What is the Monetary Unit Assumption?
Definition: The monetary unit assumption is an accounting principle or concept that suggests that the only business events and transactions that a business or company should record in its accounting books are the ones that can be measured financially.
The Monetary unit assumption concept therefore assumes that anything that cannot be measured in monetary terms is therefore useless as far as financial accounting is concerned. That is why they are not usually recorded in the accounting books. The monetary unit assumption is one of the accounting concepts that are acknowledged globally. It is an important concept because it provides a guide for financial data analysis. It is equivalent to the scientific method of finance.
The above definition and explanation point towards the need for a unit or units of value. This ties in perfectly with the fact that there are currencies such as the U.S dollar, the Sterling Pound, Euro, and Japanese Yen among many others. Currencies are thus the unit of value that is used in accounting and they represent an exchange of value after a good or service is rendered. The monetary unit assumption also requires the selected currency to be relatively stable for it to work.
The stable dollar assumption also ties in with the monetary unit assumption. It assumes that the US dollar or other currency that may be used to represent monetary value retains its purchasing power throughout time, therefore not losing value. In other words, accountants ignore concepts such as inflation when recording financial transactions in accounting books. The stability of a currency is thus an important function of accounting.
Monetary Unit Assumption Example
A company in the U.S acquired a piece of land for $30,000 in 1980 and then it purchased another similar piece of land next to the previous one in 2020 for $400,000. The two pieces of land might be the same size, so similar in dimensions but the value is different. This means that the value of the land went up during the three decades. Despite this, the company’s accountants will report that the two pieces of land are worth $430,000.
Stable Dollar Assumption Example
In the above example, the company does not consider the present value of the piece of land that it acquired in 1980 but instead records in its book the value of the land at the time of purchase. In other words, it does not adjust to inflation or price appreciation. In reality, the land should be the same market value as the adjacent piece of land that was purchased in 2020.
Different assets appreciate or depreciate differently. Adjusting for these factors would create additional complexities in the accounting books. The stable dollar assumption and the monetary unit assumption make the accounting process easier. It also makes it easier to compare the performances of different companies.
Monetary Unit Principle and Hyperinflation
Inflation is not necessarily something that the Financial Accounting Standards Board requires companies or organizations to acknowledge in their books of accounts. But one cannot help but wonder whether the situation would be like or how the monetary unit assumption would be affected if a country were to enter into a hyperinflation situation. Fortunately, the U.S has enjoyed relatively low inflation thus the lack of FASB requirements to adjust for inflation.
If the U.S was to be hit by hyperinflation, then perhaps the FASB would change the rules likely requiring companies to use a more stable currency to record transactions. Countries like South Africa and Brazil have experienced hyperinflation and so companies started to record transactions in their accounting books in the form of dollars rather than their local currencies.
Recording transactions in a more stable currency is a simpler approach than having to adjust for inflation. Also note that inflation causes a country’s currency to become volatile, which means that even adjusting for inflation might not be as viable an idea since the inflation rates can change anytime.