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?
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.
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?
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 188.8.131.52
) 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?
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?
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.