Consumption of fixed capital (CFC) is a term used in business accounts, tax assessments and national accounts for depreciation of fixed assets. It is used in preference to "depreciation" to emphasize that fixed capital is used up in the process of generating new output; CFC may include other costs incurred in using fixed assets beyond actual depreciation charges. Normally the term applies only to producing enterprises, but sometimes it applies also to real estate assets.

It refers to a depreciation charge (or "write-off") against the gross income of a producing enterprise, which reflects the decline in value of fixed capital being operated with. Fixed assets will decline in value after they are purchased for use in production, due to wear and tear, changed market valuation and possibly market obsolescence. Thus, CFC represents a compensation for the loss of value of fixed assets to an enterprise. Declining-balance depreciation of a $50,000 asset with $6,500 salvage value over 20 years. ... Fixed capital is a concept in economics and accounting, first theoretically analysed in some depth by the economist David Ricardo. ...

CFC tends to increase as the asset gets older, even if the efficiency and rental remain constant to the end. The larger the depreciation write-off, the larger the gross income of a business. Consequently, business owners consider this accounting entry as very important; after all, it affects both their income, and their ability to invest.

How much the depreciation charge actually will be, depends mainly on the depreciation rates which enterprises are officially permitted to charge for tax purposes (usually fixed by law), and on how fixed assets themselves are valued for accounting purposes. This makes the assessment of consumption of fixed capital quite complex, because fixed assets may be valued for instance at:

• historic (acquisition) cost
• operating value (as part of a "going concern")
• current sale-value in the market
• current replacement cost
• economic value
• scrap value
• deflated value (allowing for price inflation)

By how much then, do fixed assets used in production truly decline in value, within an accounting period? How should they be valued? This can be arguable and very difficult to answer, and in practice, various conventions are adopted by accountants and auditors within the framework of legal rules.

In addition, the depreciation schedules imposed by tax departments may differ from the actual depreciation of business assets. Often, governments permit depreciation write-offs higher than true depreciation, to provide an incentive to enterprises for new investment. But this is not always the case; the tax rate might sometimes lower than the real market-based rate. Furthermore, businesses might engage in creative accounting and deliberately overstate their assets held at a balance date, to increase the amount of depreciation charges, and thus boost their income. Creative accounting and earnings management are euphemisms referring to accounting practices that deviate from standard accounting practices. ...

For all these reasons, economists distinguish between different kinds of depreciation rates, arguing that the "true" consumption of fixed capital is really the economic depreciation, assessed by relating financial data to mathematical models.

Consumption of fixed capital in national accounts

In national accounts, CFC is a component of value added or Gross Domestic Product, and regarded as a cost of production. It is defined in general terms as the decline, in an accounting period, of the current value of the stock of fixed assets owned and used by a producer as a result of physical deterioration, normal obsolescence or normal accidental damage. In economics, gross domestic product (GDP) is a measure of the value of economic production of a particular territory in financial capital terms during a specified period. ...

The UNSNA manual notes that "The consumption of fixed capital is one of the most important elements in the System... It may account for 10 per cent or more of total GDP." CFC is defined "in a way that is theoretically appropriate and relevant for purposes of economic analysis". Its value may therefore diverge considerably from depreciation actually recorded in business accounts, or as allowed for taxation purposes, especially if there is price inflation. The United Nations System of National Accounts is an international standard system of social accounts, first published in 1953. ...

In principle, CFC is calculated using the actual or estimated prices and rentals of fixed assets prevailing at the time the production takes place, and not at the times fixed assets were originally acquired. The "historic costs" of fixed assets, i.e., the prices originally paid for them, may become quite irrelevant for the calculation of consumption of fixed capital, if prices change sufficiently over time.

Included in CFC are

Unlike depreciation as calculated in business accounts, CFC in national accounts is, in principle, nota method of allocating the costs of past expenditures on fixed assets over subsequent accounting periods. Rather, fixed assets at a given moment in time are valued according to the remaining benefits derived from its use.

Depreciation charges in business accounts are adjusted from historic costs to current prices, in conjunction with estimates of the capital stock.

Inclusions

• all fixed assets - that is, tangible and intangible fixed assets - owned by producers.

• fixed assets constructed to improve land, such as drainage systems, dykes, or breakwaters or on assets which are constructed on or through land - roads, railway tracks, tunnels, dams, etc.

• Losses of fixed assets due to normal accidental damage, i.e. damage caused to assets used in production resulting from their exposure to the risk of fires, storms, accidents due to human errors, etc.

• interest costs incurred in acquiring fixed assets, which may consist either of actual interest paid on borrowed funds, or the loss of interest incurred as a result of investing own funds in the purchase of the fixed asset, instead of a financial asset. Whether owned or rented, the full cost of using the fixed asset in production is thus measured by the actual or imputed rental on the asset, and not by depreciation alone. If the fixed asset is actually rented under an operating lease or similar contract, the rental is recorded under Intermediate consumption as the purchase of a service produced by the lessor. If the user and the owner are one and the same unit, CFC represents only part of the cost of using the asset.

• Certain insurance premiums related to the acquisition or maintenance of fixed assets.

Intermediate consumption is an economic concept used in national accounts, such as the United Nations System of National Accounts (UNSNA) and the US National Income and Product Accounts (NIPA). ...

Exclusions

• the value of fixed assets destroyed by acts of war, or exceptional events such as major natural disasters, earthquakes, volcanic eruptions, tidal waves, exceptionally severe hurricanes, etc. (e.g. Hurricane Katrina) which occur very infrequently.

• valuables (precious metals, precious stones, etc.)

• the depletion or degradation of non-produced assets such as land, mineral or other deposits, or coal, oil, or natural gas.

• losses due to unexpected technological developments that may significantly shorten the service lives of a group of existing fixed assets.

This article is about the 2005 hurricane. ...

Gross and net capital stocks

The value at current prices of the gross capital stock is obtained, by using price indices for fixed assets to value all fixed assets in use at the actual or estimated current purchasers' prices for new assets of the same type, irrespective of the age of the assets.

The net, or written-down value of a fixed capital asset is equal to its current replacement cost, less CFC accrued up to that point in time.