Unit of account

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In economics, unit of account is one of the money functions.

Contents

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 ]

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 ]

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.

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 can lead to confusing -- (or even meaningless) -- results. [1]

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. (2021)

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). [2]

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 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. [3]

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. [3]

See also

Related Research Articles

Gold standard Monetary system where the standard economic unit of account is based on a fixed quantity of gold

A gold standard is a monetary system in which the standard economic unit of account is based on a fixed quantity of gold. The gold standard was widely used in the 19th and early part of the 20th century. Most nations abandoned the gold standard as the basis of their monetary systems at some point in the 20th century, although many still hold substantial gold reserves.

Inflation Rise in price level in an economy over time

In economics, inflation is a general rise in the price level 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 opposite of inflation is deflation, a sustained decrease in the general price level of goods and services. The common measure of inflation is the inflation rate, the annualized percentage change in a general price index, usually the consumer price index, over time.

Deflation Decrease in the general price level of goods and services

In economics, deflation is a decrease in the general price level of goods and services. Deflation occurs when the inflation rate falls below 0%. Inflation reduces the value of currency over time, but sudden deflation increases it. This allows more goods and services to be bought than before with the same amount of currency. Deflation is distinct from disinflation, a slow-down in the inflation rate, i.e. when inflation declines to a lower rate but is still positive.

This aims to be a complete article list of economics topics:

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.

Money supply Total value of money available in an economy at a specific point in time

In macroeconomics, the money supply is the total value of money available in an economy at a point of time. There are several ways to define "money", but standard measures usually include currency in circulation and demand deposits. The central bank of each country may use a definition 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 national 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 US$1 or that US$1 will be exchanged for ¥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.

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

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

Monetary policy

Monetary policy is the policy adopted by the monetary authority of a nation to control either the interest rate payable for very short-term borrowing or the money supply, often as an attempt to reduce inflation or the interest rate, to ensure price stability and general trust of the value and stability of the nation's currency.

In economics, standard of deferred payment is a function of money. It is the function of money 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 a term in economics referring to any item that is widely acceptable in exchange for goods and services. The underlying assumption in designating a "medium of exchange" is that one cannot acquire a good or service from another, without having to provide the other with something material in exchange. Fiat money serves as the foundational medium of exchange in modern developed economies.

Financial 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.

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.

The money measurement concept underlines the fact that in accounting and economics generally, every recorded event or transaction is measured in terms of money, the local currency monetary unit of measure. Using this principle, a fact or a happening or event which cannot be expressed in terms of money is not recorded in the accounting books. Thus, it is not acceptable to record such non-quantifiable items as employee skill levels or the quality of great customer service.

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) and the US Financial Accounting Standards Board (FASB) as an alternative to traditional historical cost accounting under hyper-inflationary environments and all other economic environments. Under this IFRS and US GAAP authorized system, financial capital maintenance is always measured in units of constant purchasing power (CPP) in terms of a Daily CPI during low inflation, high inflation, hyperinflation and deflation; i.e., during all possible economic environments. During all economic environments it can also be measured in a monetized daily indexed unit of account or in terms of a daily relatively stable foreign currency parallel rate, particularly during hyperinflation when a government refuses to publish CPI data.

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

Fiat money is any money that is accepted by a government for paying taxes or debt, but is not pegged to or backed directly by gold and other valuables. Fiat money does not have significant intrinsic value or use value. Fiat money derives value from broad market and government use; parties engaging in exchange simply agree on its relative value at the time. It is a modern alternative to commodity money and representative money. Representative money, unlike fiat, represents a claim on a commodity.

Monetary policy is the monitoring and control of money supply by a central bank, such as the Federal Reserve Board in the United States of America, and the Bangko Sentral ng Pilipinas in the Philippines. This is used by the government to be able to control inflation, and stabilize currency. Monetary Policy is considered to be one of the two ways that the government can influence the economy – the other one being Fiscal Policy. Monetary Policy is generally the process by which the central bank, or government controls the supply and availability of money, the cost of money, and the rate of interest.

Inflation rate in India was 5.5% as of May 2019, as per the Indian Ministry of Statistics and Programme Implementation. This represents a modest reduction from the previous annual figure of 9.6% for June 2011. Inflation rates in India are usually quoted as changes in the Wholesale Price Index (WPI), for all commodities.

References

  1. 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)
  2. Peter Spufford (1986). Handbook of medieval exchange—Introduction. Royal Historical Society (Great Britain). p. xix. ISBN   9780861931057.
  3. 1 2 Financial Accounting Standards Research Initiative: The Unit of Account Issue