Unit of account

A unit of account in economics is a nominal monetary unit of measure or currency used to value/cost goods, services, assets, liabilities, income, expenses; i.e., any economic item. It is one of three well-known functions of money.[1] It lends meaning to profits, losses, liability, or assets.

A unit of account in financial accounting refers to the words that are used to describe the specific assets and liabilities that are reported in financial statements rather than the units used to measure them.[2]

Unit of account and unit of measure are sometimes treated as synonyms in financial accounting and economics.[2]

The unit of account in economics (unit of measure in accounting) suffers from the pitfall of not being stable in real value over time because money is generally not perfectly stable in real value during inflation and deflation. Inflation destroys the assumption that the real value of the unit of account is stable which is the basis of classic accountancy. In such circumstances, historical values registered in accountancy books become heterogeneous amounts measured in different units. The use of such data under traditional accounting methods without previous correction often leads to invalid results.[3]

All monetary units of measure, e.g., US Dollar, Euro, Yen, Yuan, Ruble, Peso, etc., - all fiat currency units - are assumed to be perfectly stable in real value during non-hyperinflationary conditions under traditional Historical Cost Accounting in terms of which the stable measuring unit assumption is applied. The Daily Consumer Price Index (Daily CPI) - or a monetized daily indexed unit of account - is generally used to index monetary values on a daily basis when it is required to maintain the purchasing power or real value of monetary values constant during inflation and deflation.

Uses

A monetary unit of account (unit of measurement) in economics allows meaningful interpretation of prices, costs, and profits, so that an entity can monitor its own performance and its shareholders can make sense of its past performance and have an idea of its future profitability. In modern economies, money in the form of currency usually serves the role of the unit of account (unit of measurement). The use of money, as a relatively stable unit of measure, improves the efficiency of market economies. However, money is generally never perfectly stable in real value which is the fundamental problem with traditional Historical Cost Accounting which is based on the stable measuring unit assumption.

Historic examples of units of measure include the livre tournois, used in France from 1302 to 1794 whether or not livre coins were minted. In the 14th century Naples used the grossi gigliati, and Bohemia used the Prague groschen.

At any one time there might be two or three units of account in one region based on the local base, silver and sometimes gold coins, and each often expressed in L.S.D units in ratio 240:12:1. The Florentine gold florin, the French franc and the electoral rheingulden all became pounds (240 denari) of account. Units of account would often survive over 100 years despite the original coins changing composition and availability (e.g. the Castilian maravedi).[4]

A modern unit of account is the European Currency Unit, used in the European Union from 1979 to 1998; its replacement in 1999, the euro, was also just a unit of account until the introduction of notes and coins in 2002.

Unit of account is the main way of calculating a carrier or ship owner’s liability in relation to carriage of goods contracts in which the Hague-Visby Rules apply.

Modern finance

The use of a unit of account in financial accounting, according to the American business model, allows investors to invest capital into those companies that provide the highest rate of return. The use of a unit of account in managerial accounting enables firms to choose between activities that yield the highest profit.

In economics, a standard unit of account is used for statistical purposes to describe economic activity. Indexes such as GDP and the CPI are so broad in their scope that compiling them would be impossible without a standard unit of account. After being compiled, these figures are often used to guide governmental policy; especially monetary and fiscal policy.

In calculating the opportunity cost of a policy, a standard unit of account allows for the creation of a composite good. A composite good is a theoretical abstraction that represents an aggregation of all other opportunities that are not realized by the first good. It allows an economic decision's benefits to be weighed against the costs of all other possible goods in that society, without having to refer to any directly. Often, this is most easily accomplished with money.

Unit of account in accounting

The unit of account in financial accounting refers to the words that are used to describe the specific assets and liabilities that are reported in financial statements rather than the units used to measure them. That is, unit of account refers to the object of recognition or display whereas unit of measure refers to the tool for measuring it.[2]

Unit of measure and unit of account are sometimes treated as synonyms in financial accounting and economics. Unit of measure in financial accounting refers to the monetary unit to be used; that is, whether it should be nominal units of money as opposed to units that are adjusted for changes in purchasing power over time.[2]

See also

References

  1. ↑ Mankiw, N. Gregory. Principles of Macroeconomics. Mason, OH: Southwestern Cengage Learning, 2008. 338-39. Print.
  2. 1 2 3 4 Financial Accounting Standards Research Initiative: The Unit of Account Issue
  3. ↑ The Taxation of Income from Business and Capital in Colombia: Fiscal Reform in the Developing World By Charles E. McLure, John Mutti, Victor Thuronyi, George R. Zodrow, Contributor Charles E. McLure, Published by Duke University Press, 1990, ISBN 0-8223-0925-4, ISBN 978-0-8223-0925-3, Page 259 : Inflation destroys the assumption that money is stable which is the basis of classic accountancy. In such circumstances, historical values registered in accountancy books become heterogeneous amounts measured in different units. The use of such data under traditional accounting methods without previous correction, makes no sense and leads to results that are void of meaning.(Massone, 1981a. p.6)
  4. ↑ Peter Spuffords (1986). "Handbook of medieval exchange; Introduction".

External links

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