Fixed capital refers to the physical assets of a business, including things like buildings and manufacturing equipment. The value of this capital is continuously depreciating due to wear and tear, or simply the effects of time. Consumption of fixed capital refers to the portion of these assets that used up over a specific period of time. While this is similar to depreciation, the two concepts have some key differences in terms of their uses and how they are calculated. Consumption of fixed capital 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 of value can be attributed to wear and tear, age, or heavy use. It can also occur due to accidents or damage, or acts of nature. Some can also be blamed on new technology, which leaves a business with out-of-date or obsolete equipment. Consumption of fixed capital reflects the value of all these losses, as well as any additional expenses incurred when replacing these assets.
While traditional depreciation is calculated based on the historic cost of an item, consumption of fixed capital reflects lost value based on current pricing. This means that CFC is often much larger than depreciation, as it reflects true replacement cost, not past costs.
Businesses prefer using this measurement rather than depreciation because it brings them greater financial benefits. This loss of value can be used as a write-off against the company's gross income for tax and accounting purposes, which helps save the company money. Given that the value of capital is constantly changing, its consumption must be recalculated for each accounting period in order to reflect its true value.
Consumption of fixed capital 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 income plus all business taxes to its aggregate CFC. In the United States, CFC represents a full 12% of GDP as of 2009 according to the Organization for Economic Cooperation and Development. Failure to include consumption of fixed capital in GDP calculations can, therefore, have a substantial impact on this number. Economists can also calculate net domestic product (NDP) by subtracting CFC from the GDP.
