What it is: A capital consumption allowance (CCA) is a macroeconomic term for depreciation of fixed assets. It represents the minimum investment amount required to maintain current productivity levels of fixed assets (capital goods). Another name for a capital consumption allowance is the consumption of fixed capital (CFC).
Machinery and equipment are examples of fixed assets. Businesses use them to produce products. As their quantity and quality increase, companies can produce more output.
By having more machines, the business can produce more output. For example, a publishing company could create more articles using a typewriter.
Quality increases output in different ways. Businesses can produce more output with the same input, using higher quality capital goods. For example, a publishing company still uses a single capital item, not a typewriter, but a computer. Computers allow companies to produce more articles without having to add many employees. Thus, quality determines the productivity of capital goods productivity. And technology is a critical factor in fixed asset quality.
Why capital consumption allowance matters
CCA is useful for converting national income from the gross domestic product (GDP). National income, or net domestic product (NNP), is equal to GDP minus CCA. To eliminate the differences in approach to the calculation of aggregate numbers, the central bureau also adds component statistical discrepancy.
CCA is a minimum investment. If wanting to increase long-term productive capacity (potential GDP), the economy must invest capital goods more than CCA. We call the difference between the value of investment and CCA as a net investment. So, in other words, the production capacity will increase if the net investment is positive.
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OK, I’ll be a little out of touch.
In a company, we cal investment in capital goods as capital expenditure (CAPEX). You can find the numbers on the cash flow statement, namely in cash flows from investing activities. Meanwhile, you may find a depreciation number on the income statement. But, if not, you can look it up in the notes section of financial statements. For the presentation of fixed assets on the balance sheet, the company presents them on a net basis, namely fixed assets, after deducting the accumulated depreciation.
Causes of the increased capital consumption allowance
CCA values increase due to physical damage, normal wear, and tear or normal accidental damage. Machines, for example, wear out near the end of their useful life. That not only lowers productivity, it also creates more repair costs. Factors such as faulty installation, man-made disasters (such as a fire), and natural disasters also increase CCA.
Also, new machines but with outdated technology are less productive than technologically advanced ones. Whether outdated technology is included in the calculation of CCA in the economy or not, so far, I have not found the answer.
Notes for you
CFCs are slightly different from the concept of depreciation in business. For example, in a financial statement, you use historical cost to calculate depreciation. You can use the depreciation method and assume different benefits and residual values. And it all comes down to a different depreciation result.
- The useful life is how long a fixed asset can produce output at its optimal level.
- The residual value is the money company gets when it sells its fixed assets when their useful lives have expired.
For example, the straight-line method yields the same depreciation rate over the useful life of the fixed asset. Meanwhile, the double-declining balance method will result in higher depreciation at the beginning of the fixed assets’ useful life.
But, in an economy, the calculation of the consumption of fixed capital (CFC) does not use historical costs. Still, it uses estimates of actual prices and rental of fixed assets during production. For example, to calculate GDP in 2019, the statistics bureau will calculate the CFC figure based on the estimated 2019 price of fixed assets.