A company must record its business activities so it can summarize the information and produce reports. In this lesson, you will learn about the monetary measurement concept.
What Is the Monetary Measurement Concept?
Let’s meet Sally who owns Sally’s Super Shoes. Sally prepares her own financial statements and then gives them to her accountant to review.
Her accountant removed a couple of items that Sally had recorded as they didn’t comply with the monetary measurement concept. Even though her accountant explained the concept to her, she still doesn’t fully understand it. Let’s see if we can help Sally gain a better understanding of this concept.Sally completes a number of transactions for her business every day. The monetary measurement concept states that a business can only record transactions that it can value in monetary terms. This means that Sally can record the sales that she makes to her customers as well as the purchases she makes from her suppliers as these transactions are recorded in dollars. Sally would also record the payments she makes on her bank loan and the taxes she pays to the government.
However, according to the monetary measurement concept, if Sally can’t place a dollar value on something, she can’t record it. For example, Sally has very knowledgeable and skilled employees who have worked for her for a number of years. Since she can’t put a value on the contributions that the employees make because of their skills, she can’t record them in her financial records. Other examples of items that Sally can’t record include her loyal customer base or the industry-leading customer service her company provides.Even though she can’t record all items, some of them will eventually have a monetary impact. For example, her loyal customers continue to buy Sally’s shoes and she can record those sales in her financial records when the sale occurs and she can quantify them.
Sally’s business could also have a significant event occur which it can’t value at the present time. Let’s assume that one of Sally’s customers slipped on some water in one of her stores and broke her leg. The customer is now suing Sally, but the case has not yet come up in court. Sally can’t currently record the amount she will have to pay as she doesn’t know the outcome of the trial or the amount of the settlement that a judge could award if Sally loses the case.However, this is an important event which could have a huge impact on Sally’s company. So, in order to ensure the accuracy of the financial information being presented, Sally will want to disclose the lawsuit in the notes to the financial statements so the users of this information are aware that the company may have to pay an amount at some point in the future.
When the case comes up in court and there is a verdict, Sally will know the outcome and the amount of any payment she must make. At this point, she would record the transaction as she can measure it in monetary terms.
Advantages of Monetary Measurement Concept
Since all businesses must follow the monetary measurement concept, one advantage is that a user of financial information can easily compare the results of one business with another business since financial results are expressed in monetary terms.Another advantage is that Sally can combine all of the business transactions for a period of time (since they are all expressed in monetary terms) and determine how profitable her business is. She can compare this information with her goals and make any changes she needs to ensure she is on track to achieve her targets.
The monetary measurement concept also prevents business owners from determining their own values for items such as the value of the company’s brand. For example, Sally could place a value on her customers’ loyalty and record it in her company’s financial records. This may make her financial statements look more favorable than they really are and users may be misled by this information.
Limitations of Monetary Measurement Concept
A limitation of the monetary measurement concept is that items that impact a company’s future financial results are not recorded. For example, Sally’s knowledgeable and skillful employees make a high-quality product which will result in more sales as customers focus on quality. Although Sally can record the sales that result from the work these employees do, she can’t record the value that her employees give to the business.
Sally’s financial statements are not as useful since they don’t include this information.Another limitation is that the value of money changes every day due to changes in foreign exchange rates and inflation which is an increase in the price of goods and a decrease in the amount of goods that someone can purchase. The monetary measurement concept assumes that the value of currency remains stable and does not change. A company’s financial statements could be misleading to users if inflation is not considered.
For example, if Sally purchased land for her business ten years ago for $500,000, its value on her company’s financial statements would still show $500,000 today even though the value of the land may now be $2,000,000.
Under the monetary measurement concept, a company can only record business transactions if they can be valued in monetary terms. A company can’t record items that it can’t put a dollar value on such as customer loyalty or the knowledge and skills of its employees.Advantages of using the monetary measurement concept include the ability to compare financial information between companies, combining information together so that owners can compare it against targets or budgets and removing the opportunity for owners to assign values to items on their financial statements to make them look more favorable.A limitation is that the monetary measurement concept does not consider the impact of inflation which is an increase in the price of goods and a decrease in the amount of goods that an individual or company can purchase with that amount of money and foreign exchange rates.