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.

Example

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.

Example

Investment and VAS 2

Working

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.