Capital maintenance is a concept which measures whether either financial capital (money and equivalents) or physical productive capital within an entity are maintained within a period. Capital is maintained only when the output/funds at the end of the period are equal to or exceed the inputs/funds at the beginning of the period. If the inputs at the beginning of the period equal the outputs at the end of the period, capital will have been "maintained." Anything in excess of maintaining this capital, is considered profit.
Capital maintenance is important because in order for a business to survive, it must at least preserve the capital that is invested in the company. Therefore, an entity should strive to, at minimum, maintain its capital.
Financial Capital Maintenance: Capital will only be maintained if financial assets (funds) equal or exceed expenses and other financial outflows, at the end of the period. Note that this calculation excludes any distributions and/or contributions to and/or from the owners of the company.
Physical Capital Maintenance: Physical capital will be maintained only if, by the end of the period, the entity maintains or exceeds the level of output/productive capacity it started with at the beginning of the period. Physical capital also excludes any distributions to owners, e.g.: dividends.
There are several bases which can be used to measure whether capital is maintained.
Bases for measurement of capital maintenance include:
Nominal Dollar Financial Capital Maintenance: This represents the nominal increase in capital.
Closing Capital - Opening Capital
Constant Dollar Financial Capital Maintenance: Income is reported after inflation to ensure purchasing power is maintained.
Closing Capital - (Opening Capital x (1+Inflation Rate))
Productive Capacity Capital Maintenance: Income earned is the amount in excess of the cost of replacing the asset.
Closing Capital - Cost to replace inventory
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