As per the idea presented by few people at CFS, the company can charge the rental operation with depreciation expense. Generally, real property never depreciates in value, but since the investment in the property generates income via appreciation of value, it is acceptable to recover the costs against the income earned, through annual depreciation deductions. In our case, the sole purpose of the company’s real estate fund, which consists of houses, hotels and commercial buildings, is to provide income in the form of rental cash flow and share of appreciation in value of those properties.
Since the property is used for an income producing activity, the company can charge rental operation with depreciation expense. Despite the ...view middle of the document...
Furthermore, such treatment provides an income statement more comparable to other real estate entities, as the rental operation costs are normally depreciated by most companies. This provides better comparability, however, at the cost of relevancy.
Alternative 2: Do not charge rental operation with depreciation expense
The other alternative for CFS is not to charge rental operation with depreciation expense, mainly because such information is not relevant to potential investors, for whom appreciation is of prime concern than depreciation. Traditionally, the purpose of depreciation is to allocate the asset’s cost over its useful life, in order to account for the continuous diminution in the value of the asset. This is usually the case when the asset is used extensively; it loses its ability to provide services. However, the properties held by CFS generally appreciates in value, thus, the diminution in value can be considered irrelevant to users of financial statements. One of the primary objectives of issuing financial statements is to provide information that is useful to decision making. The primary users of CFS’s financial statements are existing and potential investors, who are interested in fairly stated financial statements that depict the economic reality.
Furthermore, in CFS’s case, it is important to note that apart from the fact that the properties are used to generate revenues in the form of rental income, it is also the source of income itself (via its appreciation in value). Lastly, the assets are intended for resale in order to benefit from the appreciation of value. In such case, when the asset is intended to be held for sale in order to earn income, the asset should not be depreciated.