Tuesday, December 29, 2009

Jumps In Reported Equity

Investors who regularly update valuations of companies under their study will have noticed increased reported equity for many companies this year. This is not because companies have been particularly profitable, nor is this because a number of companies have issued new shares in a tepid capital market. Rather, it is simply the result of an accounting change to the treatment of minority interest.

Whereas most companies used to report minority interest as a liability, a new US GAAP accounting standard now requires companies to classify these line items as part of shareholder equity. As a result, shareholder equities of companies with consolidated subsidiaries not fully-owned have risen. Furthermore, to the extent that investors use P/B measures or screens, they will have to adjust book values for minority interests that are now incorporated as equity, but which the stockholder will not have financial rights to.

While the minority interest line item is separated on 10-Q and 10-K reports, this is often not the case for the more immediate 8-K updates. As an example, consider Best Buy (BBY). It recently reported its 3rd quarter results in an 8-K release, and shows equity (as a single line-item only) of $6.1 billion. At the beginning of the year, however, it reported equity of only $4.6 billion.

Unfortunately for shareholders, net income over the last nine months has not risen to such an extent so as to increase equity by 33%! Instead, the 8-K hides the fact that approximately $600 million of the equity is a minority interest, not belonging to the Best Buy shareholder.

While the accounting change seemingly puts investors at a disadvantage, there are benefits to the requirement that can be read about here. Nevertheless, to avoid inaccurate valuations, it is important that investors keep up with accounting changes of this nature. Accounting authorities around the world continue to work together to converge their standards; as such, further changes to US GAAP will continue, and investors must stay aware.

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