Suppose, a person buys a machinery for manufacturing cloth for 100 million Ug.shs only. He expects that this machinery will last ten years and after that period, it will be partially or completely worn out. He sets aside 10 million Ug.shs. every year from the gross national income as a depreciation reserve of the capital equipment.

After the expiry of ten years, he accumulates 100million Ug.shs and with that money he replaces the old capital equipment which has lived its useful life and maintains capital intact. The sum of money, i.e., 10million Ug.s which he annually deducts from the gross annual income, is known as depreciation allowance.

It is often pointed out by economists that the calculation of depreciation allowance every year is a difficult task.

For example, a person expects the longevity of the capital equipment, say for ten years. There is a possibility that machinery may last longer or it may go out of use earlier. So they say what needed is an approximate decision regarding the depreciation allowance. This decision should be based on high degree of judgment and guessing about the future.

Maintaining Capital Intact.

By maintaining capital intact we do not mean that capital equipment should remain the same. It should neither increase nor decrease. This can only by possible in a static society. In a progressive society, the total capital equipment of a country must increase every year, otherwise the national income will be affected adversely.

In Economics, by the phrase 'maintaining 'capital intact' is meant to make good the physical deterioration which has taken place in the capital equipment while creating income during a given period. This can only be made by setting aside a certain amount of; money every year from the annual gross income so that when the income creating equipment becomes obsolete, new capital equipment maybe created out. If the depreciation allowance is not set aside every year, the flow of income would not remain intact. It will decline gradually and the whole country will become poor.

NNP = GNP - Depreciation