Fair Value of Non-Financial Assets: Measurement, Framework, and Practical Example

Fair value has an important role in modern financial reporting: While much attention is given to the valuation of financial instruments, fair value measurement of non-financial assets — such as property, plant, equipment, biological assets, and intangible assets — is just as important and often more complex.

These assets are not typically traded on active markets. Instead, their value depends on assumptions about use, location, market participants, and economic conditions — all of which must be evaluated objectively to achieve consistent and reliable fair value estimates.

This article explores the definition, measurement hierarchy, and application of fair value for non-financial assets, under both IFRS 13 and ASC 820, with a step-by-step numerical example.

1. What Is Fair Value?

Under both IFRS 13 and ASC 820, fair value is defined as:

“The price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date.”

This is a market-based measurement, not an entity-specific one. It assumes a hypothetical sale — even if the entity has no intention of selling the asset — and reflects conditions in the principal (or most advantageous) market.

2. Scope: When Fair Value Applies to Non-Financial Assets

Fair value measurement of non-financial assets is required in various situations, including:

• Impairment testing (IAS 36 / ASC 360)

• Revaluation of property, plant and equipment (IAS 16)

• Investment property measurement (IAS 40)

• Biological assets (IAS 41)

• Business combinations (IFRS 3 / ASC 805)

• Asset retirement obligations (ASC 410)

In most of these cases, fair value is either the measurement basis or the benchmark for testing recoverability.

3. Fair Value Hierarchy

IFRS and U.S. GAAP classify fair value inputs into a three-level hierarchy, based on their observability and reliability:

• Level 1: Quoted prices in active markets for identical assets

• Level 2: Observable inputs other than quoted prices (e.g., prices for similar assets, interest rates, market multiples)

• Level 3: Unobservable inputs (e.g., discounted cash flows, appraisals, internal projections)

Most non-financial assets fall into Level 2 or Level 3, due to the absence of active markets and reliance on entity-specific inputs.

4. Highest and Best Use Principle

For non-financial assets, fair value must reflect their highest and best use — i.e., the use that would maximize the asset’s value to market participants.

This evaluation considers:

• Physical possibility (e.g., location, zoning, condition)

• Legal permissibility (e.g., applicable regulations or contracts)

• Financial feasibility (e.g., whether the use would generate a market return)

If the asset is used in combination with other assets (e.g., machinery within a factory), the fair value should reflect its value as part of that group, not on a stand-alone basis.

5. Valuation Techniques

Common valuation techniques for non-financial assets include...

A. Market Approach

• Based on comparable asset sales or market prices

• Adjusts for differences in size, condition, or location

• Often used for real estate and tangible assets

B. Cost Approach

• Based on replacement or reproduction cost, less depreciation

• Suitable for specialized or unique assets with no active market

• Must reflect physical deterioration and functional or economic obsolescence

C. Income Approach

• Based on the present value of future economic benefits

• Used when the asset generates identifiable cash flows

• Involves estimating future cash flows and discounting at an appropriate rate

6. Step-by-Step Numerical Example: Fair Value of a Factory Building

A company owns a 10,000 square foot factory building in an industrial zone. The property is in good condition and was built in 2005. Management intends to estimate its fair value using the market approach, based on recent sales of comparable buildings.

A valuation expert identifies three recent comparable transactions in the same or nearby areas:

• The first building sold for $1.2 million, but it is slightly larger (11,000 sq. ft). After adjusting downward by $60,000 for size difference, the adjusted comparable price is $1.14 million.

• The second property sold for $1.05 million and is smaller (9,500 sq. ft), but in better condition. The valuer reduces this comparable by $70,000 due to the superior condition, arriving at an adjusted price of $980,000.

• The third building is similar in size (10,000 sq. ft) but in worse condition, and sold for $1.1 million. Given the subject building's better state, the appraiser adjusts upward by $80,000, resulting in an adjusted value of $1.18 million.

Taking the average of these three adjusted prices — $1.14 million, $980,000, and $1.18 million — the estimated fair value is calculated as $1.1 million.

This reflects a Level 2 measurement under the fair value hierarchy, based on observable market data with professional adjustments.

7. Disclosure Requirements

Under IFRS 13 and ASC 820, companies must disclose:

• Valuation techniques and inputs used

• The level in the fair value hierarchy

• A reconciliation of opening and closing balances for Level 3 assets

• Sensitivity analysis (for IFRS) showing how changes in inputs affect fair value

• Any transfers between fair value levels and the reasons for them

These disclosures help users assess the subjectivity and risk in fair value measurements.

8. Common Challenges and Audit Focus Areas

Fair value estimation for non-financial assets involves significant judgment. Key issues include:

• Unverifiable assumptions in Level 3 valuations

• Over-optimistic cash flow forecasts in income approaches

• Failure to apply highest and best use principle

• Omitted obsolescence or market downturns in the cost approach

• Lack of consistency in valuation methods across periods