Misleading Signals from Operating Cash Flow in the Presence of Non-Controlling Interests

Abstract

A non-controlling interest, also known as a minority interest, exists when a subsidiary is not wholly owned by the parent company. While a careful designation of income and equity attributable to non-controlling interests is made on the income statement and balance sheet respectively, under GAAP a similar attribution is not made on the statement of cash flows. As such, investors, analysts and other users of financial statements may be unaware that operating cash flow includes amounts attributable to both controlling and non-controlling interests, potentially leading to over-estimates of cash available for dividends to controlling interests.

In this study, for a sample of firms with significant non-controlling interests, we examine the amount and placement of distributions to non-controlling interests on the statement of cash flows. We find that while distribution amounts are significant, averaging 79.2% of income attributable to non-controlling interests, there is no reporting consistency for the distributions being made. In some instances, distributions are not even disclosed on the statement of cash flows. Recommendations for change to the reporting of distributions to non-controlling interests on the statement of cash flows are made to make their placement more consistent with the manner in which non- controlling interest in income is presently reported on the income statement.

Keywords: non-controlling interest, GAAP, cash flow, financial reporting

JEL Classification: M40, M41