Academic journal article Journal of Accountancy

Financial Reporting for Real Estate: Will FASB 157 Achieve a Higher and Better Use?

Academic journal article Journal of Accountancy

Financial Reporting for Real Estate: Will FASB 157 Achieve a Higher and Better Use?

Article excerpt

[ILLUSTRATION OMITTED]

EXECUTIVE SUMMARY

* Under FASB Statement no. 157, the highest and best use of all assets, including real property, should be considered when measuring that asset's fair value.

* Fair value should be measured from a market participant's perspective-what the property would likely sell for in that asset's principal or most advantageous market-and considering the typical buyers for the asset.

* For improved properties, the highest and best use analysis requires an examination of the property's use "as vacant" and "as improved," and the uses may not necessarily be the same. The potential differences may affect the fair value reporting of real property assets.

* Statement no. 157 allows the consideration of the highest and best use of a group of assets if market participants would pay more for the group of assets in combination than they would for the assets individually.

* Specifics of how to allocate real property component values under Statement no. 157 are still being evaluated by the market, and the full impact may not be known until implementation is well under way.

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FASB Statement no. 157, Fair Value Measurements, introduces new concepts and practices to the world of financial reporting, including some that are beginning to impact the fair value measurements of real estate assets. "Highest and best use" is one of these concepts.

As it applies to fair value measurements of real property assets, highest and best use is actually a basic concept. Put simply, highest and best use is the use that maximizes the property's value. Historically, the highest and best use concept has not been consistently applied when valuing real property for financial reporting purposes, and Statement no. 157 will potentially impact the valuation of all tangible and intangible assets. This article addresses some of the more important expected changes to fair value measurements of real property assets, what challenges valuation specialists should expect when performing a valuation using Statement no. 157, and what aspects auditors and accountants should consider when using the work of a valuation specialist.

WHAT IS STATEMENT NO. 157?

Statement no. 157 provides guidance on fair value measurements, whenever such measurements are required or permitted in other FASB statements. Think of Statement no. 157 as an overlay for other statements to be used whenever fair value reporting is involved. As many as 60 other FASB statements are affected by Statement no. 157. For a comprehensive overview of the standard, see "Refining Fair Value Measurement," JofA, Nov. 07, page 30. While Statement no. 157's impact on the valuation of complex financial instruments has come under scrutiny as a result of the financial crisis, we focus here on its impact on real property valuation.

While fair value measurements can be applied to a single asset or group of assets, the maximum price is driven by the highest and best use concept. Although highest and best use is not new as a concept for valuation and is one of the most important factors underlying a real estate valuation, certain standards, such as those for purchase price accounting for business combinations (Statement no. 141 before the issuance of the revised Statement no. 141 (R)) or for impairment testing of goodwill or long-lived assets (Statement no. 142 and Statement no. 144, respectively) did not fully embrace the concept of highest and best use.

Historically, a valuation of real property was based on an entity's intended use of the property. However, because fair value is a market-based measurement and not an entity-specific measurement, under Statement no. 157 the property should be valued at its highest and best use to a typical market participant. That use can be determined only after analyzing alternative land uses and, consequently, the fair value of the property can be determined only after the appraiser concludes what the highest and best use for the site is, as the highest and best use conclusion may help determine which techniques should be used in the valuation. …

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