Unit of account

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In economics, unit of account is one of the functions of money. The value of something is measured in a specific currency. This allows different things to be compared against each other; for example, goods, services, assets, liabilities, labor, income, expenses. [1] It lends meaning to profits, losses, liability, or assets.[ citation needed ]

Economics Social science that analyzes the production, distribution, and consumption of goods and services

Economics is the social science that studies the production, distribution, and consumption of goods and services.

Unit of measurement real scalar quantity, defined and adopted by convention, with which any other quantity of the same kind can be compared to express the ratio of the two quantities as a number (International vocabulary of metrology)

A unit of measurement is a definite magnitude of a quantity, defined and adopted by convention or by law, that is used as a standard for measurement of the same kind of quantity. Any other quantity of that kind can be expressed as a multiple of the unit of measurement.

Contents

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]

Accounting standard the specific accouning discipline followed (IFRS, US GAAP, Chinese AS, France GAAP, Germany GAAP,  Russian GAAP, UK GAAP, etc.)

Financial statements prepared and presented by a company typically follow an external standard that specifically guides their preparation. These standards vary across the globe and are typically overseen by some combination of the private accounting profession in that specific nation and the various government regulators. Variations across countries may be considerable, making cross-country evaluation of financial data challenging.


Economics

Unit of account in economics allows a somewhat meaningful interpretation of prices, costs, and profits, so that an entity can monitor its own performance. It allows shareholders to make sense of its past performance and have an idea of its future profitability. The use of money, as a relatively stable unit of measure, can tend to drive market economies toward efficiency.[ citation needed ]

In microeconomics, economic efficiency is, roughly speaking, a situation in which nothing can be improved without something else being hurt. Depending on the context, it is usually one of the following two related concepts:

Historically, prices were often given in a dominant currency used as a unit of account, but transactions actually settled by using a variety of coins that were available, and often goods, all converted into their value in the unit of account. Many international transactions continue to be settled in this way, using a national value (most often expressed in the US dollar or euro) but with the actual settlement in something else.[ citation needed ]

Euro European currency

The euro is the official currency of 19 of the 28 member states of the European Union. This group of states is known as the eurozone or euro area, and counts about 343 million citizens as of 2019. The euro is the second-largest and second-most traded currency in the foreign exchange market after the United States dollar, and is divided into 100 cents.

In historical cost accounting, currencies are assumed to be perfectly stable in real value during non-hyperinflationary conditions under 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 – can be 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.

Historical cost

In accounting, an economic item's historical cost is the original nominal monetary value of that item. Historical cost accounting involves reporting assets and liabilities at their historical costs, which are not updated for changes in the items' values. Consequently, the amounts reported for these balance sheet items often differ from their current economic or market values.

Hyperinflation Rapidly accelerating inflation

In economics, hyperinflation is very high and typically accelerating inflation. It quickly erodes the real value of the local currency, as the prices of all goods increase. This causes people to minimize their holdings in that currency as they usually switch to more stable foreign currencies, often the US Dollar. Prices typically remain stable in terms of other relatively stable currencies.

Problems

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.

The unit of account in economics 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]

History

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.[ citation needed ]

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.

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.[ citation needed ]

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

Related Research Articles

A currency, in the most specific sense is money in any form when in use or circulation as a medium of exchange, especially circulating banknotes and coins. A more general definition is that a currency is a system of money in common use, especially for people in a nation. Under this definition, US dollars (US$), pounds sterling (£), Australian dollars (A$), European euros (€), Russian rubles (₽) and Indian Rupees (₹) are examples of currencies. These various currencies are recognized as stores of value and are traded between nations in foreign exchange markets, which determine the relative values of the different currencies. Currencies in this sense are defined by governments, and each type has limited boundaries of acceptance.

Inflation increase in the general price level of goods and services in an economy over a period of time

In economics, inflation is a sustained increase in the general price level of goods and services in an economy over a period of time. When the general price level rises, each unit of currency buys fewer goods and services; consequently, inflation reflects a reduction in the purchasing power per unit of money – a loss of real value in the medium of exchange and unit of account within the economy. The measure of inflation is the inflation rate, the annualized percentage change in a general price index, usually the consumer price index, over time. The opposite of inflation is deflation, a sustained decrease in the general price level of goods and services.

Financial capital is any economic resource measured in terms of money used by entrepreneurs and businesses to buy what they need to make their products or to provide their services to the sector of the economy upon which their operation is based, i.e. retail, corporate, investment banking, etc.

Money supply total amount of monetary assets available in an economy at a specific time

The money supply is the total value of money available in an economy at a specific time. There are several ways to define "money", but standard measures usually include currency in circulation and demand deposits. Each country’s central bank may use its own definitions of what constitutes money for its purposes.

Exchange rate rate at which one currency will be exchanged for another

In finance, an exchange rate is the rate at which one currency will be exchanged for another. It is also regarded as the value of one country’s currency in relation to another currency. For example, an interbank exchange rate of 114 Japanese yen to the United States dollar means that ¥114 will be exchanged for each US$1 or that US$1 will be exchanged for each ¥114. In this case it is said that the price of a dollar in relation to yen is ¥114, or equivalently that the price of a yen in relation to dollars is $1/114.The government has the authority to change exchange rate when needed.

Currency substitution Use of a foreign currency in parallel to or instead of a domestic currency

Currency substitution or dollarization is the use of a foreign currency in parallel to or instead of the domestic currency.

Monetary policy subclass of the economic policy

Monetary policy is the policy adopted by the monetary authority of a country that controls either the interest rate payable on very short-term borrowing or the money supply, often targeting inflation or the interest rate to ensure price stability and general trust in the currency.

A store of value is the function of an asset that can be saved, retrieved and exchanged at a later time, and be predictably useful when retrieved. More generally, a store of value is anything that retains purchasing power into the future.

In economics standard of deferred payment is a function of money. It is the function of being a widely accepted way to value a debt, thereby allowing goods and services to be acquired now and paid for in the future.

Medium of exchange is one of the three fundamental functions of money in mainstream economics. It is a widely accepted token which can be exchanged for goods and services. Because it can be exchanged for any good or service it acts as an intermediary instrument and avoids the limitations of barter; where what one wants has to be exactly matched with what the other has to offer.

Financial accounting field of accounting

Financial accounting is the field of accounting concerned with the summary, analysis and reporting of financial transactions related to a business. This involves the preparation of financial statements available for public use. Stockholders, suppliers, banks, employees, government agencies, business owners, and other stakeholders are examples of people interested in receiving such information for decision making purposes.

Foreign exchange reserves is money or other assets held by a central bank or other monetary authority so that it can pay its liabilities, if needed, such as the currency issued by the central bank, as well as the various bank reserves deposited with the central bank by the government and other financial institutions. Reserves are held in one or more reserve currencies, mostly the United States dollar and to a lesser extent the Euro.

The distinction between real prices and ideal prices is a distinction between actual prices paid for products, services, assets and labour, and computed prices which are not actually charged or paid in market trade, although they may facilitate trade. The difference is between actual prices paid, and information about possible, potential or likely prices, or "average" price levels. This distinction should not be confused with the difference between "nominal prices" (current-value) and "real prices". It is more similar to, though not identical with, the distinction between "theoretical value" and "market price" in financial economics.

Money Object or record accepted as payment

Money is any item or verifiable record that is generally accepted as payment for goods and services and repayment of debts, such as taxes, in a particular country or socio-economic context. The main functions of money are distinguished as: a medium of exchange, a unit of account, a store of value and sometimes, a standard of deferred payment. Any item or verifiable record that fulfils these functions can be considered as money.

Monetary inflation is a sustained increase in the money supply of a country. Depending on many factors, especially public expectations, the fundamental state and development of the economy, and the transmission mechanism, it is likely to result in price inflation, which is usually just called "inflation", which is a rise in the general level of prices of goods and services.

When a daily indexed unit of account or Daily Consumer Price Index or monetized daily indexed unit of account is used in contracts or in the Capital Maintenance in Units of Constant Purchasing Power accounting model, deferred payments and constant real value non-monetary items are indexed to the general price level in terms of a Daily Index such that changes in the inflation rate—in the case of monetary items—and the stable measuring unit assumption—in the case of constant real value non-monetary items—have no effect on the real value of these items. Non-indexed units, such as contracts written in nominal currency units and nominal monetary items, incur inflation or deflation risk in the case of monetary items. During all periods of inflation, the debtor pays less in real terms than what both the debtor and creditor agreed at the original time of the contract/sale. On the other hand, in periods of deflation, the debtor pays more in real terms than the original agreed value. The opposite is true for creditors. Contracts and constant real value non-monetary items accounted in daily indexed units of account, Daily CPI or monetized daily indexed units of account incur no inflation or deflation risk, as the real value of payments and outstanding capital amounts remain constant over time while the nominal values are inflation- or deflation-indexed daily.

Constant purchasing power accounting

Constant purchasing power accounting (CPPA) is an accounting model approved by the International Accounting Standards Board (IASB) as an alternative to traditional historical cost accounting under hyper-inflationary environments. Under this system, financial capital maintenance is measured in units of constant purchasing power (CPP) in terms of a CPI during low inflation. During high inflation and hyperinflation it can also be measured in a monetized daily indexed unit of account and in terms of a daily relatively stable foreign currency parallel rate or daily index.

Fiat money currency established as money by government regulation or law.

Fiat money is a currency without intrinsic value that has been established as money, often by government regulation. Fiat money does not have use value, and has value only because a government maintains its value, or because parties engaging in exchange agree on its value. It was introduced as an alternative to commodity money and representative money. Commodity money is created from a good, often a precious metal such as gold or silver, which has uses other than as a medium of exchange. Representative money is similar to fiat money, but it represents a claim on a commodity.

Domestic liability dollarization (DLD) refers to the denomination of banking system deposits and lending in a currency other than that of the country in which they are held. DLD does not refer exclusively to denomination in US dollars, as DLD encompasses accounts denominated in internationally traded "hard" currencies such as the British pound sterling, the Swiss franc, the Japanese yen, and the Euro.

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".Missing or empty |url= (help)