Money Measurement Concept
The Money Measurement Concept (also known as the Monetary Unit Assumption) is a basic principle in accounting that states only those transactions and events which can be measured in monetary terms are recognized in the financial statements.
In other words, it means that all business transactions and events are to be recorded in the currency of a specific country. For example, a U.S. based company will record its financial transactions in U.S. dollars.
This concept is vital as it allows for consistency in recording and reporting. It enables organizations to quantify different resources and obligations, summarize them, and present them in the company’s financial reports.
However, it’s important to note that this concept has limitations. It doesn’t account for qualitative factors such as the skill level of a company’s workforce, customer satisfaction, market reputation, etc., which can also significantly impact a company’s performance and value. Similarly, it does not consider the effects of inflation, which can distort the value of money over time.
Example of the Money Measurement Concept
Let’s consider an example to illustrate the Money Measurement Concept:
Suppose a company named ABC Corp. has the following assets:
- 10 office buildings worth $10 million each.
- A team of highly skilled employees.
- A highly reputed brand in the market.
According to the Money Measurement Concept, when ABC Corp. prepares its balance sheet, it will only include the office buildings as assets, because they can be measured in monetary terms – $10 million each, for a total of $100 million.
However, the team of highly skilled employees, while undeniably a valuable asset to the company, cannot be measured and recorded in terms of money. Therefore, they won’t be directly recorded as assets on the balance sheet.
Similarly, the company’s highly reputed brand, while it may contribute significantly to the company’s sales and customer loyalty, also can’t be expressed in terms of a specific monetary value, and thus won’t be directly recorded as an asset on the balance sheet.
Therefore, under the Money Measurement Concept, ABC Corp.’s assets would be recorded as $100 million (the total value of the office buildings), even though the company possesses other intangible and human assets of significant value.
This example underscores the limitations of the Money Measurement Concept, as it doesn’t capture all aspects of a company’s value. Nevertheless, it provides a standard and consistent method for recording and comparing financial information, which is crucial for the financial analysis and decision-making processes.