Question

Please explain (Briefly) the below assumptions with an example.

1-Time period assumption

2-Monetary unit assumption

Answer 1

TIME PERIOD ASSUMPTION:

DEFINITION:

The time period assumption (also known as periodicity assumption and accounting time period concept) states that the life of a business can be divided into equal time periods. These time periods are known as accounting periods for which companies prepare their financial statements to be used by various internal and external parties.

The length of accounting period to be used for the preparation of financial statements depends on the nature and requirement of each business as well as the need of the users of financial statements. Normally, an accounting period consists of a quarter, six months or a year.

EXAMPLE:

The Alpha company provides services valuing $2,5000 to Beta company during the first quarter of the year. The Beta company will pay the cash for these services next quarter. According to time period assumption, if Alplha company prepares its financial statements at the end of the first quarter of the year, it must include this service revenue of $2,5000 in its income statement for the first quarter.

Notice that the avobe example show that the time period assumption is closely related to matching principle and revenue recognition principle of accounting.

MONETARY UNIT ASSUMPTION:

DEFINITION:

The monetary unit concept is an accounting principle that assumes business transactions or events can be measured and expressed in terms of monetary units and the monetary units are stable and dependable. In other words, the language of business and finance is money. It doesn’t matter what currency it is as long as it’s stable and can be comparable to other currencies.

EXAMPLE:

Currently the FASB does not require that companies recognize inflation in their financial statements. There are a variety of reasons why, but mainly because the United States has enjoyed low inflationary rates for decades. Some day if the US economy changes and the US inflation rates become hyperinflationary similar to countries like Brazil and South Africa, the FASB might change SFAC No. 5 and the expectation for companies to report all financial statements in the US dollar.

Not recognizing the affects of inflation can be a little deceiving for external users, but FASB decided not to worry about it. For example, if a company purchases a building for $100,000 and holds on to it for 30 years, it will still be reported on the balance sheet for the original purchase price not adjusted for inflation. The building could vary well be worth $1,000,000 now because of 30 years of inflation.

The monetary unit principle, however, is not concerned with inflation over time. It deals more with the ability to measure transactions in money without drastic fluctuations in currency values in the short-term.