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When determining the fair value of nonfinancial assets and liabilities, it is important to consider the guidance in US GAAP. In addition, the valuation standards from the International Valuation Standards Council, updated in August 2021, can serve as a helpful resource. The valuation standards include chapters on valuation approaches and methods (IVS 105), intangible assets (IVS 210), non-financial liabilities (IVS 220), inventory (IVS 230), and several other key areas.
ASC 820-10-35 includes the following fair value concepts:
  • Selecting the appropriate market
  • Identifying market participants
  • Using market participant assumptions
  • Determining the highest and best use
  • Applying appropriate valuation approaches and techniques

Each of these topics is addressed in FV 4 and discussed in this section in the context of nonfinancial assets and liabilities.

7.2.1 Selecting the appropriate market

An important step in the valuation of nonfinancial assets and nonfinancial liabilities is the determination of the appropriate market. If there are no known markets or if the reporting entity does not have access to any markets, it should identify potential market participants and develop a hypothetical market.
In selecting a market for a specific asset or liability, a reporting entity should evaluate how the asset could be sold or the liability transferred. In making this evaluation, a reporting entity should research existing markets to determine the types of markets that exist for the asset or liability, or similar assets or liabilities if no direct inputs are available. The initial evaluation may be performed without regard to whether the reporting entity has access to a specific market. Although an inaccessible market cannot be used as a principal or most advantageous market, information related to such markets may be considered in developing the inputs that would be used in a hypothetical market. For example, assume the existence of a market for buying and selling internet domain names. Although this may not be a principal or most advantageous market for a reporting entity, it provides a reference point for the valuation of domain names.
In addition, reporting entities may consider information about markets for similar assets or liabilities or markets for assets with similar economic characteristics with which it has more experience. Assumptions about markets and market participants will involve judgment, and management will need to consider all reasonably available information when developing inputs for measures with few or no reference points.

7.2.2 Identifying market participants

The first step in developing market participant assumptions is identifying potential market participants. Market participants are those who would be interested in and could benefit from ownership of a specific asset or liability.
ASC 820-10-35-9 describes how a specific market participant does not need to be identified in order to develop market participant assumptions:

Excerpt from ASC 820-10-35-9

…a reporting entity need not identify specific market participants. Rather, the reporting entity shall identify characteristics that distinguish market participants generally, considering factors specific to all of the following:
  1. The asset or liability
  2. The principal (or most advantageous) market for the asset or liability
  3. Market participants with whom the reporting entity would enter into a transaction in that market.

In identifying market participants for purposes of measuring the fair value of nonfinancial assets and liabilities, the reporting entity should determine the most likely buyer(s). Market participants could be strategic buyers, financial buyers, or both.
  • Strategic buyers: Strategic buyers could include the acquirer’s peers or competitors, or an entity seeking to diversify its operations. Typically, strategic buyers will have synergies specific to their existing operations, and may have the ability and willingness to transact for the same assets and liabilities.
  • Financial buyers: Other buyers, including those who have no ownership interests in businesses or operations similar to that of the acquirer, may also be considered market participants in certain situations. These market participants, commonly referred to as financial buyers, may include individual investors, private equity and venture capital investors, and financial institutional investors.

Assumptions regarding an asset’s use may be different depending on whether the market participant is a strategic or financial buyer. For example, when measuring the fair value of internally developed software used in a financial reporting system, the value to a strategic buyer may be much less, given that a strategic buyer would likely continue to use its existing system. On the other hand, a financial buyer may not have a similar system in place and, therefore, would place a higher value on the software, since it would be necessary to operate the business on an ongoing basis.
A reporting entity should also consider whether strategic buyers would be interested in the asset or liability, or whether financial buyers looking to arbitrage or trade on the asset or liability would be the most likely market participants. In some cases, both types of market participants could be interested and the reporting entity will need to conclude which group is the appropriate market participant.
Identifying market participant characteristics when measuring fair value in a business combination is subjective and dependent on facts and circumstances. Helpful sources of information may include press releases, prior bid attempts, board of director presentations, due diligence documents, deal models, a list of all known bidders in the transaction and those who did not participate in the bidding process (if the transaction was subject to competitive bids), and a list of comparable companies. Reporting entities can also look to the other bidders in a bidding process in assessing whether they themselves are representative of a market participant. In the absence of this type of transparency, a reporting entity will need to determine the characteristics or profile of potential market participants as discussed above.
In a business combination, the transaction price may be a starting point in the analysis of fair value. For example, for recently acquired assets and liabilities, a starting point for determining market participant assumptions may be the acquirer. Since the acquirer successfully purchased the target company, it could look to itself to determine if it possesses unique characteristics, or whether such characteristics are similar to its competitors (strategic buyers) or financial buyers.
See further discussion regarding the determination of market participants in FV 4.2.3.

7.2.3 Using market participant assumptions

ASC 820 emphasizes that fair value is a market-based measurement, not an entity-specific measurement. The fair value of an asset or liability should be determined based on an exit price, as if a transaction involving the asset or liability had occurred on the measurement date, considered from the perspective of a market participant.
Identifying potential market participants and developing market participant assumptions are two critical components in developing fair value measurements of nonfinancial items. Certain assets measured at fair value, such as real estate and many biological assets, have established markets. In the absence of such markets, a hypothetical market and market participants must be considered. While many times an identical asset does not exist, there are often similar assets whose transactions should be considered in developing market participant assumptions. Significant judgment is required to develop the assumptions to be used in a hypothetical exit transaction. For example, there may be no apparent exit market for customer relationship intangible assets. In this case, management may consider whether there are strategic buyers in the marketplace that would benefit from the customer relationships being valued. Most entities seek to build up their customer base as they grow their businesses. As a result, participants in the industry seeking additional growth may serve as a basis for a hypothetical group of market participants.

7.2.3.1 Market participant versus entity-specific assumptions

An entity’s intended use is not considered relevant for purposes of measuring fair value because the definition of fair value is market based. ASC 805, Business Combinations, explicitly prohibits an acquirer from considering its intended use of an asset.

ASC 805-20-30-6

To protect its competitive position, or other reasons, the acquirer may intend not to use an acquired nonfinancial asset actively, or it may not intend to use the asset according to its highest and best use. For example, that might be the case for an acquired research and development intangible asset that the acquirer plans to use defensively by preventing others from using it. Nevertheless, the acquirer shall measure the fair value of the nonfinancial asset in accordance with Subtopic 820-10 assuming its highest and best use by market participants in accordance with the appropriate valuation premise, both initially and for purposes of subsequent impairment testing.

Key considerations in developing market participant assumptions include the specific location, condition, and other characteristics of the asset or liability (such as assumed growth rates, whether certain synergies are available to all market participants, and risk premium assumptions). Developing market participant assumptions for these assets and liabilities requires judgment. In such circumstances, entities often start with their own assumptions and perform procedures to assess if evidence exists that market participants would make different assumptions. In cases where an acquirer intends not to use an acquired asset for competitive reasons, different assumptions that a market participant would make would be required.
Measuring assets based on the expected use by a market participant can present a number of accounting challenges, including the assessment of useful life and residual value. In accordance with ASC 350-30-35-3(a), the useful life assessment of an asset is based on entity-specific assumptions regarding the asset’s use, while the fair value of the asset is based on market participant assumptions. The residual value of an intangible asset is assumed to be zero unless certain conditions are met (see BCG 8 for these conditions). Entities will need to apply judgment to determine the fair value and useful life of assets that an entity does not intend to use or intends to use differently than a market participant.

7.2.3.2 Market participant synergies

When determining fair value measurements in connection with a business combination, the identification and analysis of market participant synergies is a significant component of developing market participant assumptions.
Market participant synergies are synergies that are available to more than one market participant. They are considered as part of measuring the fair value of the assets that will benefit from the realization of those synergies. Buyer-specific synergies are synergies that are available only to a specific acquirer. Such synergies should not impact the determination of fair value because other potential acquirers (i.e., market participants) do not have the ability to achieve the same synergies. Instead, to the extent that the purchase price considered the value of the buyer-specific synergies, it would impact the residual ascribed to goodwill.
Market participant synergies can vary depending on the characteristics of the market participants. Strategic buyers are more likely to realize synergies because they are more likely to have overlapping functions with that of the acquired entity. Conversely, a financial buyer may be unable to combine the target with another company or business and is more likely to focus on improving efficiencies of the target as a standalone business.
Some synergies in a business combination may be easily identified and quantified, but there may be other synergies whose characteristics will require significant judgment in determining whether they are market participant or buyer-specific. Examples of synergies that strategic buyers may be able to generate include cost savings from reducing staff, consolidating distribution, closing facilities, and eliminating duplicate departments (e.g., human resources, finance and accounting, sales, and engineering). Financial buyers often also achieve cost reductions, although they may be less likely to have duplicate key functions. Other types of synergies may consist of revenue enhancements resulting from the buyer being able to sell the target’s products to its customers and vice versa.
Transaction documents may provide a useful starting point when identifying synergies. Most transaction materials discuss synergies, but do not necessarily attribute them to market participant and entity-specific categories. A robust process should be used to categorize synergies when developing market participant assumptions for fair value measurements. Transaction documents may include analyses of the following:
  • Current industry trends (e.g., consolidation) and whether the specific transaction aligns with those trends
  • Motivations of key competitors, both those that participated in a bidding process and those that did not participate (including the reasons that they did not participate)
  • The acquired entity’s growth and profitability prospects on a standalone basis and in conjunction with the operations and perspectives of the potential market participants (i.e., the actual and potential bidders). This analysis should take into account the acquired entity’s expected performance within the context of key competitors’ performance, industry performance, and the overall economy
  • Strategic intent of the acquirer versus the intent of the potential market participants to determine the rationale for the transaction

7.2.4 Determining the highest and best use

The highest and best use is the use by market participants that maximizes the value of the asset or group of assets and liabilities. The concept refers to both the different ways of utilizing the individual asset (e.g., a factory or residential site) as well as whether the maximum value is on a standalone basis or in combination with other assets. ASC 820-10-35-10C indicates that the highest and best use does not consider management’s intended use.
Ways of utilizing the individual asset
The determination of highest and best use may have a significant impact on the fair value measurement. ASC 820, Example 1, Case B (ASC 820-10-55-30 through ASC 820-10-55-31) illustrates the application of this concept to land acquired in a business combination. In the example, the land is currently used for a factory, but could be developed as a residential site. The highest and best use is determined by the greater of (1) the value of the land in continued use for a factory (in combination with other assets) or (2) the value of the land as a vacant site for residential development (taking into account the cost to demolish the factory and including uncertainty about whether the reporting entity can convert the asset to the alternative use).
Example FV 7-1 discusses the highest and best use of an investment property when redevelopment yields a higher market value.
EXAMPLE FV 7-1
Investment property — highest and best use
An entity owns an investment property, which comprises land with an old warehouse on it. It has been determined that the land could be redeveloped into a leisure park. The land’s market value would be higher if redeveloped than the market value under its current use. For simplicity, assume the warehouse and property are not a business.
Should the fair value be based on the investment property’s current use or the land’s potential market value if the leisure park redevelopment occurred?
Analysis
The property’s fair value should be based on the land’s market value for its potential use. The highest and best use valuation assumes the site’s redevelopment. This will involve demolishing the current warehouse and constructing a leisure park in its place. The market value of the current building is based on the property’s highest and best use (as a leisure park). Therefore, none of the market value should be allocated to the building. The cost to demolish the warehouse and redevelop the land should be included in determining the fair value of the land. The building’s current carrying amount should be written down to zero.


Standalone or in combination
If the highest and best use of an asset is that it should be combined with other assets, one combined fair value may need to be determined. That combined fair value must then be allocated to the individual components based on the unit of account of each.

ASC 820-10-35-11A

The fair value measurement of a nonfinancial asset assumes that the asset is sold consistent with the unit of account specified in other Topics (which may be an individual asset). That is the case even when that fair value measurement assumes that the highest and best use of the asset is to use it in combination with other assets or with other assets and liabilities because a fair value measurement assumes that the market participant already holds the complementary assets and associated liabilities.

If an entity uses an asset under circumstances that are not the highest and best use for that asset, it must disclose that fact. See FSP 20.
Example FV 7-2 evaluates the highest and best use of an asset group when redevelopment yields a higher value than the sum of each asset’s standalone selling price.
EXAMPLE FV 7-2

Valuing assets on a standalone basis or in a group — land
Three adjacent lots of land are acquired as part of a business combination. Each lot could be sold separately for $5 million. As a group, buildings could be raised on the end lots, each of which could share a parking lot (constructed on the third lot). In this area, parking is scarce and buildings with parking sell for more than buildings without parking. With the parking lot, each building would sell for a higher price; the three lots together can be sold for $20 million.
What is the highest and best use of the three adjacent lots of land?
Analysis
The highest and best use of these lots is to develop them as buildings with a parking lot. A market participant would take the center lot and use it as a parking lot to maximize the value of the lots.

This fact pattern is different from the portfolio scenario (discussed in FV 7.5.2.1) as the assets in the example work together in use. This does not happen in a portfolio. In a portfolio, you can replace an asset with a similar one without impacting the value of the rest of the portfolio. In an in use scenario there is presumably no other piece of property that could be acquired that could replace one of the three in the example and generate a similar or higher combined value. If such a scenario existed, then that would be the highest and best use.
Example FV 7-3 demonstrates the highest and best use and resulting fair value of two assets that are more valuable when consumed together.
EXAMPLE FV 7-3

Valuing assets on a standalone basis or in a group — other assets
A pharmaceutical company acquires a company with two drugs. Drug A is a cholesterol lowering drug. By itself, Drug A is moderately effective. Drug B is another moderately effective cholesterol lowering drug. When taken together, Drug A and Drug B are highly effective at lowering cholesterol levels.
On a standalone basis, Drug A has a fair value of $100 million and Drug B has a fair value of $150 million. When the drugs are valued together, Drug A and Drug B have a combined fair value of $650 million.
What is the highest and best use, and resulting fair value of these drugs?
Analysis
The highest and best use of these drugs is to sell the products together. As a result, the total fair value of Drug A and Drug B should equal $650 million. The value should be allocated to Drug A and Drug B (units of account) in a systematic and rational way reflecting the contributions of each drug.

Example FV 7-4 illustrates the highest and best use of a group of assets when market participants are strategic and financial buyers.
EXAMPLE FV 7-4
Application of the highest and best use concept
A strategic buyer acquires a group of assets (Assets A, B, and C) in a business combination. Asset C is a billing software system developed by the acquired entity for use with Assets A and B. The acquirer determines that each asset would provide maximum value to market participants principally through its use in combination with the other assets in a group; therefore, the highest and best use is in a group rather than standalone valuation premise. The unit of valuation is the asset group, which consists of Assets A, B, and C. In determining the highest and best use, the acquirer determines that market participants for Assets A, B, and C would represent both strategic and financial buyers. Strategic and financial buyers each possess different characteristics related to the use of the individual assets. The strategic buyer group has related assets that would enhance the value of the asset group. Specifically, strategic buyers have substitute assets for Asset C (the billing software). Asset C would be used only for a transitional period. The indicated fair values of individual Assets A, B, and C within the strategic buyer group were determined to be $360 million, $260 million, and $30 million, respectively. The indicated fair value for the assets collectively within the strategic buyer group is $650 million.
The financial buyer group does not have substitute assets that would enhance the value of the asset group (i.e., Asset C). Therefore, financial buyers would use Asset C for its full remaining economic life and the indicated fair values for individual Assets A, B, and C within the financial buyer group were determined to be $300 million, $200 million, and $100 million, respectively. The indicated fair value for the assets collectively within the financial buyer group is $600 million.
Which fair value should be used to determine the highest and best use of the asset group?
Analysis
The fair values of Assets A, B, and C would be determined based on the use of the assets within the strategic buyer group, because the fair value of the asset group of $650 million is higher than the asset group for the financial buyer ($600 million). The use of the assets in a group does not maximize the fair value of the assets individually; it maximizes the fair value of the asset group. Thus, even though Asset C would be worth $100 million to the financial buyers, its fair value for financial reporting purposes is $30 million.

7.2.5 Appropriate valuation approaches and techniques/methods

As described in FV 4.4, ASC 820 requires consideration of three broad valuation approaches: market approach, cost approach, and income approach, and the techniques (or methods) consistent with each. ASC 820 uses the term “technique” while valuation professionals use the term “method” to refer to the same thing.
ASC 820 does not prescribe which valuation approaches or techniques should be used when measuring fair value and do not prioritize among the techniques. Instead, ASC 820-10-35-24 states that reporting entities should measure fair value using the valuation approaches and techniques that are appropriate in the circumstances and for which sufficient data are available.
The application of the various approaches and techniques may indicate different estimates of fair value. These estimates may not be equally representative of fair value due to factors such as assumptions made in the valuation or the quality of inputs used. Using multiple valuation approaches and/or techniques can act as a check on these assumptions and inputs. The reporting entity may need to apply additional diligence in the valuation if the range of values is wide. Fair value will be based on the most representative point within the range in the specific circumstances.

7.2.5.1 Income approach

ASC 820-10-55-3F defines the income approach as follows:

ASC 820-10-55-3F

The income approach converts future amounts (for example, cash flows or income and expenses) to a single current (that is, discounted) amount. When the income approach is used, the fair value measurement reflects current market expectations about those future amounts.

The income approach is applied using the discounted cash flow (DCF) method, which requires (1) estimating future cash flows for a certain discrete projection period; (2) estimating the terminal value, if appropriate; and (3) discounting those amounts to present value at a rate of return that considers the relative risk of the cash flows. The income approach is frequently used as a primary valuation approach for the individual assets acquired, particularly intangible assets, and liabilities assumed in a business combination other than for financial assets and real property.

7.2.5.2 Market approach

The market approach is often used as a primary valuation approach for financial assets and liabilities when observable inputs of identical or comparable assets are available (e.g., real estate). It can also be used to value a business or elements of equity (e.g., NCI). The market approach may also be used as a secondary approach to evaluate and support the conclusions derived using an income approach. The market approach is not frequently used as a primary valuation approach for the individual assets acquired and liabilities assumed in a business combination other than for financial assets and real property. Individual assets and liabilities, particularly intangible assets, are seldom traded in active markets or only change hands in transactions with little information publicly disclosed.

7.2.5.3 Cost approach

The cost approach is typically used to value assets that can be easily replaced. The cost approach is rarely used as a primary valuation approach to measure the fair value of a business enterprise because it does not capture the going concern value of a business. The sum of the replacement values of a collection of assets and liabilities generally has less value than an integrated business with established operations because the cost approach would not reflect the synergistic value of the assets and liabilities operating together. The cost approach is seldom used as a valuation approach to measure the fair value of an intangible asset that is a primary intangible asset of the business because it does not capture the opportunity cost of owning the asset or the cost of unsuccessful ideas that were attempted in the process of creating the intangible asset.
1 Represents the present value at the end of the discrete projection period of all subsequent cash flows to the end of the life of the asset or into perpetuity if the asset has an indefinite life.
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