Financial Capital Maintenance

Every accounting system must rely on a given concept for capital maintenance for the purpose of valuing all its assets as well as defining the measurement unit to use. In short, the analysis of the total profits in the accounting systems requires the application of capital maintenance. The difference of a company’s capital at the end and at the start of a period stands as the accounting profit, disregarding distributions and repayments of capital, as well as any additions to capital (Weiss, 2014). As a result, it is only considered profitable for a company after an accounting period is over, if the company reflects more assets at the end than it had at the beginning of a trading period. In light of the above, the totality of the accounting profits can only be measurable as soon as there is a standard definition of the establishment of capital maintenance. There are two ways to varying concepts defining capital maintenance (Knubley & Clark, 2013). Either of the two capital maintenance concepts only remains important with respect to how much of the income earned exceeding the necessary amount required for the maintenance of capital stands out as profit. The two major concepts of capital maintenance are:

Financial Capital Maintenance: Under the provisions of the above capital maintenance concept, a profit only comes to records if the assets amount recorded at the end of a financial period is more than the asset value recorded at the beginning of the same financial period. The above difference is after the exclusion of any distributions for personal use or contributions from individual items by the business owners during that particular fiscal period. The measurement of financial capital is either given units of constant purchasing power or nominal monetary units.

Physical Capital Maintenance: Under the provisions of the physical capital maintenance, a profit is recorded only if the operating capacity (physical production capacity) of the entire business entity is more at the end of a financial year with respect to the amount of the same at the start of the same year. According to the provisions of financial capital maintenance, the net difference excludes any contributions from or distributions to the owners at the respective fiscal period for the profit.

It is a common practice for firms to adopt and implement the application of financial capital maintenance. Unfortunately, many of the conceptual frameworks in various companies’ fail to describe or give advice on the capital maintenance model proposed for the firms (Wei, 2015). As a result, the management boards of various companies are at liberty to apply the provisions of any. However, the choice of the capital maintenance method by the management should find basis on which between the two promises to provide the information users as much information as possible with regards to the interpretation of financial statements records (Hobson, 2008).

The underlying problems with the application of capital maintenance are mostly related to the applicability of the various concepts. According to the provisions of the IASB, all concepts upon which capital maintenance funds basis are only relevant for business entities whose operations is limited to industries in high inflation economies (Marttonen et al., 2013). As a result, the IASB even considers carrying out extensive research with respect to determining the importance of revise some accounting standards such as the IAS 29 (Deloitte, 2013). With respect to the above, the IASB finds it appropriate to believe that every issue having to do with capital maintenance is possible to deal with at the same time as a standard level accounting project for high inflation than in another economic situation. Therefore, it is a problem since the IASB will continue to include the current provisions and descriptions of capital maintenance until such a time when it feels necessary to change the standard level accounting requirements for a high inflation economic scenario (Puddu et al., 2013).

Under the provisions of the financial capital maintenance concept, the measurement of income happens only after maintaining the unadjusted monetary investments by the stakeholders (Mohammadi & Amini, 2013). As a result, the above method finds a lot of criticism. A major criticism comes about as a result of foreign exchange in cases where a business operates with subsidiaries in other countries. If the value of one currency is not stable, the purchasing power with respect to that money becomes unstable as well. For an Australian parent company, if the Australian dollar’s purchasing power changes rapidly over a short time, it becomes significantly misleading to use the dollar as a unit of standard measurement. As a result, due to the assumption of monetary stability, the historical amounts of the dollar are matched with the number at the present time, ending up with an undefined difference between the two values.

Additionally, the concept of financial capital maintenance gives permission for the inclusion of holding income gains. Furthermore, according to the Accounting Standards in Australia, the erosion of a company’s operating capacity should occur when those holding gains are distributed to stockholders in terms of dividends. The above brings the criticism to financial capital maintenance concept for including profits in earnings for being invalidated especially in the concept of last in first out (LIFO). The criticism for holding gains fails to be valid due to the fact that its criticism of the capital maintenance concept for something it fails to purport to do. The proponents of the time value of capital maintenance concept also include another weakness of the financial capital maintenance which comes as a result of failure to consider the cost of financing the company equity (Rapoport, 2015). However, it is possible to dismiss that cost of capital financing weakness. However, such dismissal should ensure not to consider any imputed interest with reference to the contributions of the stockholders with reference to the cost of the holders of equity security.

The new consolidation methods stand a little on their level in terms of the specific provision they hold with reference to group treating consolidated accounts (Orrell et al., 2015). For one, unlike in the cases of individual enterprises the existence of group enterprises is arguably illegal. Each of the subsidiary company, just like the parent company, is legally an independent entity. For illustration purposes, a case of debt with a parent company does not transfer the responsibility to the subsidiary company (Cowman, 2014). In the same point of view, any case of dividends received from subsidiary should be entered as a credit to the parent company’s profit. In the same point of view, the retained earnings do not feature in as credits to the parent company’s profit. All the statements for a group consolidated account contain all the information referring to operations and financial standing of every enterprise that makes up the group conglomerate. As a result, the accountants can quickly hide (through absorption) all the losses resulting from one subsidiary with the help of information from another financial (Weiss, 2012). In addition, it is also possible to hide one subsidiary’s insolvency situation by hedging it with a strong financial position of another subsidiary.  If some of the subsidiaries in a group are in operations in different areas in the economy, the resulting consolidated group statements must all comply with the International Accounting Standards to enhance clarity.  In Australia, they must comply with AASB10 as well.

Reference List

Australian Accounting Standards Board, 2015. Amendments to Australian Accounting Standards – Investment Entities: Applying the Consolidation Exception. Melbourne: Commonwealth of Australia Australian Accounting Standards Board.

Cowman, R.D., 2014. MAINTENANCE CAPITAL EXPENDITURES: CONSIDERATIONS IN CASH FLOW ANALYSIS. The RMA Journal, 96(10), pp.51-57.

Deloitte, 2013. IAS 29 — Applicability of the concept of financial capital maintenance defined in constant purchasing power units. [Online] Available at: http://www.iasplus.com/en/meeting-notes/ifrs-ic/2013/ifrs-ic-september-2013/ias-29-capital-maintenance [Accessed 21 April 2015].

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Gould, G., Chua, Y.L. & Cheong, C.S., 2012. The Impact of Mandatory IFRS Adoption on Accounting Quality: Evidence from Australia. Journal of International Accounting Research, 11(1), pp.119-46.

Hobson, S., 2008. Closer scrutiny of capital maintenance needed. Utility Weekly, 28(15), p.14.

Knubley, R. & Clark, P., 2013. Draft discussion paper: Capital maintenance. IASB Agenda. London: IFRS Foundation IFRS Foundation.

Lee, T.A., 2014. The Early Debate on Financial and Physical Capital. Accounting Historians Journal, p.Online.

Marttonen, S., Monto, S. & Kärri, T., 2013. Profitable working capital management in industrial maintenance companies. Journal of Quality in Maintenance Engineering, 19(4), pp.429-46.

Mohammadi, A. & Amini, J., 2013. Study of investors’ reaction to the maintenance level of cash amount as well as circulation capital/money in leveraged and non leverage companies. Interdisciplinary Journal of Contemporary Research In Business, 5(8), pp.300-09.

Orrell, M., Cryderman, C., Warren, A. & Renouf, J., 2015. Accounting Roundup: Year in Review—2014. The Wall Street Journal, p.Online.

Progressive Media Group, 2014. Adelaide Brighton Ltd (ABC) : Company Profile and SWOT Analysis. World Market Intelligence, p.n/a.

ProQuest, 2012. Asciano Group Annual General Meeting – Final. Fair Disclosure Wire.

Puddu, L. et al., 2013. The Consolidated Financial Statement: Are Ipsas And National Accounting Standards Comparable? The Turin City Council Case. International Journal of Business and Social Science, 4(13), p.n/a.

Rapoport, M., 2015. Tailored Accounting at IPOs Raises Flags. The Wall Street Journal, p.Online.

Wei, L., 2015. China Prepares Mergers for Big State-Owned Enterprises. The Wall Street Journal, p.Online.

Weiss, J., 2012. Proposed Accounting Standards Update, Consolidation (ASC 810): Accounting for the Difference between the Fair Value of the Assets and the Fair Value of the Liabilities of a Consolidated Collateralized Financing Entity. Miller GAAP Update Service, 12(22).

Weiss, J., 2014. Accounting Standards Update (ASU) No. 2014-13, Consolidation (ASC 810): Measuring the Financial Assets and the Financial Liabilities of a Consolidated Collateralized Financing Entity (EITF Consensus)/Proposed Accounting Standards Update (ASU). Miller GAAP Update Service, 14(17), pp.1-7.

 

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