Or The Stable Monetary Unit Assumption and Other Accounting Fallacies
Accountants make many assumptions as the record financial transactions and prepare financial statements. One of the most critical is the “stable monetary unit assumption”. This assumption presupposes that the purchasing power of the dollar is constant over time; that $1 today will purchase as much as did $1 thirty years ago. This assumption makes it possible to prepare historical-cost based balance sheets.
An historical-cost based balance sheet is one where the values of assets purchased at different times are added together using their historical acquisition costs (what the company paid for the assets at the time of their purchase) to compute the company’s financial position.
After all, a balance sheet has been defined as a picture of a company’s financial position at a point in time. That means that an asset purchased in 1970 for $30,000 has a historical cost that is the same as an asset purchased today for $30,000. Accountants, better than most, know that the purchasing power of the dollar has eroded over time. Nevertheless, we ignore that fact when we prepare financial statements.
Changes in the purchasing power of the dollar are ignored by accountants in the United States we probably shouldn’t. The following table shows the annual consumer price index since 2000 and the decline in the value of the dollar.
Today’s $ | $1 in 2000 | ||
Would | Would | ||
Year | CPI | Buy in 2000 | Buy Today |
2000 | 172.2 | $ 1.00 | $ 1.00 |
2001 | 177.1 | $ 0.97 | $ 1.03 |
2002 | 179.9 | $ 0.96 | $ 1.04 |
2003 | 184.0 | $ 0.94 | $ 1.07 |
2004 | 188.9 | $ 0.91 | $ 1.10 |
2005 | 195.3 | $ 0.88 | $ 1.13 |
2006 | 201.6 | $ 0.85 | $ 1.17 |
2007 | 207.3 | $ 0.83 | $ 1.20 |
2008 | 215.3 | $ 0.80 | $ 1.25 |
2009 | 214.5 | $ 0.80 | $ 1.25 |
2010 | 218.1 | $ 0.79 | $ 1.27 |
One dollar in 2010 would have purchased what you could have purchased in 2000 for 79 cents. Alternatively, it took $1.27 in 2010 to have the same purchasing power as you had with $1.00 in 2000. So what do you think, has your paycheck kept pace with the decline in the purchasing power of the dollar?
Everyone knows Walmart and probably knows that Walmart has shown tremendous sales growth. Take a look:
The top line of the graph shows Walmart's sales as reported on their financial statements. Walmart sales have grown from $156.2 billion in 2000 to $405 billion in 2010. But wait, there’s more. A dollar in 2000 would buy a lot more than $1 in 2010. You saw that above. In fact, the purchasing power of the dollar decreased by about 26 percent over that 10 year period.
The blue and red lines on the graph show Walmart's sales deflated to 2000 dollars and for the increase in the price of gold.
When Walmart’s sales are deflated to year 2000 dollars you can see that sales did increase, but not as much as sales in nominal dollars. If you were to price Walmart’s sales in gold then sales have actually decreased. Which bring me to the key point in this blog.
The financial press talks about the increase in the price of gold when what is really happening is a decrease in the value of the dollar. If you assume that the intrinsic value of an ounce of gold is constant over time then the worth of the dollar has been declining rapidly. Remember, an increase in the price of gold (or any other commodity) reflects two things, a price change resulting from a change in demand for the commodity, and a price change resulting from the change in the value of the dollar. Both have happened with the price of gold.
Finally, remember when you look at a company’s financial statements the amounts are expressed in nominal dollars, the value of the dollar when the financial statements were issued and not in constant dollars (dollars adjusted for changes in the purchasing power of the dollar).
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