The monetary unit assumption is based on the assumption that all transactions can be measured in money terms. GAAP assumes that the monetary unit is stable, reliable, relevant, and useful to all companies. All currencies are openly exchanged in world markets with varying exchange rates. Monetary units like the US dollar and English pound can be easily exchanged for the European Union Euro, Mexican peso, or the Japanese yen.
- The cost principle, also known as the historical cost principle, states that virtually everything the company owns or controls (assets) must be recorded at its value at the date of acquisition.
- As you may also recall, GAAP are the concepts, standards, and rules that guide the preparation and presentation of financial statements.
- The app has generated over $1 billion in sales for the company, and yet the programming skill of the programmers cannot be quantified – so their value to the company is not recorded on its balance sheet at all.
- In baseball, and other sports around the world, players’ contracts are consistently categorized as assets that lose value over time (they are amortized).
Under those circumstances the assumption is that the monetary unit is stable and is not impacted by inflation or deflation. The monetary unit assumption is one of the fundamental underlying assumptions used in accounting when preparing financial statements. Currently the FASB does not require that companies recognize inflation in their financial statements.
Non Monetary Transactions
There are some exceptions to this rule, but always apply the cost principle unless FASB has specifically stated that a different valuation method should be used in a given circumstance. The BP oil spill in Gulf of Mexico was a natural disaster but accounting only reports the financial impact in the form of claims paid, damages paid, cleanup costs, etc. Financial accounting is mainly concerned with impact of transactions and events which can be quantified in terms of currency units. If a company or its stakeholders are concerned with other aspects of its strategy and operations, other reporting frameworks, such as triple bottom line, corporate social responsibility reporting, etc., are more relevant.
The conceptual framework helps in the standard-setting process by creating the foundation on which those standards should be based. It can also help companies figure out how to record transactions for which there may not currently be an applicable standard. Though there are many similarities between the conceptual framework under US GAAP and IFRS, these similar foundations result in different standards and/or different interpretations.
How does the monetary unit assumption affect balance sheet accounts?
The role of the Auditor is to examine and provide assurance that financial statements are reasonably stated under the rules of appropriate accounting principles. The auditor conducts the audit under a set of standards known as Generally Accepted Auditing Standards. The accounting department of a company and its auditors are employees of two different companies. The auditors of a company are required to be employed by a different company so that there is independence. The monetary unit assumption assumes that all business transactions and relationships can be expressed in terms of money or monetary units. Money is the common denominator in all economic activity and financial transactions.
To properly account for the results of the operations of a business entity, the results need to be expressed and recorded in common units of measurement. Under the monetary unit assumption, it is assumed that only those transactions with monetary value should be recorded in the books of accounts. The cost principle, also known as the historical cost principle, states that virtually everything the company owns or controls (assets) must be recorded at its value at the date of acquisition. For most assets, this value is easy to determine as it is the price agreed to when buying the asset from the vendor.
Monetary Measurement Concept
In order to record a transaction, we need a system of monetary measurement, or a monetary unit by which to value the transaction. Without a dollar amount, it would be impossible to record information in the financial records. It also would leave stakeholders unable to make financial decisions, because there is no comparability measurement between companies. This concept ignores any change in the purchasing power of the dollar due to inflation. The primary exceptions to this historical cost treatment, at this time, are financial instruments, such as stocks and bonds, which might be recorded at their fair market value. This is called mark-to-market accounting or fair value accounting and is more advanced than the general basic concepts underlying the introduction to basic accounting concepts; therefore, it is addressed in more advanced accounting courses.
For the past 52 years, Harold Averkamp (CPA, MBA) hasworked as an accounting supervisor, manager, consultant, university instructor, and innovator in teaching accounting online. For the past 52 years, Harold Averkamp (CPA, MBA) has worked as an accounting supervisor, manager, consultant, university creative accounting definition instructor, and innovator in teaching accounting online. It is possible to resolve the apples and oranges problem in this way because cash, disparate physical goods, and claims against others can usually be expressed in terms of money. It is well-known that a business may have diverse kinds of assets, including land and buildings, government securities and shares of other companies, inventories of raw materials and finished goods, and cash and claims against debtors. We define an asset to be a resource that a company owns that has an economic value.
Debits and Credits
Dividends paid to shareholders also have a normal balance that is a debit entry. Since liabilities, equity (such as common stock), and revenues increase with a credit, their “normal” accumulated depreciation balance is a credit. The procedural part of accounting—recording transactions right through to creating financial statements—is a universal process. Businesses all around the world carry out this process as part of their normal operations.
