An Investigation of Revaluations of Tangible Long Lived Assets

Accounting Research Center, Booth School of Business, University of Chicago
An Investigation of Revaluations of Tangible Long-Lived Assets

Author(s): Peter D. Easton, Peter H. Eddey and Trevor S. Harris
Source: Journal of Accounting Research, Vol. 31, Studies on International Accounting (1993), pp.
1-38
Published by: Wiley on behalf of Accounting Research Center, Booth School of Business,
University of Chicago
Stable URL: http://www.jstor.org/stable/2491161
Accessed: 04-10-2015 11:32 UTC
Your use of the JSTOR archive indicates your acceptance of the Terms & Conditions of Use, available at http://www.jstor.org/page/
info/about/policies/terms.jsp
JSTOR is a not-for-profit service that helps scholars, researchers, and students discover, use, and build upon a wide range of content
in a trusted digital archive. We use information technology and tools to increase productivity and facilitate new forms of scholarship.
For more information about JSTOR, please contact support@jstor.org.
Accounting Research Center, Booth School of Business, University of Chicago and Wiley are collaborating with
JSTOR to digitize, preserve and extend access to Journal of Accounting Research.
http://www.jstor.org
This content downloaded from 146.201.208.22 on Sun, 04 Oct 2015 11:32:33 UTC
All use subject to JSTOR Terms and Conditions
Journal of Accounting Research
Vol. 31 Supplement 1993
Printed in U.S.A.
An Investigation of Revaluations
of Tangible Long-Lived Assets
PETER D. EASTON,* PETER H. EDDEYt AND
TREVOR S. HARRISt+
1. Introduction and Summary

This paper documents the revaluation practice over a ten-year pe-
riod from 1981 of a large sample of Australian firms and examines the
association between these revaluations and stock market prices and re-
turns. The analysis uses several different approaches in order to obtain
a thorough understanding of the revaluation process in Australia. We
include a description of hand-collected data from published financial
statements, follow-up interviews with chief financial officers of the sam-
ple firms, and association tests between hand-collected accounting
data and stock market measures.
The possibility of revaluing long-lived assets to reflect market prices
has been, and continues to be, controversial. Historically, part of the
debate revolved around the issue of accounting for changing prices. For
example, in the United States (U.S.), Statement of Financial Accounting
Standards (SFAS) No. 33 (FASB [1979]) required supplementary infor-
mation based on current cost (constant dollar) inventory and property,
plant, and equipment. In the United Kingdom (U.K.), Statement of
*Macquarie University and University of Chicago; tMacquarie University; and +Co-

lumbia University. We are grateful to the Australian Research Council for funding this
project. Peter Easton thanks Price Waterhouse and Trevor Harris thanks the Faculty Re-
search Fund, Columbia University, and the Rudolph Schoenheimer Fellowship for fund-
ing of their research. The research assistance of Mark Baxter and Lou Le Guyader is
gratefully acknowledged. We acknowledge comments of Richard Leftwich, Pat O'Brien,
and workshop participants at the following universities: Chicago, Macquarie, Monash,
Oregon, and Purdue.
Copyright?, Institue of Professional Accounting, 1994
2 INTERNATIONAL ACCOUNTING: 1993
Standard Accounting Practice (SSAP) No. 16 required supplementary

financial statements based on current values. These experiments with
accounting for changing prices were considered unsuccessful, at least in
part because of questions about the value-relevance of the disclosures
(SFAS No. 89, FASB [1986]). In Australia, a recommendation to present
current cost financial statements exists (Statement of Accounting Practice
No. 1) but is rarely followed. So, currently, none of these countries re-
quires comprehensive adjustments for changing prices. Yet Australia
and the U.K. allow firms to revalue long-lived assets and revaluation of
certain classes of assets is pervasive while in other countries, including
the U.S., revaluation has been strongly discouraged.'
The issue of revaluation of at least some long-lived assets is currently
under debate in several countries and organizations. For example, the
International Accounting Standards Committee (IASC) has recently ap-
proved changes in the allowed treatment of revaluation for depreciable
assets in its revision of International Accounting Standard (IAS) No. 16.2 In
the U.K. the new Accounting Standards Board has recently proposed
that the revaluation of all long-lived assets be systematized (Financial
Times [25 March 1993]), while in Australia revaluation of long-lived as-
sets is being reconsidered.3 The Japanese Ministry of Finance is pur-
portedly considering property revaluations as an acceptable accounting
1 The U.S. Securities and Exchange Commission (SEC) has since its inception pro-
scribed departures from historical cost accounting. (Walker [1992] provides a detailed
description of the history of revaluations in the U.S.) The SEC in its Accounting SeriesRe-
lease No. 4, issued in April 1938, stated it will deem financial statements to be misleading
or inaccurate if they employ accounting principles which do not have substantial author-
itative support. APB Opinion No. 6 sets out the authoritative view on asset revaluations:
" ... property, plant and equipment should not be written up by an entity to reflect ap-
praisal, market or current values which are above cost to the entity" (clause 17). Thus, in
the U.S., upward revaluations of noncurrent assets are effectively prohibited. Revaluation
decrements, on the other hand, are permitted in certain limited circumstances: APB
Opinion No. 30 requires any noncurrent assets for which disposal is imminent to be writ-
ten down to its net realizable value. In addition to this, Zucca and Campbell [1992] re-
port that some firms now write down "impaired assets," but point out this is discretionary
under U.S. GAAP, not mandatory as it is in Australia. There is some evidence that up-
ward revaluations may be required soon; see, for example, FASB No. 107: Disclosure about
Fair Value of Financial Instruments (December 1991).
2 ED No. 43 (May 1992) is the exposure draft which proposed changes to 1ASNo. 16 in-
cluding making revaluation of property, plant, and equipment an acceptable alternative
to the benchmark historical cost treatment. ED No. 43 also recommended that if revalua-
tion is adopted as a principle the revaluations must be made regularly (clause 28). ED No.
43 was an agenda item at the IASC Board meeting in March 1993 (IASC Insight [July
1992]) and, according to Sharpe [1993], changes to JAS No. 16 were approved by the
IASC in April 1993.
3 Sharpe [1993] indicates that Australian and international standard setters view the
issue of revaluations as unsettled and question their value-relevance, especially since they
are usually not systematically applied. The issue is actively debated in Australia at this
time-the recent increased interest being due to the decline in asset values during the
1991 and 1992 recession and the reluctance of firms to devalue assets during this period.
REVALUATIONS OF TANGIBLE LONG-LIVED ASSETS 3
policy to facilitate the creation of reserves which can be used to offset

provisions for possible loan losses (The Economist [February 6, 1993]).
In our sample of Australian firms the asset revaluation reserve is a
substantial portion of book value for some asset classes. For example,
in industrial firms the median proportion of book value of property at-
tributable to revaluations was 0.732 for the decade commencing 1981.
In a cross-sectional regression the annual increment to the asset reval-
uation reserve has significant explanatory power for annual returns
over the traditional earnings and earnings change variables, which sug-
gests that asset revaluations coincide with changes in underlying asset
values. The level of the asset revaluation reserve has significant explan-
atory power for price-to-book ratios, particularly for subsamples of
industrial firms with a relatively high level of revaluation activity. Inclu-
sion of revaluation reserves in book value results in a ratio of market
value to book value which is closer to unity and has lower variance.
These analyses of price-to-book ratios suggest that inclusion of the re-
valuation reserve in book value provides a better summary of the cur-
rent financial state of the firm.
Our interviews with chief financial officers of Australian firms indi-
cate that the need to lower the debt-to-equity ratio is a major reason
for choosing to revalue assets. Our results suggest that the level of the
asset revaluation reserve is a significant explanatory variable for stock
market prices and returns of the subsample of industrial firms with
high change in debt-to-equity ratio but not for firms with a low change
in debt-to-equity ratio.
The next section describes Australian generally accepted accounting
principles relevant to the revaluation of tangible long-lived assets and
discusses why firms choose to revalue these assets. We then describe
the sample, provide a summary of results from a telephone survey of
chief financial officers, and report a descriptive analysis of the extent
of asset revaluations undertaken by Australian firms. We use this back-
ground information to formulate some hypotheses which we then test.
2. Accounting for Revaluations of Noncurrent Assets in

Australia
Australian accounting practices are regulated by company law;
within this framework there is a presumption that asset revaluations
can occur. For example, disclosure laws dating from at least 1961 have
required details of valuations reported in financial statements if assets
are carried at amounts other than cost.4 In addition, accounting stan-
dards issued by both professional and regulatory bodies, which recently
have been given precise legal status, create an environment for asset
revaluations to occur.
4Ninth Schedule to the Companies Act, 1961, clause 7(6).
4 P. D. EASTON, P. H. EDDEY, AND T. S. HARRIS
In our sample period the influence on revaluations comes from (i)

Schedule 7 to the Regulations of the Companies Act 1981;5 (ii) Section
269 of the Companies Act 1981; (iii) Australian Accounting Standard
(AAS) No. 10: Accountingfor the Revaluation of Non-Current Assets and the
related ASRB No. 1010;6 and (iv) AAS No. 1: Profit and Loss Statements
and the related ASRB No. 1018.
The principles of accounting for asset revaluations as they applied in
our sample period are summarized below:
(i) Australian firms are allowed, but are not required, to revalue
noncurrent assets. Some firms do not revalue (for example,
Ashton Mining Ltd.); some revalue on an ad hoc basis (for ex-
ample, BTR Nylex Ltd.); and some revalue on a stated cycle (for
example, Coles Myer Ltd. discloses in its annual reports that it
revalues property every three years using market value).
(ii) Individual assets cannot be selectively revalued; all assets within
a class must be revalued at the same time. A class is defined as
"a category of non-current assets having a similar nature or
function in the operations of the entity. . . " (AAS No. 10, para-
graph 13). Within a group of firms, a class of assets is defined
on a firm-by-firm basis,7 so revaluation increments in one firm
cannot be offset by revaluation decrements in another firm.
However, within each firm, revaluation increments and decre-
ments within each class of noncurrent assets can be offset.
(iii) If the recoverable amount of any asset falls below the carrying
amount, that asset must be written down to its recoverable
amount (AAS No. 10, paragraph 29 and Companies Act 1981,
Section 269).
5For the sample in this paper the relevant law is the Companies Act 1981. While this
has been superseded by the Corporations Law for fiscal years beginning after our sample
period, the issues relating to revaluations have not been affected by the new law.
6 The Australian Accounting Standards, known as AASs, are issued by the Australian Ac-
counting Research Foundation (AARF) and approved by the National Councils of the
two professional accounting bodies. These are benchmarks for practice but have no real
legal standing although since 1985 they have provided the basis for the ApprovedAccount-
ing Standards issued (originally) by the Accounting Standards Review Board (ASRB). The
approved standards closely mirror the AASs but have the force of law under the Compa-
nies Act 1981 and more recently the Corporations Law. In 1988 the ASRB was replaced
by the Australian Accounting Standards Board (AASB) which is now responsible for the
determination of the approved standards which will adopt the acronym of AASB. In the
case of accounting for revaluation of noncurrent assets the relevant standards are: AAS
No. 10 issued in June 1981, ASRB No. 1010 issued in May 1987 and effective for fiscal
years from September 30, 1987, and AASB No. 1010 issued in September 1991 and effec-
tive for fiscal years ending on or after June 30, 1992. A more detailed description of the
Australian standard-setting process can be found in Martin [1990].
7As a result of a 1991 amendment to AAS No. 10 / AASB No. 1010, a class of noncur-
rent asset has been redefined on a group basis. This is outside our sample period.
(iv) The net revaluation increment or decrement relating to each

class of noncurrent assets must be accounted for as follows:
(a) a net increment is to be taken (credited) directly to an as-
set revaluation reserve account in stockholders' equity;
(b) a net decrement is to be charged (debited) to the profit
and loss account (earnings); and
(c) a reversal of a previous increment or decrement is to be
taken to the account which recorded the initial revalua-
tion (AAS No. 10, paragraph 40).
(v) When a class of assets has been revalued, depreciation ex-
pense is based on the restated carrying amount (AAS No. 10,
paragraph 46).
(vi) A gain or loss on disposal of a previously revalued asset is cal-
culated as the difference between the carrying amount and
the proceeds and is included in the profit and loss (income)
statement (AAS No. 10, paragraph 50). The portion of the re-
valuation reserve realized through asset disposal cannot be
taken back to earnings (AAS No. 1, paragraph 31).8
(vii) A realized revaluation reserve can be dispersed in several
different ways, but dispersal is optional. Besides no adjustment
(that is, leaving the realized portion in the revaluation reserve
account), a realized revaluation reserve may be transferred to
another reserve account, such as an "asset realization reserve,"
a "capital profits reserve," or retained earnings, and becomes
available for subsequent distribution as a cash dividend (for
example, BHP Ltd. made a large transfer to general reserves
in 1987).9
(viii) A revaluation reserve can be used to issue a stock dividend
(termed a "bonus issue" in Australia) which can be issued from
either the realized or unrealized component of revaluation
reserves. Under generally accepted accounting practice,
unrealized revaluation reserves are not available for cash
dividends. l
(ix) There is no specific requirement as to the method of revalua-
tion to be used although company law requires disclosure of
the year of valuation and whether the valuation was carried
out by management or an independent valuer (Schedule 7,
clause 16).11
8 This is one area in which U.K. practice differs from the Australian practice.
9 It is more common to find realized revaluation reserves transferred to asset realiza-
tion or capital profits reserves.
10
Case law on this matter is divided. Stock dividends were frequently issued ,from re-
valuation reserves until July 1987 when changes in legislation removed the tax-free status
of stock dividends issued to stockholders from revaluation reserves.
11 The reasons for choosing between independent and management valuation are dis-
cussed in section 4.
(x) Asset revaluations have no direct effect on tax liability. Tax de-
preciation is based on the initial acquisition cost using sched-
uled rates.
In sum, the income statement reports depreciation based on the re-
valued amounts, the balance sheet shows assets at the revalued amount
with the offset in a reserve account, and the notes reveal movements in
the reserve accounts.
Three recent Australian studies (Brown, Izan, and Loh [1992],
Henderson and Goodwin [1992], and Whittred and Chan [1992]) sug-
gest and explore several explanations for the incidence of revaluations
which include:
(i) asset revaluations reflect management's attempt to comply with
the requirement of company law that financial statements
present a "true and fair view";
(ii) asset revaluations lower the debt-to-equity ratio, loosen debt
constraints, and enhance financial flexibility;
(iii) asset revaluations are undertaken as a takeover defense strategy
to ensure that an underpriced bid is not successful;12 and
(iv) asset revaluations lower the return on assets and hence ex-
posure to labor unions, price control administrators, and tax
authorities. 13
We consider the second explanation to be the most plausible. In our
telephone interviews with chief financial officers (reported in section
4), the desire to lower the debt-to-equity ratio was often cited as the
primary motivation for asset revaluations.
Most public borrowing contracts require that debt does not exceed a
certain proportion of tangible assets. Obviously, this ratio is lowered if
noncurrent assets are revalued upward. Whittred and Chan [1992]
note that a typical trust deed for a public borrowing in Australia allows
revaluations performed by an independent valuer to be included in the
12
Directors may undertake and report asset valuations as a preemptive strategy against
a takeover bid. Alternatively, if an unwelcome bid is received and assets are understated
in the target's accounts, the takeover provisions of Australian company law provide a
mechanism whereby revised asset values can be conveyed to target stockholders as part of
a defensive tactic. Having performed the revaluations, directors will likely be sure these
are reported in the next set of financial statements. Brown, Izan, and Loh [1992] pro-
vide evidence that firms which are subject to a takeover bid tend to revalue assets more
than those which are not.
'3At least two features of the Australian economic environment may support this mo-
tive for asset revaluation. First, the Prices Justification Tribunal (superseded in 1983 by
the Prices Surveillance Authority) requires justification of price increases in terms of "a
comparison of [the] company's profitability with the average for the industry.... Com-
panies considered to be highly profitable [are] required to absorb a larger portion of cost
increases" (Nieuwenhuysen and Daly [1977]). Second, labor unions have been particu-
larly strong in Australia in recent decades. It has been suggested that pressure for wage
increases is affected by apparently high reported accounting return on equity. Empirical
evidence in Brown, Izan, and Loh [1992] does not support the political cost argument.
debt-to-assets measure. In private borrowing arrangements, lenders ac-

cept directors' valuations under some circumstances.
Financial flexibility is a function of the extent to which lenders per-
ceive a surplus of assets over outstanding liabilities, and upward asset
revaluation increases the reported surplus. Using the debt-to-assets
ratio and the existence of a debt covenant as proxies for closeness to
borrowing limitations, Brown, Izan, and Loh [1992] and Whittred and
Chan [1992] provide empirical evidence consistent with the explana-
tion that asset revaluations are motivated by borrowing considerations.
3. Data and Sample Selection

Initially we extracted from Compustat's Global Vantage data base all
relevant accounting information from the industrial/commercial sec-
tion for Australia. It was clear from a comparison of these data and the
annual reports that while the data were essentially accurate, some im-
portant information was unavailable or too highly aggregated to be
useful for our analysis. For example, reported reserve amounts that do
not conform to the Global Vantage categories are classified as other re-
serves. To illustrate this point, consider Coles Myer Ltd. which until
1988 used one account to accumulate both realized and unrealized re-
valuation reserves. This account was split in 1988 into an asset realiza-
tion reserve (for realized revaluations) and an asset revaluation reserve
(for unrealized revaluations). The 1988 asset revaluation reserve had a
beginning balance of A[ustralian]$0, a transfer in of A$186 million, an
increment from revaluation of A$301 million, and a transfer to asset
realization reserve of A$3 million. Global Vantagereports a zero revalu-
ation reserve balance until 1988 (while notes to the financial state-
ments of 1987 and earlier years indicate a positive balance in this
account-A$186m in 1987), and mechanical computation of the reval-
uation reserve increment based on a change in the reserve balances
will reflect an increase of A$484 million instead of the actual A$301
million. A second common problem arises because Global Vantagedoes
not differentiate revaluation increments or decrements from other ad-
justments to the revaluation reserve account. For example, in 1987,
Adsteam Ltd. has a revaluation increment of A$43 million and trans-
fers out of the reserve account of A$114 million. Thus, using the Global
Vantagedata we would have a decrement of A$71 million instead of the
increment. This difference is almost 14% of reported owner's equity.
An even more extreme example can be found in the case of Wormald
in 1989. Based on Global Vantage data we would record a revaluation
decrement of A$120 million, 52% of reported equity, while the actual
revaluation decrement was only A$5 million. In this instance, A$115
million was simply a transfer to another reserve account.
Most of our tests are carried out on detailed information taken di-
rectly from the annual reports. However, we also performed our basic
analyses on the Australian sample available on Global Vantage and
found that these data yielded different results, suggesting they are not
reliable for the questions we address. These results will be noted in the
next section.
Global Vantage lists 147 Australian firms. Of these, 95 had financial
statements for ten consecutive years from 1981 on the Australian Grad-
uate School of Management microfiche file. This sample of 95 firms
includes 28 mining firms and 67 industrial firms, based on Compustat's
four-digit industry classification code. A preliminary perusal of finan-
cial statements indicates that mining firms did not typically revalue as-
sets during our sample period-the explanation for this is contained in
section 4. To increase the sample size to 100 firms we selected 5 more
listed industrial firms across a range of nonmining business activities
for which ten years of financial statements from 1981 were available on
microfiche. While the sample of 100 firms it not random, it comprises
a comprehensive set of listed firms so that we are confident our sample
is representative of the population of Australian listed firms. The sam-
ple covers a wide range of firms in terms of size and industry.
Price, dividend data, and factors to adjust for stock splits and stock div-
idends were obtained from Macquarie University Price files constructed
from data originally obtained from the Australian Stock Exchange
(ASX).14 Using Compustat's four-digit industry classification code, we par-
tition our sample into 72 industrial firms and 28 mining firms for the
purpose of describing revaluation activity. This partition is particularly
relevant as mining firms represent a distinct class of business entity in the
Australian economy. The ASX, for example, maintains a separate listing
board exclusively for mining firms and prescribes special listing rules for
them. Under Australian company law, only mining firms can issue no-
liability stock, which places stockholders in a contractual relationship
different from that which applies in industrial firms. While some mining
firms are very large, some are little more than speculative exploration
ventures. We have both in our sample.
Finally, we contacted the chief financial officers (CFOs) of sample
firms by telephone to discuss their firms' revaluation policies. Fifty-nine
industrial firms and 21 mining firms were surveyed by telephone. The
reasons for not surveying the remaining 20 are: the firm no longer exists
or the firm is presently operating under an insolvency administration
(4); the firm declined to discuss accounting policy with us (3); the firm
has been taken over by another firm in our sample and the parent was
surveyed (6); and the CFO was unavailable during our survey period (7).
The results of this survey are summarized in the next section.
14
The Pearson correlation between annual returns calculated using the Macquarie
University files and annual returns calculated using Global Vantage data was 0.997 for the
subset of observations on both files.
4. Survey of Chief Financial Officers

The principle objective of the survey of chief financial officers was to
determine the motivations for revaluing assets.15 The results are sum-
marized in table 1. We informed the CFOs that four commonly as-
serted reasons for undertaking revaluations are to show true and fair
financial statements, to reduce the debt-to-assets ratio, to deter take-
over offers, and to reduce political visibility by lowering profitability.
Each CFO was asked to comment on these in relation to his firm and to
identify any other motivations that applied during the 1980s.
As we expected, CFOs most often stated (45%) that the primary mo-
tivation for asset revaluation was to present true and fair financial
statements as required by company law. This result is not surprising, as
it is a noncontentious motivation that can be invoked easily to mask
other underlying motivations. For this reason, the CFO was asked to
comment on secondary motivations for asset revaluation as well (multi-
ple responses were invited).
The second most commonly cited primary motivation for asset reval-
uation was the need to reduce debt-to-equity ratios (40%). This com-
ment was typically supported by the observation that valuations were
independently obtained, hence credible to lenders, and principally
concerned freehold property which had experienced sharp increases
in market values. Some CFOs pointed out that borrowing by their firms
was regulated by a long-standing trust deed which contained debt-to-
equity ratio covenants. Asset revaluations acceptable to the trustee for
the secured debt holders helped the firms stay within these borrowing
limitations. Other CFOs informed us that their negative-pledge16 bor-
rowing arrangements with restrictions based on balance sheet ratios
encouraged asset revaluations frequently. We conclude that the sup-
port found in the literature for a debt-to-equity ratio explanation of
asset revaluation activity (Brown, Izan, and Loh [1992] and Whittred
and Chan [1992]) is endorsed by the results of this telephone survey.
While only two CFOs acknowledged takeover defense strategy as a
primary motivation for asset revaluation, 22 CFOs observed that it was a
secondary motivation. There was a high level of takeover activity in Aus-
tralia during the 1980s and it was often said by CFOs that keeping the
balance sheet up to date helped prevent an unwelcome and underpriced
15 In Australian firms, the chief financial officer is

variously termed financial control-
ler, chief or group accountant, treasurer, finance director, or company secretary. We are
aware that the CFO of a firm in 1993 was not necessarily the CFO of that same firm in the
1980s. Nevertheless, in almost all instances, the quality of the comments made by the
CFO concerned leads us to believe that our conversation was with a person who presently
holds intimate knowledge of the firm's accounting policies in the 1980s.
16 Under a negative-pledge arrangement, the borrower issues unsecured debt with a
pledge to limit the amount of higher-ranking secured debt. This limit may be set in
terms of balance sheet ratios.
TABLE 1
Summary of Results of Telephone Survey of Chief Financial Officers
Panel A: Motivation for Revaluation of Assets

Primary Motivation (Single Response) No. of Responses %
True and fair financial statements 29 45
Debt-to-assets ratio 26 40
Following takeover 4 6
Takeover defense 2 3
Political costs 2 3
Stock dividend 2 3
65 100
Other Important Motivations (Multiple Responses) No. of Responses
True and fair financial statements 29
Takeover defense 22
Debt-to-assets ratio 11
Following takeover 8
Insurance 4
Stock dividend 3
Goodwill measurement 2
Restructure firm 2
PanelB: ReasonsWhyPropertyIs RevaluedMore Frequently/ExtensivelyThan OtherAssets

No. of Responses %
Biggest gap between cost and market 20 31
Valuations easily/reliably obtained 19 29
Not applicable 26 40
65 100
Panel C: Reasons Why Plant and Equipment Is Not Revalued as Frequently/Extensively

as Property (Multiple Responses)
No. of Responses
Valuations not easily/reliably obtained 30
Depreciation adjustments preferred 7
Too many items of plant and equipment 6
Effect on earnings detrimental 5
Not applicable 26
Panel D: Reasons Why Assets Are Not Revalued in Accounts by Nonrevaluing Firms
No. of Responses %
Assets not of a type appropriate to revalue 8 53
Assets of a type not easily revalued 6 40
Revaluations shown in notes only 1 7
15 100
Panel E: Use of Capital Profits Reserve and Asset Realization Reserve

No. of Responses %
For capital profits only 21 26
For realized revaluation surpluses only 19 24
For both the above 13 16
Do not use these reserves 21 26
Did not know 6 8
80 100
bid. CFOs who did not cite takeover defense as a motivation for revalua-
tion activity frequently indicated that their firm had a majority stock-
holder, reciprocal shareholdings with another firm, or a long-standing
stable shareholding that precluded takeover offers.
Four CFOs commented that their firm had engaged in one or more
major acquisitions during the 1980s and the primary motivation for
revaluation was to bring target assets to account at fair value in ac-
cordance with AAS No. 21: Accounting for the Acquisition of Assets. The ac-
quirer typically revalued its own assets at the same time.
Two CFOs indicated that limiting the exposure to political costs was
a primary motivation. One industrial firm, a listed public utility, ac-
knowledged that revaluation of assets lowered reported profitability
and reduced public scrutiny of product-pricing policy. The CFO of a
large mining firm suggested that revaluation of assets during a period
of high profitability reduced the rate of return and redirected govern-
ment attention. While other firms in regulated industries, such as pe-
troleum firms, may have had a similar motivation, the CFOs concerned
made no comments in these terms.
Two CFOs mentioned that bonus shares (stock dividends) issued
from a revaluation reserve had certain tax advantages to their stock-
holders, and this was a primary motivation for a revaluation of assets.
Three other CFOs mentioned bonus shares as a secondary motivation.
All CFOs noted that this impetus for revaluation did not apply over the
whole survey period since the associated tax advantages ceased in 1987.
Other secondary motivations cited by CFOs were: asset revaluations
followed from an internal restructuring of the firm; asset revaluations
were necessary for insurance purposes; assets of an acquired firm were
revalued to ensure that goodwill on acquisition was correctly stated;
and assets were revalued on direction from a new parent firm.
We are also interested in the observed variation in revaluation activ-
ity within the portfolio of assets held by Australian firms. From the
results shown in table 2 it is clear that property is most frequently re-
valued. We asked CFOs to comment on this and to make a comparison
between property and plant and equipment. While 40% of firms reval-
ued property and plant and equipment equally frequently, those that
revalued property more frequently cited two principal reasons for do-
ing so: first, the divergence between market values and historical costs
of property in the 1980s; and second, property can be revalued easily,
inexpensively, and independently by licensed valuation practitioners.
In contrast, 30 CFOs observed that plant and equipment are not easy to
revalue due to their specialized nature within the operations of the
firm, while 6 CFOs pointed to the volume of plant and equipment
items that would have to be revalued since AAS No. 10 requires all as-
sets within a class to be restated. Seven CFOs observed that a revalua-
tion effect was achieved more easily for plant and equipment by
slowing the rate of depreciation or by writing excess depreciation back
TABLE 2
Summary of Asset Revaluations of Australian industrial and Mining Firms
(Simmary of Financial Statement Data for 100 Firms for the Years 1981-90)
Panel A: Revaluation Reserve Increment as a Proportion of Stockholders' Equity for Revaluing Fir
ALL 1990 1989 1988 1987 1986 1985 1984 1983 19
Industrials: 1
No. of revaluers 308 29 41 35 44 35 42 25 31 2
RRIt/BV-I
Mean 0.065 0.070 0.080 0.064 0.086 0.050 0.082 0.044 0.026 0.06
Median 0.022 0.008 0.018 0.037 0.025 0.012 0.041 0.022 0.008 0.01
RRJt/BVt-l
Mean 0.091 0.084 0.111 0.078 0.143 0.081 0.106 0.056 0.036 0.08
Median 0.025 0.011 0.019 0.043 0.027 0.024 0.044 0.031 0.009 0.01
Mining:2
No. of revaluers 21 3 4 2 4 3 2 1 1 1
RRI1/BVt-I
Mean 0.101 0.008 0.063 0.272 0.190 0.021 0.244 0.004 -0.092 0.08
Median 0.016 0.009 0.087 0.272 0.117 0.001 0.244 0.004 -0.092 0.08
RRt1/BVt- I
Mean 0.132 0.010 0.075 0.399 0.214 0.020 0.364 0.006 -0.115 0.10
Median 0.022 0.011 0.090 0.399 0.165 0.001 0.364 0.006 -0.115 0.10
Panel B: Revaluations as a Proportion of Book Value: Property

Industrials Mining
Mean 0.646 0.167
Median 0.732 0.000
Std. deviation 0.298 0.285
75th percentile 0.904 0.235
Panel C: Revaluations as a Proportion of Book Value: Unlisted Investments

Industrials Mining
Mean 0.136 0.122
Median 0.000 0.000
through the profit and loss account. Only five CFOs observed that a re-
valuation of plant and equipment meant that depreciation was in-
creased and profits lowered, an unfavorable outcome for their firms.
Firms that revalued plant and equipment did so usually in relation to
long-lived plant assets, for example, a mill or refinery. Short-lived
plant and equipment items are not often revalued.
TABLE 2 -continuted
Panel D: Revaluations as a Proportion of Book Value: Plant and Equipment

Industrials Mining
Mean 0.078 0.083
Median 0.000 0.000
Panel E: Revaluation as a Proportion of Book Value: Intangibles

Industrials Mining
Mean 0.041 0.115
Median 0.000 0.000
Panel F: Revaluation Reserve as a Proportion of Stockholders' Equity

Industrials Mining
Mean 0.126 0.079
Median 0.088 0.000
Panel G: Independent Valuations as a Proportion of Total Valuations

Industrials Mining
Mean 0.493 0.207
Median 0.539 0.000
'Seventy-two firms listed by Comnpustat as industrial firms.
2Twenty-eight firms listed by Comipustat as mining firms.
RRI-t is the net increment to the asset revaluation reserve per share over time period t to t - 1.
BV is the reported book value of owner's equity per share of firIn j at timne t.
BVt is the book value per share of firmi at time t ninuis the (per share) asset revaluation reserve.
In addition to the asset revaluation reserve, many Australian firms

disclose either an asset realization reserve or a capital profits reserve,
even though they have no statutory meaning and do not appear in any
accounting standard. We are interested in determining the link be-
tween these reserves and revaluation activity within our sample. CFOs
were asked whether the asset realization reserve or the capital profits
reserve carried only realized revaluation surpluses, only "real" capital
profits (that is, the difference between proceeds and book value), or a
mixture of the two. Some firms (26%) used an asset realization or cap-
ital profits reserve exclusively for "real" capital profits, but nearly as
many (24%) used the reserves to carry realized revaluation surpluses
transferred out of the asset revaluation reserve. A smaller proportion
(16%) used them to carry both realized revaluation surpluses and
"real" capital profits. If the 15 nonrevaluing firms are removed from
the sample, then 32 of 65 firms in the CFO survey subsample (49%) use,
either exclusively or in part, their asset realization or capital profits re-
serve to carry realized revaluation surpluses. For revaluing firms with-
out an asset realization reserve or a capital profits reserve, or those
which used these reserves exclusively for "real" capital profits, realized
revaluation surpluses are typically retained within the asset revaluation
reserve.
Prior to July 1987, there was a tax incentive to earmark revaluation
surpluses, hence the proliferation of asset realization and capital
profits reserves. Several CFOs stated that, as this tax incentive no
longer exists, their firms have since reduced the number of reserves
shown in stockholders' equity. The current approach is to transfer re-
alized revaluation surpluses to retained profits and eliminate the asset
realization and capital profits reserves altogether.17
Table 2 (discussed in detail in the next section) shows that over the
1981-90 period, 49.3% (mean) of all valuations in industrial firms were
disclosed as independent valuations (median 53.9%). Our discussions
with CFOs indicate this figure understates the influence of indepen-
dent valuers on balance sheet values. Many CFOs commented that di-
rectors' valuations disclosed in the balance sheet were supported by
independent valuations. It is fairly common practice for directors to
review recently obtained independent valuations for balance sheet dis-
closure purposes and to cite these valuations as directors' valuations.
The extent to which this practice is understood in the capital market is
unknown.
The nonrevaluers in our sample are almost exclusively mining firms.
The CFOs of six mining firms stated they did not have freehold prop-
erty and that other assets, such as mining rights, tenements, and leases,
were not easily revalued. Mining firms that were producers as well as
explorers often held assets in joint venture (undivided interest) ar-
rangements with other firms. The CFO of one mining firm claimed it
was not appropriate to revalue shared assets. Some other producers
commented on the difficulty of valuing mineral and petroleum reserves
17 Surprisingly, six CFOs admitted they were unsure of the composition of their asset
realization or capital profits reserves. In addition, one industrial firm acknowledged it
had lost track of the composition of its asset revaluation reserve, but planned to ascertain
the portion of realized revaluation surpluses that could now be transferred to retained
profits.
when commodity prices fluctuate on world markets and estimates of

the extent of reserves held are difficult to establish. Bank of Queens-
land Ltd., the only nonmining firm not to revalue assets at all, stated
that its assets were principally financial or monetary, and revaluation
was inappropriate.18
5. Description of Asset Revaluation Activity

Descriptive data for the 100 sample firms for the period 1981 to 1990
are summarized in table 2. Panel A shows the extent of yearly revalua-
tion activity by focusing on the net increment to the revaluation reserve
(excluding transfers) as a proportion of beginning-of-year stockhold-
ers' equity for revaluing firms. Measures with and without the revalua-
tion reserve balance in stockholders' equity are shown. Panel A shows
that not all firms revalue assets every year. In 1987, revaluation activity
was at its highest, as 44 of the 72 industrial firms and 4 of the 28 mining
firms revalued assets. From our study of financial statements it is appar-
ent that a three-year revaluation cycle is the most common, but the
starting year of a revaluation cycle varies among firms. The proportion
of revaluation reserve increment to reported stockholders' equity for
industrial firms was 6.5% (mean) and 2.2% (median) over the ten-year
period. While the mean proportion is higher for mining firms, it is
based on a very small number. As discussed in section 4 and indicated
in panels B through F of table 2, most mining firms are nonrevaluers.
Panels B, C, D, and E of table 2 show revaluations relative to four
categories of noncurrent assets subject to revaluation: property (land
and buildings), unlisted investments,19 plant and equipment, and in-
tangibles.20 A comparison of these panels shows that property is, by
far, the most frequently revalued noncurrent asset2' followed by un-
listed investments, plant and equipment, and intangibles in that order.
To illustrate this point: the mean (median) portions of the book value
of each asset class in industrial firms due to revaluations are 0.646
(0.732) for property, 0.136 (0.000) for unlisted investments, 0.078
(0.000) for plant and equipment, and 0.041 (0.000) for intangibles.22
18 Mark to market accounting for financial instruments was not countenanced

by Aus-
tralian financial institutions in the 1980s.
19 Schedule 7 requires disclosure of all investments but, in
practice, only unlisted in-
vestments are typically revalued. Company law requires that the market value of listed
investments at the balance sheet date be shown as a note.
20 Schedule 7 lists receivables and inventories among noncurrent assets but neither is
subject to revaluation. Receivables are monetary and AAS No. 2: Measurement and Presenta-
tion of Inventories in the Context of the Historical Cost System (clause 8), first issued February
1976, does not allow inventories to be carried at amounts in excess of cost.
21Since October 1, 1989 company law has required the disclosure of the "current
value" of property, codifying long-standing practice.
22AAS No. 10 (paragraph 53) requires firms to disclose in relation to each class of as-
set: (i) the portion of that class carried at cost, (ii) the portion of that asset class carried
Many firms do not revalue unlisted investments, plant and equipment,

or intangibles at all. Revaluations of unlisted investments may be due
to a desire to improve the balance sheet without a depreciation effect.
Intangibles are hardly ever revalued because AAS No. 18 (paragraph
36) does not allow revaluations of purchased goodwill, often the most
substantial component of intangibles.23 Our data show that other in-
tangibles, such as patents, mastheads, trademarks, and copyrights, are
infrequently revalued by our sample firms.
Panel F of table 2 shows that revaluation reserves comprise an aver-
age of 0.126 (median of 0.088) of stockholders' equity for industrial
firms but not for mining firms (mean of 0.079, median of 0.000). This
panel reports a conservative measure of revaluation activity because
the closing balance on the revaluation reserve is net of any transfers to
other reserves (for example, stock dividends).
Revaluations can be made either by management or by an indepen-
dent valuer. Reported valuations of property are most often indepen-
dent valuations. For other assets, directors' valuations are frequently
reported. Panel G of table 2 shows that independent valuations are a
greater proportion of total valuation for industrial firms (mean of
0.493, median of 0.539) than for mining firms (mean of 0.207, median
of 0.000). The reason is that industrial firms hold more freehold prop-
erty than mining firms, property is a significant component of industri-
als' total assets, industrial firms revalue more frequently than mining
firms, and property is more often subject to independent valuation.
Furthermore, as noted in the previous section, the influence of inde-
pendent valuers is higher than reported in financial statements since
directors often base their own valuations on independent opinions.
6. Development of Empirical Analysis

The objective of the empirical tests is to evaluate whether and how
asset revaluations result in alignment between information reflected in
annual reports and information implicit in stock prices and returns.
Prices are used to assess the extent to which the financial statements,
including asset revaluations, reflect the state of the firm at a point in
time, while returns are used to assess the summary of change in finan-
cial state that is provided in the financial statements.24
at independent valuation, and (iii) the portion of that asset class carried at directors' val-
uation. The mean and medians shown in panels B through E of table 2 are calculated as
((ii + (iii))I((i) + (ii) + (iii)).
23 AAS No. 18: Accountingfor Goodwill,first issued March 1984. This standard prohibits
the recognition of internally generated goodwill and hence prevents the revaluation of
purchased goodwill.
24 Extant studies of the return-revaluations relation which use traditional association
tests include Sharpe and Walker [1975], Standish and Ung [1982], and Emanuel [1989]
Intuitively, if asset revaluations reflect value changes that are also per-
ceived by the market (and incorporated in stock prices), the ratio of
price-to-book value will be closer to one when the asset revaluation is in-
cluded in book value of owner's equity than when it is excluded. Exclu-
sion of the revaluation reserve provides an adjusted measure, roughly
comparable to the U.S. historical cost-based measure of owner's equity.
If the asset revaluations are value relevant, variation in the reserve
amount will explain variation in the price-to-adjusted book ratio.
Analysis of price-to-book ratios focuses on the extent to which reval-
uations to date align book and market values but does not consider
whether Australian GAAP recognize value changes in a timely fashion.
For this reason, we also analyze the relation between returns and earn-
ings, adding the net increment to the revaluation reserve (which is an
'earnings-like" number)25 to earnings levels and earnings change vari-
ables as described in Easton and Harris [1991] (henceforth EH). If
changes in the asset revaluation reserve are not timely in the sense that
they recognize value increments known to the market in a prior pe-
riod, this variable will have no explanatory power for returns of the
period. However, as the return interval increases we expect the explan-
atory power of the net increment to revaluation reserve to increase
since the changes in asset values will tend to be reflected in the
changes in both balance sheet reserves and prices within the same
(longer) interval.
6.1 PRICE-TO-BOOK MODELS
While our empirical models are based on the theoretical foundation

in Ohlson [1989; 1992], we use a more heuristic approach described in
EH and Easton, Harris, and Ohlson [1992] (henceforth EHO). The as-
sets of a firm may be divided into those for which, as a first approxima-
tion, book value is valuation sufficient and those for which earnings are
valuation sufficient. Since most firms have assets of both types, the
value of the firm may be expressed as a weighted function of earnings
and book value.26 That is:
using Australian, U.K., and New Zealand data respectively. As Brown and Finn [1980] ar-
gue, interpretation of the results of these studies is difficult because any evidence of a
price reaction may be due to either information in asset revaluation or information in
contemporaneous increases in profitability, increases in dividends, or the announcement
of stock dividends.
25 Like earnings, the net increment to the asset revaluation reserves is a measure of
change in value.
26Arguments supporting the expression of price as a weighted function of earnings and
book value are provided in EH and in OhIson [1989]. EH discuss two extreme models
where earnings and book value are both valuation sufficient and then they combine these
models using the arguments provided in Ohlson. Since these models are silent on the
choice among generally accepted accounting principles which may be used to generate
Pt= wo1BVj + 2 + vt (1)

where:
P t is the price of a share of firm j at time t,
BV* is the reported book value of owner's equity per share of firm j
at time t,
E* is the earnings per share information in the financial statements
of firm j at time t, and
Vjt is the unexplained portion of price per share.
Reported book value in the U.S. is based on the historical cost of as-
sets, while in Australia it includes the asset revaluation component.
That is, in Australia:
BV* = BVI + RRf (2)

where:
BVjt is the book value per share of firm j at time t minus the (per
share) asset revaluation reserve, similar to U.S. book value, and
RRjt is the asset revaluation reserve per share of firm j at time t.
In the U.S., the asset revaluation reserve does not exist so BVj= RBV>.
Australian financial statements disclose two earnings measures-one
from the profit and loss statement (as in the U.S. income statement)
and the other from the difference between reported book value in
consecutive balance sheets. The relation between these two earnings
measures may be written as follows:
E} = ABV7 = Et - dt + DSj (3)
where:
Ejtis earnings per share of firm j at time t as reported in the profit

and loss (income) statement, and
DSt is the change in book value for firm j at time t arising other than
from earnings less dividends. That is, DS1 captures the extent to
which the difference between two consecutive measures of book
value in the balance sheet does not articulate with earnings as
reported in the income statement. Since clean surplus refers to
the articulation of the balance sheet and the income statement,
we refer to lack of articulation as "dirty surplus."27
In the U.S., E* -- E.28
It It*
earnings and book value, we choose earnings and book value variables which are intu-
itively most closely aligned with value changes and value respectively.
27 Clean surplus does not hold precisely in the U.S. either because of foreign currency
translation adjustments, write-downs of impaired assets, and certain adjustments allowed
uinder accounting principles for postemployment benefits. Nevertheless, dirty surplus is
more material and pervasive in Australia.
28 Historical cost accounting earnings data (comparable to U.S. earnings) cannot be
reconstructed because depreciation in Australia is based on the revalued asset amount
The portion of DSjt which is the focus of this study is the net incre-
ment to asset revaluation reserve. This is not necessarily equal to the
change in the balance in the asset revaluation reserve because of trans-
fers between this reserve and other reserve accounts. However, since
these transfers in and out of the revaluation reserve are offset by other
changes in equity they are not themselves a part of dirty surplus. Other
components of DS1t which we do not differentiate include changes in
foreign currency translation reserves and adjustments to retained earn-
ings to conform to accounting standards introduced during the report-
ing period. That is:
DSut RRHt + otherj (4)
where:
RR[j. is the net increment to the asset revaluation reserve (that is,
the difference between revaluation increments and decre-
ments (reversals of increments)) per share of firm j over pe-
riod t - 1 to t,29 and
otherj1 is all other dirty surplus items (per share) for firm j over pe-
riod t - 1 to t.
Substituting (2), (3), and (4) into (1) yields:
P (t IV(Bjt + RR. t) 2
w2(E1t + RI t) + Cj(5)
where:
?t 1t -w w2 (otherp - d 0
and the revaluation component of depreciation is not separately disclosed by firms. How-
ever, since the classes of assets which are most often revalued have either a long deprecia-
tio'n life (buildings and long-lived plant and equipment) or are not depreciated at all
(land), the revaluations will have little impact on reported Australian earnings except when
an asset is sold. As discussed in section 2, revaluation decrements (other than reversals of
increments) are charged to earnings under AAS No. 10, causing Australian GAAP earnings
to differ from historical cost-based earnings. However, during the 1980s asset market
prices generally increased and relatively few revaluation decrements were charged to earn-
ings by Australian companies. The position has changed dramatically since 1990.
29The intuition for the role of earnings in the Ohlson model (equation (1)) will also
apply to the net increment to the revaluation reserve if this increment represents growth
opportunities. This argument (provided by Whittred and Chan [1992]) is as follows. Un-
derinvestment incentives arise in the presence of risky debt and are exacerbated by con-
ventional borrowing limitations. They also increase as the proportion of debt-to-equity
increases since this will result in a greater share of any added value going to debt hold-
ers. The problem becomes more costly if the foregone growth opportunities imply either
high leverage and/or investments that do not qualify for debt financing. Thus upward re-
valuations which decrease the reported debt-to-equity ratio may be seen as a signal of
extant growth opportunities.
30 To simplify the exposition of the empirical models and to reduce the number of re-
ported statistics, otherfi and d.t are included in and subsequently in the regression error
term. Inclusion (or exclusion) of these variables has no effect on the statistical inferences
from the estimates of the regression coefficients on the remaining variables.
Dividing (5) by BVRtyields:
P. E. RR. RRI.
BV.
-it jt.
~~~BV BVrn.
jt BV.Ijt vp (6
We divide by (adjusted) BVjt(that is, BV}j- RRit) rather than reported

BVjtbecause we are interested in whether RRit results in a better align-
ment of Pjt and BVit. Also, dividing by BVjt results in equation (6),
which facilitates the use of RRit as the numerator in a variable explain-
ing variation in the ratio of price to book. According to our theoretical
model, the level of the revaluation reserve would not be an explanatory
variable for price-to-reported book values (that is, with the revaluation
reserve included). In regressions based on equation (6) we expect 02 to
be positive if the revaluation reserves result in a better alignment of
market values and book values. We expect 03 to be positive if revalua-
tion activity varies with the degree of misalignment of market value
and book value.
When estimating regression (6) we found that correlation between
RRjtIBVjtand RRjtIBVjt affects the estimates of 02 and 03 and their
statistical significance. As a result we also considered three restricted
forms of the regression:
P. E. RR.
+ + Y,
i~t =
BV_ BV.
1I1B~t I~t (6I)
BV. (6a)
Ijt jt Ijt
P.t E.1 RRI.t
jt jI t
= + i 1 BVj + Vit
BVjt (6c)
We use estimates of ?2 and O" to provide evidence of the (separate) ex-

planatory power of RRjtIBV/tand RRlJtIBVitand we use a partial-F test
comparing the R2 from equation (6c) to the R2 from the unrestricted re-
gression (6) as evidence of the joint explanatory power of these variables.
The dependent variable in equation (6) is the price-to-book ratio.
This ratio is a market-based measure of goodwill and has been the fo-
cus of several recent research endeavors (for example, Amir, Harris,
and Venuti [1993], Fairfield and Harris [1991], Fama and French
[1992], Ou and Penman [1989], and Penman [1991]). We also con-
sider the distributional properties of this ratio with and without the
revaluation reserve. If the revaluation reserve explains a portion of
goodwill, the average price-to-book ratio with the revaluation reserve

will be closer to one than the ratio without the reserve. Similarly, we
expect the distribution of the price-to-book ratio including the revalu-
ation reserve to have a lower variance. This approach is also advocated
in Bernard, Merton, and Palepu [1992].
6.2 RETURN MODELS
Equation (1) is the economic model underlying the return-based

analyses as well as the price-based analyses. Substituting (3) and (4)
into (1), taking first differences and deflating by beginning-of-period
prices, yields:
E. AE. RRI.j ARRI.

Pj=o + Pi p 5+ + 3p + 4 p. + ?t (7)
-t- 1 j-t-1 -t- 1 It-1
where F includes otherjtlPJtl, AotherjtIPj,-i and djt-11P 31

The coefficient P3 captures the extent to which the net increment to
the asset revaluation reserve explains stock returns. Given that firms
choose when to revalue assets, and that asset value changes may al-
ready be incorporated in price, it is plausible that returns over a fiscal
period may not capture the impact of revaluation increments. The
alignment of book and market values via the revaluation process may
not occur in the same period as the asset actually changes value.
Hence, the revaluation reserve increment (RRIat) will not necessarily
have explanatory power for returns of the same period (Rjt).
The period t - 1 to t in the return models is, implicitly, the fiscal pe-
riod for which earnings are reported. However, as EHO demonstrate,
additional insights may be obtained by extending the length of the re-
turn interval and aggregating earnings over this interval. As the return
interval increases, the net increment to the asset revaluation reserve is
expected to reflect asset value changes occurring within the interval
(assuming the increments reflect true changes in asset values). We use
the EHO methodology to examine this prediction.
The extension of the EHO model to include dirty surplus is straight-
forward. Over a longer interval 0-, T. the dirty surplus relation (equa-
tion (3)) may be written:
T T T T
{BVjT- BVjo} = E - d.t+ i, RRIJ + i other7.t. (8)

t =1 t=1 t=1
31 The inclusion of these variables in regression (7) has no effect on statistical infer-
ences based on the coefficients Po, P P2' P3, and A4.
Consider equation (7) with t defined over the interval I--T so that
the deflator is P 0; then substituting (8) into this equation and rears
ranging yields:
T T T
-
P
JT
+ TFVS
T ]T 0O I jI +FVFT jT
-= Et _
RRI t E= other.t
jt A
AJT
10
P - + + (9
P. P. P
The variables FVSJTand FVI9Tare described in detail in EHO. FVST

denotes the total amount an investor can withdraw at date T due to the
payment and subsequent reinvestment of dividends paid during the
period 0 to T. FVFjT represents the earnings that would accrue from re-
investment of dividends paid during the period 0 to T.32 As discussed
in EHO, it is not apparent how to incorporate change in earnings into
the long window model except as a means of trying to explain the
change in goodwill which is captured by Agjt/Pjoin this model.33 The
empirical model resulting from (9) is:34
T T
P +FVS ~~~~~ IE.+FVFiT XRRIJ
PjT + jTF JO_-
P__ t=_ it IT E
_ it
p =I 70 +', p + Y2 pT + (10)
The potential advantage of extending the return interval is that, if

the assets continue to appreciate (as they did in Australia during most
of the 1980s), the net increment in revaluation reserve should reflect
the cumulative value changes, since the timing of the revaluation is less
important. However, the argument invoked in EHO is that over time
value-relevant events are captured in earnings (assuming clean sur-
plus). This argument, together with the basic tenet that asset values
increase because of expected future income (or cash), implies that
32When extending the return interval to very long periods it is necessary to analyze
dividends paid throughout the period. The practice which is common for shorter peri-
ods (that is, calculating returns assuming all dividends are paid at the end of the return
interval or all dividends are reinvested in the firm and that earnings of the period are
not affected by dividends paid during the return interval) may introduce excessive error
in the measurement of returns and earnings. The variables FVFjt and FVSjt are designed
to take these dividends into account. We assume (in the reported tests) dividends are re-
invested at 10% but the results are not qualitatively different for assumed interest rates
between 0 and 20%.
33 The empirical evidence indicates that change in earnings is rarely a significant ex-
planatoiy variable for returns over intervals longer than one year.
T
34 The inclusion of i otherj1IP.o in regression (10) does not affect statistical infer-
ences on yj and 72. It has therefore been excluded from the reported results.
increments in revaluation reserves will become irrelevant (that is, have

no additional explanatory power over earnings for returns) over a
sufficiently long window. This would be especially true for revaluations
of assets other than property, and for assets which have been sold so
that gains are realized. Hence, we expect the significance Of Y2 to
increase initially as the return interval increases but to decline over
longer intervals, since earnings will capture the value changes over this
longer period.
7. Test Results
Based on the evidence in table 2, which shows that mining firms re-
value assets rarely and the level of asset revaluation reserve is relatively
very low, we conduct all empirical tests only on the subsample of 72 in-
dustrial firms. In all regression analyses observations with an R-student
statistic greater than 3 or less than -3 are deleted.35
7.1 PRICE-TO-BOOK MODELS
The ratio of price-to-reported book value was less than one for 260
of the 671 industrial firm-year observations for which we have data.
Within these 260 observations the net change to the asset revaluation
reserve (excluding transfers) was positive in 123 cases, zero in 105
cases, and negative in only 32 cases. Thus, revaluation tended to in-
crease the misalignment of market and book values in almost half of
these cases. However, including the asset revaluation reserve in book
value decreases the mean (median) ratio of market value to book value
over all 671 observations from 1.50 (1.37) to 1.29 (1.18); the standard
deviation decreases from 0.69 to 0.61. That is, the revaluation of assets
generally results in better alignment of market and book values.
Table 3 summarizes tests based on regression (6) in which the ratio of
market value to book value, excluding the balance in the asset revalua-
tion reserve, is the dependent variable. The estimates of the coefficients
O'tand vo are obtained from a restricted form (regression (6a)), but
these estimates and their standard errors differ very little across all four
forms of regression (6). The estimate of the coefficient Oft on return on
equity (Ejt/BVjt) is statistically significant (at the 0.05 level) in every
year. The degree of association (as reflected in the levels of signifi-
cance of the t-statistics) is lower than in U.S. studies (for example,
Fairfield and Harris [1991] and Penman [1991]) although our sample
sizes are much smaller than those in the U.S. studies. The estimate of
the coefficient 4ct on the ratio of the level of revaluation reserve to
35 The R-student statistic of observation jt is the standardized residual of this observa-

tion where the variance used in the standardization procedure excludes observation jt.
See Belsey, Kuh, and Welsch [1980].
36 We include t subscripts on the regression coefficients in the table of results because
we conduct year-by-year regressions.
TABLE 3
Regressions of Ratio of Market-to-Book Value on Return on Equity, Ratio of Level of Revaluation
Reserve to Book Value, and Net Incremnentto Revaluation Reserve to Book Value
P. E. RR.
Byjt R
'Q~t (Q~tBV < R
BV v' (6a)
+ 091
BVjt (~t(~ BV. BV + ~ (b
P. ~~E. RRIj
+ + V.
J ~~~~~~~(6
b)
By. RV 3 RV
Partial F
Year 0', 0it 02t ' 3,t RR&RRI R2 N
1981 0.88 2.30 0.46 0.60 0.14 57
(49)*** (2.4)** (2.1)** (2.4)*k 2.88* :
1982 0.68 1.74 0.06 0.04 0.07 60

*" 0,05
(6.2) (2.7)*k*k* (0,3) (0.9)
1983 0.90 0.73 0.66 1.56 0.11 70

(I 1.5)* (2.4) (2.5) * (2.0)" 3.63" *
1984 0.84 2.31 0.30 0.30 0.23 71

* 1.95
(9. 0) (4.3)k**k (2.0)"k (1.4)
1985 1.01 2.22 0.62 1.25 0.32 72

(8.7) * * * (3.1)*k* (2.8)*** (2.8) * k 4.90* *
1986 1.13 3.92 0.74 0.67 0.46 70

(10.7)*** (5.9)* (2.5) (1.0) 6.20***
1987 1.62 2.03 0.36 0.86 0.06 72

(10.5)*** (2.6)** (0.7) (1.06) 0.48
1988 1.70 0.40 0.92 1.97 0.10 71

(15.7)*** (2.3)* * (2.3)** (3.3) ** 5.42*:k
1989 1.24 3.56 0.58 1.27 0.25 66

(9. 1) :_0* (55)>*k* (1.7)* (1.8)* 1.68
1990 1.44 0.89 0.02 -1.32 0.27 62

(16.0)*** (4.2) ** (0.1) (-1,9)* 2.50"
Mean 1.14 2.01 0.47 0.72

(10.4)*** (6.5)**k (5.1)*** (2.5)**
t-statistics (corrected for heteroscedasticity using White's [1980] consistenit variance-covariance

matrix) in parentheses.
*Significant at the 0.1 level.
*Significant at the 0.05 level.
***Significant at the 0.01 level.
P., is the pr-ice of a share of firm j at time t.
BV7. is the book value of owner's equity per share of firm j at time t less the firm's revaluation
it
reserve at that time.
EBtis accounting earnings per share of firm j for period t - 1 to t.
is the revaluatidonreserve per share portion of owner's equity for firm j at time 1.
H! is the net (per share) increment to asset revaltuation reserve over periocl t - 1 to t for- firn j.
Partial F RR & RRJIis the partial F-statistic for the significance of introdtucing both RRj,/BV>tand
RRI, /BV1, as additional explanatojry variables to the simple regression of P1j/BVj, on E., /BVIt.
f2 is the adjusted coefficient of determiniation from the multiple regression of Pj//BVjt on E. /BVj,
RR11/BVj , and RRJ lBfjt.
Nis the number of observations in the regression.
Mean is the mean of the ten regression coefficient estimnates.
book value is significantly positive (at the 0.05 level) in six of the ten
years. The estimate of the coefficient ?3'ton the net increment to the as-
set revaluation reserve is significantly positive (at the 0.10 level) in five
years and significantly negative in 1990.37 The partial-Fstatistic indicat-
ing the significance of the incremental explanatory power of both RR t
BVjtand RRLJt/BV-t is significant (at the 0.10 level) in six of the ten an-
nual regressions.
Bernard [1987] notes that the correlation in residuals in regressions
similar to regression (6) may lead to downward bias in the estimates of
the standard errors of coefficient estimates; thus the t-statistics in table
3 should be interpreted cautiously. He recommends basing inferences
on the mean of the coefficient estimates across all years (based on the
assumption that these estimates are independent). These means and
their corresponding t-statistics are presented in the last two rows of
table 3. The mean of the estimates of the coefficient O2t is 0.47, with a
t-statistic of 5.1, indicating that including the asset revaluation reserve
in book value results in better alignment of market value and book
value. The mean of the estimates of the coefficient O3t is 0.72, with a
t-statistic of 2.5, indicating that revaluation activity is greater when the
misalignment of market value and book value is greater.38
In general, the price-to-book regressions support the notion that
economic goodwill (or future growth opportunity) captured by the ra-
tio of price-to-book value, excluding the revaluation reserve, is also
captured by return on equity. Although the year-by-year analysis may
be affected by cross-sectional correlation in residuals and the infer-
ences from means of coefficient estimates are based on only ten esti-
mates, the evidence suggests that both the balance in the asset
revaluation reserve and the net increment to this reserve are signifi-
cant explanatory variables for economic goodwill.39
7.2 RETURN MODELS
The first set of tests of the returns models is based on regression (7)
and is presented in tables 4 and 5. Table 4 presents the correlations
among the regression variables. Consistent with the results reported in
EH for U.S. data, the Spearman and Pearson correlations for returns and
deflated earnings levels range from 0.26 to 0.71. The correlations of re-
turns and earnings levels (column (1)) equal or exceed the correlations
37In the unrestricted form of regression (6) the estimate of the coefficient 42t is
significantly positive (at the 0.05 level) in 1986 only, and the estimate of the coefficient
43, is significantly positive in 1988 and significantly negative in 1990. All other estimates
of the coefficients are not significantly different from zero.
38The means (t-statistics) of the annual regression coefficients 42t and 43t in the unre-
stricted regression (6) are 0.28 (3.7) and 0.41 (1.3).
39For the Global Vantage data the R2 for regression (6) (pooled cross-section and time-
series) was 0.07 with coefficient estimates (t-statistics) of 0.60 (6.9), -0.03 (-0.4), and 0.04
(0.3) for the respective explanatory variables.
Co 0 o Co Co 1 Co Co X t
I I I I
e w ~~~~~~~*
X~~*
t X
t o ~ 6 6 66 6 6 666666n boo XO
t e t , N o o N o O No o o N~~~~~~~~~~~~~II
;4
j
b
'?mt X *
~*
*
*
*
*
*
*
* * *
*
*
*
* *
*
*
*
* *
*
*
*
*
E >g* ** * * * * * * * * * * * * * * *
EH~~ * *? *Q * * X * *q *s * * *q * * * *s x*
w s * * * * * * * * * * * * * * * * * *
t t3 * * * * * * * * * * * * * * * * * *
'~~~1 S 10( 101 O1 Co 101 101 JbZ-XP-Ntn
t3;
CS
~ t
00
Co
00 00
10
00
(0
00
onnoo 1>
00
00
OOOO 00
C
00
Q) c
.0
o~~~~~~~
s>1~~~~
t ;>
.U I -
C C
0_ t
U cr. o
o~~~~~
Q Q Qw vQ
0 I ,> EbD I
(Z bjD cn X =
O._I . =(i
0..
t<l-
| X
' ^.=
.E X
* ^_~ 1/ C+m
**r
Q
C
M4s
t
CO 10 CO (0 ~~~~~~~~~~~~~~~
~~~~~~~~~~* *
O
Cl
C~T C-1 CO CO CO 10~
- C~~~ 10 (04 1> O

A 6 C 11 10 CO! 6-~t l~c~
< ? ? I I I o o -,Io.q o o
? ? **
> + +
R ~~~~~O O 0 O ???> l????
n C*
C) 0* r(z) 0 1
n C) C14 00 ,C "tI o I I I I
*~~~~~ ~
*s *
R~~ ~~~~~~~~~~~~~~~~~~~~~~~~~~
_ + _ I I
~~~~~~
O s 10o (0 > .
t + +
C s~~~~~~~M osxON
txo 00 0 00 00 O0 00 0nO
cQ _* Q
.0
0~~~~~~~~~~~~~U
z~~~~~~~
*0 *
0 b.0
0 ~~~~~~o
bbD
X~~~~- t 0
00
b.* o
C4
0 ~~~0 L, O
O~~~~Q Q. Q
*0 QQ
.
r. u
S m =eSO > = *
-? 0; o 9
Q .0; 99
,0 _ - ,
r~~~ o 9
z e -& -_ >_
between returns and change in earnings (column (3)) in eight of the nine
years, consistent with the results in EH. The correlation between returns
and earnings plus the revaluation reserve increment (column (2)) is gen-
erally less than the correlation between returns and earnings, which sug-
gests that the revaluation reserve increment tends to add noise to the
earnings. The correlation between returns and the revaluation reserve
increment (RRPJtIPtj-) (column (4)) varies considerably from year to
year: the Pearson correlation is significantly positive (at the 0.05 level) in
1985 only and the Spearman correlation is significantly negative (at the
0.10 level) in 1990 only. There is a generally positive correlation between
RR[jtlPyt I and EtlP1t I (column (6)), with 1988 and 1990 having negative
correlations. In 1982 and 1985 the Pearson correlation is significantly
positive, while in 1988 it is significantly negative (at the 0.01 level).
Table 5 reports the results for the annual return regressions based
on equation (7). Although correlation between RRJjt/Pjt I and ARRJt/
Pt-, had little effect on the results, we analyze a set of restricted forms
of regression (7). That is, in addition to the unrestricted form, we
consider:
and:jJt
E.A AE.
Rjt =f' +f + +r3"' + cjt'. (7c)
jt-l jt-1
The estimates of the coefficients for cot 131t' and ~2t reported in table 5
are obtained from regression (7a) but these estimates and their standard
errors differ veiy little across all four forms of regression (7). Similar to
the results for the U.S. reported in EH, the estimate of the coefficient at
on earnings levels is positive in all years and statistically significant at the
0.05 level in seven of the nine years. On the other hand, the estimate of
the coefficient :2 on earnings change is significantly positive (at the 0.05
level) in only two of the nine years and is negative in four years. The es-
timate of the coefficient f~3ton the net increment to the asset revalua-
tion reserve is significantly positive in two years at the 0.10 level, as is the
estimate of the coefficient onsothe change
t in this variable. The mean
of the estimates of 3t is 0.37, with a t-statistic of 2.2, and the mean of the
estimate of rth is 0.22, with a t-statistic of 1.4. The joint explanatory
power of RfcetIP'ti and ARRijtIPstca is significant in only two of the nine
years (partial-F statistics of 5.20 and 3.44 in 1988 and 1989 respectively).
Overall, these results provide some evidence that the reported incre-
ments to the asset revaluation reserve do not capture asset value changes
in the year when the change occurred.40
The results for the longer return interval analysis (equation (10)) are
reported in table 6. Panel A reports the correlations among the regres-
sion variables and panel B reports the regression results. Consistent
with results in EHO, the correlations between returns and aggregate
earnings explain a large portion of returns over a long interval. The
annual return-earnings correlations reported in column (1) of table 4
are around 0.5, while both the Pearson and Spearman correlations are
0.86 for the 1982-90 window reported in column (1) of table 6, panel
A. Panel B shows the estimate of the regression coefficient on earnings
is 1.40 for the nine-year window and an average of 1.89 for the three
nonoverlapping three-year windows. These coefficient estimates are all
significant at the 0.01 level and are comparable to the results reported
in EHO.
The Pearson correlation between long interval returns and the ag-
gregate net increment to the asset revaluation reserve is significantly
positive (at the 0.05 level) for all reported long intervals, but the Spear-
man correlation is considerably lower and not significantly different
from zero in the 1982-84 and 1988-90 intervals. The correlation be-
tween aggregate earnings and the net increment to the asset revalua-
tion reserve is significant (at the 0.05 level) for the 1985-87 and the
1982-90 intervals-the Pearson correlation is particularly high for the
nine-year interval (0.86).
Table 6, panel B shows that the estimates of the coefficient on the
aggregate net increment to the asset revaluation reserve are signifi-
cantly positive (at the 0.05 level) in two of the three nonoverlapping
three-year intervals. However, the coefficient estimate is significantly
different from zero in all three-year intervals other than the 1985-87
interval (data for the 1984-86 interval are provided as an illustration of
other three-year intervals). The coefficient on the revaluation reserve
increment is significantly negative for the nine-year return interval. We
predicted that this coefficient would not be significant for long return
intervals because the information in the net increment to the revalua-
tion reserve would also be captured in earnings. This idea is reflected
in the high correlation between earnings and the net revaluation in-
crement. An ex post explanation for a negative coefficient is that the
40For the Global Vantage data the R2 from regression (7) (pooled cross-section and
time-series) was 0.45 with coefficients (t-statistics) of 0.21 (3.4), 0.58 (5.7), -0.30 (-3.5),
and 0.32 (4.0) for the respective explanatory variables. These are clearly different from
those reported in tables 4 and 5. For the deflated measures of RRI the Pearson and
Spearman correlations between corresponding observations in the Global Vantage data set
and our hand-collected data are 0.25 and 0.55 respectively.
32 P. D. EASTON, P. H. EDDEY, AND T. S. HARRMS
TABLE 6
Analysis of Relations Between Multi-Year Returns, Aggregate Earnings, and Aggregate Net
Increments to Revaluation Reserve
Panel A: Correlations
T T
F IT
EVS +FVF j + V RXRRJI
F IT
(1) Corr IT _0 t_____I_ (2) Corr IT 10
IJo JO JO JO
rT E.1?FVF>.
T
XRRJJ1
(3) Corr t-1 t-i
P0 P I
Years (1) (2) (3) N

1982-84 0.79*** 0.46*** 0.25* 56
0.75*** 0.21 0.16
1985-87 0.81*** 0.44*** 0.46** 71
0.74*** 0.29** 0.26**
1988-90 0.71*** 0.27** 0.03 62
0.77*** 0.18 0.11
1982-90 0.86*** 0.62*** 0.86*** 47
0.86*** 0.35** 0.31**
portion of the revaluation reserve increment which is not captured by

earnings of long return intervals tends to overstate changes in value
occurring during the return intervals.
7.3 SUMMARY
The analysis of the distributional properties of the price-to-book
ratio (with and without including the asset revaluation reserve in the
book value of equity) demonstrates that the revaluation of assets on the
balance sheet results in a book value of owner's equity that is more
closely aligned with the market's assessment of the value of owner's eq-
uity. Both the level of the asset revaluation reserve deflated by book
value (excluding the balance in asset revaluation reserve) and the
deflated net increment to the revaluation reserve have significant incre-
mental explanatory power over return on equity for cross-sectional vari-
ation in price-to-book ratios. The results from the returns analysis are
consistent with the notion that revaluation activity is not timely inas-
much as the cross-sectional variation in the net increment to revalua-
REVALUATIONSOF TANGIBLE LONG-LIVED ASSETS 33
T A B L E 6 -continued
Panel B: Regression Results
T T
P + FVS- - P. XE.I +FVF jT

X.~
Mo e:
Model: JjT JIJT 0 = Y ti +
jO = 1I
I
1_ _ _ _ _ _
+ pt jT (10)
jO JO jO
Years Yot Ylt 72t R2 N

1982-84 -0.24 1.57 0.43 0.68 56
(-2.8)*** (9.1)*** (3.6)***
1984-86 0.00 2.60 1.12 0.69 69
(0.0) (9.6)*** (3.6)***
1985-87 0.21 2.99 0.47 0.65 71
(1.1) (9.6)* (1.2)
1988-90 -0.14 1.11 1.03 0.55 62
(-2.4)** (8.2)*** (2.9)***
1982-90 0.52 1.40 -0.40 0.78 47
(1.6) (9.2)*** (-3.4)***
t-statistics (corrected for heteroscedasticity using White's [1980] consistent variance-covariance
matrix) in parentheses.
Pearson correlations in first row and Spearman correlations in second row.
*Significantt at the 0.1 level.
**Significantt at the 0.05 level.
***significant at the 0.01 level.
tis the price of a share of firm j at time t.
is accounting earnings per share of firm j for period t - 1 to t.
d t is dividends per share of firm j paid at t.
JR&Jt is the net (per share) increment to asset revaluation reserve over period t - 1 to t for firm j.
F1JSjT denotes the total amount an investor can withdraw at date T due to the payment and subse-
quent reinvestment of dividends paid during the period 0 to T.
FVFJT represents the earnings that would accrue from reinvestment of dividends during the period
0 to T.
tion reserve is only weakly related to variation in annual returns (which

presumably reflect changes in underlying asset values). However, the
net increment to the asset revaluation reserve over longer (three-year)
intervals does have significant explanatory power for returns.
8. Additional Tests and Specification Checks

The analyses in section 7 assume that a balance in the asset revalua-
tion reserve and the revaluation reserve increment are equally value-
relevant for all sample firms. However, the discussion in sections 2 and
4 suggests we might expect differences across subsets. Hence we repeat
many of the analyses for subsets of the data. The results for the price-
to-book regressions for each of the subsets are presented in table 7,
while the results for the returns regressions are presented in table 8.
Because lowering the debt-to-equity ratio was a major reason given
for firms choosing to revalue their assets, we partition the sample into
TABLE 7
Regressions Based on the Ratio of Market to Book Value for Partitions of the Sample
P. E.F RR.
P. Ot i it
BV = O+ OtBV_ + 02tBV + vJt (6a)
P. F.
E RRI.
V= +
+ 0 t
4BV + t By + V (6b)
Sample Partial F
Partition 4.t RR& RRI R2 N
Low Debt/ 1.19 1.88 0.07 0.66 0.21 0.16 66
Equity (8.9) ** (3.2)*** (0.2) (1.1)
High Debt/ 1.66 0.61 0.79 1.67 2.97** 0.05 71

Equity (10.8)*** (1.9)* (2. 1)* (2.2)**
Low Change in 1.57 0.46 -0.38 -1.35 1.20 0.07 69
Debt/Equity (14.9)**B (2.8)* B* (-0.8) (-1.1)
High Change in 1.62 0.51 0.87 1.90 8.09B** 0.16 70
Debt/Equity (14.7)*** (2.3)** (3.0)*** (3.9)***
Low RR/BV 1.32 1.80 -0.07 1.80 0.18 0.02 68
* (2.1)** (2.1)*"
(8.5)** (-0.1)
High RR/BV 1.17 0.14 0.92 0.98 12.11*** 0.24 69
(10.3)*** (0.9) (4.9)*** (3.8)***
Low Positive 0.75 3.14 0.22 4.58 0.14 0.12 69
RRI/BV (4.8)*** (3.6)*** (0.5) (0.2)
High Positive 1.44 -0.03 0.63 0.61 3.94*** 0.06 70
RRJ/BV (11.8)*** (-0.1) (2.8)*** (2.1)**
See notes to table 3.
Sample partitions are based on the observations for each firm from the year with the lowest ratio
and the year with the highest ratio.
high and low debt-to-equity samples and into high and low change in
debt-to-equity samples. We also partition the sample based on the ex-
tent of revaluation. It can be argued that revaluations are more relevant
for firms with a larger share of owner's equity based on revaluations
since this may indicate that the values of assets on the balance sheet are
more up to date and increments are more timely. Alternatively, it can
be argued that revaluation reserves are discounted by the market and
may be less relevant for firms with high proportions of revaluation re-
serves in equity because the reserves are used to "prop up" firm value.
In the latter case we expect the revaluation disclosures of firms that re-
value to have a lower association with value. In order to consider these
ideas, we partition the pooled sample on the basis of the proportion of
revaluation reserves relative to reported owner's equity (PRRjtIBVjt).
Since the high RRjtIBVjt versus low RRjtIBVjt partition focuses on reval-
uations to date rather than revaluations during the time period in
N s O~~~~C
00 Gq C)
0 Cl0C 0
ctc P
Cl l < Cl C<
C l Cl
S~~~~~~~~~~f
- .o tt rf O .c 't oo
+
t_~
~~~~~~~~*
Cb CnL
ce~~~~~~~~~~~M 00 "M Q t- o G %n
00 ;t I I
+:''00
< o. I o*oto 00~-G C) 00* C 00C 0
0~~~~~~~~~~~~0
t N~~I' I I I
C:L t 000.
t
+
s~~~~~~~; C-
*
6IobttstbO
* * *
cn+ +* * * * * *
.? ~ ~ ~~~~~~~* * * *
L ' 7..NOO% t~~~~~C, *Cl 00C Cl* G*C 00C b 00O
0 MOOG
OOOCOCG IC~~~~~~~~~~~~~~-
t~~~~~~~~~~~ X~~~~~~~~~~~~~~~i
I I
bC
I
biD. b *onNC
36 P. D. EASTON, P. H. EDDEY, AND T. S. HAMS
which they are reported, we also partition into high positive and low
positive RRIt IBVj1subsamples.41
The samples for each of the partitions are based on the observations
for each firm from the year with the lowest ratio and the year with the
highest ratio. Outliers (observations with an R-Student statistic greater
than 3 or less than -3) were removed so the final samples are not of
equal size.
The effect of partitioning the data is apparent from the partial-F
statistics comparing the explanatory power of regression (6) with the
restricted regression (6c) of the price-to-book ratio on return on equity
(see table 7). This statistic is significant (at the 0.05 level) for each of
the high-ratio partitions, indicating that reporting asset revaluations in
the balance sheet is particularly informative when (i) the level of debt
or the change in the debt level is high, and (ii) the level of revaluation
activity to date or the level of revaluation activity during the reporting
period is high. Note also that the revaluation variable which explains
cross-sectional variation in price-to-book ratios in the high RRjtIBVjt
and high RRI.tIBVjt subsamples is the net increment to the asset reval-
uation reserve, consistent with the idea that firms tend to revalue when
the difference between market value and book value is high.
In the analyses of returns based on subsamples (reported in table 8)
the coefficients on the deflated net revaluation increment (RRI1 /P.t_)
and the deflated change in the net increment (ARR~jtlP1t1) are signifi-
cantly different from zero when there is a relatively high change in
debt and when the level of revaluation activity to date is relatively high
(the t-statistics on both of these variables and the partial-F statistics are
all significant at the 0.05 level for the high change in debt/equity and
the high RRjtIBVjt partitions). These results are consistent with the idea
that revaluations are relevant and timely when firms are changing the
level of debt and when firms have a relatively high balance in their as-
set revaluation reserve.
9. Conclusions
Our analyses support the conclusion that book values including asset
revaluation reserves are more aligned with the market value of the firm
than book values excluding asset revaluations. That is, asset revaluation
reserves as reported under Australian GAAP help to provide a better
summary of the current state of the firm. Thus, allowing or requiring
firms to revalue assets upward should be carefully considered by orga-
nizations such as the U.K. Accounting Standards Board, the Japanese
41 There are very few cases of a net decrement to the asset revaluation reserve. We do
not consider these in the partition because the apparent reluctance of firms to reverse
previous revaluation increments suggests that such decrements provide very different in-
formation (for example, signaling or confirming very bad news) compared with revalua-
tion increments.
Ministry of Finance, and the International Accounting Standards Com-

mittee as they debate the merits of various proposed changes in asset
revaluation practice.
The evidence across all firms and years suggests that the balance in
the asset revaluation reserve explains cross-sectional variation in price-
to-book ratios but the explanatory power of the net increment to this
reserve is weak. However, both the balance of the reserve and the net
increment have significant explanatory power when (i) the debt level is
relatively high, (ii) the change in debt level is relatively high, (iii) the
balance in the asset revaluation reserve as a portion of book value is
relatively high, or (iv) the net increment to the revaluation reserve as a
proportion of book value is relatively high.
The conclusion that increments to revaluation reserves do not gener-
ally occur during the year in which underlying asset values change is
weakly supported by tests of significance of the coefficient on the net re-
valuation reserve increment in the annual return regressions. However,
when there is a relatively high change in debt levels or a relatively high
balance in the asset revaluation reserve in the sample year, the timing of
the revaluation increment does appear to be more aligned with changes
in underlying asset values since the coefficient on the net increment to
revaluation reserve is positive and significant at the 0.05 level.
REFERENCES
AMIR, E.; T. S. HARRIS; AND E. K. VENUTI. "A Comparison of the Value-Relevance of U.S.
versus Non-U.S. GAAP Accounting Measures Using Form 20-F Reconciliations."Journal
of Accounting Research (Supplement 1993): 230-64.
BERNARD, V. "Cross-Sectional Dependence and Problems of Inference in Market-Based
Accounting Research." Journal of Accounting Research (1987): 1- 48.
BERNARD, V.; R. C. MERTON; AND K. G. PALEPU. "Mark-to-Market Accounting for U.S. Banks
and Thrifts: Lessons from the Danish Experience." Working paper, University of Mich-
igan, August 1992.
BESLEY, D. A.; E. KUH; AND R.E. WELSCH. "Regression Diagnostics." New York: Wiley, 1980.
BROWN, P., AND F. FINN. "Asset Revaluations and Stock Prices: Alternative Interpretations
of a Study by Sharpe and Walker." In ShareMarketsand Portfolio Theory,edited by R. Ball
et al., pp. 349-54. St. Lucia: University of Queensland Press, 1980.
BROWN, P.; H. Y. IZAN; AND A. L. LOH. "Fixed Asset Revaluations and Managerial Incen-
tives." Abacus (1992): 36-57.
EASTON, P. D., AND T. S. HARRIS. "Earnings as an Explanatory Variable for Returns." Journal
of Accounting Research (Spring 1991): 19-36.
EASTON, P. D.; T. S. HARRIS; AND J. A. OHLSON. "Accounting Earnings Can Explain Most of
Security Returns: The Case of Long Return Intervals." Journal of Accounting and Economt-
ics (April 1992): 119- 42.
EMANUEL, D. "Asset Revaluations and Share Price Revisions." Journal of Business Finance
and Accounting (Spring 1989): 213-27.
FAIRFIELD, P. M., AND T. S. HARRIS. "An Investigation of Intrinsic Value and Risk as Expla-
nations of the Returns to Price-to-Earnings and Price-to-Book Value Trading Strate-
gies." Working paper, Columbia University, 1991.
FAMA, E. F., AND K. R. FRENCH. "The Cross-Section of Expected Stock Returns." Journal of
Finance (1992): 427-65.
Prices. Stamford, Conn.: FASB, 1986.
HENDERSON, S., AND J. GOODWIN. "The Case against Asset Revaluations." Abacus (1992):
75-87.
INTERNATIONAL ACCOUNTING STANDARDS COMMITTEE. International Accounting Standard No. 16:
Accounting for Property, Plant and Equipment. London, 1982.
MARTIN, C. An Introduction to Accounting, 3d ed. New York: McGraw-Hill, 1990.
NIEUWENHUYSEN, J., AND A. DALY. The Australian Prices Justification Tribunal. Parkville: Mel-
bourne University Press, 1977.
OHLSON, J. A. "Accounting Earnings, Book Value and Dividends: The Theory of the
Clean Surplus Equation (Part 1)." Working paper, Columbia University, 1989.
."Earnings, Book Value and Dividends in Security Valuation." Working paper,
Columbia University, October 1992.
OU, J., AND S. PENMAN. "Accounting Measurement, Price-Earnings Ratio, and the Infor-
mation Content of Security Prices." Journal of Accounting Research(Supplement 1989):
111- 44.
PENMAN, S. H. "An Evaluation of Accounting Rate of Return." Journal of Accounting, Audit-
ing and Finance (1991): 233-56.
SHARPE, M. "Measurement of Assets Other Than Financial Assets." Paper presented at
Macquarie University, May 7, 1993.
SHARPE, I. G., AND R. G. WALKER. "Asset Revaluations and Stock Market Prices." Journal of
Accounting Research (Autumn 1975): 293-310.
STANDISH, P., AND S. UNG. "Corporate Signalling, Asset Revaluations and the Stock Prices
of British Companies." The Accounting Review (October 1982): 701-15.
WALKER, R. G. "The SEC's Ban on Upward Asset Revaluations and the Disclosure of Cur-
rent Values." Abacus (1992): 3-35.
WHITE, H. "A Heteroscedasticity-Consistent Covariance Estimator and a Direct Test for
Heteroscedasticity." Econometrica(1980): 817-38.
WHITTRED, G., AND Y. K. CHAN. "Asset Revaluations and the Mitigation of Underinvest-
ment." Abacus (1992): 58-73.
ZLICCA, L. J., AND D. R. CAMPBELL. "A Closer Look at Discretionary Writedowns of Impaired
Assets." Accounting Horizons (September 1992): 30-41.

An Investigation of Revaluations of Tangible Long Lived Assets

Uploaded by

Document Information

Original Title

Copyright

Available Formats

Share this document

Share or Embed Document

Sharing Options

Did you find this document useful?

Is this content inappropriate?

Copyright:

Available Formats

An Investigation of Revaluations of Tangible Long Lived Assets

Uploaded by

Copyright:

Available Formats

Accounting Research Center, Booth School of Business, University of Chicago

An Investigation of Revaluations of Tangible Long-Lived Assets

1. Introduction and Summary

*Macquarie University and University of Chicago; tMacquarie University; and +Co-

Copyright?, Institue of Professional Accounting, 1994

Standard Accounting Practice (SSAP) No. 16 required supplementary

policy to facilitate the creation of reserves which can be used to offset

2. Accounting for Revaluations of Noncurrent Assets in

4Ninth Schedule to the Companies Act, 1961, clause 7(6).

In our sample period the influence on revaluations comes from (i)

(iv) The net revaluation increment or decrement relating to each

debt-to-assets measure. In private borrowing arrangements, lenders ac-

3. Data and Sample Selection

4. Survey of Chief Financial Officers

15 In Australian firms, the chief financial officer is

Panel A: Motivation for Revaluation of Assets

PanelB: ReasonsWhyPropertyIs RevaluedMore Frequently/ExtensivelyThan OtherAssets

Panel C: Reasons Why Plant and Equipment Is Not Revalued as Frequently/Extensively

Panel E: Use of Capital Profits Reserve and Asset Realization Reserve

Panel B: Revaluations as a Proportion of Book Value: Property

Panel C: Revaluations as a Proportion of Book Value: Unlisted Investments

Panel D: Revaluations as a Proportion of Book Value: Plant and Equipment

Panel E: Revaluation as a Proportion of Book Value: Intangibles

Panel F: Revaluation Reserve as a Proportion of Stockholders' Equity

Panel G: Independent Valuations as a Proportion of Total Valuations

In addition to the asset revaluation reserve, many Australian firms

when commodity prices fluctuate on world markets and estimates of

5. Description of Asset Revaluation Activity

18 Mark to market accounting for financial instruments was not countenanced

Many firms do not revalue unlisted investments, plant and equipment,

6. Development of Empirical Analysis

While our empirical models are based on the theoretical foundation

Pt= wo1BVj + 2 + vt (1)

BV* = BVI + RRf (2)

Ejtis earnings per share of firm j at time t as reported in the profit

Dividing (5) by BVRtyields:

We divide by (adjusted) BVjt(that is, BV}j- RRit) rather than reported

P.t E.1 RRI.t

We use estimates of ?2 and O" to provide evidence of the (separate) ex-

goodwill, the average price-to-book ratio with the revaluation reserve

Equation (1) is the economic model underlying the return-based

E. AE. RRI.j ARRI.

where F includes otherjtlPJtl, AotherjtIPj,-i and djt-11P 31

{BVjT- BVjo} = E - d.t+ i, RRIJ + i other7.t. (8)

The variables FVSJTand FVI9Tare described in detail in EHO. FVST

The potential advantage of extending the return interval is that, if

increments in revaluation reserves will become irrelevant (that is, have

7.1 PRICE-TO-BOOK MODELS

35 The R-student statistic of observation jt is the standardized residual of this observa-

1982 0.68 1.74 0.06 0.04 0.07 60

1983 0.90 0.73 0.66 1.56 0.11 70

1984 0.84 2.31 0.30 0.30 0.23 71

1985 1.01 2.22 0.62 1.25 0.32 72

1986 1.13 3.92 0.74 0.67 0.46 70

1987 1.62 2.03 0.36 0.86 0.06 72

1988 1.70 0.40 0.92 1.97 0.10 71

1989 1.24 3.56 0.58 1.27 0.25 66

1990 1.44 0.89 0.02 -1.32 0.27 62

Mean 1.14 2.01 0.47 0.72

t-statistics (corrected for heteroscedasticity using White's [1980] consistenit variance-covariance

7.2 RETURN MODELS

C~T C-1 CO CO CO 10~

- C~~~ 10 (04 1> O

L ' 7..NOO% t~~~~~C, Cl 00C Cl G*C 00C b 00O