The (Stable) Monetary Unit Assumption
If you go through an entity's financial statement, you will see that every business transaction or event is recorded in monetary term or currency. Why is that so?
One of the recognizable and accepted accounting principles is "The Monetary Unit Assumption" which assumes money as a unit of measurement and that an entity should record only those business transactions or events in the financial statements which can be expressed or measured in monetary terms (unit of currency). For example, many companies use USD or EUR for recording their business transactions and events.
Assumptions behind the Monetary Unit Assumption
• Long-run stability of currency
• Currencies have purchasing power
• Ignore deflation and inflation effects on the currency and/or the time value of money
The monetary unit assumption consists of two main areas:
• Every business transaction or event can be expressed in monetary terms and the events that are non-quantifiable should be omitted.
• In the long run, the monetary unit should be stable and should not lose its purchasing power over time.
Monetary unit assumption and monetary value
In order to communicate the financial information properly, an entity should record only those business transactions or events in the financial statements which can be expressed or valued in monetary term. Every business event should be first translated into unit of currency such as USD, POND, YEN, EUR or PKR. Business transactions that can not be expressed in monetary terms are non-quantifiable events and thus should be omitted from the financial statements. Non-quantifiable items are for example employee skill levels, employee motivation, management expertise, and customer service quality.
- On 20 April 2010, the largest oil spill ever was caused (the Deepwater Horizon oil spill). Because of the monetary unit assumption, accounting only records the financial impact of this disaster including cleanup cost, damages, and claims paid, etc. But revenue loss and workers' death was ignored.
- Assume that ABC Company has very passionate, skilled and talented employees. These employees could be considered as valuable assets, but the company can not record them as its asset in its financial statements, because they cannot be measured or expressed in the monetary unit. The skillset and expertise of the employees can not be expressed in dollars.
Monetary unit assumption and inflation effect
The monetary unit assumption assumes that money will not lose its purchasing power over time and its value remains stable for the long term, thus ignoring the effects of deflation and inflation. Because of low inflationary rates in the United States, FASB currently prohibits recognizing inflation effects in the company's financial statements. The monetary unit assumption as well as the cost principle of accounting requires to value assets and liabilities on its original historical cost. The assumption is also known as the stable dollar assumption
According to FASB, it is stated in Statement of Financial Accounting Concepts No. 5 that "The monetary unit or measurement scale in current practice in financial statements is nominal units of money, that is, unadjusted for changes in purchasing power of money over time. The Board expects that nominal units of money will continue to be used to measure items recognized in financial statements".
Assume that ABC Company purchased a plot of land at a cost of €45,000 in 2008. At that time, the company recorded this event at its original price of €45,000 in the company's books of account. In 2020, the company purchases another similar plot of land at a cost of €500,000. There is a huge difference between the prices because of the inflation rate and the time value of money. The company will record its 2 plots of land at a cost of €545,000 (€45,000 +€500,000) in the company's books of account. The company will not make adjustments in the amount of land purchased in 2008 because of the monetary unit assumption.
Report: Statement of Financial Accounting Concepts No. 5 by Financial Accounting Standards Board
Article: Brain Mass, "The Stable-Monetary Unit Assumption"