Question

• Debate 5‐1 Concepts of Capital Maintenance

  SFAC No. 5 states that the concept of capital maintenance is critical in distinguishing an enterprise’s return on investment from return of its investment. Two concepts of capital maintenance are discussed: physical capital maintenance and financial capital maintenance.

  Team Debate:

  Team 1:

  Present arguments in favor of the physical capital maintenance concept.

  Team 2:

  Present arguments in favor of the financial capital maintenance concept.

Answer 1

First of all ,we should know," what is capital maintenance?"

Capital Maintenance,it is an accounting concept based on the principle that a company's income should only be recognized after it has fully recovered its costs or its capital has been maintained. It is also known as capital recovery. A company receive its capital maintenance when the amount of its capital at the end of the period is not changed from the beginning. The amount which is more then this is treated or considered as profit.

Now there are two types of capital maintenance. They are

1. Physical Capital Maintenance

2. Financial Capital Maintenance

According to financial capital maintenance, a company earns a profit only if the amount of its net assets at the end of a period exceeds the amount at the beginning of the period. This excludes any inflows from or outflows to the owners, such as 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.

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 implies that a company only earns a profit if its 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.