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  Approaches to Equity Maintenance

Introduction to Approaches to Equity Maintenance

Two broad approaches to equity maintenance have raced for acceptance.

These are now described as follow:

  • Maintaining the owners' investment

The 1st approach is regarded with making sure that the general purchasing power of the investment of owners in the business is keep during a period of inflation. For doing this, a general price index, like the Retail Price Index (RPI), is employed to compute changes in the purchasing power of the pound. (A general price index is constructed through taking a basket of goods and services at a specific point in time and expressing their total cost at a base value of 100. The costs of these goods and services are then calculated frequently over time and any changes are described in relation to the base value.) A set of financial statements is then ready by using the price index measures for dissimilar dates.

Financial transactions taking place at dissimilar dates will be expressed in terms of their purchasing power at a single, common date - the end of the accounting period. This is completed by adjusting for the change in the price index among the date of the transaction and the end of the accounting period. Profit presented for distribution will be derived through expressing both the revenue that received and the cost of the goods sold for the period in terms of their current (end-of-accounting-period) purchasing power. The cost of assets obtained will also be stated in terms of their current purchasing power.

  • Maintaining business operations

The 2nd approach to maintaining equity intact is regarded with making sure that the business is able to preserve its scale of operations. For this, the particular price changes that influence the business must be taken into account while preparing the financial statements. Current cost accounting (CCA) is a significant method of accounting for particular price changes. It is principally, but not exclusively, relies on the current cost of replacing an item. Other words, the current costs than the historic costs of items are reported.

Within CCA, the profit presented for distribution is generally calculated through matching revenue with the cost of replacing the goods which were sold. In several cases, price changes that influence a business will not correspond to general price changes taking place in the economy (even though, for the sake of convenience, that the particular price of goods changed in line along with the general rate of inflation).

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