Magazine article The CPA Journal

Interpreting 'Legally Permissible' in Applying Fair Value Guidelines

Magazine article The CPA Journal

Interpreting 'Legally Permissible' in Applying Fair Value Guidelines

Article excerpt

When issued, FASB Statement of Financial Accounting Standards (SFAS) 157, Fair Value Measurements (now largely captured in Accounting Standards Codification [ASC] Topic 820), sought to bring a consistent definition and framework to the deployment of fair value measurements in accounting. It is expected that the fair value frontier will continue to push outward and eventually encompass more than just financial assets and liabilities. Already, such is the case for allocating purchase price among all the assets and liabilities acquired in a business acquisition transaction. Similar issues arise in testing for impairment.

As with any sweeping rule change, a new realm of technical questions and problems can be expected. Clearly, FASB was thoughtful of the imprecision and subjective nature inherent in fair value assessments. Thus, FASB sought to provide considerable guidance, such as in providing a fair value hierarchy with three alternative levels of asset valuation (e.g., values based upon quoted prices in active markets). Further, great care was taken to provide exceedingly precise definitions. For instance, ASC 820-10-35-10 provides specific guidance on the application of fair value measurement to assets:

A fair value measurement assumes the highest and best use of the asset by market participants, considering the use of the asset that is physically possible, legally permissible, and financially feasible at the measurement date. Highest and best use is determined based on the use of the asset by market participants, even if the intended use of the asset by the reporting entity is different.

Precision has its own trappings, however, and care is needed to apply proper judgment in application of the standard. In particular, this article will focus on the meaning of "legally permissible" within this specific definition.

Case Study in Real Estate Valuation

Freeway Properties holds a large parcel of undeveloped land. The property is currently used as a hay meadow and is subject to a very nominal ad valorem tax because of agricultural exemption provisions. This parcel abuts a major interstate highway and is within the city limits of a large city named Mega. The property was incorporated (annexed) into the city limits of Mega several years earlier. As is the custom, Mega designated the land as agricultural zoning at the time of its annexation. Other properties in the area are now frequently being rezoned and developed for commercial retail and warehouse usage, consistent with Mega' s master plan for this highway corridor. Nevertheless, Freeway Properties is not yet ready to develop its tract, and prefers to maintain the agricultural zoning and tax status. There is no assurance that the property could be rezoned, but it seems likely than such a request would be approved.

Freeway Properties is being acquired by Ownallco Investments, and a question has arisen about the fair value allocation process. Specifically, should the undeveloped tract of land be valued by Ownallco based upon its agricultural zoning, or should the value attached to the land be based upon its much higher commercial potential? Any amount not assigned to the land will, instead, be assigned to goodwill.

Evaluating Applicable GAAP

Revisiting the previous definition, it seems clear enough that the land must be accounting-valued based upon its agricultural usage. Agriculture is the only legally permissible use. On its face, this answer seems quite clear and unambiguous.

However, this reading is widely inconsistent with the "highest and best use" principles that are intrinsic and explicit throughout the fair value standards. Highest and best use means the use of an asset by market participants that would maximize the value of the asset. A market participant would not acquire the land for agricultural purposes but would base its value on the likelihood of successful rezoning.

The measurement process to assess highest and best use to a typical market participant is necessarily tied to a comprehensive assessment of alternative uses for a property, which in turn may drive which specific valuation techniques are most appropriate. …

Search by... Author
Show... All Results Primary Sources Peer-reviewed


An unknown error has occurred. Please click the button below to reload the page. If the problem persists, please try again in a little while.