# Monetary Unit Assumption: Definition & Examples

Instructor: Deborah Schell

Deborah teaches college Accounting and has a master's degree in Educational Technology.

When a business transaction occurs, accountants must decide the amount to record in the company's books. One way of doing this is the monetary unit assumption, which you will learn about in this lesson.

## What Is the Monetary Unit Assumption?

Let's meet Jake who has just assumed ownership of the family's manufacturing business. He recently purchased some new equipment and his accountant indicated that the cost should be added to the cost of his existing equipment. He doesn't understand how equipment purchased this year could be grouped with equipment purchased by his father ten years ago as the value of a dollar has changed over that period of time. Let's see if we can help Jake with this problem.

The monetary unit assumption states that a company must record its business transactions in dollars or some other unit of currency. Companies use the dollar since it is stable in value and available everywhere. It also provides a consistent method of comparing the results of one company with those of another.

So when Jake paid \$100,000 for the new equipment, this amount would be added to the cost of his dad's purchases in the assets section of his company's financial records.

## Problems with Monetary Unit Assumption

While the monetary unit assumption provides a stable basis upon which to value transactions, there are two important limitations: inflation and handling items which are difficult to quantify.

The monetary unit assumption does not take into account the impact of inflation, or the rise in prices and the corresponding decrease in the purchasing power of money. We know that a person could buy more with \$1.00 in 1965 than they could today. The monetary unit assumption does not provide for differences in the value of a dollar due to the passage of time.

Let's assume that the equipment account for Jake's company includes a piece of machinery that Jake's dad purchased 10 years ago for \$25,000. After recording the new equipment purchase, the value of the equipment account would be \$125,000 (\$100,000 + \$25,000). There is no adjustment for the change in the value of a dollar over the ten years between purchases. This could give the reader of the financial statements a false impression of the value of the assets, especially if many of them are older assets that are not as efficient.

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