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Sunday, 4 August 2013

Difference between the transaction and capital maintenance approach to measuring income

Difference between the transaction and capital maintenance approach to measuring income

"Two approaches to measuring income are commonly discussed in the accounting literature: the transaction approach and the capital maintenance approach. Under the transaction approach, income is calculated by analyzing the effects of revenue and expense transactions during a period. Any change in the value of the enterprise that is not a result of a transaction is not reflected in the enterprise's net income. Income from continuing operations under current GAAP is based on the transaction approach."


Pj Sorn 


The capital maintenance approach is also called the balance sheet approach of measuring income.

The constant purchasing power of capital is automatically maintained constant in real value under Capital Maintenance in Units of Constant Purchasing Power in terms of a Daily Index (e.g., the Daily CPI during low and high inflation and the daily USD parallel rate during
 hyperinflation) for an indefinite period of time in all entities that at least break even in real value - ceteris paribus - at all levels of inflation and deflation with the stable measuring unit assumption never being implemented; i.e., monetary items always and everywhere inflation adjusted daily and constant real value non-monetary items always and everywhere measured in units of constant purchasing power in terms of a daily index, both under complete coordination (everyone and everything - computer programs - always doing it). 

Under CMUCPP, as defined above, income calculated under the transaction approach as well as the capital maintenance approach would be exactly the same. 


Capital maintenance was and is only and issue under Historical Cost Accounting because it is impossible to maintain the constant purchasing power or real value of capital constant under financial capital maintenance in nominal monetary units (HCA) although the IASB states misleadingly in IFRS in the Conceptual Framework (2010), Par. 4.59 (a) that "Financial capital maintenance can be measured in nominal monetary units". The IASB misleads people in the above that the real value of capital can be maintained constant under HCA per se. That is generally impossible during inflation and deflation. Yes, financial capital can be maintained constant IN NOMINAL VALUES in nominal monetary units, but, not - generally - its real value (constant purchasing power).


Since the constant purchasing power of capital is automatically maintained constant under CMUCPP in terms of a daily index - as defined above, income is thus calculated in terms of the transaction approach; i.e., by analyzing the effects of revenue and expense transactions during a period.


Nicolaas Smith

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