Non-Current Method, Features, Advantages, Challenges

Non-Current Method is an approach used in the translation of financial statements of foreign subsidiaries when preparing consolidated accounts for the parent company. This method is rooted in the idea that different types of financial statement items should be translated at different exchange rates, depending on their nature and duration. It is less commonly used today, having been largely replaced by the Temporal Method and the Current Rate Method under modern accounting standards such as IFRS and US GAAP. However, it remains an essential concept for understanding historical translation practices and the evolution of accounting methods.

Features of the Non-Current Method

1. Translation Basis:

   • Non-current assets and liabilities (e.g., property, plant, equipment, long-term debt) are translated at the historical exchange rate, which is the rate in effect when the items were acquired or incurred.
   • Current assets and liabilities (e.g., cash, accounts receivable, accounts payable) are translated at the current exchange rate, which is the rate prevailing at the reporting date.

2. Income Statement Translation:

   • Revenue and expenses related to current assets and liabilities are translated at the average exchange rate for the reporting period.
   • Expenses associated with non-current assets (e.g., depreciation, amortization) are translated at the historical exchange rate.

3. Equity Items:

   • Equity components such as common stock and retained earnings are translated at historical rates.
4. Currency Translation Adjustment:

Translation differences arising from the use of historical rates for non-current items are included in the income statement rather than as a separate adjustment in equity.

When is the Non-Current Method Used?

The Non-Current Method is applied in scenarios where:

1. The foreign subsidiary is considered an extension of the parent company rather than an independent entity.
2. The parent company exerts a high level of operational and financial control over the foreign subsidiary.
3. Historical accounting standards or specific regulatory requirements mandate its use.

Advantages of the Non-Current Method

• Emphasis on Control:

By reflecting historical rates for long-term items, the method reinforces the notion that non-current items are influenced by the parent company’s policies and long-term strategies.

• Connection to Historical Costs:

Translating non-current items at historical rates preserves their original cost, aligning with traditional accounting principles.

• Relevance for Certain Relationships:

Useful when the foreign subsidiary’s operations are highly integrated with the parent company, justifying the emphasis on historical rates.

Challenges of the Non-Current Method

• Lack of Market Relevance:

By using historical rates for non-current items, the method fails to reflect the current market value of assets and liabilities, reducing the relevance of financial statements for users.

• Complexity in Application:

Differentiating between current and non-current items and applying distinct rates increases the complexity of the translation process.

• Potential Distortion in Profitability:

Including translation adjustments in the income statement can lead to volatility in reported profits, making performance assessment difficult.

• Limited Compatibility:

Modern accounting frameworks favor methods that reflect the economic reality of the reporting entity, rendering the Non-Current Method less relevant.

Steps in the Non-Current Method

1. Identify Current and Non-Current Items:
   • Segregate the balance sheet items into current and non-current categories.
2. Determine Exchange Rates:
   • Use the current exchange rate for current items and the historical exchange rate for non-current items and equity.
3. Translate the Balance Sheet:
   • Translate each item based on its category and the applicable exchange rate.
4. Translate the Income Statement:
   • Translate revenues and expenses related to current items at the average exchange rate.
   • Translate expenses associated with non-current items at the historical exchange rate.
5. Adjust for Translation Differences:
   • Include any translation adjustments in the income statement, affecting the overall profit or loss.

Example of the Non-Current Method

U.S.-based parent company owns a subsidiary in Canada. The subsidiary’s financial data is as follows:

Translation:

1. Current Assets and Liabilities:
   • Cash: 50,000 ×1.20 = $60,000
   • Accounts Receivable: 30,000 × 1.20 = $36,000
   • Inventory: 70,000 × 1.20 = $84,000
   • Accounts Payable: 40,000 × 1.20 = $48,000

2. Non-Current Items:

   • Equipment: 200,000 × 1.10 = $220,000
   • Long-Term Debt: 100,000 × 1.10 = $110,000

3. Income Statement:

   • Revenues related to current items (e.g., sales): Translated at the average rate.
   • Depreciation (related to equipment): Translated at the historical rate of 1.10.