Determining the highest and best use of non-financial assets
The fair value of a non-financial asset is determined based on its ‘highest and best use’. This refers to the most advantageous use of the asset that would maximise its value. The perspective of market participants guides this determination, even if the entity has a different intended use or no use for the asset. When the most valuable use of an asset involves combining it with other assets (and liabilities), the fair value should be estimated with the assumption that these other assets (and liabilities) are available to the market participants.
The highest and best use considers its physically possible, legally permissible, and financially feasible uses. The physically possible use relates to the asset’s inherent properties, like the location or size of a property. The legally permissible use reflects any legal limitations, such as zoning regulations for a property. The financially feasible use evaluates whether the asset, when utilised in a manner that’s both physically possible and legally permissible, can yield sufficient income or cash flows to offer a return that market participants would expect from such an investment (IFRS 13.27-30; IFRS 3.B43).
Examples 1-3 in the accompanying IFRS 13 illustrate application of these requirements.
Valuation: stand-alone basis vs grouped assets
Depending on the ‘highest and best use’ determination, a non-financial asset’s fair value can be measured in two ways (IFRS 13.31, B3):
- On a stand-alone basis: The asset’s value is determined individually.
- In combination with other assets: This could be alongside other assets as a group, or with other assets and associated liabilities.
Incorporating an asset’s use with other assets into its fair value measurement can be achieved through:
- Value adjustments: For instance, to determine the fair value of a machine that has been set up and is operational, one would start with the value of a non-operational machine and then add installation and configuration costs.
- Market participant assumptions: As an example, the value of work-in-progress inventory might be calculated based on the assumption that market participants would convert this stock into finished products.
- Valuation techniques: The Multi-period Excess Earnings Method is a typical technique used.
- Value allocation: The total value of a group of assets might be apportioned among the individual assets using reasonable allocation methods.
When valuing assets and considering associated liabilities, it is important to include only those liabilities that finance working capital. Liabilities that are used to finance assets outside the asset group, known as financing liabilities, are specific to each entity and should not be included in the asset’s valuation. Instead, the compensation of entities providing financing, whether through debt or equity, is reflected in the market prices of the assets or through an appropriate discount rate when using present value techniques.
Lastly, any assumptions about the ‘highest and best use’ of a non-financial asset must remain consistent for all assets in a particular group, or within a combined group of assets and liabilities.
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