Gengulphus wrote:The difference between the "whole thing as a going concern" and "sum of the parts" values is the general concept of 'goodwill', but that's not to be confused with the accounting concept, which only takes acquired goodwill into account - i.e. when a company acquires another, the difference between what the acquirer paid for it and what its identifiable net asset value is becomes accounting goodwill on the balance sheet, but when a company simply builds up its business organically, any resulting increase in its general-sense goodwill does not go on to its balance sheet. So essentially, the difference between net asset values on the consolidated and parent-company balance sheets is due to goodwill the direct subsidiaries have built up organically - though the issue is further complicated by the general fact that book values may well not be realistic current values...
Yes, maybe the penny is starting to drop. The value assigned to the purchased assets on the parents BS, relates to the actual sum exchanged, and hence includes the purchased thing's organic goodwill, whereas when the value of purchase is included in the consolidated sheet it is based on estimates of the working book value (which is very subjective), and if there is a remainder, this is bunged in the "accounting" goodwill column in the consolidated accounts to make the books balance. (Hmm... I definitely need to do some background reading on this sometime).
No, definitely not. "Estimates of the working book value (which is very subjective)" are not involved in producing accounting goodwill - they're occasionally involved in getting rid of it, but not in producing it. Let me give an extended example of how it works:
Company P wants to set up two businesses. It's uncertain about their prospects, and doesn't want its other businesses exposed to either of them going bust, nor either of them to be exposed to the other going bust. That sort of protection is the basic purpose of limited companies, so it sets up two limited companies S1 and S2, putting £5m into each and owning 100% of their shares. They each buy £2m of equipment, etc, employ a few staff and set about developing their businesses, retaining the remaining £3m cash to pay their staff and other costs until they can get their businesses going. At this point, company P's parent balance sheet has its shares in its subsidiaries S1 and S2 each down with a book value of £5m, and its consolidated balance sheet instead has the subsidiaries' book values consolidated in: non-cash assets with a book value of £2m and cash of £3m. Total £10m for the two on both balance sheets.
A couple of years go by while S1 and S2 get their businesses going, and as they've chosen a depreciation period of 4 years for the equipment, in that time half the book value of the subsidiaries' non-cash assets depreciates away, so now £1m each. Also, their expenditure on salaries, etc, has pulled their cash down to £1m each. Company P's shares in them still have a book value on its balance sheet of £5m each, as all is going to plan and P's directors reckon there's no need to treat them as having lost value: the £3m reduction in their non-cash assets is balanced by the fact that they are now going concerns and can easily be reckoned to be worth £5m as such. I.e. it's fair to reckon that they are still worth what they're on the books at. But company P's consolidated balance sheet instead consolidates in the subsidiaries' book values of their assets, and that's just £1m each for non-cash assets and £1m cash each. So the subsidiaries are on the parent company balance sheet for a total of £10m and the consolidated balance sheet for a total of £4m. No goodwill entry appears in the accounts: the fact that the directors reckon the subsidiaries are each worth £3m more of going-concern value than their identifiable asset value might be the general concept of goodwill, but it is not
recognised in the accounts, i.e. it is not the accounting concept of goodwill.
Over the next several years, the subsidiaries' businesses do very well, and they expand rapidly, ploughing all their profits back into the businesses. This includes buying a lot more equipment, much more than is needed to make up for their old equipment wearing out, becoming obsolete, etc (which is what depreciation of those assets is meant to roughly model in accounting terms, without the cost of having to re-value all the equipment every year), and so their non-cash assets expand a great deal, to say £10m each. Their cash doesn't rise, because although they're making good cash profits, they're spending them - not just on that increase in their equipment, but also in a bigger sales force, more stocks, etc - all things required to support their greater level of business. So their cash remains at £1m each. So by the end of that period, their identifiable assets are worth £11m each: the directors of their parent company P might reckon that each of them is easily worth £50m, i.e. another £39m of going-concern value, but that does not affect its balance sheets at all: the parent company balance sheet still shows them at their book value of £5m each; the consolidated balance sheet instead shows their non-current assets of £11m each. I.e. again, the general concept of 'goodwill' does not get reflected in the accounts at all.
By then, each of the subsidiaries has saturated its natural market, and can no longer make good use of all the cash profits it's making, so they have maybe £5m per year surplus profits each. Neither has an obvious new business area to break into, so their parent company P has them pay their profits (minus what's needed to replace worn out equipment, etc) out as dividends, which all go to P. As a result, the parent company balance sheet still has them at their book value of £5m each, but now has its cash rising at £10m per year from those dividends, specifically going up when each dividend is paid. The consolidated balance sheet instead still has the subsidiaries' assets at £11m each, now no longer rising as the new expenditure on them is merely balancing their deprecation. But its cash too is rising at £10m per year, though with a timing difference: the consolidated cash balance rises as the money comes into the subsidiaries and does not change when it is later paid to the parent as a dividend, because the rise in the parent's cash then is matched by the fall in the subsidiaries' cash.
While all that was going on, a different parent company Q happens to have been going through a very similar story with its subsidiaries T1 and T2. Around this time, though, Q develops an urgent need for a lot of cash and finds itself having to sell assets to get it. P has been wanting to get into the business areas of T1 and T2 for some time but hasn't been able to, e.g. because T1 and T2 hold patents on key technology in their areas. And so after some negotiation, P and Q agree that P will buy T1 and T2 off Q for £50m each. That improves Q's parent company balance sheet by removing T1's and T2's book values of £5m each from it and adding £100m cash to it (making a balance-sheet gain of £90m in the process), and Q's consolidated balance sheet by removing the £11m each of T1's and T2's assets from it and adding £100m cash to it (making a balance-sheet gain of £78m in the process).
But what about P's balance sheets? It's pretty clear that as far as its parent company balance sheet is concerned, its shareholdings in T1 and T2 have book values of £50m each, and the appearance of those book values on the balance sheet is balanced by the disappearance of £100m cash from it. This is the normal situation when a company buys an asset: the cash spent on the asset is the book value put down for it, so value shifts on the balance sheet from cash to it, but the two balance out and so there's no change to the total. The total may change afterwards, e.g. because an asset which will wear out is depreciated, but this is generally done according to fixed accounting rules and not by using the directors' opinions about what they are worth or trying to decide what it is valued at in any other way. This might well differ from the asset's real market value or value to the company - for instance, computer equipment is usually depreciated quite quickly, typically over three years, but when I was employed, I had a computer on my desk that was over 10 years old, would still have had some market value (though probably not a lot) and was still the best one I had for some tasks (though the more modern PC I also had on my desk was better for most jobs). It's only when an asset is professionally re-valued (typically for property assets, as they are held for long periods, typically rise in value over time, and are valuable enough for it to be worth an occasional professional valuation fee to get greater accounting accuracy), or has obviously suffered a bad loss of value (known as being 'impaired') that the book value is adjusted. Usually, it's only if and when the asset is sold that the balance sheet total is changed by the gain or loss between the sale proceeds and the asset's book value, as happened to Q's balance sheet values above (note that the increase in the value of its shareholdings of T1 and T2 from £5m each to £50m each will really have happened spread out over many years - but in balance sheet terms, it will have all appeared abruptly at the point of sale).
The same is generally true of the consolidated balance sheet, but purchases of companies (or of enough shares in a company to change a <= 50% holding to a > 50% holding, so that it becomes a consolidated subsidiary) are an exception. That's because the consolidated balance sheet 'looks inside' subsidiaries to see their underlying assets. So what happens when P buys T1 and T2 off Q is that £100m of cash comes off P's consolidated balance sheet and only two lots of £10m non-current assets and two lots of £1m cash go on to it - and if that were all that happened, its total would therefore drop by £78m. That's when the accounting concept of goodwill comes into play. It basically assumes that because P's directors were willing to actually pay
£39m above the identifiable asset value of each of T1 and T2, and not just say they thought
they had that much extra going-concern value, that they really do each have that much extra going-concern value, and so the consolidated balance sheet also has £39m each of goodwill added to it, neatly making the additions to and subtractions from it balance out, so that as for any other purchase, purchases of subsidiaries don't themselves change either balance sheet value (though what happens subsequently to the purchased asset might well do so).
Some years later, it becomes clear that while S1's and T1's businesses are still going strong, S2's and T2's businesses are now declining, and the directors conclude that they cannot be revived, only have that decline managed (for example, it might be that competitors have invented far superior products for the needs addressed by S2's and T2's products, have managed to get patent protection for those inventions that the directors feel cannot be effectively challenged, and are asking far more to license the patents than the directors feel they can economically pay). As a result, S2 and T2 are clearly no longer worth anything like as much as the £50m each that they were - maybe only £15m each. As far as P is concerned, its shareholdings in S2 and T2 are on the parent company balance sheet with book values of £5m and £50m respectively. They reckon the shareholding in S2 is still worth at least about book value, but that in T2 is now clearly worth much less than book value, and so they impair the book value of T2 by £40m from £50m to £10m. The consolidated balance sheet has £1m cash and £10m book value of non-cash assets other than goodwill for each of them, and additionally has £39m of goodwill for T2, so no change happens to it for S2's clearly reduced value, but T2 clearly no longer has anything like as much going-concern value as it once had, so they declare the goodwill to be impaired and take its book value down to £4m (or indeed they might write it off entirely to reduce the risk of having to declare further impairments in future years). Such impairments (or complete write-offs) is the one circumstance in which the directors' opinions on the value of goodwill (or indeed other assets) are taken into account, and they generally reduce book values rather than increase them - and they are done fairly formally, not casually. In particular, companies with goodwill on their balance sheets are required to do an annual goodwill impairment review.
As they manage the subsequent decline of S2 and T2, there will probably be further balance sheet changes. For example, both ought to run down their stocks as the decline continues, so the £10m of non-cash assets other than goodwill for each of S2 and T2 will probably drop - and if the decline happens too fast to be able to use all the stocks, some of them are likely to have to be written off. But I think I've covered all the main points by now, so I'll stop the example at this point!
I should also say that I only intend the example as a broad-brush picture, to illustrate the basic principles without going into huge amounts of detail. That's partly because some of the detail will just obfuscate that broad-brush picture (for instance, that there's generally a lot more items on balance sheets than the few I've actually mentioned) and partly because I don't actually know anything like all the detail of the accounting rules (so I cannot guarantee that there aren't any exceptions to what I've said in various special circumstances...).
Finally, to relate this to your original question about minority interests, you might try working out how things go if each of the four subsidiaries S1, S2, T1 and T2 was actually started in response to someone external having invented a product and patented the invention approaching P or Q for help with bringing the invention to market, and the subsidiaries being set up as a result of agreements by which the company would put £10m and the inventor their invention into the company, getting 80% and 20% respectively of its shares in return, and the inventors having resisted subsequent attempts by the company to buy out their 20% minority shareholdings.