In Financial Accounting, accountants records transaction which are measurable in monetary terms. This is because, money provides a common denominator by which different kind of facts about an entity or organisation can be expressed in numerical term. This result in addition and subtraction easy.
According to Money Measurement concept in accounting, business records only those transactions which are measurable in money or monetary terms.
Money Measurement Concept Example
Suppose a business owns 1,00,000 of cash, 300 kg of raw material, 3 trucks and 20,000 square feet of land and so on. One cannot add these amount and came up with a meaningful conclusion. However if we express above items in monetary terms, then a conclusion can be made out.
Suppose business has 1 lakh cash, 50,000 of raw material, 7 lakh of trucks and 20 lakh of land. Now we can add it up and can easily find out what the business owns. In simple words, record only those transaction that re expressed in monetary terms in books of accounts.
Limitation To Money Measurement Concept
Money measurement concept has severe limitations when it comes to preparing the accounting report. Accounting does not considers qualitative factors such as disturbing relation between sales manager and production manager, ill health of CEO of the company, introduction of an innovate product by the competitor, etc.
In simple and short words, accounting does not provide a true and fair picture of what exactly is happening inside or outside the organisation. So, whoever is reading the accounting, he just focuses on the numbers of profits rather than the reasons behind it.
What is the money measurement concept?
The money measurement concept states that a business should only record an accounting transaction if it can be expressed in terms of money. This means that the focus of accounting transactions is on quantitative information, rather than on qualitative information. Thus, a large number of items are never reflected in a company's accounting records, which means that they never appear in its financial statements.
Examples of items that cannot be recorded as accounting transactions because they cannot be expressed in terms of money include:
LIMITATIONS
- Employee skill level
- Employee working conditions
- Expected resale value of a patent
- Value of an in-house brand
- Product durability
- The quality of customer support or field service
- The efficiency of administrative processes
All of the preceding factors are indirectly reflected in the financial results of a business, because they have an impact on either revenues, expenses, assets, or liabilities. For example, a high level of customer support will likely lead to increased customer retention and a higher propensity to buy from the company again, which therefore impacts revenues. Or, if employee working conditions are poor, this leads to greater employee turnover, which increases labor-related expenses.
The key flaw in the money measurement concept is that many factors can lead to long-term changes in the financial results or financial position of a business [as just noted], but the concept does not allow them to be stated in the financial statements. The only exception would be a discussion of pertinent items that management includes in the disclosures that accompany the financial statements. Thus, it is entirely possible that key underlying advantages of a business are not disclosed, which tends to under represent the long-term ability of a business to generate profits. The reverse is typically not the case, since management is encouraged by the accounting standards to disclose all current or potential liabilities of a business in the notes accompanying the financial statements. In short, the money measurement concept can lead to the issuance of financial statements that may not adequately represent the future upside of a business. However, if this concept were not in place, managers could flagrantly add intangible assets to the financial statements that have little supportable basis.
The Money measurement concept is one of the basic accounting principles or theories that form part of the larger set of accounting rules. Record keeping and performance measurement are key components of an accounting cycle. Financial accounting is based on
several principles such as business entity concept, historical cost, accrual basis accounting principle, matching principle, and money measurement concept. A business entity can decide to use all or part of these principles, however, once decided the entity needs to uniformly apply the same accounting principles all over the
entity record keeping. The money measurement concept as the name suggests is a performance measurement accounting tool that evaluates performance in monetary terms. Simply put, all business performance metrics are measured in currency values. This leads to the conclusion that any business activity that does not involve monetary value will not be
recorded. The concept has its valuable advantages and limitations though. Businesses operate in different ways; hence their performance metrics can also be different. For example, a business can measure its performance by the number of units produced in a production period. A restaurant may use the number of customers served at premises or take away. Recording accounting data in accordance with accounting standards and measuring results provide analyses and help in measuring performance.
Using a uniform measure to analyze these performance metrics can help understand these performance indicators easily. The money measurement concept applies the monetary value principle to all these accounting entries. Financial accounting prepares records for management and analyses for the investors or shareholders. Measuring all business operations or performances in one metric such as monetary value provides a consistent approach. Financial accounting deals with
quantified data of business operations. Historically, financial accounting was concerned only with bookkeeping and recording of cost and revenues only. Modern financial accounting demands for continuous performance measurement. All quantifiable data stated in currency valuation forms the basis for money measurement. It then leads financial accountants to the unit of measure principle. That requires all monetary values to be stated in one currency either local or foreign. Accounting principles
such as Generally Accepted Accounting Principles [GAAP] does not make it compulsory to use any particular currency or money measurement rules. GAAP rules however call for a uniform and consistent approach in all record keeping. Financial data without measurement provides no value to financial accountants and shareholders. A business can improve efficiency only if it can identify or measure its performance. At the end of each accounting
period, financial statements depict an entity’s performance. If that performance is measured differently according to activity it will not make any sense. Let’s say, a company manufactures confectionery items, it can measure performance in labor hours taken to produce a certain number of units. It can also use the raw material, or the number of employees to reach a certain production level. All that information is necessary for operation efficiency measurement, but it cannot be stated on the
balance sheet. The money measurement concept converts all these performance metrics to monetary values and makes it easier to analyze the business performance. The money measurement concept or principle has certain characteristics as below:What is Money Measurement Concept in Accounting?
Importance of Money Measurement Concept
The Characteristics of Money Measurement Concept
- It provides a common denominator of performance measurement i.e. money
- Only those business activities will be recorded that can be interpreted in monetary value
- Monetary value presentation of business results make it easier to communicate between business management and shareholders
- The monetary value will be recorded at historic money values
- This concept takes money as a stable unit of measure i.e. it does not consider the inflation effect of transactions
The money measurement concept complies with most of the basic financial accounting concepts. Converting all business operation results into one single measure of money makes it easier for management and shareholders to understand and communicate.
Limitation of Money Measurement Concept
However, as with any theoretical concept, it also offers some limitations:
- It ignores any valuable business events that we cannot measure in quantifiable terms such as increased revenue with new market campaigns
- The concept ignores the inflation effect on historic costs
- We cannot compare the absolute monetary value results without scaling and adjustments
- Some business processes cannot be quantifiably recorded in monetary values such as a business with a service center. For example, a consultancy business.
- It does not provide in-depth analyses for any deviation from original standards set
- Many business entities prefer to evaluate performance in non-quantifiable measures
Let us compare the money measurement concept with two entities in the same business industry. Two companies’ techno blue and Crislu jewelers produce 1,000 product units and make sales of $ 30,000 per month. Techno blue has 3 salesmen and 430 labor hours in the production facility. Crislu jewelers use 6 salesmen and 380 labor hours.
Techno blue achieves $ 10,000 per salesman per month; Crislu Jewelers achieves $ 5,000 per salesman per month.
Techno blue achieves 2.32 labor hours per unit and Crislu jewelers 2.63 labor hours per unit.
Techno blue’s marketing staff is more efficient than Crislu as they are achieving the same sales with half of the salesforce. Crislu jeweler’s production is more efficient than techno blues as they are using fewer workers to produce the same products. The money measurement concept provides a valuable comparison with total sales values recorded in dollar amounts. The shareholders would primarily be interested in total monthly sales provided they meet the targets. At the same time, the money measurement concept will be unable to provide the variance in details for operations and sales employees. In that scenario, both the management and shareholders would want to dig deeper into the causes of under and over achievements in production.
With all the benefits and limitations, the money measurement concept provides a valuable contribution to financial accounting basics. It complies with the financial accounting concepts of monetary value measurements, record-keeping in a single measure, and data presentation. However, it lacks the financial management tools such as non-monetary activity recording and measurement. It also ignores the inflation effects on recorded transactions. Nonetheless, the money measurement concept provides valuable contributions towards financial accounting and forms the basis for financial management concepts.