In accounting, fixed capital is any kind of real, physical

asset In financial accounting, an asset is any resource owned or controlled by a business or an economic entity. It is anything (tangible or intangible) that can be used to produce positive economic value. Assets represent value of ownership that can ...

that is used repeatedly in the production of a product. In

economics Economics () is the social science that studies the production, distribution, and consumption of goods and services. Economics focuses on the behaviour and interactions of economic agents and how economies work. Microeconomics analyzes ...

, fixed capital is a type of capital good that as a real, physical

is used as a

means of production The means of production is a term which describes land, labor and capital that can be used to produce products (such as goods or services); however, the term can also refer to anything that is used to produce products. It can also be used as an ...

which is

durable Durability is the ability of a physical product to remain functional, without requiring excessive maintenance or repair, when faced with the challenges of normal operation over its design lifetime. There are several measures of durability in use, ...

or isn't fully consumed in a single time period.Varri P. (1987) Fixed Capital. In: Durlauf S., Blume L. (eds) The New Palgrave Dictionary of Economics. Palgrave Macmillan, London. "fixed capital", '' The New Palgrave: A Dictionary of Economics'', 1st Editio

/ref> It contrasts with circulating capital such as raw materials, operating expenses etc. The concept was first theoretically analyzed in some depth by the economist Adam Smith in

The Wealth of Nations ''An Inquiry into the Nature and Causes of the Wealth of Nations'', generally referred to by its shortened title ''The Wealth of Nations'', is the '' magnum opus'' of the Scottish economist and moral philosopher Adam Smith. First published in ...

(1776) and by

David Ricardo David Ricardo (18 April 1772 – 11 September 1823) was a British political economist. He was one of the most influential of the classical economists along with Thomas Malthus, Adam Smith and James Mill. Ricardo was also a politician, and a ...

On the Principles of Political Economy and Taxation '' the Principles of Political Economy and Taxation'' (19 April 1817) is a book by David Ricardo on economics. The book concludes that land rent grows as population increases. It also presents the theory of comparative advantage, the theory tha ...

(1821). Ricardo studied the use of machines in place of labor and concluded that workers' fear of technology replacing them might be justified. Thus fixed capital is that portion of the total capital outlay that is invested in fixed assets (such as land improvements, buildings, vehicles, plant, and equipment), that stay in the business almost permanently—or at the very least, for more than one accounting period. Fixed assets can be ''purchased'' by a business, in which case the business owns them. They can also be ''leased'', ''hired'' or ''rented'', if that is cheaper or more convenient, or if owning the fixed asset is practically impossible (for legal or technical reasons). Refining the classical distinction between fixed and circulating capital in ''

Das Kapital ''Das Kapital'', also known as ''Capital: A Critique of Political Economy'' or sometimes simply ''Capital'' (german: Das Kapital. Kritik der politischen Ökonomie, link=no, ; 1867–1883), is a foundational theoretical text in materialist phi ...

'',

Karl Marx Karl Heinrich Marx (; 5 May 1818 – 14 March 1883) was a German philosopher, economist, historian, sociologist, political theorist, journalist, critic of political economy, and socialist revolutionary. His best-known titles are the 1848 ...

emphasizes that the distinction is really purely relative, i.e. it refers only to the comparative rotation speeds (turnover time) of different types of physical capital assets. Fixed capital also "circulates", except that the circulation time is much longer, because a fixed asset may be held for 5, 10 or 20 years before it has yielded its value and is discarded for its salvage value. A fixed asset may also be resold and re-used, which often happens with vehicles and planes. In

national accounts National accounts or national account systems (NAS) are the implementation of complete and consistent accounting techniques for measuring the economic activity of a nation. These include detailed underlying measures that rely on double-entry ...

fixed capital
is conventionally defined as the stock of tangible, durable fixed assets owned or used by resident enterprises for more than one year. This includes plant, machinery, vehicles and equipment, installations and physical infrastructures, the value of land improvements, and buildings. Th

explicitly includes produced intangible assets (e.g. mineral exploitation, computer software, copyright protected entertainment, literary and artistics originals) within the definition of fixed assets. ''Land'' itself is not included in the statistical concept of fixed capital, even though it is a fixed asset. The main reason is that land is not regarded as a product (a reproducible good). But the value of ''land improvements'' is included in the statistical concept of fixed capital, is regarded as the creation of

value-added In business, total value added is calculated by tabulating the unit value added (measured by summing unit profit sale price and production cost">Price.html" ;"title="he difference between Price">sale price and production cost], unit depreciation ...

through production.

Estimating the value

There are two primary methods for estimating the stock of fixed capital in any nation: direct measurement of the capital stock and perpetual inventory calculations.Young, A., & Musgrave, J. C. (1980). Estimation of capital stock in the United States. The measurement of capital (pp. 23-82). University of Chicago Press. Attempts have been made to estimate the value of the stock of fixed capital for the whole economy using direct enterprise surveys of "

book value In accounting, book value is the value of an asset according to its balance sheet account balance. For assets, the value is based on the original cost of the asset less any depreciation, amortization or impairment costs made against the asset. T ...

", administrative business records, tax assessments, and data on

gross fixed capital formation Gross fixed capital formation (GFCF) is a macroeconomic concept used in official national accounts such as the United Nations System of National Accounts (UNSNA), National Income and Product Accounts (NIPA) and the European System of Accounts (ES ...

, price

inflation In economics, inflation is an increase in the general price level of goods and services in an economy. When the general price level rises, each unit of currency buys fewer goods and services; consequently, inflation corresponds to a reduct ...

and

depreciation In accountancy, depreciation is a term that refers to two aspects of the same concept: first, the actual decrease of fair value of an asset, such as the decrease in value of factory equipment each year as it is used and wear, and second, the ...

schedules. A pioneer in this area was the economist Simon Kuznets. The "perpetual inventory method" (PIM) used to estimate fixed capital stocks was invented by Raymond W. Goldsmith in 1951 and subsequently used around the world. The basic idea of the PIM method is, that one starts off from a benchmark asset figure, and adds on the net additions to fixed assets year by year (using

data), while deducting annual estimates of economic

based upon an explicit service life assumption, all data being adjusted for price inflation using a

capital expenditure Capital expenditure or capital expense (capex or CAPEX) is the money an organization or corporate entity spends to buy, maintain, or improve its fixed assets, such as buildings, vehicles, equipment, or land. It is considered a capital expenditure ...

price index. In this way, one obtains a

time series In mathematics, a time series is a series of data points indexed (or listed or graphed) in time order. Most commonly, a time series is a sequence taken at successive equally spaced points in time. Thus it is a sequence of discrete-time data. Ex ...

of annual fixed capital stocks. This data series can also be modified further with various other adjustments for prices, economic depreciation, etc. (several variants of the PIM approach are nowadays used by economic historians and statisticians).

Economic depreciation

Depreciation as an economic concept distinguishes between "...the value of the stock of capital assets and the annual value of that asset's services, distinguishing between depreciation and inflation as sources of the change in asset value, and distinguishing between the depreciation in asset values and deterioration in an asset's physical productivity."Hulten, C. R., & Wykoff, F. C. (1980). The measurement of economic depreciation. Urban Institute. Accessed a

/ref> Depreciation is the cost of the stock of capital assets allocated over their service lives in proportion to estimates of their service lives, net of maintenance and repair costs. Economic depreciation, therefore, is "...the decline in asset price (or shadow price) is due to aging and varies with age" Economic depreciation is also characterized by an " ... age-price relationship in which the largest rate of price decline occurs in the early years of asset life." The

write-off permitted for tax purposes may also diverge from that of economic depreciation or "real" depreciation rates. The key factor is the estimate of "economic

service life A product's service life is its period of use in service. Several related terms describe more precisely a product's life, from the point of manufacture, storage, and distribution, and eventual use. Service life has been defined as "a product li ...

". Economic depreciation can, however, be estimated with "...sufficient precision to be useful in policy analysis."

Investment risk

A business executive who

invests Investment is the dedication of money to purchase of an asset to attain an increase in value over a period of time. Investment requires a sacrifice of some present asset, such as time, money, or effort. In finance, the purpose of investing is ...

in or accumulates fixed capital is tying up

wealth Wealth is the abundance of valuable financial assets or physical possessions which can be converted into a form that can be used for transactions. This includes the core meaning as held in the originating Old English word , which is from an I ...

in a fixed asset, hoping to make a future profit. Thus, such investment usually implies a risk. Sometimes depreciation write-offs are also viewed partly as compensation for this risk. Often leasing or

renting Renting, also known as hiring or letting, is an agreement where a payment is made for the temporary use of a good, service or property owned by another. A gross lease is when the tenant pays a flat rental amount and the landlord pays for a ...

a fixed asset (such as a vehicle) rather than buying it is preferred by enterprises because the cost of using it is lowered thereby, and the real owner may be able to obtain special tax advantages.

Sources of funding for fixed capital investment

An owner can obtain funding for the purchase of fixed capital assets from the aptly named capital market, where loans are given on a long-term basis. Funding can also come from reserve funds, the selling of shares, and the issuing of

debenture In corporate finance, a debenture is a medium- to long-term debt instrument used by large companies to borrow money, at a fixed rate of interest. The legal term "debenture" originally referred to a document that either creates a debt or acknowle ...

s, bonds or other promissory notes.

Factors which influence fixed-capital requirements

*The nature of the undertaking- the nature of the business, certainly plays a role in determining fixed capital requirements. A florist, for example, needs less fixed capital than a vehicle-assembly factory. * The size of the undertaking- a general rule that states: the bigger the business, the higher the need for fixed capital. * The stage of development of the undertaking- the requirement of capital for a new undertaking is usually greater than that needed for an established business that has reached optimum size.

References