Understanding Keynes on Income, Saving, and Investment.

Keynes covers these topics in chapter 6 of his General Theory. The chapter is very wordy and contains few examples – Keynes was not a good communicator of his ideas. This piece seeks to present his key ideas from chapter 6 in a more user friendly way so as to make them more accessible to a wider audience. A brief case study will be used.

Keynes’s model excludes the foreign sector and thus assumes UK firms operate within a closed economy. Apart from the business and possibly the household sector, Keynes’s model makes no explicit reference to other sectors of the UK economy, eg the government or financial sector.

However, Keynes is correct to make this apparent omission because the trading section of a firm’s traditional income statement is alone relevant to the determination of how much wealth has been created in a period. The remaining sections of a traditional income statement report the revenues associated with the other sectors of the economy, and merely show how the created wealth has been distributed among the factors of production. Keynes calls these remaining costs “factor costs”. These factor costs, eg wages, rent, taxes, interest, and dividends can be associated with suitably chosen sectors, eg households, government, financiers, and/or rentiers. Keynes concentrates on wealth creation, not on how the wealth is distributed between the other sectors. For this reason, this exposition starts with a traditional, widely used and understood trading account before developing it into a value added statement.

Consider the following consolidated trading accounts of the B2B and B2C sectors of the domestic economy. The trading accounts are prepared in traditional format which any accountant would instantly recognise.

Trading Accounts (£k)Consolidated
Purchases 01,000
Closing inventories+100+200
Cost of goods sold– 1001,200
Gross profit + 900+ 800

The purchases figures in trading accounts consist entirely of revenue expenditure, eg raw materials, goods for resale, etc. The purchases figure for the consolidated B2B sector is zero because the aggregate purchases of B2B firms will cancel against B2B sales revenue on consolidation. In other words, B2B firms will be selling and buying from each other and, in aggregate, the sector’s purchases and sales will cancel out to zero (unless they import). For this reason, only sales made to B2C firms will be recorded in the B2B sector’s consolidated account. This is why the sales revenue of the consolidated B2B sector is identical to the purchases of the B2C sector. These like items will cancel when the B2B sector is consolidated with the B2C sector. The following table shows the consolidation of the two sectors and the cancellation of the like items:

Trading Accounts (£k)Consolidated
AdjustmentB2B consolidated
with B2C
Revenue+ 1,000+ 2,000 – 1,000+ 2,000
200400– 600
Purchases 01,000+ 1,000 0
Closing inventories+ 100+ 200+ 300
Cost of goods sold1001,200+ 1,000– 300
Gross profit + 900+ 800+ 1,700

The above trading accounts can be rearranged so that value added is yielded by the bottom line in place of gross profit. Value Added is what Keynes deemed, in the context of national income accounting, to be income (Y). He rejects using the bottom line (the net profit or net income) of traditional income statements as a relevant measure of income in the context of national income accounting. This is because net profit is calculated after deducting factor costs from gross profit. The factor costs are the revenue of the other sectors of the economy and so will cancel out on consolidation.

The value added statements of the two business sectors are shown below.

Code DescriptionConsolidated
B2B (£k)
B2C (£k)
ARevenue+ 1,000+ 2,000
A1Purchases 0– 1,000
IInventory adjustment100 200
Y Value Added+ 900+ 800

The letters appearing under the code heading are those used by Keynes in his General Theory to denote either a) the category into which an item falls or b) as a specific identifier. For example, closing and opening inventories both fall into the “Investment” category and hence have an I against them. A and A1 are specific identifiers and denote Revenue and Purchases respectively. The inventory adjustment ensures that it is materials used, or goods sold, that is set against revenue, not the purchases figure. So for the B2C sector, raw materials used, or goods sold, £1,200k has been set against revenue.

Value Added Statements can be consolidated using the same rules as with the trading account, i.e., cancel linked items and then aggregate the remaining items, as shown below.

Code DescriptionConsolidated
B2B (£k)
B2C (£k)
Adjustment (£k)Consolidated Value
Added Statement (£k)
ARevenue+ 1,000+ 2,000– 1,000+ 2,000
A1Purchases 0– 1,000+ 1,0000
IInventory adjustment100 200 300
YValue Added+ 900+ 800+ 1,700

Purchases (A1)

In a traditional trading account, the purchases figure (A1) will consist entirely of revenue items. An inventory adjustment is usually required to ensure that unused materials, or unsold goods, from the previous period are set against the current period’s revenue. The inventory adjustment also ensures that unused materials or unsold goods in the current period are carried over to the immediately following period.

Keynes, however, in his General Theory, includes both capital and revenue items within A1. So for Keynes, if a firm makes a one-off purchase of capital equipment from another firm then Keynes would designate the transaction as (A) by the seller and as (A1) by the purchaser. When capital items are included in A1, the purchasing firm’s value added will be understated because A1 will be overstated. An adjustment is necessary to correct for this and this is done via a capital adjustment which will show the part of A1 which is capital expenditure as investment (I).

Capital Adjustments

In his General Theory, Keynes brings up the need to recognise the deterioration of the entrepreneur’s capital equipment in the calculation of value added. He proposes what, in practice, might be an over elaborate calculation for capital consumption. However, his formula is elegant because it also yields how much capital formation has taken place. This calculation is hopefully explained correctly below.

Keynes’s calculation seeks to compare the theoretical value of capital equipment which has been hypothetically mothballed, to the actual value of the same equipment after it has been used in production. His premise is that capital equipment used in production loses value due to use and should have a lower value than identical, well maintained capital equipment that has hypothetically lain idle in the period. His method for determining the capital adjustment, using his notation, is to apply the following formula:

(G – B) – G

where G represents the theoretical end value of capital equipment that has been idle for the period after B has been spent improving it or keeping it in good working condition, and

where G is the actual end value of capital equipment after it has been used in production in the period.

G – B enables the opening valuation of the capital equipment to be determined.

Three possible cases may arise and Keynes’s formula is used below to illustrate.

Case 1: Capital consumption occurs

This occurs when (G – B) > G.

Put simply, this means the closing valuation of the capital equipment is less then the opening valuation. This indicates depreciation through use has occurred.


The theoretical end value (G) of idle equipment was £300,000 after spending £100,000 on idle equipment maintenance (B) during the period. The actual value (G) at the period end was £175,000.

The first step is to insert the relevant figures on the left hand section of the table. The theoretical opening balance can thereby be obtained and transferred to the right side section. The actual closing valuation (given) is then inserted. The capital adjustment (shown in red) is the difference between the actual closing valuation and the theoretical opening valuation.

Equipment idle£kEquipment used£k
Opening valuation (G – B)200Opening valuation200
Maintenance expenditure (B)100Capital consumption(25)
closing valuation (G)
closing valuation (G)

So in case 1 capital consumption is £25,000 and this amount should be charged to the entrepreneur’s value added statement. It represents disinvestment and should be coded with an I. The accountant’s production unit basis for depreciation may suffice as a reasonable proxy measure consistent with Keynes’s conception of capital consumption.

Case 2: No capital consumption or formation occurs

This occurs when (G – B) = G

The theoretical end value (G) of idle equipment was £300,000 after spending £100,000 on idle equipment maintenance (B) during the period. The actual value at the period end was £200,000.

Equipment idle£kEquipment used£k
Opening valuation (G – B)200Opening valuation200
Maintenance expenditure (B)100Capital consumption0
closing valuation (G)
closing valuation (G)

In this case, no capital consumption occurred so no charge to the value added statement is required in respect of capital consumption.

Case 3: Capital formation occurs.

This occurs when (G’ – B) < G.

Put simply, this means the closing valuation is higher than the opening valuation. This indicates that capital equipment has been acquired during the period


The theoretical end value (G) of idle equipment was £300,000 after spending £100,000 on idle equipment maintenance (B) during the period. The actual value at the period end was £450,000.

Equipment idle£kEquipment used£k
Opening valuation (G – B)200Opening valuation200
Maintenance expenditure (B)100Capital formation250
closing valuation (G)
closing valuation (G)

In this case, the firm may have been increasing its capital equipment by its own labour or by purchasing it from another firm. When capital equipment is produced in-house, the wages and salaries of that part of the labour force assigned to the production of the capital equipment will have been capitalised (i.e., included in the actual valuation). Capital equipment produced by an individual firm for its own use should be recognised in the individual’s firm’s value added statement as investment expenditure and should be coded as I.

In the value added statements that follow the capital adjustment from case 1 above has been incorporated into B2B’s results. The capital adjustment from case 3 has been incorporated in B2C’s results.

IInventory adjustment(100)(200)(300)
ICapital adjustment(25)250225
Value Added8751,0501,925

Apart from items on the edges, eg Suplementary Costs, income determination under Keynes’s scheme is concluded.

Consumption Expenditure (C)

The revenue figure of £2,000 in the consolidated column represents the total sales made by B2C firms to consumers. This is because all B2B sales figures have been eliminated by the consolidation process. The revenue figure in the consolidated value added statement thus represents consumption expenditure (C). Using Keynes’s notation consumption expenditure can be otained from the total of A minus the total of A1. The consolidated revenue, as shown above, is the result of the sum of A minus the sum of A1 .

Saving (S)

Saving is by (strict) definiton equal to income minus consumption. The consolidated value added figure of £1,925 represents aggregate income. Subtracting the aggregate consumption expenditure figure of £2,000, a negative figure for aggregate saving (S) of – £75 is obtained. It is no accident that the aggregate saving figure is equal to the aggregate investment figure shown in the consolidated value added statement.

User cost (U)

Keynes appears to set much store by this figure. The user cost repesents the costs that have been consumed (as distinct from being incurred). It is the sum of materials used/goods sold (A1 – inventory adjustments) and capital adjustments (capital consumption – capital formation). The user cost (U) can (theoretically) be negative in which case it is added to revenue. The user cost (U) can be calculated from A1 – I. It is most meaningful at individual firm level since A1 becomes zero on consolidation. The user cost for the B2C sector can be seen to be equal to £950 (£1,000 + £200 – £250). Value Added, which is now the accepted definition of income for national income determination, can be obtained from subtracting an individual firm’s user cost from the firm’s revenue (A) (eg, £2,000 – £950 = £1,050).

Investment Expenditure (I)

This is equal to the inventory adjustment plus the capital adjustment. If the closing inventories are higher than the opening inventories then investment will have occured. If the closing inventories are lower then disinvestment will have occurred.

Capital consumption decreases the period’s investment. Capital formation will increase investment.

Positive investment increases value added.


The above exposition is a condensed summary of chapter 6 of Keynes’s General Theory. The exposition is intended to make accessible the important material in that difficult-to-read chapter to a wider, less specialised readership, eg accountancy and business studies students. The more marginal topics in that chapter have not been given much weight in this exposition.

Chapter 6 shows that income for national income accounting is most closely aligned to the gross profit figure which is found in traditional commercial income statements. Gross profit figures are augmented with capital adjustments to arrive at value added. Keynes’s proposed formula for capital adjustments has been unpacked so as to make it more understandable. The resulting income is known as value added.

Keynes’s analysis has its focus on the creation of wealth. The distribution of wealth to the other sectors of the economy does not figure in his analysis. However, the government does prepare analyses to show “who got what” via the income approach to GDP determination.

Keynes shows how investment is equal to saving by adhering strictly to the defintion of saving as being equal to Income minus Consumption. In the consolidated value added statement value added (income) has been determined as £1,925k and consumption expenditure as £2,000k. Hence saving is – £75k.

Keynes’s analysis assumes a closed economy. The introduction of a foreign sector would appear to render some of his analysis inadequate.

Self-built assets and value added

Dealing with capitalised costs

Instead of purchasing non-current assets from third party suppliers, a firm may choose to itself construct or erect an asset for use in its own business. In these cases, costs and expenses which would otherwise be revenue in nature should be capitalised. Capitalised costs will not appear in a firm’s statement of profit or loss and hence materials and labour costs will be understated in this account, notwithstanding disclosure by way of a note.


ca[italised costs profit or loss

During the period, a new warehouse was constructed by the firm’s workforce for the firm’s own use at a cost of £4m. The materials cost of the construction was £1m and the labour cost assigned to the construction came to £3m. These costs were capitalised and hence do not appear in the above statement of profit or loss. A value added statement brings these costs in to view because the construction is part of the value created by the firm during the period.

Capitalisation of costs value added statement

Workings and notes

Bought in materials, goods, and services

Purchases of all materials, goods, and services whether or not capital or revenue but excluding depreciation.

To pay employees

All wages and employment on-costs including labour costs assigned to the construction of the new warehouse.

Investment adjustment

The capitalised cost of materials (£1m) and labour (£3m)

Inventory adjustment

Closing inventory minus opening inventory. This represents additional investment in inventory if positive or disinvestment in inventory if negative.

Depreciation adjustment

The total of the depreciation charges shown in the profit or loss statement. This is a measure of capital consumption during the period. In the national accounts, the government may substitute its own figure for a firm’s measure of capital consumption.

Link to the national income accounts

The total of the adjustments will be shown as an investment activity in the national income accounts where it will be denoted as I


I is for investment

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.

Investment and VAS

Additional information

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.


Investment and VAS 2


Working for investment and VAS

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.


Value Added Statements for Dummies

This is a short presentation to demonstrate how value added statements are prepared and to explain how they differ from the accountant’s traditional profit or loss account. A single example will be used which will capture the essential differences.


Below is shown a firm’s statement of profit or loss and value added statement. The two statements are shown side-by-side for ease of comparison.

During the period, the firm purchased plant and machinery for use within the business at a cost of £30m. Because this is capital expenditure, there is no entry in the statement of profit or loss to record this purchase. In the value added statement, the £30m cost appears against “bought-in materials, goods, and services” to obtain the “net value of output” figure. The firm’s investment activity is then shown by the investment adjustment to arrive at “net value added.”

VAS for dummies

Derivation of value produced figures

Bought-in materials, goods and services is equal to the purchases figure taken from the profit or loss statement (£80m) plus the capital expenditure (£30m).

The inventory adjustment is equal to the closing inventory minus the opening inventory. If this figure is positive then it represents additional investment in inventory. If negative then it represents disinvestment in inventory.

The depreciation adjustment is the total depreciation charged to the profit or loss account. This will usually be shown as a negative figure in the value added statement and represents consumption of capital in the period.

The investment adjustment is equal to the capital expenditure during the period. If this adjustment is positive then investment in new productive capacity has occurred. If negative, then disinvestment in productive capacity has occurred. The new productive capacity may consist of either tangible or intangible assets or some mixture.

Derivation of value distributed figures

To pay employees is the wages figure taken from the profit or loss account. The figure should include employer’s on costs, including employer’s National Insurance Contributions, and other employment taxes where they exist

To pay government is the sum of business rates and corporation tax charged to the profit or loss account. The figure represents the contribution the firm makes to the upkeep of the nation’s infrastructure and public services that enable firms to flourish.

To pay rentiers is the sum of property rents, licence fees, patent and copyright charges and the like. Payments to parties who derive income from ownership rather than from provision of a service or goods are recorded under this heading.

To pay financiers is the sum of interest charges in the profit and loss account plus dividends paid in the year. Payments of interest and dividends paid should be offset by interest and dividends received. Interest and dividends received are distributions of  value added produced by other firms. 

Undistributed value is equal to the retained profits shown in the profit or loss statement.

Value Added Statements


Being slightly nerdy and having a background in accountancy and an amateur interest in some of the current economic controversies, the topic of value added statements and national income accounting interests me. Hence this post. I hope those with an interest in accounting and bookkeeping for national income will find this interesting and useful.

What is value added?

Value added is a measure of wealth creation. At an individual firm level, value added is measured as sales revenue minus the cost of all goods and services purchased from outside the firm. At an individual firm level, a value added statement provides a useful and interesting alternative to a traditional income statement.

Value added is used in accounting for national income because a nation’s value added is the same as a nation’s GDP. Value added statements can assist in evaluating government spending projects.


The government proposes to spend £100 m on a much needed public housing programme. It will borrow funds from wealthy private sector savers to finance the project.

Of the additional GDP created by the project, 10% will be paid to government by way of taxation and 10% will be saved by the private sector. The remaining 80% of additional GDP will be spent on wages and salaries. The recipients of wages and salaries will spend their entire incomes on consumption. This consumption expenditure will be spent 3 parts on imported goods and 5 parts on domestically produced goods and services.

The multiplier effect

The spending in shops, restaurants, cinemas, and on other consumables by workers becomes the income of those supplying the goods and services to the workers. These suppliers will then pay their labour force, who in turn will then spend their wages on consumable goods and services in shops, restaurants etc. However, at each turn of the cycle, the value of transactions will shrink by 50% because the 10% saving rate, the 10% tax rate, and the 30% import rate removes 50% of income received from circulation by the time wages are next paid. This  process will continue until all the additional demand generated by the £100 m initial government injection has disappeared. This will occur when the additional GDP has reached £200m. It stops at this point because the multiplier value used in the illustration is 2*. Had the multiplier value been 1.5 then the process would stop when the additional GDP (value added) reached £150 m (1.5 x £100m)

The following statement reports the additional GDP once all transactions have completed.

Value Added Statement

Some final points

The statement is in two parts. The top part shows how value has been created. The lower part shows how the value has been distributed among the stakeholders. In the above example, providers of finance capital have not been shown as stakeholders. This is a deliberate omission, made to aid exposition

The above example is a simple one. For example, we have assumed that all wages have been spent on consumption. In reality, this is unlikely to be the case because workers may save, just as the firms have done in this example.

Secondly, we are not showing how much of the value added has been distributed to finance creditors and shareholders as interest and dividends respectively. Their share of valued added has been subsumed under savings instead of itemising their respective share of value added .To keep the illustration simple, all consumption expenditure has been assumed to derive from wages and salaries. In reality, dividends and interest payments will impact consumption expenditure.

Another simplification is that all consumption expenditure has been paid for out of income. This is nowadays an unrealistic assumption since it is common for workers to borrow to fund their consumption expenditure. A simplifying assumption has been made in the illustration that workers do not spend more than they have earned.

More elaborate value added statement to incorporate more complex and realistic scenarios are relatively easy to prepare.

The coding shown on the value added statement illustration denotes the item corresponding to the expenditure method of measuring national income, eg G = Government expenditure, C = Consumption, M = Imports and Y = National Income, T = Taxation and S = Savings.

* A multiplier value is calculated as the reciprocal of the sum of leakages. In the illustration, the leakages were tax = 10% + saving  = 10% + imports = 30% = 50%.  The reciprocal of 50% = 2, which is the value of the multiplier used in the illustration

In praise of value added statements


In this post I express my long standing enthusiasm for the value added statement and my disappointment that they are currently unfashionable. I am enthusiastic because of their relevance to a wider group of users than are traditional income statements. They can be  particularly relevant and useful to employees. Value added statements possess simplicity and elegance and are underpinned by a co-operative philosophy  between workers and capitalists. Along with employee representation on corporate boards of directors, value added statements can contribute to the enfranchisement / empowerment of workers. I believe such an outcome is a good thing.

The traditional income statement

All firms will (or should) produce an income statement. An income statement looks at a firm’s performance from the point of view of the owners. Owners may be sole traders, partners, or a company’s shareholders.  An income statement’s purpose is to report how much profit has been made by a firm in an accounting period and how this profit was achieved. Clearly, such statements with profit as their primary focus are orientated towards business owners. Of course, in countries where profits and income are taxed, the traditional income statement is useful for taxation purposes too.

Labour costs

In income statements, wages and salaries are not seen as payments to contributors towards wealth creation. Instead, labour costs are seen and treated as a cost burden that reduces owner profit. Labour costs are often subsumed within cost of sales, administration costs and distribution costs and so may not be visible on the face of the income statement.


Although tax is accounted for differently, it too is viewed negatively. Instead of tax being seen as a contribution to wider society, it is seen and treated as a deduction from owner profit. In short, it is seen as a burden that reduces the disposable income of owners.

The treatment of wage costs and taxation charges in the traditional income statement reflects and promotes the interests of the dominant capitalist class, that is, the object of economic activity is to enrich the owners of firms. Benefits received by labour and by wider society are seen as incidental  to the firm’s activities, to be minimised, where possible, so as to maximise owner disposable income

Here is Tesco PLC’s group income statement for 2012. This can be contrasted with Tesco’s value added statement shown in the next section.

Tesco income statement processed

Value added statements

The traditional income statement is not the only way of presenting a firm’s results. Items of cost in an income statement can be unpacked, rearranged and recast for the benefit of a wider group of people – the stakeholders. The new information is reported in a value added statement.


Stakeholders consist of a firm’s workers, its providers of loan capital, its owners, the government, and society at large.  Each stakeholder contributes to the wealth creation of a firm. The government is included in the list of wealth creators because of its role in providing the transport, legal and financial infrastructures, education, health, and other services. Without these services business activity would not thrive.  In a value added statement, none of the stakeholders are given primacy.

Value added: an alternative metric

In a value added statement profit does not feature as the primary metric. Instead, value added, a measure of wealth creation, replaces the profit metric. The value added metric changes the implied orientation of a firm from owners to stakeholders. Value added is measured as the difference between a firm’s sales revenue and the costs of materials, goods and services bought-in from outside the firm. Where a firm has other sources of income, it is convenient to add these into sales revenue, as demonstrated in the statement below.

Tesco Value Added Statements


Financial reports have political and social significance The financial reports prepared by accountants are not neutral – they reflect the perspective and interests of the dominant social class – capitalists.

Capital increasingly has gained the upper hand over labour in recent times.  Accounting practice reflects capital’s dominance, and financial statements may seem quite opaque and irrelevant to workers and to society at large. Of course, worker incomprehension of financial reports suits the purpose of capital. Opaque financial reports create information assymetry which favours capitalists over workers in wage and related negotiations.

Value added statements go some way to redressing this information assymetry and power imbalance. It is probably too optimistic to hope that legislatures around the world will legislate to require companies to include a value added statement in their corporate reports. This is a predictable consequence of capital’s dominance and its hold over governments.

Despite this, it is usually feasible to convert a firm’s income statement into a value added statement, although this depends on using information that is found elsewhere in a company’s corporate report, most notably in the notes to the accounts.

In the above example, I was able to produce Tesco’s group value added statement, but not a value added statement for Tesco UK. This is because Tesco’s financial statements have not segmented labour costs by country. I was hence unable to identify the UK specific element from the published consolidated figure for Tesco’s  labour costs..

I shall continue to extol the virtues of value added statements, despite their being out of fashion. I hope you and others will do the same