Monetary Unit Principle

For example, a U.S. based company will record its financial transactions in U.S. dollars. Since historical costs are based on actual transactions, they provide an objective basis for valuing assets. This objectivity minimizes subjective judgment calls that could distort financial reporting. In premodern China, the need for credit and for circulating a medium that was less of a burden than exchanging thousands of copper coins led to the introduction of paper money. This economic phenomenon was a slow and gradual process that took place from the late Tang dynasty (618–907) into the Song dynasty (960–1279).

Medium of exchange

If a transaction cannot be expressed in dollar value, it should not be included in the company’s financial books. Assume that a U.S. corporation purchased a two-acre parcel of land at a cost of $80,000 in 2004. Then in 2024 the corporation purchased an adjacent (nearly identical) two-acre parcel at a cost of $500,000. After the 2024 purchase is recorded, the balance in the corporation’s general ledger account Land is $580,000.

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The Monetary Unit Principle, also known as the Monetary Unit Assumption, is a basic principle of accounting that assumes a stable currency is going to remain the principal currency for the foreseeable future. This principle allows businesses to keep their accounting records in one single currency, without considering inflation or deflation. Importantly, this concept introduces many complexities in accounting in the sense that assets which cannot be accurately expressed in terms of monetary units are not usually reflected in business accounts. Under the monetary unit assumption, it is assumed that only those transactions with monetary value should be recorded in the books of accounts. The monetary unit principle, however, is not concerned with inflation over time.

How does the monetary unit assumption affect the valuation of a company?

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Applications of the Monetary Unit Principle

This is an important aspect to consider for a business entity because it cannot be automatically calculated from other accounts on a balance sheet. At this time both silver and gold were considered legal tender, and accepted by governments for taxes. However, the instability in the ratio between the two grew over the 19th century, with the increase both in the supply of these metals, particularly silver, and of trade. This is called bimetallism and the attempt to create a bimetallic standard where both gold and silver backed currency remained in circulation occupied the efforts of inflationists.

This system had been used in ancient India since the time of the Mahajanapadas. Fiat money, if physically represented in the form of currency (paper or coins), can be accidentally damaged or destroyed. However, fiat money has an advantage over representative or commodity money, in that the same laws that created the money can also define rules for its replacement in case of damage or destruction.

• These concepts, along with others, will be affected by changes in inflation and deflation rates.
• Hence, the management team will not be included in the reported amounts on the balance sheet.
• Legal tender, or narrow money (M0) is the cash created by a Central Bank by minting coins and printing banknotes.
• When gold and silver were used as money, the money supply could grow only if the supply of these metals was increased by mining.
• The monetary unit assumption as it applies to a U.S. corporation is that the U.S.dollar (USD) is stable in the long run.
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Two-Part Assumptions

• Assume that a U.S. corporation purchased a two-acre parcel of land at a cost of $80,000 in 2004.
• ABC School does not report a loss at all on its financial statements because of the monetary unit assumption, even though it might have experienced a decrease in revenue.
• Our work has been directly cited by organizations including MarketWatch, Bloomberg, Axios, TechCrunch, Forbes, NerdWallet, GreenBiz, Reuters, and many others.
• That is, when buying a good, a person is more likely to pass on less-desirable items that qualify as “money” and hold on to more valuable ones.
• Another problem with this assumption is that it can be deceiving or misleading for external users of financial statements.
• When you access this website or use any of our mobile applications we may automatically collect information such as standard details and identifiers for statistics or marketing purposes.

Stakeholders can trust that reported values reflect actual expenditures rather than speculative estimates. When a company purchases an asset, such as equipment or property, it records the transaction at its purchase price. For example, monetary unit concept if a company buys machinery for $50,000, this amount is recorded as an asset on its balance sheet.

Monetary Unit Assumption FAQs

Foreign currency is commonly bought or sold on foreign exchange markets by travelers and traders. M0 is base money, or the amount of money actually issued by the central bank of a country. It is measured as currency plus deposits of banks and other institutions at the central bank. M0 is also the only money that can satisfy the reserve requirements of commercial banks.