ASC 820 Nonfinancial Assets: Highest and Best Use and the In-Use vs. In-Exchange Premise
Why fair-valuing land, buildings, and equipment asks what a market participant would do with the asset, not what the entity actually does.
- Part 1: Fundamentals
- Part 2: Worked Examples
- Part 3: Level 3 Inputs & Valuation Techniques
- Part 4: Nonfinancial Assets & Highest and Best Use
- Part 5: Disclosures
A Different Question for Nonfinancial Assets
For financial instruments, fair value measurement generally takes the asset as it is and asks what a market participant would pay for it. For nonfinancial assets — real estate, equipment, intangible assets — ASC 820 asks a broader question first: what is the asset’s highest and best use, and is that use different from how the reporting entity is actually using it?
The Highest and Best Use Test
Highest and best use is the use of a nonfinancial asset by market participants that would maximize its value, considering a use that is:
- Physically possible — the physical characteristics of the asset support the use
- Legally permissible — the use is not restricted by zoning, covenants, or other legal constraints, considering restrictions market participants would take into account
- Financially feasible — the use generates adequate income or return to justify it, after accounting for the costs of converting the asset to that use
Critically, this test is applied from the perspective of market participants, not the reporting entity’s actual or intended use. An entity’s own plans for an asset are irrelevant to the fair value measurement if a different use would be more valuable to market participants generally.
Worked Example: Land Held for a Warehouse
Company Z owns a parcel of land currently used as a warehouse and distribution facility. The surrounding area has been rezoned for mixed-use residential and commercial development, and comparable nearby parcels are being redeveloped into residential towers. Market participants would recognize that the land is significantly more valuable if redeveloped than if it continues as a warehouse site.
Even though Company Z has no intention of redeveloping the land and continues to operate the warehouse, the fair value measurement of the land (for example, in a business combination purchase price allocation, or an impairment test) must reflect its highest and best use as a redevelopment site — assuming that use is physically possible, legally permissible under the new zoning, and financially feasible after demolition and construction costs. The measurement is not reduced to reflect the entity’s actual, lower-value use.
In-Use vs. In-Exchange Premise
Highest and best use for a nonfinancial asset is evaluated under one of two premises. Under an in-use premise, the asset would provide maximum value to market participants principally through its use in combination with other assets as a group (for example, specialized manufacturing equipment that only has value as part of a production line). Under an in-exchange premise, the asset would provide maximum value to market participants principally on a standalone basis (for example, land that could be sold and redeveloped independently of any other asset). The premise selected drives which valuation inputs and comparable transactions are relevant.
Practical Takeaway
Highest and best use most frequently comes up in business combination purchase price allocations and impairment testing of real estate and specialized equipment. Preparers should resist the instinct to default to the entity’s current use as the answer — the standard explicitly requires looking past what the entity is doing with the asset today to what a market participant would do with it, and that difference can be financially significant, particularly for real estate in areas undergoing zoning or land-use changes.
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