Abstract

This study titled “the effects of asset revaluation on a company’s financial performance” investigated the way company financial performance is affected by asset revaluation. Thus the study sought to examine: the level of awareness on the application of asset revaluation in Cameroon Development Corporation; the effect of asset revaluation on Cameroon Development Corporation’s net worth; the effect of asset revaluation on Cameroon Development Corporation’s operating income. Three hypotheses were formulated to guide the study.  The survey research design was used. The accessible population comprised of 36 accountants from Cameroon Development Corporation. The purposive sampling technique was used in selecting the respondents. Questionnaires and observation guides were the instruments used for data collection. The empirical analysis included one explanatory variable and two dependent variables, being net worth and operating income. Data was analyzed qualitatively and quantitatively. Qualitatively, the mean, median, mode, standard deviation and percentages were used descriptively while quantitatively, the Pearson correlation coefficient, trend analysis, linear, multiple regression and chi square were used inferentially. Based on the analysis, the results indicated generally that, asset revaluation significantly affected net worth. Specifically, it indicated that asset revaluation does not significantly affect operating income and there was a significant level of awareness on the application of asset revaluation. The study therefore recommends that management of Cameroon Development Corporation should encourage training and development programs, workshops and seminars for accountants on asset revaluation procedures. Shares should be offered to the public as a source of finance and improvement of financial performance.

CHAPTER ONE

INTRODUCTION

1.1 Background of the Study

The comparability of financial statements among businesses is vital for performance analysis and benchmarking. When two business enterprises in the same industry and economic conditions apply different accounting policies, an unsound economic decision may arise which raises questions on the reliability of financial statements. However, inherent differences among financial statements presented can resultantly complicate this process. These differences may result from a country’s national accounting standards, its legal system, societal and accounting values, business culture, and development stage of its capital market. (Alexander et al., 2009; Nobes and Parker, 2010). These differences could also arise as a result of changes in the values of assets (fixed, current or intangible) and asset revaluation. Revaluation of assets could either result in an increase or decrease in the values of assets. Poorly performing company’s benefit more from revaluing assets, this is because these company’s have a smaller net worth, and they have a larger probability of violating the legal requirements with respect to their net worth.  This is because the net worth increases when assets are revalued; badly performing company’s can cut their expected re-organization costs substantially by an asset revaluation.

However, in a world of incompletely informed investors, as the revaluation reduces the return on equity, poorly performing companies that revalue will have more difficulty attracting new funds. If investors believe that the revaluation of assets is a negative signal, then it is less likely that funds will be provided for an investment project or they will be provided only at a higher cost. In accordance with the International accounting standard board (IASB), there exist three current international accounting standards relating to asset revaluations, which are IAS 16 ‘Property Plant and Equipment’, IAS 36 ‘Impairment Assets’ and IAS 38 ‘Intangible Assets’. According to IAS 16 an item of property, plant and equipment may be revalued to the extent that a fair value can be determined. In accordance with the International Accounting Standards once a decision has been made to revalue a class of non-current assets, the valuations must be kept up to date. This implies that, if the fair value basis of measurement is adopted, revaluations must be made with sufficient regularity to ensure that the carrying amount of each asset in the class does not differ materially from its fair value at the balance sheet date. It should also be noted that IAS 16, does not permit offsetting of revaluation gains and losses within a class of property, plant and equipment.  In accordance with IAS 36, non-current asset should be written down to its recoverable amount while IAS 38 permits intangible assets to be re-valued upwards only when there is an ‘active market’ for the asset.

In several countries (Australia, Belgium, and the United Kingdom), accounting laws allow for the value of fixed assets to be revalued upward, without a previous write-down at managers’ discretion.

Research on the value relevance of this accounting practice in Australia (Standish and Ung, 1982; Easton et al., 1993), in New Zealand (Emanuel, 1989; Courtney and Cahan, 2004), in the United Kingdom (Barth and Clinch, 1998; Aboody et al., 1999), and for Hong Kong firms (Jaggi and Tsui, 2001) provides mixed results. Taking into consideration the fact that the choice of whether or not to implement revaluation lies with management but this is not the case in Cameroon for the implementation of revaluation of asset is stipulated and required by the decree; N⁰ 2011/0975/PM, for both natural and physical persons. This practice in Cameroon is newly introduced and most companies are still trying to implement it and understand its effect on the company’s net worth be it;  operating cash flows, operating income, debt to equity ratio, return on capital employed, market value and share price, debt to asset ratio.

There is good reason to question the motivations and effects underlying the practice of asset revaluation. This is because we are interested in knowing if there is any direct effect on the company’s net worth but little or no direct effect on the company’s cash flow besides implementation costs (additional audit fees). It is reasonable to think that these costs are compensated (Watts, 1977). It may therefore be interesting to understand the origins of the compensations, in order to comprehend the reasons why managers opt for upward revaluations. Information asymmetry on the company’s assets value should be reduced by this departure from the historical cost principle. This is to ensure that the value of assets recorded and reported in the financial statements are a true representative of the company’s financial performance.

However, an increment in the value of an asset arising from revaluation is recorded as revaluation surplus under the equity in the statement of financial position; this value could either affect the net worth of the company positively or negatively.

The revaluation of asset in Cameroon was enacted in the decree: N ° 2011/0975/PM. This decree sets out the terms for the revaluation of depreciable assets and non depreciable assets.  In the Republic of Cameroon, all natural or legal persons under the real plan, industrial, commercial, agricultural, mining, craft or profession are required to revalue their assets. All of these persons are required to revalue their tangible and intangible assets, depreciable and non-depreciable including buildings, land, property and equipment, goodwill acquired as per the OHADA accounting law. Previous studies found evidence that supports the view that investors value information about the revaluation of non-current assets. Aboody et al., (1999) in the UK and Jaggi and Tsui (2001) in Hong Kong both found that there was a positive association between upward fixed asset revaluation and the company’s future operating performance. Additionally, they found that upward fixed asset revaluations were positively associated with share prices and returns. In New Zealand, Courtenay and Cahan (2004) confirmed that fixed asset revaluation increments were positively associated with returns.

In Australia, accounting practices are guided by the Australian GAAP, which permits companies to revalue non-current assets upward when the asset’s recoverable amount exceeds its carrying amount. Also, it requires companies to revalue non-current assets downward when the asset’s recoverable amount falls below its carrying amount. Two new standards relevant to asset revaluation are AASB 116, “Property, Plant and Equipment” and AASB 138, “Intangible Assets”. Both standards were introduced in 2005 and are equivalent to IAS 16 “Property, Plant and Equipment”, and IAS 38 “Intangible Assets” issued by the IASB. These standards were made applicable by -profit entities that comply with requirements of AASB 116 and AASB 138. The AASB (Paragraph 36, AASB 116) standard states that if an item of property, plant and equipment and the entire class of property have to be revalued, an increase in the assets carrying amount as a result of asset revaluation shall be credited directly to equity under the heading of revaluation reserve. This would either increase or decrease the company’s net worth. However, the increase shall be recognized in profit and loss to the extent that it reverses a revaluation decrease of the same asset previously recognized in the profit or loss (AASB 116, Paragraph 39).

In New Zealand, FRS-3, Accounting for Property, Plant and Equipment was approved in March 2001 by the Accounting Standards Review Board under the Financial Reporting Act of 1993 and has recently been replaced by relevant International standards. (IAS 16, IAS 38 and IAS 36) FRS-3 deals with accounting for items of property, plant and equipment under the historical cost and modified historical cost systems of accounting; this standard accounts for the consumption or loss of economic benefits embodied in items of property, plant and equipment.

However, this standard does not deal with investment properties and properties intended for sale. This standard stipulates that an item of property, plant and equipment must be initially recognized at historical cost, this includes cost directly attributable to bringing the item to working condition for its intended use, but subsequent to initial recognition, an item or property, plant and equipment may be revalued to a fair value. FRS-3 defines ‘fair value’ as the amount for which an asset could be exchanged, or a liability settled, between knowledgeable, willing parties in an arm’s length transaction. While the annual revaluation of items of property, plant and equipment is not required by the standard, the adoption of a system involving annual revaluation, especially of land and building, is encouraged in order to provide more relevant information to users of an entity’ financial report and to depict the net worth of the company at any point in time.

1.2 Statement of Problem

In a financial system where balance sheets are continuously marked to market, asset price changes show up immediately as changes in the financial position of the company, changes in asset prices arise as a result of changes in the values of assets which affect the financial performance of the company. When two business enterprises in the same industry and economic conditions apply different accounting policies, an unsound economic decision may arise which raises questions on the reliability of financial statements. However, inherent differences among financial statements presented can resultantly complicate this process. These differences may result from a country’s national accounting standards or policies precisely revaluation of assets. Asset revaluation will result in a change in the price of an asset, thereby affecting the company’s financial performance positively or negatively.

The practice of asset revaluation in Cameroon was recently made mandatory by the Prime Ministerial Decree N ° 2011/0975/PM; this practice is reluctantly adhered to by most companies operating in Cameroon. Therefore determining the effect of asset revaluation on a company’s financial performance is not an area of concern to most companies as it is not included in most company policies. That is most companies are not aware of the effect of asset revaluation on the company’s financial position and level of profitability. This is because the practice of asset revaluation is unfamiliar and not well known. Though recently most companies’ try to acquaint them with this practice, there are still issues and doubts as to whether asset revaluation will positively or negatively affect the firm’s net worth or operating income. Some companies in Cameroon actually revalue assets because it is required by law not voluntarily because the concept and practice of revaluation is not understood, that is it cannot be interpreted, implemented and most of all its effect on a company’s financial position and profitability cannot be assessed. If this practice is not well understood, how then can we evaluate the effect asset revaluation has on a company’s financial performance. Inflationary trends over time (1 to 10 years, for example) in a state can lead to a distortion between the historical values in an assessment of a company and the current values (economic) market. It is not clearly ascertained as to whether the revalued amount or fair values are used in the subsequent financial year. This is so because it is not clear on which of these values are used, we cannot clearly associate the effect asset revaluation has on a firms net worth. This revaluation might be an upward revaluation or a downward revaluation. The balance sheets do try to portray a true picture of the firm’s assets and it financial position though to an extent it does not reflect the true picture of the much sought asset and financial situation of companies. The OHADA legislator in Article 35 of the accounting law establishes the principle of valuing items appearing in the balance sheet, the evaluation of accounting items is based on the historical cost convention and on applying general principle of prudence and continuity of operation. The rising concern, about the value relevance of financial information has motivated research into factors which are associated with asset revaluations in the United Kingdom, Hong Kong, Australia and New Zealand as well as Cameroon. This is because investors and those with a stake in the company are interested in knowing that their investments are secure and will yield dividend at year end. The revaluation allows a company to re-evaluate its record under conditions laid down by the authorities and in compliance with the provisions of Articles 62 to 65 of the OHADA accounting law. Accounting standards provide various choices for companies in preparing financial statements with respect to matters such as asset valuation methods, methods of depreciation and inventory valuation to avoid unsound decision making. There exist three current international accounting standards relating to asset revaluations, which are IAS 16 ‘Property, Plant and Equipment’, IAS 36 ‘Impairment Assets’ and IAS 38 ‘Intangible Assets’ as mentioned above.  This study attempts to answer the following questions:

1. What is the effect of asset revaluation on a company’s financial performance?
2. What is the level of awareness on the application of asset revaluation in CDC?
3. To what extent does asset revaluation affect CDC’s is net worth?
4. To what extent does asset revaluation affect CDC’s operating income?

1.3 Research Objectives

The main objective of this study is to examine the effect of asset revaluation on a company’s financial performance. The general purpose of this study is to assess the relationship between asset revaluations by Cameroon Development Corporation from the year 2004 to 2015 and the changes in net worth and operating income. This research has the following specific objectives:

1. To assess the awareness on the application of assets revaluation in CDC
2. To examine the effect of assets revaluation on CDC’s net worth.
3. To examine the effect of assets revaluation on CDC’s operating income.
4. To make recommendations on the usage of assets revaluation to improve on CDC’s financial performance.