The Money measurement concept is one of the basic accounting principles or theories that form part of the larger set of accounting rules. Record keeping and performance measurement are key components of an accounting cycle. Financial accounting is based on several principles such as business entity concept, historical cost, accrual basis accounting principle, matching principle, and money measurement concept. A business entity can decide to use all or part of these principles, however, once decided the entity needs to uniformly apply the same accounting principles all over the entity record keeping.
What is Money Measurement Concept in Accounting?
The money measurement concept as the name suggests is a performance measurement accounting tool that evaluates performance in monetary terms. Simply put, all business performance metrics are measured in currency values. This leads to the conclusion that any business activity that does not involve monetary value will not be recorded. The concept has its valuable advantages and limitations though.
Businesses operate in different ways; hence their performance metrics can also be different. For example, a business can measure its performance by the number of units produced in a production period. A restaurant may use the number of customers served at premises or take away. Recording accounting data in accordance with accounting standards and measuring results provide analyses and help in measuring performance. Using a uniform measure to analyze these performance metrics can help understand these performance indicators easily. The money measurement concept applies the monetary value principle to all these accounting entries. Financial accounting prepares records for management and analyses for the investors or shareholders. Measuring all business operations or performances in one metric such as monetary value provides a consistent approach.
Financial accounting deals with quantified data of business operations. Historically, financial accounting was concerned only with bookkeeping and recording of cost and revenues only. Modern financial accounting demands for continuous performance measurement. All quantifiable data stated in currency valuation forms the basis for money measurement. It then leads financial accountants to the unit of measure principle. That requires all monetary values to be stated in one currency either local or foreign. Accounting principles such as Generally Accepted Accounting Principles (GAAP) does not make it compulsory to use any particular currency or money measurement rules. GAAP rules however call for a uniform and consistent approach in all record keeping.
Importance of Money Measurement Concept
Financial data without measurement provides no value to financial accountants and shareholders. A business can improve efficiency only if it can identify or measure its performance. At the end of each accounting period, financial statements depict an entity’s performance. If that performance is measured differently according to activity it will not make any sense. Let’s say, a company manufactures confectionery items, it can measure performance in labor hours taken to produce a certain number of units. It can also use the raw material, or the number of employees to reach a certain production level. All that information is necessary for operation efficiency measurement, but it cannot be stated on the balance sheet. The money measurement concept converts all these performance metrics to monetary values and makes it easier to analyze the business performance.
The Characteristics of Money Measurement Concept
The money measurement concept or principle has certain characteristics as below:
- It provides a common denominator of performance measurement i.e. money
- Only those business activities will be recorded that can be interpreted in monetary value
- Monetary value presentation of business results make it easier to communicate between business management and shareholders
- The monetary value will be recorded at historic money values
- This concept takes money as a stable unit of measure i.e. it does not consider the inflation effect of transactions
The money measurement concept complies with most of the basic financial accounting concepts. Converting all business operation results into one single measure of money makes it easier for management and shareholders to understand and communicate.
Limitation of Money Measurement Concept
However, as with any theoretical concept, it also offers some limitations:
- It ignores any valuable business events that we cannot measure in quantifiable terms such as increased revenue with new market campaigns
- The concept ignores the inflation effect on historic costs
- We cannot compare the absolute monetary value results without scaling and adjustments
- Some business processes cannot be quantifiably recorded in monetary values such as a business with a service center. For example, a consultancy business.
- It does not provide in-depth analyses for any deviation from original standards set
- Many business entities prefer to evaluate performance in non-quantifiable measures
Let us compare the money measurement concept with two entities in the same business industry. Two companies’ techno blue and Crislu jewelers produce 1,000 product units and make sales of $ 30,000 per month. Techno blue has 3 salesmen and 430 labor hours in the production facility. Crislu jewelers use 6 salesmen and 380 labor hours.
Techno blue achieves $ 10,000 per salesman per month; Crislu Jewelers achieves $ 5,000 per salesman per month.
Techno blue achieves 2.32 labor hours per unit and Crislu jewelers 2.63 labor hours per unit.
Techno blue’s marketing staff is more efficient than Crislu as they are achieving the same sales with half of the salesforce. Crislu jeweler’s production is more efficient than techno blues as they are using fewer workers to produce the same products. The money measurement concept provides a valuable comparison with total sales values recorded in dollar amounts. The shareholders would primarily be interested in total monthly sales provided they meet the targets. At the same time, the money measurement concept will be unable to provide the variance in details for operations and sales employees. In that scenario, both the management and shareholders would want to dig deeper into the causes of under and over achievements in production.
With all the benefits and limitations, the money measurement concept provides a valuable contribution to financial accounting basics. It complies with the financial accounting concepts of monetary value measurements, record-keeping in a single measure, and data presentation. However, it lacks the financial management tools such as non-monetary activity recording and measurement. It also ignores the inflation effects on recorded transactions. Nonetheless, the money measurement concept provides valuable contributions towards financial accounting and forms the basis for financial management concepts.