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ACCA Applied Skills · Financial Reporting · Recognition and measurement

Kestrel Co began the year with net assets of $1,200,000 and had no owner transactions. Closing net assets were $1,500,000. Specific prices of the assets Kestrel holds rose by 15% during the year, while general inflation was 8%. Which profit figure results under physical capital maintenance (using the specific price increase)?

Profit is $120,000. Physical capital maintenance uses the specific price rise of 15%, so opening capital of $1,200,000 must grow to $1,380,000 before any profit arises. Closing net assets of $1,500,000 less $1,380,000 leaves $120,000.

  1. A$120,000Correct
  2. B$300,000
  3. C$204,000
  4. D$180,000

Explanation

Capital to maintain physically = 1,200,000 x 1.15 = 1,380,000. Profit = 1,500,000 - 1,380,000 = 120,000. Option 1 is nominal profit. Option 3 uses 1,200,000 x 1.15 - 1,200,000 = 180,000 as profit, which is the price rise itself, i.e. a capital maintenance adjustment, not profit. Option 2 uses 8% inflation: 1,500,000 - 1,296,000 = 204,000, the wrong index.

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