Financial statements are prepared using monetary values. In Nigeria, the Naira is used, the United Kingdom uses GBP, and the US uses the Dollar. This serves as a money measurement in reporting financial transactions. But there are weaknesses in using money to measure business activities. This article explains it.
Money measurement concept definition
The money measurement principle explains that money is the appropriate measurement for business transactions and reporting the financial results of an entity. This is why financial statements are recorded using money as the unit of value. In Nigeria, the Naira is used as a measurement basis. This blog uses the Naira (NGN) symbol when measuring and explaining financial transactions, with some exceptions.
In economics, money is a store of value and a unit of measurement. Accountants do the same. Therefore, all finance experts agree that using currencies is more reliable in measuring business activities.
Generally, there are two forms of measuring items. Quantitative and qualitative measurement. Quantitative measurement makes use of numbers, but qualitative measurement is non-numerical. Number measurement is not limited to money or currency. It can be in kilograms, barrels, and so on.
The point is that in all the numerical ways of measuring items, finance professionals use currencies. However, the problem of using money as a measurement basis is that it neglects the negligence that will result from avoiding other parameters that have aided successful businesses.
Limitations of monetary measurement
Based on historical cost
Money measurement is based on historical cost. This means that stakeholders will rely on past information in making decisions. However, decisions are expected to be taken from both past, present, and future information.
Use uncertain future values
At times the future values of money can be used in preparing reports such as a budget, forecast, or financial model. But this is based on estimates and a level of probability. This results in uncertainty of future values used. Stakeholders will partially trust such a measurement or will only do so because it is from an expert and not because it is certain to occur.
Human errors
When posting business transactions into the books of accounts, humans can make errors. An amount of NGN 560,000 may be posted as NGN 650,000. This error distorts the reliability of financial results.
Over-reliance on numbers
Managers and other stakeholders may focus more on numbers whereas other non-monetary factors might affect the business. To avoid this, companies are mandated to provide qualitative information such as CSR and sustainability reports.
Failing to consider qualitative aspects of business
Stakeholders may rely on money measurements from financial reports without examining the qualitative aspect of the business. Other areas, such as PESTEL analysis, can be used to understand the business environment, which is mainly qualitative.
Applying the money measurement concept
Without the money measurement principle, other accounting concepts and conventions cannot stand. Also, it enables the reporting of financial information.
Application to materiality
The money measurement concept aids in deciding the materiality threshold of companies. With it, an accountant or auditor can decide on what monetary value they can place as a materiality level for a company.
Preparing financial statements, budgets, and models
The preparation and presentation of financial statements, budgets, forecasts, and models are possible, thanks to monetary values. Preparers have a basis for deciding what value to inscribe for each line item in those statements.
Accounting bases
Accounting bases are cash and accrual bases. The terms cash and currency are inseparable. The accrual basis in IFRS standards is based on money as a unit of value. Deciding what amount is earned and incurred for income and expenses, respectively, is a money measurement.
Conclusion
Finally, there is nothing wrong with using money as a measurement basis for financial information. While making decisions, users of the information should rely on both quantitative and qualitative data.