Key Takeaways
- Highest and best use applies only to non-financial assets; financial instruments are excluded because they have no alternative physical use.
- The analysis considers three filters: physical possibility, legal permissibility, and financial feasibility.
- IFRS 13.29 presumes that the asset's current use is its highest and best use unless market evidence indicates otherwise.
- Failing to assess highest and best use can misstate fair value by 20% or more when a property's market value as redeveloped exceeds its value under current use.
What is Highest and Best Use?
IFRS 13.27 requires the fair value measurement of a non-financial asset to reflect the use that market participants would consider when pricing the asset. That use does not need to match the entity's intended use. A manufacturer holding a warehouse in a district rezoned for residential development must consider whether a market participant would price the warehouse as industrial storage or as a residential redevelopment site. The answer determines the fair value.
IFRS 13.28 sets out the three conditions. The use must be physically possible (the site's size, location, and condition support it), legally permissible (zoning, permits, and contractual restrictions allow it), and financially feasible (the use generates a return sufficient to justify any conversion cost). IFRS 13.29 creates a practical presumption: the entity may assume current use is highest and best use unless market or other factors suggest otherwise. That presumption, however, is rebuttable. ISA 540.13(a) requires the auditor to evaluate whether management's chosen valuation technique reflects the correct use assumption before accepting the output. When market evidence points to an alternative use, the auditor who accepts current-use valuation without challenge risks understating assets on the balance sheet.
Worked example: De Wit Vastgoed B.V.
Client: Dutch real estate company, FY2025, revenue EUR 130M, IFRS reporter. De Wit holds a 4,200 m² commercial office building in Rotterdam acquired in 2018 for EUR 9,500,000. The building is currently leased to a single tenant generating annual rental income of EUR 620,000. The carrying amount at 31 December 2025 is EUR 8,800,000 (measured at fair value under IAS 40). In 2024 the municipality rezoned the surrounding blocks for mixed-use residential and commercial development, and two comparable sites within 500 metres sold for residential conversion at prices 35% above their office-use valuations.
Step 1 — Assess physical possibility
The building sits on a 2,100 m² plot with no structural constraints preventing conversion to residential units. An independent surveyor confirms that the load-bearing structure supports residential floor plans without major reinforcement.
Step 2 — Assess legal permissibility
The 2024 rezoning permits residential development up to eight storeys on this plot. The existing tenant lease expires in March 2027 with no renewal option. No heritage designation or environmental restriction applies.
Step 3 — Assess financial feasibility
De Wit's external valuer models two scenarios. Under current office use, the building's fair value (income capitalisation at a 7.1% yield) is EUR 8,730,000. Under residential conversion, the valuer estimates a gross development value of EUR 14,200,000 for 38 apartments, less conversion costs of EUR 2,900,000 and a developer's margin of 15% (EUR 2,130,000), producing a residual land value of EUR 9,170,000. The residential-conversion value exceeds current-use value by EUR 440,000.
Step 4 — Determine highest and best use and measure fair value
Residential conversion passes all three filters and produces a higher value. IFRS 13.27 requires fair value to reflect this use. De Wit records the building at EUR 9,170,000, an uplift of EUR 370,000 from the prior carrying amount of EUR 8,800,000, recognised in profit or loss under IAS 40.35.
Conclusion: the fair value of EUR 9,170,000 reflecting residential conversion is defensible because all three IFRS 13.28 conditions are satisfied with external evidence, the residual-value approach rests on observable comparable transactions, and the prior current-use assumption was rebutted by market activity in the immediate vicinity.
Why it matters in practice
Teams accept the entity's current-use assumption without testing whether market evidence supports an alternative use. IFRS 13.29 creates only a rebuttable presumption, not a safe harbour. When zoning changes or comparable transactions suggest a higher-value use, the auditor must challenge the assumption or risk understating the asset's fair value. ISA 540.13(b) requires evaluation of whether the assumptions underlying the estimate (including the use assumption) are appropriate for the method applied.
Entities treat the three conditions as a checklist but fail to document financial feasibility with actual numbers. Recording that an alternative use is "physically possible and legally permissible" without modelling whether it generates adequate returns leaves the highest-and-best-use conclusion unsupported. IFRS 13.91 requires disclosure of the valuation techniques and inputs used, and an unquantified feasibility assertion does not satisfy that requirement.
Highest and best use vs. existing use
| Dimension | Highest and best use (IFRS 13) | Existing use |
|---|---|---|
| Definition | The use that maximises value from a market-participant perspective | The use to which the entity currently puts the asset |
| Measurement basis | May require modelling an alternative use scenario (e.g., residential conversion of a commercial property) | Reflects the asset's current income stream or operational contribution |
| When they diverge | Rezoning, market shifts, or physical improvements create a higher-value alternative | Divergence signals that the entity's current deployment of the asset is suboptimal from a market perspective |
| Standard requirement | IFRS 13.27–33 mandates highest and best use for all non-financial asset fair value measurements | No IFRS requirement exists to measure at existing use; it is the default only when the IFRS 13.29 presumption holds |
| Audit risk | Understated fair value if the auditor accepts existing use without testing market evidence | Overstated fair value if the entity assumes an alternative use that fails one of the three feasibility conditions |
The distinction matters on engagements involving investment property and owner-occupied property measured at revalued amounts because the difference between existing-use and highest-and-best-use valuation can be material. An auditor who does not ask whether the IFRS 13.29 presumption still holds may sign off on a fair value that understates the asset by hundreds of thousands of euros.
Related terms
Frequently asked questions
Does highest and best use apply to financial instruments?
No. IFRS 13.31 limits the concept to non-financial assets. Financial instruments (bonds, derivatives, equity investments) do not have an alternative physical use, so their fair value is measured based on the instrument's contractual cash flows and market pricing without a use assessment. The concept is most relevant to property, plant, equipment, and investment property measured at fair value.
What happens if highest and best use differs from the entity's intended use?
The entity still measures fair value based on highest and best use per IFRS 13.27. If a market participant would pay more for the asset under an alternative use, that alternative drives the measurement regardless of management's plans. The entity does not need to convert the asset. It only needs to reflect in the fair value what the market would pay. IAS 40.51 requires investment property fair value to incorporate market-participant assumptions, reinforcing this principle.
How do I document that current use is highest and best use?
State the conclusion explicitly in the working paper, then record the basis. If no rezoning, comparable sales at higher-value uses, or physical conversion opportunities exist, reference the absence of contradicting market evidence under IFRS 13.29. If indicators of an alternative use do exist, document why the alternative fails one of the three IFRS 13.28 conditions (physical, legal, or financial). ISA 540.18 requires the auditor to evaluate the reasonableness of the entity's conclusion, so the file must show the evidence considered.