The Stable Monetary Unit Concept of Accounting

All accountants make key conceptual assumptions when reporting financial information. Because many of these assumptions are necessary for financial statements to have value, it is usually best to understand and review them when considering financial documents. Among the various conceptual assumptions that underlie modern accounting is the stable monetary unit concept.

The stable monetary unit concept assumes that the value of the dollar is stable over time. This concept essentially allows accountants to disregard the effect of inflation -- a decrease, in terms of real goods, of what a dollar can purchase. Because of this assumption, past financial statements are usually not updated even if the value of money substantially changes. The concept is generally a practical necessity, even though the assumption can present some serious challenges if the currency is either deflating or inflating quickly.

In everyday use, the concept means that accountants treat records from different periods as if they are substantially the same. The values of accounts or purchases are not adjusted for inflation, and balances may be changed by adding new purchases to past purchases, as if the value of money had never changed. As a result, a purchase that takes place after significant inflation might appear more expensive in the record, though the difference is mainly due to the diminished purchasing power of the dollar. This allows for the practical convenience of using one continuous accounting record throughout time.

Though the stable monetary unit assumption makes the process of accounting more manageable, it can sometimes present problems. If the value of money rapidly changes due to market conditions or the effects of policy, a business's financial statements may be less useful for comparison with prior records. If the values of accounts or past statements are not subsequently adjusted to address the inflation or deflation, the accounting record may not accurately represent a business's financial performance. This issue presents a link between day-to-day accounting practice and broader market trends or government policy.

The reliance of businesses on the stable monetary unit concept suggests a role for policy in maintaining a currency's purchasing power. According to Jerry Jordan of the Federal Reserve Bank of St. Louis, central banks and government should try to preserve a stable currency so that "prices provide households and businesses with reliable information about the relative costs of goods and services." Other economists argue that a policy response is not necessary, especially if the value of money is based on tangible, finite resources like gold. In either case, businesses and investors must consider the possible impact of changes in the purchasing power of the dollar when reviewing past performance.