i. Capital Concepts

A financial concept of capital is that the capital of an entity is measured as its net assets, which is also its equity. Where a financial concept of capital is used, the main concern of users of the financial statements is with the maintenance of the nominal financial capital of the entity.

With financial concept of capital maintenance, a profit is not earned during a period unless (excluding new equity capital raised during the period and adding back any distribution of dividends to shareholders) the financial value of equity (net assets) at the end of the period exceeds the financial value of equity at the beginning of the period.

A physical concept of capital is that the capital of an entity is represented by its productive capacity or operating capability. Where a physical concept of capital is used, the main concern of users of the financial statements is with the maintenance of the operating capability of the entity.

With a physical concept of capital maintenance, a profit is not earned during a period unless (excluding new equity capital raised during the period and adding back any distribution of dividends to shareholders) the operating capability of the business is greater at the end of the period than at the beginning of the period.

Current value accounting reflects the concept of physical capital maintenance.

In a period of inflation, profits reported using a financial concept of capital will normally be higher than profits reported using a physical concept of capital, such as current value accounting.

Financial capital maintenance is likely to be the most relevant to investors as they are interested in maximising the return on their investment and therefore its purchasing power while Physical capital maintenance is likely to be most relevant to management and employees as they are interested in assessing an entity’s ability to maintain its operating capacity.

ii. Profit is calculated under each concept in the following ways:-