What is Capital Consumption Allowance?
Capital consumption allowance is an accounting adjustment that is made to recognize the decline in value of a company’s capital assets due to wear and tear, obsolescence, or other factors. The allowance is designed to prevent businesses from overstating their net worth or equity by not accounting for the decline in the value of their assets.
How is Capital Consumption Allowance Calculated?
Capital consumption allowance is calculated by subtracting the value of the asset at the beginning of a period from the value of the asset at the end of the same period. The resulting amount is then deducted from the company’s net worth or equity. This calculation is typically done on a yearly basis, although it can be done more frequently if needed.
Examples of Capital Consumption Allowance
Below are some examples of capital consumption allowance:
- A company owns a fleet of vehicles which are depreciated over time due to wear and tear. The company will calculate its capital consumption allowance by subtracting the value of the vehicles at the beginning of the year from the value of the vehicles at the end of the year.
- A company owns a factory building which has become obsolete due to changing technology. The company will calculate its capital consumption allowance by subtracting the value of the building at the beginning of the year from the value of the building at the end of the year.
- A company owns a piece of machinery which has become obsolete due to the introduction of new technology. The company will calculate its capital consumption allowance by subtracting the value of the machinery at the beginning of the year from the value of the machinery at the end of the year.
Conclusion
Capital consumption allowance is an important accounting adjustment that allows businesses to accurately reflect the decline in value of their capital assets. By subtracting the value of the asset at the beginning of a period from the value of the asset at the end of the same period, businesses are able to prevent overstating their net worth or equity. For more information, please refer to the Investopedia and Accounting Tools websites.