Fixed assets, such as buildings and manufacturing equipment, lose value over time due to wear, age, and other factors. The consumption of fixed capital reflects this loss and is used for tax and accounting purposes. It is also used in macroeconomic analysis, with CFC accounting for 12% of US GDP in 2009.
Fixed assets refer to the physical assets of a business, including buildings and manufacturing equipment. The value of this capital continuously depreciates due to wear or simply the effects of time. The consumption of fixed capital refers to the part of these assets that has been used up in a given period of time. While this is similar to depreciation, the two concepts have some key differences in terms of how they are used and calculated. Fixed capital consumption may also be known as capital consumption adjustment, capital consumption allowance or simply CFC.
No matter how carefully a business maintains its equipment and property over time, these assets will almost always lose value. This loss in value can be attributed to wear, age or heavy use. It can also occur due to accidents or damages or acts of nature. Some may even be blamed for new technology, which leaves a business with outdated or outdated equipment. The consumption of fixed assets reflects the value of all these losses, as well as any additional expenses incurred in replacing these assets.
While traditional depreciation is calculated based on the historical cost of an item, fixed capital consumption reflects the value lost based on the current price. This means that CFC is often much larger than depreciation, reflecting actual replacement costs, not past costs.
Businesses prefer to use this measurement rather than depreciation because it brings them more financial benefits. This impairment can be used as a write-off from the company’s gross income for tax and accounting purposes, which helps save the company money. Since the value of capital is constantly changing, its consumption must be recalculated for each accounting period in order to reflect its true value.
Fixed capital consumption is also used in macroeconomic analysis when studying the economy as a whole. For example, gross national product (GDP) can be calculated by adding a country’s aggregate net profit plus all corporate taxes to its aggregate CFC. In the United States, CFCs account for a full 12% of GDP as of 2009 according to the Organization for Economic Co-operation and Development. Failure to include consumption of fixed assets in GDP calculations can therefore have a substantial impact on this number. Economists can also calculate net domestic product (NDP) by subtracting CFC from GDP.
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