Question

What is the monetary unit assumption?

Answer 1

The monetary unit assumption states that a company must record it's business transactions in dollars or some other units of currency without adjustment for inflation. Companies use the dollar since it is stable in value and available everywhere. It also provides a consistent method of comparing the results of one company with those of another. For example, when Mr. A paid $100 for the new machine, this amount would be added to the cost of his dad's purchases in the assets section of his company's financial records.

The monetary unit is an easy and universally recognised form of communicating financial information. It is an effective basis of recording, reporting, and analyzing financial data which can help businesses make rational decisions.

Implications of Monetary unit assumption

There are certain implications that come with the usage of Monetary unit assumption .

1. A company has to record every transaction in a monetary unit. The reason for this is that monetary unit brings a lot of stability in the long run.

2. A company has to record every business event in a monetary unit ie, USD. Thus is because monetary unit brings stability in the long run.

3. A company's books should contain only those events and transactions that can be measured in the form of a monetary unit. If an event or transaction cannot be measured in dollar form, it should not be included in a company's books of accounts.

Limitations

While the monetary unit assumption provides a stable basis upon which to value transactions, there are two important limitations : inflation and handling items which are difficult to quantify. The monetary unit assumption does not take into account the impact of inflation, or the rise in prices and the corresponding decrease in the purchasing power of money, but in accounting we assume that the currency units are stable in value. This is alternatively called stable dollar assumption. This is why accounting figures are interpreted across time without adjusting them for inflation.  

However, there are exceptional circumstances called hyperinflation when the accounting standards require adjustment of prior period figures. In such situations the monetary unit assumption does not hold.

The monetary unit assumption becomes less important as accounting standards allow more transactions to be accounted for under the fair value model.

Assets,revenues, liabilities and expenses have to be recorded at their dollar values or any other monetary unit. A company's greatest strength could be the skill and talent of its business or engineering team. This is significantly harder to put a monetary value upon and so , will not be considered for inclusion in the books of accounts. This is because the company is allowed to only include those transactions that have monetary value.

Conclusion

Monetary unit assumption helps makes accounting simpler, as companies do not have to convert long term assets to their current value every year. The most effective way to communicate economic activities is through the dollar. It gives a quantifiable value to any activity, making it easier to record that activity in the financial statements.

Money is universal, comprehensible, understandable and the easiest way to convey financial activities. It is the common denominator in all economical and financial transactions. Which is why it makes for a good basis when comparing companies and other accounting measurements. In other words, accounting considers transactions that can be communicated in monetary value.