Physical capital maintenance is very different from financial capital maintenance

May 9, 2013 in Uncategorized

Physical capital maintenance is very different from financial capital maintenance

In IFRS the Conceptual Framework (2010), Par. 4.59 (b) states the following:
 ‘Physical capital maintenance. Under this concept a profit is earned only if the physical productive capacity (or operating capability) of the entity (or the resources or funds needed to achieve that capacity) at the end of the period exceeds the physical productive capacity at the beginning of the period, after excluding any distributions to, and contributions from, owners during the period.’
The (1) physical capital maintenance concept is a fundamentally (totally) different capital maintenance concept compared to the two financial capital maintenance concepts, namely (2) financial capital maintenance in nominal monetary units (traditional Historical Cost Accounting) and (3) financial capital maintenance in units of constant purchasing power (restatement as required in IAS 29 during hyperinflation or monetary correction or indexation as widely implemented in Latin America from the early 1960´s to mid the 1990´s and carried on in Chile till 2008).
The Conceptual Framework, Par. 4.57 states:
‘Under a physical concept of capital, such as operating capability, capital is regarded as the productive capacity of the entity based on, for example, units of output per day.’
So, it is all about ‘units of output per day’. An entity must be using ‘units of output per day’ as a measurement basis to maintain its physical capital.
Physical capital maintenance is not just another way or an additional way of looking at or presenting the two financial capital maintenance concepts.
Actual physical capital maintenance is not generally used in any economy. Prof. Rachel Baskerville from Victoria University in New Zealand states in her paper ‘100 Questions and Answers about IFRS’, Question 39:
‘It is equally possible for a company to adopt a concept of physical capital; i.e. the cycle of operation moves from assets/goods to dollar to goods/assets. Some public sector entities consider that their stewardship responsibilities are best served by reporting physical capital maintenance e.g. is the capacity of the waterworks, waste water system etc. in the local town the same as, or better, than it was last year?
Some Key Performance Indicators (KPIs) will be chosen to report this.
The Framework states:  ― ‘Under a physical concept of capital, such as operating capability, capital is regarded as the productive capacity of the entity based on, for example, units of output per day.”

So: physical capital maintenance is not generally about ‘measurements currently reported in balance sheets’. Physical capital maintenance is not often used.
Nicolaas Smith
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