This weeks blog is a lift from one of my whats app exchanges responding to a student’s query. My responses are often voice notes – but on this occasion I composed a reply as I wanted to use numbers to make my point. I thought it deserved a wider audience.
The original question
Good morning, Tom I hope you had a lovely weekend. Please could you clarify why when NCI is measured as a proportion of net assets that the goodwill arising is only attributable to the parent company. I know this is true, but I just don’t quite understand why. Could you please explain?
Good question. Let me just reiterate. It is true that when NCI is measured as a proportion of net assets that the goodwill arising is only attributable to the parent company. The significance of this means that the impairment loss on the goodwill will only reduce retained earnings and none will be charge to the NCI. It also means when we are dealing with group exchange differences on the re translation of goodwill there will also be no impact for NCI.
Let me illustrate with numbers to prove the point.
Let’s take an 80% investment in a subsidiary that cost $200 and where NCI was measured as a proportion of the net assets which were $100.
The correct way to calculate goodwill is as follows.
Controlling interest / Parent’s investment (80%) 200
NCI as a proportion of net assets (20%) (20% x 100) 20
Less Net assets (100)
Goodwill attributable to the parent 120
However please consider the following explanation of how that $120 goodwill has arisen
The parent has paid $200 for the controlling interest in the subsidiary. It has paid $200 for an 80% stake in the $100 net assets of the subsidiary. So the parent has paid $200 and in return has only got a share of net assets of $80 (80% x $100). So when you compare what the parent paid ($200) with what the parent got ($80) we see that the premium that the parent has paid is $120. This goodwill therefore just belongs to the parent. (Read that again – it should make sense and there is no mention of the NCI at all).
I give you this explanation to give you absolute certainty that when NCI is measured as a proportion of net assets, the goodwill is attributable to the parents only. It still remains the case that where NCI is measured at fair value then the goodwill arising will be in full and so any impairment loss or exchange difference will impact the NCI accordingly. I urge you always to calculate goodwill the proper way to show the introduction of NCI however it is measured.