How is the investment component, denoted by I, of national income determined? An explanation is proffered here by converting the following simple statement of profit or loss into a value added statement.
During the period, the firm replaced some plant and machinery at a cost of £10m.
Points to note
A statement of profit or loss does not record purchases of a capital nature. Hence the purchase of plant and machinery for £10m is not reported in the statement of profit or loss.
A value added statement does report purchases of a capital nature.
National Income Accounts
If every firm prepared a value added statement the total of the net investment adjustments would represent the nation’s periodic investment activity shown in the national accounts prepared by the government. This figure for the periodic investment activity is shown as I in the national accounts.
NB. The government may substitute its own standard calculation of the depreciation adjustment so as to achieve consistency.