Accounting for a Redeemable Noncontrolling Interest

When a parent company owns more than 50% but less than 100% of a subsidiary, it consolidates the subsidiary’s financial statements. The portion of the subsidiary’s equity the parent does not own is known as a noncontrolling interest (NCI).

The accounting becomes more complex when the NCI has a redemption feature. This feature grants the NCI holder the right to sell their stake back to the parent company, or obligates the parent to buy it back, upon certain conditions. This characteristic transforms the NCI into a hybrid instrument with qualities of both equity and a financial liability. The potential for a future cash outflow to redeem the interest necessitates a specialized accounting approach under U.S. GAAP.

Defining Characteristics of a Redeemable Noncontrolling Interest

A standard noncontrolling interest’s value changes based on the subsidiary’s profits or losses and any dividends paid. This changes when the interest becomes redeemable.

An NCI is considered redeemable if it can be sold back to the parent company at the holder’s option or if its redemption is mandatory upon a specific event or on a set date. A common example is a put option, which gives the NCI holder the right to sell their shares to the parent at a predetermined price or a price based on a formula.

Other triggers can also make an NCI redeemable, such as the subsidiary failing to meet a performance target or not completing an initial public offering (IPO) by a certain deadline. In other cases, the redemption is unconditional and required on a fixed date. These conditions create an obligation for the parent that is not within its control, which is why distinct accounting rules apply.

Balance Sheet Classification and Presentation

Because the redemption feature means the capital may not be permanent, accounting standards under ASC 480 prohibit classifying it within permanent stockholders’ equity. The potential requirement for the parent to use its assets for settlement means it cannot be treated as a permanent part of the company’s equity.

At the same time, it is not always classified as a true liability. A liability is a present obligation, but the redemption of an NCI might be conditional on an event that is not certain to occur, such as meeting a performance target.

To address this, companies present redeemable NCIs in a separate section of the balance sheet between total liabilities and permanent equity. This category is often called “mezzanine equity” or “temporary equity,” signaling that the instrument has characteristics of both debt and equity.

Financial statement disclosures must provide clarity on these instruments. Companies are required to describe the redemption features, including the terms, price formula, and number of shares involved. The carrying amount of the redeemable NCI must also be disclosed, along with how it is being measured and adjusted over time, which allows investors to understand potential future cash obligations.

Initial and Subsequent Measurement

On the acquisition date, a redeemable NCI is recorded at its fair value, which is the price it could be sold for in an orderly transaction. This initial valuation establishes the baseline for all subsequent accounting adjustments.

After initial recognition, the carrying value of the interest is adjusted over time to its expected redemption amount through a process called accretion. The company determines the likely redemption payment and systematically increases the NCI’s balance sheet value to that amount over the period until redemption.

For example, if an NCI with an initial fair value of $15 million is redeemable in five years for $20 million, the $5 million difference is recognized over the five-year period. This is handled as an adjustment to retained earnings or income available to common stockholders, not directly through the income statement. Each year, the NCI’s carrying value would increase by $1 million.

This accretion adjustment ensures that the NCI’s carrying value equals its redemption price by the redemption date. The specific accounting for the periodic accretion charge can vary, but the chosen method must be applied consistently.

Impact on Net Income and Earnings Per Share

A redeemable NCI affects the allocation of net income and the calculation of earnings per share (EPS). The complexity arises in the calculation of EPS for the parent company’s common shareholders.

According to accounting standards under ASC 260, the periodic accretion used to increase the NCI’s carrying value is treated as a charge against the parent’s earnings for EPS purposes. This adjustment functions similarly to a preferred stock dividend.

The accretion amount is subtracted from the parent’s net income in the numerator of the EPS formula. This results in a lower figure for “income available to common stockholders” and a lower reported EPS.

The logic is that the accretion represents a return to the NCI holder that is satisfied before calculating earnings available to the parent’s common shareholders. This treatment is required even if the redemption is not certain to occur due to the potential for a future cash settlement that is outside the parent’s control.

Accounting for the Settlement of Redemption

When the parent company pays cash to redeem the NCI, the transaction is recorded as an equity transaction. This means it does not generate a gain or loss on the income statement.

Upon redemption, the redeemable NCI is removed from the balance sheet at its current carrying value, and the cash account is credited for the amount paid. Any difference between the cash paid and the NCI’s carrying value is recorded as a direct adjustment to the parent company’s additional paid-in capital (APIC).

For instance, if the NCI’s carrying value is $20 million but the parent pays $22 million to settle it, the $2 million difference reduces the parent’s APIC. If the parent settles the obligation for $19 million, the $1 million difference would increase APIC. This treatment keeps the transaction entirely within the equity section of the balance sheet.