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Concept of Capital Maintenance

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izaan16sep
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126 views3 pages

Concept of Capital Maintenance

Uploaded by

izaan16sep
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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Concept of Capital Maintenance

a) Financial Capital --- (Nominal Basis )

e.g., Opening Capital 1000

Closing Capital 1200

Profit 200 (assuming no new capital invested and no dividend declaration)

Some one say there is inflation in the country, suppose 10% so there is profit of 200 but not consider the
inflation factor.

b) Financial Capital (Real Term )

Opening Capital 1000

Closing Capital 1200 Inflation rate 8%

Profit

*** Opening Capital 1000

Inflation 8% 80 so opening capital is 1080 and 1200 difference


the real profit is Rs.120 not 200

c) Physical Capital ----- A person invest machine Rs.800 and stock Rs.200 = Capital of 1000
SO this capital is not in cash term , so
MACHINE Stock Capital
800 200 1000
80 (10% increase) 10(5% increase) `1090
880 210 1090
Closing Capital 1200 --- genuinely I gain 110 rs. Not 200

SO CAPTIAL DEFINE

1) Currency unit ( Financial capital ---- on nominal basis )


PROFIT IS closing capital- opening capital
2) Purchasing power ( Financial capital ---- Real term )
Closing capital – opening capital (adjusted for general inflation )= profit
3) Replacement cost of capacity
Closing capital –opening capital (adjusted for specific inflation ) = profit

Example -1

X Ltd commenced business on 1st January, with a single item of inventory which costs Rs.10000. During
the year it sold the item for Rs.14000 (cash).

During the year general inflation was 5% but the inflation specific to the item was 10%.
So we form Journal entries

1-1-20 inventory 1000

To capital 1000

31-12-2- cash 14000

Sale 14000

== CGS 10000

To inventory 10000

Financial capital (Nominal terms) Financial Capital (Real Terms) Physical Capital

Historical Cost accounting purchasing power accounting current cost acc


No Inflation Effect General Inflation Specific inflation

Statement of Comprehensive income (SOCI)

Sale 14000 14000 14000

CGS 10000 10000 10000

G.P 4000 4000 4000

Adjustment for inflation (500) (1000) 0CI

Profit 3500 3000

Statement of Financial position (SOFP)

CASH 14000 14000 14000

Equity

S.Capital 10000 10500 11000

Re.earning 4000 3500 3000

Total 14000 14000 14000

Example -2

Carrie starts in business on 1st January Year 1. Carrie’s sole shareholder contributed capital of Rs.1000.
Carrie’s purchased one item of inventory for Rs.1000 and sold that inventory for cash of Rs.1400 . At the
end of YEAR 1 The replacement cost of the same item of inventory is Rs.1100 . General inflation during
the year was 7%.

Required:
Calculate the profit for the year and set out a summary statement of financial position as of 31 st
December year 1 under the following capital maintenance concepts.

 Physical capital maintenance


 Financial capital maintenance
 Historical cost accounting
 Constant purchasing power accounting.

Important point

What is profit Closing Capital – Opening Capital(Adjustment for relevant inflation )

So The Extended form is : we say --- profit is

------

Closing Capital

Less opening capital

Less new capital introducted

Add dividend paid during the year

Less adjustment for the relevant inflation

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