Conceptual Framework for Financial Reporting

Concepts of capital maintenance and the determination of profit
The concepts of capital in paragraph 8.1 give rise to the following concepts of
capital maintenance:
(a)
Financial capital maintenance. Under this concept a profit is earned only
if the financial (or money) amount of the net assets at the end of the
period exceeds the financial (or money) amount of net assets at the
beginning of the period, after excluding any distributions to, and
contributions from, owners during the period. Financial capital
maintenance can be measured in either nominal monetary units or
units of constant purchasing power.
(b)
Physical capital maintenance. Under this concept a profit is earned only if
the physical productive capacity (or operating capability) of the entity
(or the resources or funds needed to achieve that capacity) at the end
of the period exceeds the physical productive capacity at the beginning
of the period, after excluding any distributions to, and contributions
from, owners during the period.
The concept of capital maintenance is concerned with how an entity defines
the capital that it seeks to maintain. It provides the linkage between the
concepts of capital and the concepts of profit because it provides the point of
reference by which profit is measured; it is a prerequisite for distinguishing
between an entity’s return on capital and its return of capital; only inflows of
assets in excess of amounts needed to maintain capital may be regarded as
profit and therefore as a return on capital. Hence, profit is the residual
8.1
8.2
8.3
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Conceptual Framework
A90
© IFRS Foundation

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amount that remains after expenses (including capital maintenance
adjustments, where appropriate) have been deducted from income. If expenses
exceed income the residual amount is a loss.
The physical capital maintenance concept requires the adoption of the current
cost basis of measurement. The financial capital maintenance concept,
however, does not require the use of a particular basis of measurement.
Selection of the basis under this concept is dependent on the type of financial
capital that the entity is seeking to maintain.
The principal difference between the two concepts of capital maintenance is
the treatment of the effects of changes in the prices of assets and liabilities of
the entity. In general terms, an entity has maintained its capital if it has as
much capital at the end of the period as it had at the beginning of the period.
Any amount over and above that required to maintain the capital at the
beginning of the period is profit.
Under the concept of financial capital maintenance where capital is defined in
terms of nominal monetary units, profit represents the increase in nominal
money capital over the period. Thus, increases in the prices of assets held over
the period, conventionally referred to as holding gains, are, conceptually,
profits. They may not be recognised as such, however, until the assets are
disposed of in an exchange transaction. When the concept of financial capital
maintenance is defined in terms of constant purchasing power units, profit
represents the increase in invested purchasing power over the period. Thus,
only that part of the increase in the prices of assets that exceeds the increase
in the general level of prices is regarded as profit. The rest of the increase is
treated as a capital maintenance adjustment and, hence, as part of equity.
Under the concept of physical capital maintenance when capital is defined in
terms of the physical productive capacity, profit represents the increase in
that capital over the period. All price changes affecting the assets and
liabilities of the entity are viewed as changes in the measurement of the
physical productive capacity of the entity; hence, they are treated as capital
maintenance adjustments that are part of equity and not as profit.
The selection of the measurement bases and concept of capital maintenance
will determine the accounting model used in the preparation of the financial
statements. Different accounting models exhibit different degrees of relevance
and reliability and, as in other areas, management must seek a balance
between relevance and reliability. This Conceptual Framework is applicable to a
range of accounting models and provides guidance on preparing and
presenting the financial statements constructed under the chosen model. At
the present time, it is not the intention of the Board to prescribe a particular
model other than in exceptional circumstances, such as for those entities
reporting in the currency of a hyperinflationary economy. This intention will,
however, be reviewed in the light of world developments.
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Conceptual Framework
© IFRS Foundation
A91

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