goodwill is not an identifiable asset.

In accordance with IFRS 3:19, in the consolidated financial statements of the acquirer, some of the acquiree’s equity instruments will, depending upon their terms and conditions, be required to be measured at fair value (or using the principles of IFRS 2 in some cases) and be treated as a component of NCIs. This may include instruments such as preference shares, options and multiple class shares held by parties other than the acquirer. It will not be acceptable to use a ‘historical’ or nil measure for these types of instruments.

Legal obligation to launch a takeover bid

Question:

An entity acquires a controlling interest in a listed entity. The entity is obliged, by local law, to launch a takeover bid for the remaining shares. Is the entity required to recognise a financial liability for this obligation under IAS 32, or a provision under IAS 37?

Solution:

No. A financial liability arises from the existence of a contractual obligation of one party to the financial instrument (the issuer) to deliver cash to the other party (the holder). [IAS 32 para 17]. A statutory requirement to launch a takeover bid is a legal obligation but not a contractual obligation. As regards IAS 37, the legal requirement to launch a takeover bid gives rise to an obligation to exchange one asset (such as cash) for another (such as shares in the acquiree), and so it is executory in nature. Contracts that are executory in nature are excluded from the scope of IAS 37. Accordingly, neither IAS 32 nor IAS 37 requires a liability to be recognised, unless onerous. However, recognising the acquisition and a financial liability for the amount of the offer as linked transactions is an acceptable approach. This reflects that an outflow of economic benefits in relation to the mandatory tender offer is expected. Furthermore, this matter was discussed by the Interpretations Committee and the IASB in May 2013. Whilst no conclusion was reached, it was observed that the obligation to launch a takeover bid is economically similar to a put option written on a non-controlling interest. It follows that recognising a liability in the manner similar to that recognised for a put option written on a non-controlling interest under IAS 32 would provide relevant information to the users of the financial statements. Management should disclose the accounting treatment adopted and, where a liability is recognised, the nature of the liability and how it is measured.

Emission rights acquired in a business combination

Emission rights acquired in a business combination – example

Entity A acquires Entity B. Entity B’s accounting policy is to adopt the ‘net liability’ approach for the recognition of emission rights. Entity B has been granted emission rights by the government for no charge and, at the acquisition date, it holds emission rights in excess of actual emissions made. Accordingly, no asset or provision is recognised in the financial statements of Entity B in respect of emissions.

On acquisition, Entity A’s consolidated financial statements should include the emission rights held by Entity B as an asset and should include a separate provision for the actual emissions made as at that date. Both the asset and the provision should be recognised at fair value, in accordance with IFRS 3. The ‘net liability’ approach may not be applied in the consolidated financial statements; instead, the consolidated financial statements should thereafter reflect an expense for actual emissions made from the date of acquisition until the end of the reference period.

Fair value at acquisition date should be measured by reference to an active market for emission rights or, if no active market exists, on a basis that reflects the amount that would have been received to sell the rights in an orderly transaction between market participants, based on the best information available.

Non-controlling interest in a reverse acquisition:  Reverse acquisition with a non-controlling interest

Entity B, a large unlisted business, has combined with entity A, a small, listed business. Before the combination, entity A had 100 shares in issue, which were widely held. Entity B had 60 shares in issue, held by the B family. The combination was designed to provide entity B with a stock exchange listing. The combination was accomplished through entity A issuing 2.5 new shares in exchange for each ordinary share of entity B. B’s shareholders exchanged 54 shares for those of entity A.

Entity A, therefore, issued 135 ordinary shares in exchange for 54 of entity B’s ordinary shares. The transaction is a reverse acquisition since entity B’s shareholders own 135 out of 235 shares in entity A (57.4%). Entity A’s shareholders own 100 out of 235 shares (42.6%).

Entity B can nominate the board of directors and to control entity A. The six shares that remain outstanding in entity B would continue to have voting rights, but only as non-controlling interest holders. Entity B is the accounting acquirer, but there is a non-controlling interest, because the holders of six shares in entity B did not take part in the exchange transaction. They have no interest in the combined entity; their interest is limited to entity B. In entity A’s consolidated financial statements, the non-controlling interest is 10% (6/60 issued shares of entity B).

The non-controlling interest should reflect the non-controlling interest shareholders’ proportionate interest in the pre-combination carrying amounts of the legal subsidiary’s net assets. Entity B is the accounting acquirer, so its assets remain at their pre-combination carrying amounts, and the non-controlling interest is 10% of the pre-combination carrying amount of entity B’s net assets.

The fair value of the consideration that is effectively transferred is the same, whether a non-controlling interest exists or not, because all of the shareholders of the legal parent (accounting acquiree) participate in the exchange.

Business combinations achieved without consideration transferred

Where a business combination occurs through contract alone, without consideration transferred, the acquirer attributes the acquiree’s net assets recognised to the owners. Any equity interests held by parties other than the acquirer are an NCI. In extreme cases, where all of the equity interests are held by a party other than the acquirer, this means that all of the acquiree’s equity is attributed to the NCI.

Measurement of non-controlling interest in a business combination achieved by contract alone

The measurement of non-controlling interest will determine whether or not goodwill is recognised in a combination by contract alone. Consider the following example. Entities A and B decide to combine to form a dual-listed entity (DLE).

Both entities will retain their original listing, but they will have the same board of directors. Entity A is the larger entity, and its shareholders will receive 55% of the DLE’s profits. The board will comprise four entity A members and three entity B members. The fair value of entity A is C62.3 billion; the fair value of entity B is C49.3 billion. The IFRS 3 value of entity B’s identifiable net assets is C38.5 billion.

How is the business combination accounted for? Non-controlling interest is measured at fair value

Entity A is determined to be the acquirer. Goodwill is the difference between 1 and 2 below: 1 the aggregate of: (i) consideration transferred; (ii) any non-controlling interest; (iii) the acquirer’s previously held interest; and 2 The IFRS 3 value of net identifiable assets. Accordingly, the amounts are as follows:

1             (i) nil;

(ii) C49.3 billion;

(iii) not applicable; and

2             C38.5 billion.

Goodwill of C10.8 billion is recognised in a combination achieved by contract alone, where the non-controlling interest is recognised at fair value. Non-controlling interest is measured at proportionate share of net assets Entity A is determined to be the acquirer. Goodwill is calculated as above, being the difference between 1 and 2 below: 1 (i) nil; (ii) C38.5 billion; (iii) not applicable; and 2 C38.5 billion.

No goodwill is recognised in a combination achieved by contract alone, where the non-controlling interest is measured at its proportionate share of net assets.