Reporting Minority Interest
Beginning in the years 2008 and 2009, the Financial Accounting Standards Board (FASB) introduced a massive change to how minority interest was classified on the balance sheet by requiring companies to list minority interest under the shareholders' equity section and not the liabilities section where it had previously found its home.
This was a major shift in accounting policy and means that for annual reports and Form 10-K filings after this date, you'll need to look further down the balance sheet to find the minority interest section. It also means you'll need to be aware of this inconsistency when studying or analyzing older annual reports, as the minority interest section will appear as a type of debt.
While both positions can be justified (the old thinking was that minority interest was a liability that was "owed" to the minority stockholders; the new thinking is that the minority stockholders aren't owed anything, they own it, so it is appropriate to label it as an equity allocation), I believe the move to the equity section is a more intelligent presentation of economic reality.
How Minority Interest Works
The following real-world example demonstrates the workings of minority interest. Berkshire Hathaway is perhaps the most famous holding company in the United States, if not the world. This investment vehicle of billionaire Warren Buffett's has made minority interest a key strategic weapon in its never-ending quest for intelligent acquisitions.
Buffett will find an attractive business, often family-owned or controlled by a handful of people, and then offer to acquire at least 80 percent of the stock. The 80-percent number is important because this is the cutoff at which the current corporate tax rules in the United States mean that the acquired business will be treated as a fully-consolidated subsidiary and the parent holding company won't have to pay taxes on dividends from that subsidiary.
Once Berkshire Hathaway ccompletes its acquisition of 80 percent or more of a company's stock, any remaining minority stake in the hands of the noncontrolling stockholders has to be reflected in Berkshire Hathaway's financial statements. That is where minority interest comes into play.
Example: The Minority Interest of Nebraska Furniture Mart on Berkshire Hathaway's Balance Sheet
In 1983, Nebraska Furniture Mart in Omaha, Nebraska, was the most successful home furnishings store in the United States. Its gross annual sales exceeded $88.6 million and the company had no debt. After noticing how successful the furniture business was, fellow Omaha native Warren Buffett approached the owner, Rose Blumkin, and offered to buy the company from her.
Due to fights with her children and grandchildren, Rose leaped at the chance to sell the empire she had built from nothing. She had started with no money, had fled to the United States to escape the Nazis, and couldn't even read or write English even after becoming one of the richest women in her state.
The sale transaction would Blumkin to remain in charge of the business she loved, continue to hold a meaningful stake, and raise a large amount of cash for estate planning purposes. Almost immediately, she offered to sell 90 percent of the privately held Nebraska Furniture Mart stock to Berkshire Hathaway for $55 million.
The next day, Buffett walked into the store and handed her a check. This made NFM a partially-owned subsidiary of Berkshire. Since subsidiaries are controlled by their parent companies, accounting rules allow for them to be carried on the parent company's balance sheet. 1 When Berkshire Hathaway bought its 90-percent stake in Nebraska Furniture Mart, it was able to add the assets and liabilities of the furniture giant to its own balance sheet.
This accounting treatment presented a problem. Berkshire Hathaway could now consolidate Nebraska Furniture Mart's balance sheet with its own balance sheet, but, technically, it didn't own all of Nebraska Furniture Mart. Remember, Rose Blumkin sold 90 percent of her company, but she still retained the other 10 percent. That means that 10 percent of the ?current assets, inventory, property, plant, and equipment, and other assets belonged to her.
To adjust Berkshire's balance sheet to reflect this, Berkshire Hathaway had to calculate Rose's 10-percent share of everything and report it under the minority interest section of their balance sheet. Since this was before the 2008 and 2009 accounting rule changes, back then, minority interest was shown as a liability (debt) on Berkshire Hathaway's balance sheet.
Today, if you look at Berkshire Hathaway's balance sheet, among its many minority interests shown under the shareholder equity section are the shares of Nebraska Furniture Mart owned by Rose Blumkin's heirs. These days, Berkshire Hathaway owns 80 percent of Nebraska Furniture Mart and the Blumkin family owns 20 percent following the latter's decision to exercise an option to repurchase 10 percent of the company on top of the 10 percent they originally retained at the time of the acquisition.
When looking at the minority interest section of the balance sheet, it is unlikely management will offer detail on the specific firms in which minority interest is held. For that, you will need to investigate the legal structure of the parent business and find out exactly how much it owns of each subsidiary, then do some calculations to allocate the assets and liabilities based on ownership percentages.
1.) A company can integrate the balance sheet of its subsidiary if it owns 80% or more. It can report earnings of the subsidiary if it owns 20% or more.
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