A business must keep track of all its activity to compile the data and create reports. It becomes essential to keep records with the utmost care in financial matters. Depending on the company's revenue growth, it can attract more investors. That’s why the money measurement concept in accounting is very important for every business.
Did you know? The money measurement concept focuses on quantitative rather than qualitative data in accounting transactions.
What Is the Money Measurement Concept?
Also read: What is Double Entry System of Accounting ? Understanding Double Entry System
Let us first define the money measurement concept. The money measurement concept is an accounting principle stating that a company must only keep track of transactions and occurrences which they can quantify. Transactions like prices, which can translate into cash outflows and inflows, are measurable in the national currency. This allows for the provision of quantitative data instead of qualitative data. The money measurement concept, mostly known as the measurability concept, asserts that when recording all events and transactions in an accounting system, it is important to determine whether the event can be priced or measured in terms of money value.
Only those transactions that one can value in money must be recorded and compensated for. If an amount is not viable, then a company shouldn’t include it in the accounting records. To help clients properly know the financial status and effectiveness of the business, one has to mention the details of the accounting information as per the applicable government rules.
Some Examples Where the Money Measurement Concept Can Be Used
Below are some examples of the instances where you can use the money measurement concept:
Example 1
A business cannot measure the employee value in terms of external monetary worth and record it on an income statement, as it can only have revenue and expenses. However, the talents and abilities of employees help a business advance and operate well. So, businesses can record the cost of recruiting, training and retaining employees in the financial statement.
Example 2
The work environment, organisational culture, protective measures, etc., all contribute to the subjective advantage of the firm. But as per the money measurement principle, a firm cannot quantify it. Businesses cannot document them since it will have an indirect effect on the business's economic condition.
Example 3
One must note the different currencies one will use during cross-border transactions. Consider an entrepreneur who sells products for ₹60 lakhs in India and $300,000 in the US.
How much did he sell overall?
A business must record all the payments in a single currency and consistent currency units to avoid this confusion,
Let's say that one Dollar equals ₹78.60, so ₹60 lakhs plus ₹234 lakhs equals ₹294 lakhs in overall sales. The money measurement concept gives an understanding of accounting information with the necessary flexibility.
Also read: What are Accounting Principles and Accounting Concepts - Here's a Detailed Overview
Criticism of Money Measurement Concept
Several accounting elements embrace cash as a unit of worth. There are numerous organisations, nonetheless, whose assets may not have a high numerical value, and they might not be able to describe in monetary terms. Instead, certain firm characteristics, like the calibre of the staff, administration, organisational climate, brand recognition, and geography, add up to a multiplicity of benefits for the business, but you will not find them in the accounting records since they have no monetary worth. Additionally, because a shift in the cost of goods and services influences the worth of a particular organisation's assets, the money measurement concept does not account for the shifting purchasing power of the currency. This demonstrates that the idea of monetary measurement is insufficient to capture the actual value of a company.
Importance of Money Measurement Concept
A company uses the money measurement concept as a medium for recording transactions involving assets, obligations, damages, earnings, and investments. It is useful in creating and displaying the statement of financial position and the Profit and Loss report. With the money measurement concept, business valuation calculations have become simpler as it only considers transactions documented in money units. This makes it easier for the company to assign the price to a structure, machinery purchased, and equipment the business uses. One can calculate the organisation's worth by adding all these things and deducting the total liabilities. Many organisations document the transactions based on the assumption that there is no frequent change in cash value.
Advantages of Money Measurement Concept
Below are some of the advantages of the money measurement concept:
- Aids in keeping track of commercial transactions.
- The company documents every financial transaction that occurs within an enterprise.
- Helpful in creating income reports.
- Simpler to analyse the outcome from one time to another as more records are kept.
- Serves as the foundation for legal proof.
- The shareholders and investors receive sufficient data related to the company's development to enable them to draw precise conclusions about their investments.
- Questions and issues relating to taxes are understandable.
- As long as investments, profits and losses are accurately assessed, valuing a business becomes simple.
Also read: Perpetual Inventory System - Methods, Advantages and Disadvantages
Limitations of Money Measurement Concept
Below are some of the limitations of the money measurement concept:
- The inability to document non-financial activities that advance an organisation in money units hinders the accurate assessment of resources that they may require in the future.
- Various things can bring long-term modifications to an organisation that is unaccounted for.
- The accounting ledger is likely to understate a company's long-term capacity to create massive profits since some significant competitive benefits they miss to reveal or account for.
- The exchange prices vary, and the worth of the currency is not constant owing to price increases and devaluation. In this case, when the company does foreign commerce, the accounting ledger may not give accurate details about the expansion of the industry.
Some Important Factors in the Money Measurement Principle
Remember, in the money measurement principle, there are some more factors to consider while analysing the firm's financials. It is vital to keep the following elements in mind, whether you can account for the transactions or not.
Background of the Firm's Sponsors
This information is crucial because the balance sheet will not really discuss the stakeholders in the company. A thorough background check is important to know your sponsors because these things do matter more than just the statistics. It's a good idea to know the history and shareowners of the business. If the shareholders are well-known, we know they will be an asset to the company.
Competitors
Knowing the market's competitiveness is useful since it informs us about profitability. The market dynamics, such as a monopoly, party system or dictatorial marketplace, wherein the businesses work. Knowing the constraints enables us to assess the industry's long-term growth prospects.
Range of Operations
It will inform us of the company's Research & Development division. It will also show us how dependent the company is on the invention.
Industrial Facilities
It will also inform us of the firm's geographical reach. The facilities might be in an excellent location, which may not reflect the firm's worth because you will not see them on the financial statements.
Working Environment
If the firm's working environment or culture is negative, in that case, staff retention would be low, which will also increase costs. However, the money measurement concept cannot quantify this impact.
Also read: Learn about Inventory Accounting - Meaning, Objectives, Types & Method
Conclusion
The money measurement concept in accounting is a measurable performance concept that aids in preparing and presenting the firm's balance sheets. But it might not accurately reflect and foresee a company's highs and lows and the ambiguities that might exist in the future. Even if it has several drawbacks, the company can fix them. Nowadays, all commercial enterprises worldwide use this method to document and show their accounting operations.
Follow Khatabook for the latest updates, news blogs, and articles related to micro, small and medium businesses (MSMEs), business tips, income tax, GST, salary, and accounting.
