Cost, Equity, and Consolidation Reporting Methods

How to Report Investment Interests

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A minority interest is the portion of a company's stock that is not owned by its parent company. This is also sometimes called a "noncontrolling interest." The amount of interest held in the subsidiary, or "controlled," company is often less than 50%. If it weren't, the company would no longer be a subsidiary of the parent company.

There are several ways that a minority interest might be reported for tax reasons. For instance, if Macy's Inc. were to buy 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's earnings on its income statement. The answer depends on the amount of the company's voting stock that Macy's would own.

Key Takeaways

  • There are several ways that a company might report a minority interest in another firm for tax purposes.
  • If the company owns 20% or less of the other company, it will use the cost method, which reports dividend income and the asset value of the investment.
  • If the company owns more than 20%, it will use the equity method, which reports its share of the firm's earnings.
  • The consolidated method includes all revenue and liabilities but goes into effect only when a company has a majority interest in the investment.

The Cost Method

The cost method is used when the investing company has a minority interest in the other company, and it has little or no power over the other company's affairs. Often this is true for investing companies that own 20% or less of the other company.

A firm that owns less than 20%, but still exerts a lot of control, would need to use the equity method (see below).

Example

In this scenario, Macy's would not be able to report its share of Saks's earnings, except for the income from any dividends it received on the Saks stock. The asset value of its shares would be reported on the balance sheet at cost or market value, whichever were lower. Accordingly, if Macy's were to buy 10 million shares of Saks stock at $5 per share for a total cost of $50 million, it would record any earnings it received from Saks on its income statement. On its balance sheet, Macy's would record $50 million under investments. 

If Saks stock were to rise to $10 per share, the 10 million shares would be worth $100 million. Macy's balance sheet would be changed to reflect $50 million in unrealized gains, less a deferred tax allowance for the taxes that it would owe if it were to sell the shares.

On the other hand, if the stock were to drop to $2.50 per share, the value would reduce to $25 million.

The balance sheet value would be written down to reflect the loss of a deferred tax asset, which would reflect the deduction the company could claim if it were to take the loss by selling the shares.

The income statement would never show the 5% of Saks's yearly profit that belonged to Macy's. Only dividends paid on the Saks shares would be shown as dividend income. That is added to total revenue or sales in most cases. Unless you were to look deep into the company's 10-K, you might not even realize that the Saks dividend income is included in total revenue as if it came from sales at Macy's own stores.

The Equity Method

The equity method is meant for investing companies that hold a great deal of power over the other company while owning a minority stake, as is often the case for firms with between 21% and 49% of ownership. In some cases, a company could own less than 21% and still have enough control that it would need to use the equity method to report it.

In most cases, Macy's would include a single-entry line on its income statement reporting its share of Saks's earnings. For example, if Saks were to earn $100 million, and Macy's were to own 30%, it would include a line on the income statement for $30 million in income (30% of $100 million).

Macy's would report its share of Sak's earnings even if these earnings were never paid out as dividends, and whether or not Macy's ever actually saw $30 million.

The Consolidation Method

The consolidated method only goes into effect when a firm has a controlling stake in the other firm. With this method, as the majority owner, Macy's must 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 portion of the business it didn't own.

For example, if Macy's were to own 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.