Gross Investment, Net Investment and Depreciation - Humanities/Arts PDF Download

Gross Investment, Net Investment and Depreciation!

Investment or capital formation refers to addition to the capital stock of an economy. For example, construction of building, purchase of machinery, addition to inventories of goods, etc.

Gross Investment:

The total addition made to the capital stock of economy in a given period is termed as Gross Investment. Capital stock consists of fixed assets and unsold stock. So, gross investment is the expenditure on purchase of fixed assets and unsold stock during the accounting year.

However, gross investment does not indicate the actual change in economy’s stock of productive assets for a given year. During the production process, some amount of fixed capital is used up. This loss of fixed capital is known as depreciation. By subtracting depreciation from gross investment, we get Net Investment.

Net Investment:

The actual addition made to the capital stock of economy in a given period is termed as Net Investment.

Net Investment = Gross Investment – Depreciation

Let us now understand the meaning of depreciation.

Depreciation (Consumption of Fixed Capital):

Depreciation refers to a fall in the value of fixed assets due to normal wear and tear, passage of time or expected obsolescence (change in technology). The concept of depreciation is very important to differentiate between Gross value and the Net value, ‘Gross’ is inclusive of depreciation, whereas, ‘net’ excludes it.

Gross Value = Net Value + Depreciation

Depreciation is also known as:

(i) Current Replacement Cost; (ii) Replacement cost of Fixed Capital; (iii) Capital Consumption Allowance.

Depreciation of assets is mainly due to 3 reasons:

(i) Normal wear and tear:

Continuous use of fixed assets in production process decreases their productive capacity and value.

(ii) Passage of time:

Value of fixed assets also decreases with the passage of time, even if they are not being put to use in the business. Natural factors like rain, winds, weather, etc. contribute to fall in their value.

(iii) Expected obsolescence:

Value of fixed assets also decreases due to expected obsolescence (i.e. loss in value due to change in technology or change in demand for goods and services).