Economists often define wealth as an increase or decrease in the entity’s ability to purchase goods and services. Accountants use a more specific measurement—they consider only increases and decreases resulting from actual transactions. If a transaction has not taken place, they do not record a change in wealth.
The accountant’s measurement of wealth is shaped and limited by the assumptions underlying generally accepted accounting principles that were introduced and discussed in Chapter 1. These included the use of historical cost, matching expenses to revenues or the period in which they are incurred, and assumptions about a stable monetary unit, a separate business entity, revenue recognition, , and going concern. These assumptions mean that accountants record transactions in one currency (for example, dollars), currency retains its purchasing power, and changes in market values of assets are generally not recorded.
Economists, on the other hand, make different assumptions. They often recognize changes in market value of assets. For example, if an entity purchased land for $100,000 that subsequently increased in value to $125,000, economists would recognize a $25,000 increase in wealth. International Financial Reporting Standards generally do not recognize this increase until the entity actually disposes of the asset; accountants would continue to value the land at its $100,000 purchase cost. This practice is based on the application of the historical cost principle, which is a part of GAAP.
Economic wealth is also affected by changes in the purchasing powerof the dollar. For example, if the entity has cash of $50,000 at the beginning of a time period and purchasing power drops by 10% because of inflation, the entity has lost wealth because the $50,000 can purchase only $45,000 of goods and services. Conversely, the entity gains wealth if purchasing power increases by 10%. In this case, the same $50,000 can purchase $55,000 worth of goods and services. However, accountants do not record any changes because the monetary unit principle assumes that the currency unit is a stable measure.
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