Question

Define “Capital Maintenance” in the context of business law

Answer 1

“Capital Maintenance” in the context of business law

Capital maintenance, also known as capital recovery, 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. A company achieves capital maintenance when the amount of its capital at the end of a period is unchanged from that at the beginning of the period. Any excess amount above this represents the company's profit.

The doctrine of capital maintenance - i.e. that a company must obtain proper consideration for shares that it issues and that having received such capital it must not repay it to members except in certain circumstances - is a fundamental principle of company law.

• Capital maintenance, also called capital recovery, is an accounting concept that says a company's income should only be recognized after it has fully recovered its costs or its capital has been maintained.
• The capital maintenance concept means a company only generates a profit if it fully recovers the costs associated with operations during a selected accounting period.
• There are two primary types of capital maintenance: financial capital maintenance and physical capital maintenance.
• During times of high inflation, a company may need to adjust its asset valuations in order to determine if it has achieved capital maintenance.

Effect of Inflation on Capital Maintenance

A high rate of inflation—especially inflation that has occurred over a short period of time—can impact a company's ability to accurately determine if it has achieved capital maintenance. The value of a company's net assets may increase along with the increase in prices. However, this increase could misrepresent the true value of the company's assets. For this reason, during inflationary times a company may need to adjust the value of its net assets in order to determine if it has achieved capital maintenance.