Monetary vs. Nonmonetary Items: What’s the Difference?

In accounting, all assets and liabilities are classified as either monetary or nonmonetary. This distinction affects how an item is valued on financial statements and how its value behaves under different economic conditions. This classification provides a framework for analyzing a company’s performance and stability.

Defining Monetary Items

Monetary items are assets and liabilities with a value fixed in a specific number of currency units, such as U.S. dollars. Their defining feature is a right to receive or an obligation to pay a set amount of money. This numerical value does not change, so these items are not restated on financial statements to reflect market changes, even if their purchasing power fluctuates.

Monetary assets represent a claim to a fixed sum of cash. Common examples include:

• Cash
• Accounts receivable, which is the amount owed to a company by its customers
• Notes receivable, which are formal promises of payment for a set amount
• Investments in marketable debt securities, such as bonds

Monetary liabilities are obligations to pay a fixed amount to another party. Examples include:

• Accounts payable, which is the money a company owes to its suppliers
• Notes payable and bonds payable
• Lease liabilities
• Cash dividends that have been declared but not yet paid

Defining Nonmonetary Items

Nonmonetary items are assets and liabilities whose value is not fixed in currency units and can change over time due to market conditions. Their characteristic is the absence of a right to receive or an obligation to deliver a fixed sum of money.

Common nonmonetary assets include tangible items like inventory, property, plant, and equipment (PP&E). The value of these assets fluctuates with factors like replacement cost, market demand, and depreciation. Intangible assets, such as patents, copyrights, and goodwill, are also nonmonetary because their value is based on future economic benefits.

Nonmonetary liabilities represent an obligation to provide goods or services instead of a fixed amount of cash. Examples include unearned revenue, where a company owes a product after receiving payment, and warranty obligations, which commit a company to provide future services or replacements.

Significance in an Inflationary Environment

The distinction between monetary and nonmonetary items is heightened during periods of inflation. Inflation erodes the purchasing power of money, meaning a dollar today buys more than a dollar in the future. This has different consequences for each category.

Holding monetary assets during inflation results in a loss of purchasing power because their dollar amount is fixed while their real value declines. For instance, if you hold $10,000 in cash for a year with a 5% inflation rate, that cash will still be $10,000, but it will only buy what $9,500 would have bought a year prior.

Conversely, holding monetary liabilities can be advantageous during inflation. A company with significant fixed-rate debt will repay its loans with dollars that are worth less than the ones it borrowed. This gain in purchasing power can partially offset the negative effects of inflation.

Nonmonetary assets often serve as a hedge against inflation because their nominal dollar values can increase with the general price level. The value of assets like real estate, equipment, and inventory tends to rise with inflation, preserving the company’s purchasing power. For example, the market price of inventory is likely to increase, protecting the company’s capital from erosion.

Accounting for Nonmonetary Exchanges

A nonmonetary exchange is a transaction where a company trades assets or services without a significant amount of cash changing hands, such as trading a used truck for manufacturing equipment. The accounting for these transactions is guided by rules in the Financial Accounting Standards Board’s Accounting Standards Codification Topic 845.

The main principle for these exchanges is “commercial substance.” A transaction has commercial substance if it is expected to cause a meaningful change in the company’s future cash flows. This assessment determines whether a gain or loss on the exchange can be recognized.

If an exchange has commercial substance, it is recorded at the fair value of the asset given up or received, whichever is more measurable. Any difference between the fair value and the book value of the surrendered asset is recognized as a gain or loss. If an exchange lacks commercial substance, the new asset is recorded at the book value of the old asset, and no gain is recognized.