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. That is why we assume that money is a good basis for comparing companies and other accounting measurements. In other words, accounting looks at transactions that can be communicated in money or monetary units.
GAAP assumes that the monetary unit is stable, reliable, relevant, and useful to all companies. It is also universally available. 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.
Currently the FASB does not recognize the affects of inflation in financial reporting. This is mainly because the US has enjoyed low inflationary rates for decades. If the US economy changes and the US inflation rates become hyperinflationary similar to countries like Brazil and South Africa, the FASB might change SFAC No. 5 which states that the US dollar is expected to be used for financial statements in the future.
Examples
– A manufacturing plant is started in 1955. It acquires a piece of land and builds a small factory on the land costing $50,000 in 1955. Today, this piece of land and building is worth over $1,000,000 because of inflation. The monetary unit assumption does not take into consideration inflation. The balance sheet of this company will still show the land and building at historical cost unadjusted for inflation.
– During the middle of the night a retailer’s store is vandalized. The sign is spray-painted over, the windows are broken, and some merchandise is stolen. The retailer’s financial statements will only report a loss on the damaged property. It will not report lost potential sales due to down time wait for repairs or additional inventory because of the monetary unit assumption. Lost sales are hypothetical and can’t be measured in real monetary units.
– One of Nike’s famous athletes is caught in a scandal and many people stop buying Nike products in protest of the athlete. Nike does not report a loss at all on its financial statements because of the monetary unit assumption. Since a boycott involves no business transactions, the monetary unit dictates that Nike shouldn’t report anything.
