Monetary unit assumption has two parts. The first part says that the monetary unit is stable in the long run and does not lose it’s purchasing power. The second part of the assumption says that every transaction and event related to an entity should be recorded in the financial statements of the entity with a monetary unit. This monetary unit can be dollars, yen, pound, rupees or any other monetary unit. If a Transaction or event cannot be described in a monetary unit, it should not be recorded in the books.
Monetary unit Assumption is just like an accounting guideline or accounting principle where we are directed to use U.S dollars as it is assumed that U.S dollar is constant and stable in the long run. Similarly, if we are unable to express an item in U.S dollars, we cannot record such an item in our books.
The monetary unit assumption is just an assumption that assumes that transactions and events can be recorded in a monetary unit as it is constant and stable in the long run.
Inflation has no effect on the assumption as this assumption does not take inflation into consideration. For example, if a piece of land is purchased in 1970 at $30,000, it will appear at the same cost of $30,000 even in 2019. This is because this assumption assumes that the monetary unit is stable in the long run.
Monetary Unit Assumption Examples
Examples of the First Part of the Assumption
- Suppose NHIRKM Engineers bought a building in 1988 at a cost of $80,000. It recorded the building with $80,000 in its books. Now suppose in 2019, it bought a similar building at a cost of $600,000. It will record buildings at an amount of $680,000 ($80,000 + $600,000). You know there is a huge difference in purchasing power between 1988 and 2019, but we are not accounting for it. This is all because of this assumption.
- Suppose ABC Ltd. Purchased a Land in 1930 at a cost $30,000. It recorded that transaction in its books with $30,000. Similarly, it purchased another piece of the same land in 2030 at a cost of $300,000. Now if we look at the books of ABC Ltd. We will find out that Land is recorded at $330,000. ($30,000+$300,000).
Examples of the Second Part of the Assumption
- Suppose XYZ software house has very talented and intellectual software engineers. But it cannot record them as their assets. This is because the monetary unit assumption directs us to record only those transactions that can be expressed in U.S dollars. We cannot express talent in dollars. Similarly, we cannot express the intellectuality of someone in dollars.
- Suppose students of Smart Science School hold the highest position in the city. This is because of helpful, talented, intellectual and exam-focused teachers of Smart Science School. Now if you look at the books of Smart Science Schools, you’ll find furniture, fixtures and other assets. You will not find its famous teacher being recorded as an asset. This is because of this assumption which directs us to record only those transaction and events that can be expressed in a monetary form. As we cannot express talent, intellectualism and exam-focused techniques of teachers in a monetary form, we cannot record as an asset.
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Implications of Monetary Unit Assumption
- You’ve to record every business transaction in a monetary unit. This’s because the monetary unit is stable in the long run.
- You’ve to record every business transaction and event in a monetary unit i.e. USD. The reason is the same, the monetary unit is constant and stable in for a long term.
- Your books should contain only those transactions and events that can be expressed in the form of a monetary unit. If a transaction or event cannot be expressed in dollars form, it should not be included in the books.
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Problems with Monetary Unit Assumption
- A problem with the monetary unit assumption is that it does not take the effect of inflation into consideration. For example, as we stated in our examples, a building purchased in 1988 at a cost of $80,000 was still recorded at $80,000 even in 2019. You know, prices have increased a lot since 1988, but monetary unit assumption does not take this into consideration.
- Another problem with this assumption is that it can be misleading or deceiving for external users of financial statements. For example, in our first example, NHIRKM Engineers has buildings worth $680,000. It might not be $680,000 currently, as $80,000 out of $680,000 is from 1988.