Discuss the Accounting Concepts of Income and Capital and Their Role in Income Determination.

I will begin my discussion of this by quoting Hick’s income definition;

“We ought to define a man’s income as the maximum value which he can consume during a week, and still expect to be as well off at the end of the week as he was at the beginning”.

One of the main issues in income determination is the capital maintenance concept, which is a concept used to determine the definition of profit, that provides the basis for different systems of inflation accounting

The main principle behind it is that earnings can only be realised after an organisation's capital has been maintained at a predetermined level, basically to protect the issued capital of the company for the benefit of creditors.

Capital maintenance contains two concepts; a financial concept and a physical concept. Most entities adopt a financial concept of capital maintenance. Under this concept a profit is earned only if the monetary amount of net assets at the end of the period, excluding distributions/contributions to/from owners, exceeds the monetary amount of net assets at the beginning of the period. Financial capital maintenance is usually measured in monetary units; however, the requirement to report the impact of hyperinflation results in the measurement of assets and liabilities in monetary units of constant purchasing power.

The physical capital maintenance concept is that the physical capital is only 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 any distributions to, or contributions from, owners during the financial period.

Generally, the capital maintenance doctrine legally protects creditors from unforeseen risks and the limited liability of shareholders. Indeed, the June 2001 report defines this concept as a way of ensuring that the full value of the capital is received and that...