Capital MaintenanceExplained & Defined

Denise Elizabeth P
Senior Financial Editor & Contributor
Last Updated: August 4, 2022
Date Published: August 4, 2022

What is Capital Maintenance?

Capital Maintenance is an accounting method wherein a profit is only recognized after all the costs have been recovered fully or capital has been maintained.

Capital Maintenance is achieved when the beginning balance and ending balance of the capital account remain the same.

However, if the ending balance is greater than the beginning balance, it means that firm recognized a profit. 

How Capital Maintenance Works

The concept of capital maintenance suggests that when all the costs related to the operations of the company for the specific accounting period have been fully recovered, profits are recognized.

Profits are determined if the beginning balances of capital assets and other financial information are known. 

Types of Capital Maintenance

capital maintenance

Financial Capital Maintenance

Financial capital mainly considers the availability of funds in the firm’s account at the beginning and end of the accounting cycle without the consideration for other capital assets.

To recognize a profit in this method, the ending amount of the net assets must exceed the beginning amount of net assets, after eliminating any distributions made to the owner and any contributions from them.

Nominal monetary units or constant purchasing power units can be used as a method to measure financial capital maintenance. 

As the name suggests, financial capital maintenance only pertains to the cash amount generated in a given period. 

The two sub-categories of financial capital maintenance are money financial capital maintenance and real financial capital maintenance. 

Profit is recognized under money financial capital maintenance when the ending net assets exceed the beginning net assets, with assets valued at historical cost (the purchase price of the asset).

Under real financial capital maintenance, the same computation is applied under money financial capital maintenance but the assets are valued at current prices. 

Physical Capital Maintenance

In Physical capital maintenance, the future economic benefit from the tangible assets is being considered.

It measures the ability of a physical asset to generate cash inflow over time.

They can also be called cash-generating assets and do not deal with the maintenance of such assets. 

Profit can only be recognized if the operating capacity of the company at the end of the period exceeds the operating capacity at the beginning of the period without including the contributions from and distributions to the owner. 

The Effect of Inflation on Capital Maintenance

Accurately determining if a company has achieved capital maintenance can be challenging due to inflation, especially if it occurs within just a short period of time.

When inflation happens and prices increase, so will the net assets of the company.

When this happens, it may lead to a misrepresentation of the value of a company’s asset.

Adjustment of the value of the net assets can be the remedy to determine a more justifiable value for capital maintenance. 

FundsNet requires Contributors, Writers and Authors to use Primary Sources to source and cite their work. These Sources include White Papers, Government Information & Data, Original Reporting and Interviews from Industry Experts. Reputable Publishers are also sourced and cited where appropriate. Learn more about the standards we follow in producing Accurate, Unbiased and Researched Content in our editorial policy.

  1. Penn State "CHAPTER 6 CAPITAL MAINTENANCE" Chapter 6. August 4, 2022