Financial Reporting · Recognition and measurement

Capital Maintenance and Concepts of Capital for ACCA FR

Updated 11 October 2026 · Fact-checked

Capital maintenance decides when an entity has made a profit. Profit is earned only if closing net assets exceed the amount needed to keep opening capital intact. Financial capital maintenance keeps money or purchasing power intact. Physical capital maintenance keeps the entity's operating capability intact. Inflation makes historical cost profit look higher.

Understand Capital Maintenance and Concepts of Capital

Profit is the increase in wealth over a period. To measure it, you must first decide what capital you want to keep intact. Only the amount earned above that is profit. This is the idea of capital maintenance.

The previous Conceptual Framework (the 1989 Framework, as revised in 2010) described two concepts of capital. The 2018 Conceptual Framework removed the detailed chapter on concepts of capital and capital maintenance, but the ideas still explain how profit depends on what capital you keep intact. In a financial concept of capital, capital is the net assets or equity of the entity. It can be measured in nominal money units or in units of constant purchasing power. In a physical concept of capital, capital is the entity's productive capacity, such as units of output per day.

This gives two capital maintenance concepts. Under financial capital maintenance, profit is earned only if closing net assets (excluding owner distributions and contributions) exceed opening net assets. Under physical capital maintenance, profit is earned only if the entity's closing productive capacity exceeds its opening capacity. In practice, this means the entity must be able to replace its assets at higher prices before it counts any profit.

Prices change, so the choice matters. Under financial capital maintenance in nominal money units, a rise in asset prices is profit. Under constant purchasing power, only the rise above general inflation is profit. Under physical capital maintenance, price rises on the assets needed to keep capacity are not profit. They go to equity as a capital maintenance adjustment (a revaluation-type reserve).

Historical cost accounting, the most common basis, uses nominal money capital. In times of rising prices, it can overstate profit. Costs such as depreciation and cost of sales are charged at old prices, while revenue is at current prices. The entity may then pay out profits it needs to replace its assets. IFRS does not require either concept of capital maintenance, and the IASB has not issued a capital maintenance standard.

Key rules to remember

Financial capital maintenance (nominal): Profit = Closing equity − Opening equity (before distributions and contributions); Used under historical cost. Any rise in the value of assets counts as profit.
Financial capital maintenance (constant purchasing power): Profit = Closing equity − (Opening equity × closing index ÷ opening index); Opening equity is restated by general inflation. Only the excess is profit.
Physical capital maintenance: Profit = Closing equity − Opening equity restated at the increase in specific prices of the entity's non-monetary operating assets; Use the price index of the entity's own assets, not the general price index. The specific-price restatement applies to the non-monetary assets that maintain capacity. Monetary items and liabilities are not restated by the specific index.
Capital maintenance adjustment: Adjustment = opening net operating assets (capacity-maintaining) × specific price increase (physical), or opening equity × general inflation (CPP); This amount is the price effect that is excluded from profit. It is taken to equity, not to profit. Under physical capital maintenance, the specific price increase applies only to the net operating assets that maintain capacity, not to all opening equity.

How to solve Capital Maintenance and Concepts of Capital questions

Use this method for any written or objective question on capital maintenance.

1Identify what the question asks: define a concept, calculate profit, or discuss the effect of inflation.
2Identify the capital concept: financial (money or purchasing power) or physical (operating capability).
3Find opening equity (opening net assets) and closing equity. Remove any dividends paid or capital introduced during the year.
4Choose the right index: the general price index for constant purchasing power, or the specific asset price index for physical capital.
5Restate opening equity: multiply it by closing index ÷ opening index, or by (1 + specific price increase).
6Subtract the restated opening equity from closing equity to get profit. Compare with nominal profit and note the difference as the capital maintenance adjustment.
7If asked to discuss, comment on the effect: overstated profit, excess dividends, and loss of operating capability under historical cost.

Quickest way: Three-line profit under each concept

When to use it: Use for numerical objective test questions where you must compute profit under a stated capital maintenance concept.

Write nominal profit first: closing equity − opening equity (adjusted for distributions).
Compute the maintenance adjustment: opening equity × general inflation for constant purchasing power, or opening capacity-maintaining net operating assets × specific price increase for physical capital.
Profit under the concept = nominal profit − adjustment. A negative result means no real profit, only erosion of capital.

Common mistakes in Capital Maintenance and Concepts of Capital

Saying physical capital maintenance means keeping the same physical assets, or that it ignores money.
The word 'physical' suggests tangible items.
Fix: Define it as keeping operating capability (productive capacity). The test is whether the entity can still produce the same output. Value is measured using current replacement prices.
Using the general inflation index for physical capital maintenance.
Students treat all inflation as the same.
Fix: General index for constant purchasing power. The specific index for the entity's own assets for physical capital.
Restating closing equity instead of opening equity.
Closing figures feel more current, so they seem the ones to adjust.
Fix: Restate opening equity to closing price level, then compare with closing equity as it stands.
Including dividends and new share issues in profit.
The closing less opening equity change is treated as profit automatically.
Fix: Add back distributions to owners and deduct capital contributed before computing profit.
Putting the capital maintenance adjustment through profit or loss.
It is seen as a normal expense of inflation.
Fix: Take it to equity as a reserve. Profit is measured after this amount is set aside, but the adjustment itself is not an expense in profit or loss.
Claiming historical cost always overstates profit.
Inflation is the usual case, so the rule is overgeneralised.
Fix: Say it overstates profit when prices rise. If prices fall, the effect is reversed.

Worked examples

Example 1

An entity had opening equity of ₹10,00,000 and closing equity of ₹12,50,000. No dividends were paid and no shares were issued. The general price index rose from 100 to 110 over the year. Calculate profit under (a) nominal financial capital maintenance and (b) financial capital maintenance in constant purchasing power.

Show the solution

(a) Nominal profit = ₹12,50,000 − ₹10,00,000 = ₹2,50,000.
(b) Restate opening equity: ₹10,00,000 × 110 ÷ 100 = ₹11,00,000.
Profit = ₹12,50,000 − ₹11,00,000 = ₹1,50,000.
The difference of ₹1,00,000 is the capital maintenance adjustment, which is needed to keep purchasing power intact.

Answer: (a) ₹2,50,000; (b) ₹1,50,000. Historical cost profit is ₹1,00,000 higher than the profit after preserving purchasing power.

Example 2

An entity began the year with net assets of ₹8,00,000, all of which are specialised equipment and inventory (there are no monetary items or liabilities). Over the year, the specific prices of these assets rose by 15%. Closing net assets, measured at current cost at the year end, were ₹10,00,000. No distributions or capital contributions occurred. Calculate profit under physical capital maintenance and explain why it differs from nominal profit.

Show the solution

Nominal profit (increase in net assets) = ₹10,00,000 − ₹8,00,000 = ₹2,00,000.
Opening capital needed to keep capacity: ₹8,00,000 × 1.15 = ₹9,20,000.
Profit under physical capital maintenance = ₹10,00,000 − ₹9,20,000 = ₹80,000.
The capital maintenance adjustment is ₹9,20,000 − ₹8,00,000 = ₹1,20,000, taken to equity.
It differs because ₹1,20,000 of the nominal profit is needed just to replace the assets at higher prices.

Answer: Profit under physical capital maintenance is ₹80,000, against nominal profit of ₹2,00,000. The ₹1,20,000 difference is a capital maintenance adjustment in equity, not profit.

Exam tips

Learn the two definitions word for word. Section A questions often test which concept a statement describes.
In a calculation, always state which index you use and why. The marker follows the logic even if one figure is off.
For discussion questions, link historical cost to overstated profit, excess dividends and unreplaced assets. Then name the alternative models.
Remember that IFRS does not require either concept, and the 2018 Framework removed the detailed chapter on them. Avoid saying IFRS requires physical capital maintenance.
Set out each step on a separate line in Section C. Method marks are given for restating opening equity correctly.

Practice questions from Recognition and measurement

Capital Maintenance and Concepts of Capital in other exams

The same ground in other exams, if you are preparing for more than one or want another angle on it.

Capital Maintenance and Concepts of Capital: frequently asked questions

What is the difference between financial and physical capital maintenance?

Financial capital maintenance keeps the money value or purchasing power of net assets intact. Physical capital maintenance keeps the entity's operating capability intact. Under the first, profit is the rise in net assets above the restated opening amount. Under the second, profit arises only after the entity could replace its productive assets.

How does inflation affect historical cost accounting profit?

When prices rise, historical cost charges costs such as depreciation and cost of sales at old prices, while revenue is at current prices. Profit is therefore overstated. The entity may distribute profit it needs to replace assets, and asset values in the statement of financial position are understated.

Which concept does IFRS require?

IFRS does not require either concept, and the IASB has not issued a capital maintenance standard. The previous Framework (1989, revised 2010) described both concepts and did not require either. The 2018 Conceptual Framework removed that detailed chapter. In practice, most entities use historical cost with financial capital maintenance in nominal money units.

What is a capital maintenance adjustment?

It is the amount of apparent profit that must be retained to keep capital intact when prices change. It is excluded from profit and credited to an equity reserve. It is not an expense in profit or loss.