Cost, Equity, and Consolidation Reporting Methods
How to Report Investment Interests
A minority interest is the proportion of a subsidiary company's stock not owned by its parent company. This is sometimes called a noncontrolling interest. The amount of interest held in the subsidiary is typically less than 50%; otherwise, the corporation would no longer be a subsidiary to the parent company. There are several possible ways that a minority interest might be reported for tax purposes.
For example, if Macy's Inc. purchased a portion of Saks Fifth Avenue, it stands to reason that Macy's would be entitled to that same portion of Saks' earnings. This raises the question of how Macy's would report its share of Saks' earnings on its income statement. The answer depends on the percentage of the company's voting stock that Macy's owns.
The Cost Method
The cost method is designed for situations when the investing company has a minority interest in the other company and it exerts little or no significant influence in the other company's affairs. Typically this is true for investing companies that own 20% or less of the investment, but a company that has less than 20% and still exerts significant influence would need to use the equity method (covered below).
Under this scenario, Macy's would not be able to report its share of Saks' earnings, except for the income from any dividends it received on the Saks stock. The asset value of the investment would be reported at the lower of cost or market value on the balance sheet.
This means that, if Macy's purchased 10 million shares of Saks stock at $5 per share for a total cost of $50 million, it would record any dividends received from Saks on its income statement. On the company's balance sheet, it would record $50 million under investments.
If Saks rose to $10 per share, the 10 million shares would be worth $100 million. Macy's balance sheet would be adjusted to reflect $50 million in unrealized gains, less a deferred tax allowance for the taxes that it would owe if it sold the shares.
On the other hand, if the stock dropped to $2.50 per share, this would reduce the investment's value to $25 million. The balance sheet value would be written down to reflect the loss of a deferred tax asset. This would reflect the deduction available to the company if it were to take the loss by selling the shares.
The income statement would never show the 5% of Saks' annual profit that belonged to Macy's. Only dividends paid on the Saks shares would be shown as dividend income (which is actually added to total revenue or sales in most cases). Unless you delved deep into the company's 10-K, you may not even realize that the Saks dividend income is included in total revenue as if it were generated from sales at Macy's own stores.
The equity method is meant for investing companies that exert significant influence over the other company while still retaining minority ownership. This will typically be the case for companies with between 21% and 49% of ownership, but in some cases, a company could own less than 21% and still have enough influence that it would need to use the equity method for reporting.
In most cases, Macy's would include a single-entry line on its income statement reporting its share of Saks' earnings. For example, if Saks earned $100 million and Macy's owned 30%, it would include a line on the income statement for $30 million in income (30% of $100 million), even if these earnings were never paid out as dividends. This is the case whether or not they ever actually saw $30 million.
The consolidated method only goes into effect when a company has a majority (controlling) interest in the investment. With this method, as the majority owner, Macy's would be required to include all of the revenues, expenses, tax liabilities, and profits of Saks on the income statement. It would then also include an entry that deducted the percentage of the business it didn't own.
For example, if Macy's owned 65% of Saks, it would report the entire $100 million in profit and then include an entry labeled "minority interest" that deducted the $35 million (35%) of the profits it didn't own.