Under the concept of highest and best use, fair value is determined based on the price at which an asset could theoretically be employed in its highest and best use, rather than the use in which the asset is currently employed. The highest and best use is subject to the following limitations:
- Physically possible. The physical characteristics and location of the asset may limit its alternative uses. For example, machinery that is bolted into a concrete platform may be so immovable that any other potential highest and best uses are not possible.
- Legally permissible. There may be legal restrictions on how an asset may be used, which bar certain alternative uses. For example, zoning regulations may prevent a plot of land in an industrial area from being used to construct high-rise residential apartments.
- Financially feasible. The alternative use must incorporate the costs incurred to convert the asset to that use, while still producing investment returns.
The highest and best use concept usually only applies to non-financial assets. There is rarely a use for it when valuing liabilities.