Question

What is the basic accounting problem created by the monetary unit assumption when there is significant inflation? What appears to be the FASB position on a stable monetary unit?

Short answer

The basic accounting problem created by the monetary unit assumption is that it does not account for the outcome of inflation or increase in price and the corresponding decrease in purchasing power of people. The FASB expects unadjusted dollar amounts to be used for determining items listed in financial statements.

Step-by-step solution

Meaning of Monetary Unit Assumption

The monetary unit assumption is also termed a money measurement concept. This assumption implies that only those business activities are noted in the accounting books which can be stated in cash. At the same time, non-monetary events like labor-management relations, sales policy, labor unrest, the effectiveness of competition, and so on, which are of vital importance to the business concern, do not find a place in accounting. This is because their effect is not estimable and quantifiable in terms of money.

Basic accounting problem created by the monetary unit assumption

The monetary unit assumption presumes that the measuring unit (the dollar) stays the same so that dollars of various years can be accumulated without any modification. When the dollar value changes significantly with time, the monetary unit assumption decreases its effectiveness.

FASB position on a stable monetary unit

The Financial Accounting Standards Board (FASB) in Concept No. 5 shows that it anticipates the dollar not adjusted for inflation or deflation to be used for the purpose of evaluating items identified in financial statements. Except if the situation changes considerably, will the Board account for the steadier unit of measurement.