Monetary Unit Assumption
The monetary unit assumption is the accounting concept that only records the business transaction in monetary unit. If the transactions can not translate into monetary units, accountant will not require to record in the financial statements. In the current practice, most companies use US dollar (USD) as the functional currency due to its long term stability; they assume that US dollar will not decrease their purchase power over time. However, some countries require the company to present its financial statement in local currency.
The company look at the business event and translate it into USD, EUR, or YEN and make a proper recording into the book. Without monetary measurement, we will not be able to communicate financial information to readers.
Monetary Unit Assumption Example
- The company invests $ 500,000 into the business, and the management purchase some fixed asset $ 200,000, inventory $ 100,000, and pay for rental expense $ 20,000.
- Due to high pressure from clients, the company requires all employees to work overtime for two weeks without any additional pay.
- The company purchases land for $ 100,000, and 2 years later, the value of land is $ 120,000 due to inflation.
Explanation
- The accountant will record the following transactions into the financial statements:
- Share Capital: $ 500,000
- Fixed Asset: $200,000
- Rental expenses: $ 20,000
- In this situation, we do not record any transactions as we cannot translate the activity into a monetary amount. We may record overtime expense when we can quantify the amount.
- Due to the monetary unit assumption, the value of the asset in the balance sheet cannot adjust due to inflation.
Note: This example does not relate to the revaluation method, which states in the IAS 16 property plan and equipment.
All items in the financial statement, such as assets, liabilities, equity, revenue, and expense, must record at their dollar value. And at the same time, the monetary unit must follow the concept of a stable dollar value assumption, which able to maintain the value over time. As the accounting transactions will not reflect with the inflation, and there is no adjustment made.
By recording in US dollar (USD), it enables the companies to compare their financial statement. And it leads to one standard for all of them.
Feature of Monetary Unit Assumption
- Record only transaction with a monetary amount
- USD is the most common one for all countries over the world
- Ignore inflation and deflation
Problem with the monetary unit assumption
There are several issues when we apply this assumption. A problem with the monetary unit assumption is that it ignores inflation and can lead to a misunderstanding of financial information.
Not take into account the inflation
Even the property purchased in 2000 cost $ 20,000, it still records in the balance sheet with the same amount without any consideration of inflation. The same property may cost ten times higher, but base on this assumption, we will not record it.
Misunderstanding
For example, we have to property shown in the balance sheet, one cost $ 30,000, and another cost $ 300,000. We may think the second property is far better than the first one. However, when we look closer, both are very similar in every feature. The difference is they are bought at different times. The first one was bought in 2000 while another in 2020.