Fixed Assets such as buildings and machinery are used over several years to produce goods and services. Over time, they decline in value due to wear and tear and general obsolescence as better new technology becomes available. In National Accounts, this decline in value is called Consumption of Fixed Capital (CFC).
Fixed assets can be tangible (such as buildings and machinery) but also intangible property (such as Intellectual Property like patents and copyrights) which does not have physical form. These non-physical assets also decline in value over time and are subject to Consumption of Fixed Capital. This concept of CFC is a way of counting the cost of the use of the asset in a year, even when there has not been an explicit expenditure on the asset in that year. The Fixed Asset is the thing itself, the machine or the patent, the fixed capital is the value of that asset in euros.
Consumption of Fixed Capital is similar to the concepts of depreciation and amortization in business accounting that is allowable for tax purposes. In National Accounts, we estimate the CFC for all the assets in the country (using a method called the Perpetual Inventory Model or PIM). The depreciation in companies' annual accounts is not used, though it is usually quite similar.
Different kinds of assets decline in value at different rates. For example, a patent for consumer electronic devices will be much less valuable after ten years because new devices will have come on the market, while a building might only have lost a small portion of its original value in that decade.
In general, assets are treated as declining in value more sharply in their early lifetime, and more slowly as they get older. This is called geometric depreciation and applies a constant rate of depreciation to the remaining value of the asset in each time period. For example, an asset initially worth €100 and with a constant depreciation rate of 1/5 is worth €80 after the first year, €64 after the second year (€80 - €80/5 = €80 - €16 = €64), €51.20 after the third year and so on. In other cases, straight line depreciation is a more appropriate model for an asset's decline in value. For straight line depreciation, the value of assets decreases by a constant value each year. For example, if the asset has a useful lifetime of 10 years and a straight line method is applied the asset, it would be worth €90 after the first year, €80 euro the second year, €70 after the third year and so on.
The value added in production that does not take account of the CFC is 'Gross' Value Added. The value added in production after CFC has been treated as a cost is called the 'Net' Value Added. This use of ‘Gross’ and ‘Net’ to mean before and after depreciation is also used for other terms in National Accounts, such as Gross National Income and Net National Income.
Foreign-Owned Corporations in Ireland have large Intellectual Property assets, and large assets of leased aircraft. The CFC on these assets adds significantly to the Gross National Income but because most of the value added from the use of these assets flows out, this CFC has little real involvement with the domestic economy. These assets are held in Ireland by foreign owners and the decline in value is borne by the foreign investors. For this reason, Modified Gross National Income takes out the effect of the depreciation of IP and aircraft to give a truer measure of Ireland’s economy.
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