What is 'Capital Maintenance'

Capital maintenance is an accounting concept based on the principle that income is only recognized after capital has been maintained or there has been a full recovery of costs. Capital maintenance has been reached when the amount of a company's capital at the end of a period is unchanged from that at the beginning of the period, with any excess amount treated as profit.

BREAKING DOWN 'Capital Maintenance'

Capital maintenance, also known as capital recovery, means that a profit is only generated once the costs associated with operations during a selected accounting period have been fully recuperated. To calculate the profit, the total value of the business's financial and other capital assets at the beginning of the period must be known. The two basic subsections of capital maintenance are financial capital maintenance and physical capital maintenance.

Financial Capital Maintenance

According to International Financial Reporting Standards (IFRS), under the definition of financial capital maintenance, a profit is earned only if the amount of net assets at the end of a period exceeds the amount at the beginning of the period, excluding any inflows from or outflows to owners (e.g. contributions and distributions). It can be measured either in nominal monetary units or constant purchasing power units.

Financial capital maintenance is only concerned with the actual funds available at the start and the end of a specified accounting cycle and does not include the value of other capital assets.  The two ways of looking at financial capital maintenance are money financial capital maintenance and real financial capital maintenance. Under money financial capital maintenance, profit is measured if the closing net assets exceed the opening net assets, with both measured at historical cost.  Under real financial capital maintenance, profit is measured if the closing net assets exceed the opening net assets, with both measured at current prices. 

Physical Capital Maintenance

Physical capital maintenance is not concerned with the cost associated with the actual maintenance required on tangible items, such as equipment. Instead, it focuses on a business's ability to sustain cash flows into the future by maintaining access to income-generating assets in use within the business's infrastructure.

The definition of physical capital maintenance, according to the IFRS, implies that a profit is earned only if the enterprise's productive or operating capacity at the end of a period exceeds the capacity at the beginning of the period, excluding any owners' contributions or distributions.

Capital Maintenance and Inflation

Inflation has the ability to skew the value of net assets even when the underlying asset has not changed in quantity or condition. For businesses operating in a hyperinflationary environment, adjusting values to reflect the rate of inflation properly may be required.

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