Two approaches to measuring income are commonly discussed in theaccounting literature: the transaction approach and the capital maintenanceapproach. Under the transaction approach, income is calculated by analyzing theeffects of revenue and expense transactions during a period. Any change in thevalue of the enterprise that is not a result of a transaction is not reflected in theenterprise's net income. Income from continuing operations under currentGAAP is based on the transaction approach.
Under the capital maintenance approach
, however, net income is definedas the difference between the net assets (assets minus liabilities) at the beginning of a period and net assets at the end of the period, excluding owners'contributions and distributions during the period. The capital maintenanceapproach captures all changes in the value of the enterprise during a period,regardless of whether the change resulted from a transaction.Accounting concept that a profit can be realized only after capital of thefirm has either been restored to its original level (called 'capital recovery') or ismaintained at a predetermined level. It is necessary, therefore, to determine thevalue of capital before the amount of profit can be computed. Capitalmaintenance (paid from the capital funds budget) is the work performed using asystematic management process to plan and budget for known cyclical repair and replacement requirements that extend the life and retain the usablecondition of facilities and systems. This includes what is commonly known as“deferred maintenance”: work that has been deferred on a planned or unplanned basis to a future budget cycle or postponed until funds are available; when thework is performed the deferred maintenance backlog is reduced. The conceptsof capital give rise to the following
concepts of capital maintenance
financial capital maintenance concept
is that the capital of acompany is only maintained if the financial or monetary amount of its net assetsat the end of a financial period is equal to or exceeds the financial or monetaryamount of its net assets at the beginning of the period, excluding anydistributions to, or contributions from, the owners.
physical capital maintenance concept
is that the physical capital isonly maintained if the physical productive or operating capacity, or the funds or resources required to achieve this capacity, is equal to or exceeds the physical productive capacity at the beginning of the period, after excluding anydistributions to, or contributions from, owners during the financial period.