The Money Measurement Convention

The money measurement convention

Both trade and accounting existed before the invention of money, which we know began to circulate in the 6th century B.C. Its role as a common denominator by which the value of assets of different kinds could be compared encouraged the extension of trade. By Roman times, money had become the language of commerce, and accounts were kept in money terms. Hence, there is an accounting tradition which dates back some 2000 years of keeping the records of valuable assets and of transactions in monetary terms. It should not appear surprising, therefore, that accounting information today reflects the time-hallowed practice of dealing only with those facts which are capable of expression in money.

The money measurement convention sets an absolute limit to the type of information which may be selected and measured by accountants, and hence limits the type of information which accountants may communicate about a business enterprise.

For some time, it has been known that a competitor has developed a better product, and that the company is likely to lose its market. The managing director is ill, the production manager and the accountant are not on speaking terms and the labour force is resentful about the deterioration in working conditions in the factory. The buildings are dilapidated, but the land itself is valuable. The equipment is old and needs a great deal of maintenance, and as a result, there is a considerable wastage of labour hours owing to machinery breakdown.

It is clear from the foregoing example that the most significant information of interest to shareholders is not what is contained in the balance sheet but the information which is left out of it, and which is much more relevant to an understanding of the firm's position. Yet, the accountant is unable to measure and communicate that information to shareholders directly in money terms, although all these facts may explain poor income figures. The reader of a financial accounting report should not expect, therefore, that all or perhaps even the most important facts about the business will be disclosed, and this is why there is such a premium on 'inside' information in order to make correct assessments of the firm's true position. One of the major problems of accounting today is to find means of solving the measurement problem: how to extend the quality and the coverage of information in a way which is meaningful. The advantage of money, of course, is that people are able to grasp the meaning of facts which are stated in money, and it remains the most obvious standard of measurement in accounting.

There are further problems associated with the practice of using money as a standard of measurement in accounting. Money does not have a constant value through time, nor does the value of specific assets remain the same in relation to money. Until recently, accountants turned a blind eye to this problem by assuming that the money standard did have a constant value. The rising rates of inflation in the 2000s and 2000s destroyed this fiction.

Financial accounting records serve two distinct and important purposes. First, they provide evidence of the financial dimensions of rights and obligations resulting from legal contracts. For this purpose these records must be kept in the form of unadjusted money measurements. Second, they are used as a basis for providing financial information for shareholders, investors and a variety of users who need such information for decision making. For this purpose, the money measurements must reflect the economic reality of business transactions and for this reason must be adjusted for changes in price levels. In this part, we shall discuss the first purpose of financial accounting records, and in Parts 3 and 4, we shall discuss the second purpose.

It is clear from our discussion so far that the abandonment of either of the two conventions which we have examined would alter the nature of financial accounting completely. Communicating information about a business entity in money terms is the basis of modern financial accounting theory and practice. The conventions which we shall now discuss relate to the treatment of data.

Learn More About Accounting Internship

Read on: Fundamental Conventions

Fundamental conventions

(a) The entity convention

The practice of distinguishing the affairs of the business from the personal affairs of its owner originated in the early days of double-entry book-keeping some 400 years ago. Accounting has a history which reaches back to the beginning of civilization, and archaeologists have found accounting records which date as far back as 4000 B.C., well before the invention of money. Nevertheless, it was not until the 15th century that the separation of the owner's wealth from the wealth invested in a business venture was recognized as necessary.... see: Fundamental Conventions