ABACUS, Vol. 28, h’o. 1.

1992

SCOTT HENDERSON AND JENNY GOODWlN

The Case Against Asset Revaluations

The upward revaluation of non-current assets is a common feature of

contemporary accounting in Australia. This paper presents a case against
the practice. The effects of revaluations are examined and possible reasons
why firms revalue are considered. It is argued that asset revaluation is
theoretically unsound, being inconsistent with the accounting structure
within which it occurs. It is concluded that there are significant costs but
few obvious benefits associated with revaluation.
Key words: Fixed assets; Revaluation; Valuation.

Asset revaluations are accepted virtually without question as a generally accepted

Australian accounting practice. This article presents a case against the practice.
It is argued that, not only is the practice theoretically unsound, but that there
are few practical benefits arising from its use. Indeed, revaluations have wiped
millions of dollars from the reported profits of Australian companies. The article
urges a critical review of the whole practice as a matter of urgency.’
It is significant that asset revaluation is not generally permitted in North America.2
In the United States, APB Opinion No. 6 (1965) states that: ‘Property, plant, and
equipment should not be written up by an entity to reflect appraisal, market or
current values which are above cost to the entity’. Furthermore, the SEC has
effectively outlawed the upward revaluation of assets in Accounting Series Release
No. 4 (1938) which states: ‘Financial statements. . . prepared in accordance with
accounting principles for which there is not substantial authoritative support will
be presumed to be misleading or inaccurate despite disclosures contained in the
certificate of the accountant or in footnotes to the statements’. While this is not
a direct reference to revaluations, it is accepted that the write-up of assets is an
accounting principle which does not have ‘substantial authoritative support’.

I The article addresses only the practice of revaluing non-current assets subsequent to acquisition. The
issue of assigning fair value to individual assets in a business acquisition is not considered.

2 The main exception to this relates to quasi reorganization where assets can be revalued to reflect
fair value. However, in this situation, upward revaluations would be rare and it is far more likely
that a non-current asset would be written down to reflect a lower fair value. Walker (1992)7discusses
the effect of ASR4 in detail.

SCOTTHENDERSON is Professor of Accounting, University of Adelaide, and JENNY GOODWINis a

Senior Lecturer in the Department of Accounting and Valuation, Lincoln University, New Zealand
The authors wish to thank the University of Regina, Saskatchewan, for the use of facilities when
this paper was being prepared.

75
 ABACUS

Financial statements that include revaluations are regarded as misleading or

inaccurate.3
The Canadian opposition to upward asset revaluation is expressed in Section
3060 of the CICA Handbook (1990). Para. 18 states simply: ‘A capital asset should
be recorded at cost’. The North American prohibition on upwards asset revaluation
is based upon their belief that the practice is not consistent with the principles
of historical cost accounting. The valuation procedures, they argue, rely upon
judgment and estimates to such an extent that the result is too subjective for inclusion
in the accounts. It is not reliable. Historical cost, on the other hand, arguably
is more objective and at the date of acquisition of the asset may be regarded as
a reasonable or minimal approximation of value. It is the amount which is matched
with revenue over the life of the asset. Non-current assets, it is argued, are simply
prepaid expenses. As the assets are being held and used and sale is not contemplated,
any figure other than original cost is irrelevant. These arguments are familiar to
most Australian accountants from the current cost accounting (CCA) debate of
the 1970s. It appears they were accepted then and, consequently, CCA was not
adopted. They do not, however, appear to be accepted in relatoin to asset revaluations.

LEGISLATIVE AND PROFESSIONAL GUIDELINES

The Australian accounting profession provides very little guidance to practitioners
about how the revaluation increment should be determined. Statement of Accounting
Standards AAS 10, Acounting for the Revaluation of Non-Current Assets (1983)
and the equivalent approved standard, ASRB 1010 (1987), are concerned only with
how to account for and what to disclose concerning any revaluation. Commentary
paragraph (vi) of ASRB 1010 and para. 14 of AAS 10 both make it clear that
the accounting standard or statement is only concerned with how to account for
revaluations rather than when they should occur and on what basis they should
be carried out. AAS 10 (1983) and ASRB 1010 (1987) refer to Sections 269(7) (c)
and 267 of the Companies Code as placing ‘constraining factors’ on the process
of revaluation.
In 1991 the Companies Code was replaced by the Corporations Law. Sections
269(7) (c)and 267 become Sections 294(4) and 289 of the Corporations Law. Section
294(4) requires that directors should take reasonable steps to ascertain whether
the recorded value of a non-current asset exceeds the amount ‘that it would have
been reasonable for the company to expend to acquire the asset as at the end
of the financial year’. This probably means year-end replacement cost.4 If it does

3 It is acknowledgedthat the SEC has recently supported a move away from historical cost by advocating
that certain investment securities can be ‘marked to market’ in financial statements. At this stage,
the recommendation relates only to monetary assets held by financial institutions and there is no
evidence that the SEC is supporting a more general move away from historical cost for non-monetary
assets. (See Wyatt, 1991.)

4 The actual meaning of this phrase is not clear as, arguably, it would not be ‘reasonable’ to expend
more to acquire an asset than the company expects to recover from either its use or sale (i,e., its
recoverable amount). We are interpreting the phrase at its face value which suggests replacement
CflSt.

76
 THE CASE AGAI NST ASSET REVALUATIONS

exceed the replacement cost, then there must be adequate disclosure to ensure that
the accounts are not misleading. This suggests that current replacement cost is
the upper limit to the carrying amount of an asset. In contrast, AAS 10 (1983)
and ASRB 1010 (1987) suggest that the carrying amount of a class of assets should
not exceed its recoverable amount. ASRB 1010(1987) defines the ‘recoverable amount’
of an asset in para. 10 as
the net amount that is to be expected to be recovered -
(a) from the total cash inflows less the relevant cash outflows arising from its continued
use and through its subsequent disposal; or
(b) through its sale.
Compliance with both the Corporations Law and ASRB 1010 (1987) probably
sets a valuation ceiling as the lower of replacement cost or recoverable amount,
although the matter is a little confused by reference to both single assets and to
classes of assets. This is broadly consistent with ED49, Accounting for Identijiable
Intangible Assets (ASRB, 1989), which is more explicit about the revaluation of
intangibles. Para. 31 states: ‘The basis for the revaluation of a class of identifiable
intangible assets shall be the lowest cost at which the assets within the class could
currently be obtained in the normal course of business, such amount being determined
by independent valuation’. The Draft also stresses that the carrying amount of
any intangible asset must not exceed its recoverable amount. It would appear that
the profession, in this Exposure Draft, is endorsing the lower of replacement cost
and recoverable amount as a revaluation ceiling. However, this applies to individual
assets rather than to the whole class of assets as required in AAS 10 (1983) and
ASRB 1010 (1987).
The limits imposed by ceilings of this type are largely illusory. The determination
of replacement cost or recoverable amount depends upon estimate and forecasts
which make the process subjective.
Section 289 of the Corporations Law relates to accounting records and implies
that there should be acceptable documentation to support a valuation increment.
In most cases, companies employ ‘experts’ to provide valuations. When the
revaluation is first reported, the identity of this expert should be disclosed in the
accounts (ASRB 1010, para 40). An expert valuation is, as with all valuations,
still subjective. The worth of any documentation provided by an expert is a matter
for speculation although no doubt it may be of some comfort to auditors.
Directors do not have to obtain an expert valuation and are permitted to place
upon the asset their own valuation, described in the accounts as ‘Directors’Valuation’.
In these cases, the worth of any documentation is questionable. It is interesting
to note that the profession is recommending the use of independent valuations
for intangibles, presumably because of the level of subjectivity involved in revaluing
assets of this nature. It can be argued, however, that the basis for revaluation
of all non-current assets should be the same, with differences in estimation being
of degree rather than kind.
Schedule 5 of the Regulations (Clause 32) requires certain companies to disclose
the current value of their interests in land and buildings. Current value is defined

77
 ABACUS

as ‘the most recent valuation made within the last 3 years before the end of that
financial period’. Where current values are not recorded in the accounts, footnote
disclosure is required. No reference is made as to the basis of valuation or to
who should undertake the valuation. Directors’ valuations are clearly acceptable
provided they are not aggregated with independent valuations.
In 1988, the National Companies and Securities Commission issued Policy
Statement No. 135, Revaluation of Non-Current Assets. The statement extended
an earlier policy statement relating to the revaluation of intangible assets only.
Prompted by a concern that some revaluations in prospectuses may have provided
misleading information to potential investors, it requires that any revaluation in
a prospectus must be supported by an independent expert’s report. Details of the
valuation such as assumptions on which it is based, data used, calculations and
valuation methods adopted must be clearly disclosed. However, while the statement
refers to valuations appearing in reports in general, it concentrates only on disclosure
requirements in prospectuses and does not directly apply to annual financial
statements.
It seems reasonable to conclude, therefore, that there is a measurement anarchy
with respect to revaluations. Objective rules are lacking and the measurement process
rests on the discretion of directors. In the 8 March 1990 issue of New Accountant,
Walker has written that in the area of asset revaluations, ‘Australian accounting
rules are among the most lax in the world’ (p. 10). We concur.

THE EFFECTS O F REVALUATION

When an asset is revalued upwards,5 its carrying amount is increased to its agreed
‘value’ and the revaluation increment is recorded in an ‘asset revaluation reserve’
account. The revaluation increment is not treated as revenue. For a depreciable
asset, the new carrying amount becomes the basis for depreciation in subsequent
years.
For a depreciable asset, upward revaluation has the following effects upon the
financial statements:
1. Depreciation expense is greater after an upward revaluation, resulting in lower
reported profits. This is not merely a movement of profits from one period
to another. Expenses are increased, profits are lost and are not regained in
subsequent periods.
2. The gain on the eventual sale of the revalued asset is lower because its carrying
amount is higher.
3. The sum of the lower profits arising from higher depreciation and the lower
gain on sale of the asset is equal to the amount of the revaluation. For example,
if an asset is revalued upward by $300,000, then profits over the periods up
to and including that in which the asset is sold will be reduced by a total
of $300,000. (See the example in Table 1.)
5 The Accounting Standards do not allow the revaluation of single assets. The whole asset class should
be revalued. For convenience, we will refer to single assets rather than to a class. This method of
exposition makes no difference to our conclusions.

78
 THE CASE AGAINST ASSET REVALUATIONS

TABLE
1

Assume a depreciable asset is purchased at the beginning of year 1 at a cost of $5OO,OOO. It has a
ten-year useful life with no residual value. Straight-line depreciation is used ($50,000pa). At the end
of Year 4 the asset is revalued by $300,000.

Carrying amount at end of Year 4 $300,000

Asset revalued by 300,000
New carrying amount 600,000

Depreciation over next two years 200,000

(600,000/6 x 2)
Carrying amount at end of Year 6 400,000
The asset is then sold for 250,000
Loss on sale $150,000

If the asset had not been revalued:

Carrying amount at end of Year 6 $200,000
Asset sold for 250,000
Gain on sale $50,000

Total effect on profit over two year period:

Increased depreciation expense Years 5 and 6 $100,000
Difference on sale 200,000
Total reduction of profit which equals the amount of the revaluation $300,000

4. While the asset is held, the revaluation results in both higher total assets and
higher shareholders’ equity. The amount of these increases is equal to the
valuation increment less any increased accumulated depreciation resulting from
the revaluation.
5. While the asset is held, there will be changes in financial ratios: (a) the rate
of return on total assets will be reduced because of the decrease in reported
profits and the increase in the carrying amount of the asset; (b) the rate of
return on shareholders’ funds will be reduced as a result of the decrease in
reported profits and the increase in shareholders’ funds; (c) the debt/ asset
and debt/equity ratios will be reduced because of the increase in the carrying
amount of the asset and the increase in shareholders’ funds.
For a non-depreciable asset there will be no effect on reported profits while
the asset is held. However, the other effects noted for depreciable assets will
nevertheless be present.
In addition to these effects on the financial statements, there are also likely to
be a number of actual costs or cash outflows associated with asset revaluation.
These include expenses directly associated with obtaining a valuation, particularly
when an independent valuer is used. There is also likely to be an increase in audit
fees as auditors are likely to have more difficulty verifying subjective valuations

79
 ABACUS

compared to an historical cost-derived value. With a directors’ valuation, the auditor

may have to obtain evidence from an expert valuer to verify the reasonableness
of the valuation. Where the company has obtained an independent valuation, the
auditor may need to rely on the work of the valuer as an expert. In both cases,
guidelines are set down in Statement of Auditing Practice AUP 22, Using the Work
of an Expert (Australian Accounting Research Foundation, 1985). The skills,
competence and objectivity of the valuer as well as the work performed are to
be assessed. In these situations the auditor continues to be responsible for forming
an opinion on the financial information (Statement of Auditing Standards AUS 1,
1990, para. 20) and it can be argued that the level of inherent audit risk is increased
both by the subjectivity involved and the need to rely on a third party.

THE REASONS WHY AUSTRALIAN FIRMS REVALUE ASSETS

Whittred and Chan (1992) claim that ‘asset revaluations are a common feature
of Australian accounting and reporting practice, with an average of over 23 per
cent of firms revaluing each year between 1972 and 1985. Given the profit reductions
associated with the practice, there must be powerful incentives to revalue assets.
We will consider six possible reasons for asset revaluation: (a) to provide a lower,
more realistic measure of profit; (b) to provide more meaningful data on the balance
sheet; (c) to create a reserve from which bonus shares can be issued; (d) to improve
asset backing per share and to increase share prices; (e) to improve the debt/asset
ratio; or (f) as a result of opportunistic behaviour by managers.6

A Lower, More Realistic Measure of Profit

It can be argued that historical cost becomes less meaningful or relevant as an
asset gets older and that depreciation based upon historical cost becomes less and
less an indicator of the current cost of using the assets. Revaluing assets and basing
depreciation on the revalued amount goes some way towards matching current
value expenses against current value revenues to report current value profits.
Chambers (1973, p. 56) suggested that one of the reasons companies revalue
may be to correct ‘apparently excessive earnings’. However, this argument appears
inconsistent with recent behaviour and should be viewed with some scepticism.
It is our belief that, in general, Australian firms are reluctant to adopt profit-
reducing accounting practices, particularly when the reduction in profit does not
lead to a reduction in the liability to pay income tax and the profits cannot be

6 An alternative approach would be to adopt a contracting theory framework and classify possible
reasons on the basis of the underlying incentive that might lead managers to portray a particular
outcome. However, contracting theory with respect to revaluations is not well developed at this stage
and we believe that such an approach would cloud some of the fundamental issues. We have therefore
considered possible reasons based on the effect of revaluations from the viewpoint of the reporting
entity. We have, however, concluded with a discussion of possible managerial motivation for revaluation
based on opportunistic behaviour. These contracting cost incentives are explored in Brown, Izan
and Loh (1992) and Whittred and Chan (1992).

80
 THE C A S E A G A I N S T ASSET REVALUATIONS

recovered in subsequent periods as part of a ‘smoothing’ process. Witness the recent

controversy about AAS 18, Accounting for Goodwill (1984). It was generally agreed
that the requirements of this standard were theoretically sound within the context
of contemporary accounting, but were nevertheless unacceptable because they
reduced profit for many firms. In this case, ‘practical’ considerations were judged
to be more important than theoretical niceties. Given this reaction to AAS 18,
it is hard to take seriously an argument that the business community is willing
to accept lower profits from asset revaluations because it leads to more ‘relevant’
financial statements.
It could, perhaps, be argued that the business community was willing to accept
CCA in the 1970s because it believed that the proposed system would result in
more realistic profit measurement. In the same way, the business community today
accepts asset revaluations because they result in an improved measure of profit.
It will be recalled, however, that others argued the real objective of the business
sector in supporting CCA in the 1970s was not to reduce profits but to reduce
cash flows to the government, to employees and to shareholders (see Clarke 1982).
When it became clear that CCA would not achieve those objectives, business support
for the proposed system evaporated. Support for CCA based upon arguments for
better accounting masked the real reason, which was a desire to limit wealth transfers
to other sectors of the community. Similarly, it seems likely that current support
for asset revaluations based upon a desire for better accounting is a socially acceptable
excuse or a cover for some other reason for the support.

More Meaningfiul Data on the Balance Sheet

Arguably, firms revalue in order to report ‘more realistic’ asset values on the balance
sheet. Historical costs, particularly of long-life assets such as land and buildings,
become increasingly less relevant with the passage of time. Revaluing assets puts
‘value’ on the balance sheet. In today’s jargon, it gives ‘representational faithfulness’.
More traditionally, Chambers (1973, p. 55) described it as providing ‘a truer and
fairer view’.
Again, we can question this motive. If companies were concerned with
representational faithfulness and they believed that current values were necessary
in order to present a true and fair view, then they would revalue all of their non-
current assets on a systematic and regular basis. This is not the case. Revaluation
appears to be non-systematic, with many companies recording a variety of valuations
spread over a number of years.7 From a user’s point of view, the usefulness of
the information generated can be questioned.

For example, the 1988 Financial Statements of S.A. Brewing Holdings Ltd contain seven different
valuations for land and buildings (1980, 1981, 1984, 1985, 1986, 1988 and cost) and three different
valuations for plant and equpment (1979, 1981 and cost); CSR Limited’s 1988 Financial Statements
contain five valuations for land and buildings (1974, 1984, 1985, 1987 and cost) and six valuations
for plant and equipment (1962, 1977, 1980, 1985, 1987 and cost); Amatil Limited’s 1988 Financial
Statements contain five valuations for land and buildings (1980, 1985, 1986, 1988 and cost) and four
valuations for plant and equipment (1975, 1984, 1986 and cost).

81
 ABACUS

A Reserve from which Bonus Shares Can Be Issued

The revaluation of non-current assets creates a reserve which can be used to make
bonus share issues to shareholders. Theoretically, such issues add nothing to the
value of the firm. They have, however, been welcomed by shareholders because
they are seen to convey favourable information to the market. Dividends per share
tend to be maintained on the larger share base and shareholders therefore assume
that, by making a bonus issue, directors are signalling that the future prospects
of the company are positive and it can afford to increase its dividend payout.*
Bonus share issues have also been used as a defence against takeover bids. However,
Casey and Eddey (1986) point out that the takeover regulations in force since 1981
have reduced the scope for issuing bonus shares as a delaying tactic when a bid
is made. It could be argued that bonus issues are made to deter possible bids
rather than as a defence against an actual bid and the asset revaluation reserve
creates a means to achieve this strategy.
In Australia, with the introduction of dividend imputation and capital gains tax
legislation, bonus issues have become less attractive to shareholders. Since 1 July
1987, bonus share issues from any source other than the share premium reserve
have been treated as dividends and taxed accordingly. They are also subject to
capital gains tax when sold. We believe that these tax implications outweigh the
advantages of bonus issues and that it can no longer be argued that the creation
of a reserve is a plausible explanation for asset revaluations.

Improved Asset Backing and Increased Share Price

Another possible reason for business support for asset revaluation is that it allows
increases in asset backing per share virtually at the discretion of directors. Possibly
increases in asset backing will lead to increases in share prices, a reduction in the
cost of capital and hence will discourage takeover attempts.
If the capital market is efficient, an asset revaluation should only have an impact
on share prices if that revaluation tells the market something that it does not already
know. The financial statements are not the only source of information available
to the market and current values can be predicted from other sources. Many suggest
(the authors included) that sophisticated users will not be fooled by anything as
simple as an asset revaluation which causes no change in the entity’s basic condition
(see Brealey and Myers, 1988). With an efficient capital market, asset revaluations
are unlikely to lead to share price increases.
On the other hand, if investors are naive and thus likely to be influenced by
revaluation-induced increased asset backing, then they will also probably be
influenced by the accompanying fall in profits and rate of return. Any increase
in share price due to improved asset backing would be at least partly offset by
decreases in the share prices due to deteriorating performance.
8 A distinction can be drawn between bonus issues and share splits. While the end result of both
practices is very similar, it is only bonus issues that require the capitalization of a reserve. Interestingly,
the research evidence suggests that, unlike bonus issues, share splits are not interpreted as a favourable
signal to the market (see, e.g. Ball, Brown and Finn, 1977). While the reasons for this are unclear,
it may indicate why managers appear to have had a preference for bonus issues rather than share
splits.

82
 THE CASE AGAI NST ASSET REVALUATIONS

Empirical studies on the effect of revaluations on share prices, although providing

mixed results, do support our arguments. Sharpe and Walker (1975) concluded
that revaluations influence share prices but their results were disputed by Brown
and Finn (1980) because of a lack of adequate controls of other variables such
as increases in profit, dividends and the announcement of bonus issues. Standish
and Ung (1982), in a British study, found the apparent influence diminished once
they attempted to control for these other variables. In a New Zealand study, Emanuel
(1989, pp. 221,224) found that ‘any evidence supportive of the “information content
of asset revaluations” argument is sparse’ and that, once other variables were
controlled, ‘the less it appeared that one could attribute any price reaction to the
asset revaluation’.
We conclude that, irrespective of capital market efficiency, asset revaluations
are unlikely to have a significant effect on share prices.

Improved DebtlAsset Ratio

Asset revaluations, as they are practised in Australia, result in increased shareholders’
equity for as long as the asset is held. This increase in reported equity may improve
perceptions of the company by suggesting that leverage is less than it would otherwise
be. This apparent reduced leverage may enhance borrowing capacity, thereby
lowering the cost of capital. In general, most long-term borrowing comes from
one of two sources -from institutional lenders such as banks and finance companies
or from public debt issues. We will discuss these two types of debt separately.
Institutional lenders have the power to demand current valuations of assets before
they lend, particularly if those assets are being offered as security for a loan. Amounts
recorded in general-purpose accounting reports are not likely to be relevant. As
far as this type of borrowing is concerned, it is unlikely that capacity to borrow
will be enhanced by asset revaluations in the financial statements.
Public debt issues are governed by contracts such as trust deeds which contain
restrictive covenants. Many trust deeds or indentures contain covenants which specify
a maximum liability-to-asset ratio. In Australia, it appears that the typical trust
deed from a public issue of debentures restricts total liabilities to 60 per cent of
total tangible assets and secured liabilities to 40 per cent of total tangible assets
(Stokes and Leong, 1988; Whittred and Zimmer, 1986). If these percentages are
exceeded, then the trustee may conclude that the borrower has defaulted and demand
rectification of the breach or repayment of the loan. As a general rule, the trustee
will assess the borrower’s compliance with the covenants by reference to the
borrower’s published balance sheet.
It has been argued that the ability to revalue assets provides an opportunity
for directors to avoid breaching a debt/ asset covenant. Asset revaluation increases
the carrying amount of the assets and lowers the debt/asset ratio. Whittred and
Chan (1992) argue that this means that firms are more likely to revalue when their
level of leverage is increasing and their borrowing capacity is reduced. Their empirical
evidence tends to support this view.
It is likely that trustees are aware of asset revaluations diluting the strength of
restrictive covenants and that they modify the covenants accordingly. Whittred and

83
 ABACUS

Chan (1992) note that, typically, the deeds define total tangible assets to exclude:

any amount by which the book value of any tangible asset is written up subsequent
to the annual balance date immediately preceding the date of the Deed, except where
such writing up is made in accordance with and so that the book value does not exceed
a valuation by an independent valuer approved by the Trustee.

In other words, lenders are well aware of asset revaluations and are prepared to
allow them to reduce the reported debt/asset ratio provided that the valuation
is acceptable to the trustee. It seems likely that restrictive covenants in trust deeds
will be tighter in an environment where revaluations occur. In other words, the
covenants assume that there will be revaluations of assets. In these circumstances,
revaluations are forced upon the borrowers by trust deeds which are based upon
the assumption that they will occur.

Opportunistic Behaviour by Managers

The preceding discussion of reasons for asset revaluation has been from the viewpoint
of the reporting entity. It is also possible that managers may revalue assets because
it is consistent with improving their personal well-being. This opportunistic behaviour
would occur, for example, if management remuneration packages were directly
related to the reported value of aggregate assets. It seems unlikely, however, that
remuneration will be related only to asset amounts. Such a package would encourage
managers to expand assets regardless of profitability and would not be in the interests
of the reporting entity.
Empirical evidence suggests that management remuneration packages are usually
related to performance measures such as reported earnings or rates of return
(Emmanuel, Otley and Merchant, 1990, p.230, and Whittred and Zimmer, 1990,
pp. 28-9). In these circumstances, opportunistic behaviour would be not to revalue
assets, as this reduces both profits and rates of return on assets or equity.
Remuneration packages may also include shares or share options which may
encourage managers to attempt to inflate the price of shares. However, it was shown
above that asset revaluations do not appear to have a significant effect on share
prices. It is therefore unlikely that managers’ remuneration packages will lead to
asset revaluations as opportunistic behaviour.
It is also possible that managers may indulge their egos by expanding that part
of the reporting entity over which they have control beyond the point where the
owners’ wealth is maximized (Morris, 1967, pp. 62-3). In this situation, opportunistic
behaviour is related to power and prestige rather than to salary. While this type
of opportunistic behaviour may occur, it is unlikely to be widespread because of
the associated impact on profitability.
Managers may also revalue assets to avoid the personal stigma associated with
a breach by their company of a covenant of a trust deed. The effect of this behaviour
has been considered in the previous subsection.
In conclusion, while it is possible that asset revaluations may be the result of
opportunistic behaviour in a few cases, it is unlikely to be a major reason for
the practice.

84
 THE C A S E A G A I N S T ASSET REVALUATIONS

It would appear, therefore, that the only plausible reason for the revaluation
of assets with a subsequent fall in profits is to comply with the covenants of trust
deeds. The need to revalue arises because revaluations are anticipated by the lenders.

IMPLICATIONS

Several implications emerge from this discussion:

1. The revaluation of assets is inconsistent with the accounting structure within
which it occurs. It violates the traditional accounting principle of historical
cost and objectivity. It is not allowed in the United States and Canada and
it destroys the logical base of contemporary accounting.
2. There are significant costs associated with asset revaluations. Over the life
of the asset, profits are reduced by the amount of the valuation increment.
In addition, there are actual expenses incurred in obtaining a valuation and
there is also likely to be an increase in audit fees.
3. There would appear to be few obvious benefits from revaluation. The creation
of a reserve to enable a bonus share issue is less attractive due to recent
changes in tax legislation. It is unlikely that an improvement in asset backing
per share will raise share prices. It is also unlikely that an improvement in
asset backing per share will raise share prices. It is also unlikely that a
revaluation-induced lowering in the debt asset ratio will improve the company’s
borrowing capacity. Furthermore, covenants in trust deeds appear to allow
for revaluations.

CONCLUSION

Asset revaluations cannot be justified on theoretical grounds as part of an historical

cost accounting system. Under that system, assets that are held for use should
be shown at cost because they are prepaid expenses. Revaluing them destroys the
logic of the system and results in accounting reports based upon a hybrid capital
maintenance concept. If, in the interest of ‘representational faithfulness’, it is believed
that the market values of non-current assets should be disclosed, then this may
be done by way of a note to the accounts. The logical basis of the accounting
system would be unaffected. Alternatively, if it is believed that current values should
be reported on the balance sheet, then the whole historical cost system should
be abandoned and a new current value system should replace it.
On more pragmatic grounds, present Australian asset revaluation practices reduce
reported profits, rates of return on assets and rates of return on equity. There
appears to be no advantage to the reporting entity apart from aiding compliance
with restrictive covenants of trust deeds. Even this is an illusory advantage as the
trust deeds are framed in anticipation of asset revaluations.
For too long the practice of revaluation has been accepted uncritically as part
of contemporary accounting. It is time to seriously reconsider this practice.

85
 ABACUS

REFERENCES

Accounting Principles Board, APB Opinion No. 6, Status of Accounting Research Bulletins, AICPA,
New York, 1965.
Accounting Standards Review Board, Approved Accounting Standard ASRB 1010, Accounting for the
Revaluation of Non-Current Assets, ASRB, June 1987.
Accounting Standards Review Board and Public Sector Accounting Standards Board of the Australian
Accounting Research Foundation, ED 49, Accounting for Identifiable Intangible Assets, AARF,
Melbourne, August 1989.
Australian Accounting Research Foundation, Auditing Standards Board, Statement of Auditing Practice
AUP 22, Using the Work of an Expert, June 1985.
Australian Society of Accountants and the Institute of Chartered Accountants in Australia, Statement
of Accounting Standards AAS 10, Accounting for the Revaluation of Non-Current Assets, June
1981 (amended November 1983 and December 1983).
-, Statement of Accounting Standards AAS 18, Accounting for Goodwill, March 1984.
Australian Society of Certified Practising Accountants and the Institute of Chartered Accountants in
Australia, Statement of Auditing Standards A US I , November 1990.
Ball, R., P. Brown and F. J. Finn, ‘Share Capitalisation Changes, Information and the Australian
Equity Market’, in R. Ball, P. Brown, F. J. Finn and R. R. Officer (eds), Share Market and
Portfolio Theory, University of Queensland Press, 1980.
Brealey, R. A,, and S. C. Myers, Principles of Corporate Finance, 3rd edn, McGraw-Hill, 1988.
Brown, P., and F. J . Finn, ‘Asset Revaluations and Stock Prices: Alternative Interpretations of a Study
by Sharpe and Walker’, in R. Ball, P. Brown, F. J . Finn and R. R. Officer (eds), Share Markers
and Portfolio Theory, University of Queensland Press, 1980.
Brown, P., H. Y. Izan and A. L. Loh, ‘Fixed Asset Revaluations and Managerial Incentives’, Abacus,
March 1992.
Canadian Institute of Chartered Accountants, Handbook Section 3060,CICA, 1990.
Casey, R. S., and P. H. Eddey, ‘Defence Strategies of Listed Companies Under the Takeover Code,
Australian Journal of Management, December 1986.
Chambers, R. J., Securities and Obscurities: A Case for Reform of the Law of Company Accounts,
Gower Press, 1973.
Clarke, F. L., A Tangled Web ofprice Variation Accounting, Garland Publishing, 1982.
Emanuel, D. M., ‘Asset Revaluations and Share Price Revisions’, Journal of Business Finance and
Accounting, Spring 1989.
Emmanuel, C . , D. Otley and K. Merchant, Accounting for Management Control, 2nd edn, Chapman
and Hall, 1990.
Morris, R., The Economics Theory of ‘Managerial’Capitalism, Macmillan, 1967.
National Companies and Securities Commission, Policy Statement 135, Issue 3, Revaluation of Non-
Current Assets, 1988.
Securities and Exchange Commission, Accounting Series Release No. 4 , SEC, 1938.
Sharpe, I. G., and R. G . Walker, ‘Asset Revaluations and Stock Market Prices’, Journal of Accounting
Research, Autumn 1975.
Standish, P. E. M., and S. Ung, ‘Corporate Signalling, Asset Revaluations and the Stock Prices of
British Companies’, The Accounting Review, October 1982.
Stokes, D., and T. K. Leong, ‘Restrictive Covenants and Accounting Information in the Market for
Convertible Notes; Further Evidence’, Accounting and Finance, May 1988.
Walker, R. G., ‘Australia v. The World: How Standards Stack Up’, New Accountant, 8 March 1990.
-,‘The SEC’s Ban on Upward Asset Revaluations and the Disclosure of Current Values’, Abacus,
March 1992.
Whittred, G., and Y. K. Chan, ‘Accounting Information in the Market for Debt’, Accounting and
Finance, November 1986.

86
 THE C A S E A G A I N S T ASSET REVALUATIONS

-, ‘Asset Revaluations and the Mitigation of Underinvestment’, Abacus, March 1992.

Whittred, G., and I. Zimmer, ‘Accounting Information in the Market for Debt’, Accounfing and Finance,
November 1986.
Whittred, G., and I. Zimmer, Financial Accounting: Incentive Effects and Economic Consequences,
2nd edn, Holt Rinehart and Winston, 1990.
Wyatt, A,, ‘The SEC Says: Mark to Market’, Accounting Horizons, March 1991.

87