AASB issues long-awaited fair value measurement guidance for not-for-profit public sector entities

On 22 December 2022, the Australian Accounting Standards Board (AASB) published amendments to AASB 13 Fair Value Measurement that provide additional guidance to not-for-profit (NFP) public sector entities determining fair value of assets not held primarily for their ability to generate cash inflows. The amendments are contained in amending standard, AASB 2022-10 Amendments to Australian Accounting Standards – Fair Value Measurement of Non-Financial Assets of Not-for-Profit Public Sector Entities, and are discussed in more detail below.

Highest and best use

Fair value measurement of a non-financial asset assumes that a market participant would either:

  • Use the asset according to its ‘highest and best use’, or
  • Sell it to another market participant who would use the asset according to its ‘highest and best use’.

When considering ‘highest and best use’ of non-financial assets, preparers of financial statements take into account the use of the asset that is physically possible, legally permissible and financially feasible.

Highest and best use must be financially feasible

NFP public sector entities dealing with assets that are not held primarily for their ability to generate cash inflows would find it difficult to justify that a different use of the asset is ‘financially feasible’ considering that they typically do not provide a financial return, but are held to enable government services to be provided.

AASB 2022-10 therefore clarifies for these entities that an asset’s use is financially feasible if market participants, including, but not limited to other NFP public sector entities, would be willing to invest in the asset’s service capacity, considering both:
  • The capability of the asset to be used to provide needed goods or services to beneficiaries
  • The resulting cost of those goods or services.

When is ‘current use’ assumed to be ‘highest and best use’?

An entity’s ‘current use’ of a non-financial asset is presumed to be its ‘highest and best use’ unless market or other factors suggest that a different use by market participants would maximise the value of the asset (AASB 13, paragraph 29).

This requirement could often prove complex for NFP public sector entities having to identify hypothetical, alternative uses for their assets and determining value associated with those alternative uses.

The process of searching for ‘highest and best use’ could result in additional costs to NFP public sector entities in cases where it is very unlikely that the asset would, or could, be used other than for its current use. For example, where:

  • The asset is specialised and costs to convert to an alternative use would be high
  • The asset is used to provide services to the public, and the entity is highly likely to continue using the asset to provide the services to the public.

AASB 2022-10 therefore clarifies that NFP public sector entities are only required to consider whether ‘highest and best use’ differs from ‘current use’ for a non-financial asset not held primarily to generate cash inflows at the measurement date when it is either:

  • Classified as held for sale or held for distribution to owners under AASB 5 Non-current Assets Held for Sale and Discontinued Operations, or
  • Highly probable that the asset will be used for an alternative purpose to its current use. To be highly probable, all of the following criteria must be met:
    • The alternative purpose is physically possible, legally permissible, and financially feasible (as explained above)
    • The appropriate level of management is committed to a plan to change the use of the asset to the alternative purpose, and an active programme to complete the plan has been initiated
    • Any approvals required to change the asset’s use have been obtained
    • Based on reasonably available information, it is highly probable that the current use of the asset will cease under the plan within one year.

These requirements should relieve some of the burden of needing to consider alternative uses for public sector reporters’ assets.

Market participant assumptions

AASB 13 requires entities to measure fair value using assumptions that market participants would use when pricing an asset or a liability. However, they need not identify specific market participants. AASB 13 also requires entities to use valuation techniques that maximise the use of observable inputs and minimise the use of unobservable inputs.

Unobservable inputs are those for which observable market data is not available. Instead, they must be developed using the best information available about assumptions that market participants would make when pricing the asset or liability. When developing unobservable inputs, the entity:

  • May begin with its own data
  • Then adjust that data if there is reasonably available information that market participants would use different data.

The entity is not required to do an exhaustive search to obtain information about market participant assumptions.

Observable market data is not always freely available for non-financial assets of NFP public sector entities (for example, because they are specialised assets, or have specific service delivery purposes).

In such cases, NFP public sector entities must use their own assumptions as a starting point to develop unobservable inputs, and then adjust those assumptions to the extent reasonably available information indicates that other market participants would use different data.

Refer AASB 13, Illustrative Example 3

NFP public sector entities are not required to apply exhaustive efforts to identify whether other market participant assumptions are reasonably available, or whether the entity’s own data should be adjusted. However, when information about other market participant assumptions is reasonably available, then this cannot be ignored.

Application of the cost approach

The cost approach reflects the amount that would be required currently to replace the service capacity of an asset. This is often referred to as current replacement cost (CRC). CRC is based on the cost that a market participant buyer would incur to buy or construct a substitute asset of comparable utility, adjusted for obsolescence.

When determining fair value using CRC for non-financial assets not held primarily to generate cash inflows, NFP public sector entities must:
  • Firstly, estimate the cost currently required for a market participant buyer to acquire or construct a reference asset
  • Secondly, adjust the estimate above for any:
    • Differences between the current service capacity of the reference asset and the subject asset (for example where the modern equivalent asset is engineered to a higher standard than the subject asset)
    • Obsolescence (physical deterioration, functional obsolescence, and economic obsolescence).

Note: The subject asset is the asset for which the fair value measurement is being determined. The reference asset is a suitable alternative to the subject asset that a market participant buyer would consider when developing pricing assumptions about the subject asset. Judgement is required to identify the most appropriate reference asset.

Estimating the replacement cost of a reference asset

AASB 2022-10 notes the following guidance for NFP public sector entities when estimating the replacement cost of the reference asset:

  • Assume that the reference asset will be acquired or constructed at the subject asset’s existing location
  • If the market selling price of a comparable asset and market participant data needed to measure fair value of the reference asset are not observable:
    • Use the entity’s own assumptions as a starting point to develop unobservable inputs to measure current costs required to acquire of construct the reference asset
    • Then adjust those assumptions if reasonably available information indicates that other market participants would use different data
  • Include the following costs in the reference asset’s replacement cost if they are necessarily incurred in the hypothetical acquisition or construction of the reference asset at fair value measurement date:
    • Costs required to restore another entity’s asset, if that asset would be disturbed in a hypothetical acquisition or construction of the reference asset (these costs are not included if the disturbed asset requiring restoration is included in the same consolidated group) – refer AASB 13, Illustrative Example 2
    • Other disruption costs that would hypothetically be incurred when acquiring or constructing the reference asset. For example, if the reference asset such as a drainage pipe is being replaced, operation of the road may be disrupted, and costs of redirecting traffic should be included - refer AASB 13, Illustrative Example 1
    • If the subject asset is fixed to a parcel of land, site preparation costs for the reference parcel of land on which the reference asset would hypothetically be constructed. However, site preparation costs are excluded if they are included in the fair value of the subject parcel of land. Site preparation costs could include costs to prepare the land (e.g. earthworks), as well as costs to remove and dispose of any unwanted existing structures on the land to make way for the hypothetical construction of the reference asset - refer AASB 13, Illustrative Examples 1 and 4
  • For heritage assets - where the heritage features are an essential part of the asset’s service capacity, replacement cost of the reference asset generally means the cost of replacing the heritage features of the subject asset, assuming construction using modern cost-effective materials and processes which are sympathetic to the original heritage design and structure.

Judgement is required to determine which costs would necessarily be incurred when acquiring or constructing the hypothetical reference asset with the same service capacity and condition as the subject asset at measurement date. The entity need not undertake exhaustive efforts to obtain information regarding these costs, but must include them when data is reasonably available.

Economic obsolescence

If a non-financial asset of a NFP public sector entity not held primarily to generate net cash inflows suffers a reduction in demand for its services, adjusting for economic obsolescence as noted above does not require that a formal decision has been made to reduce the physical capacity of that asset.

No adjustment is made for economic obsolescence where surplus service capacity is necessary for ‘stand-by’ or safety purposes (such as to deal with contingencies), even if the surplus capacity is seldom or never used. This could occur, for example, where a back-up electricity generation plant maintains a capacity buffer to cater for periods of peak demand.

Simple example – Economic obsolescence

A public school’s building has capacity for 500 students.

Due to demographic changes, a school for 100 students would meet current and reasonably foreseeable requirements, including a buffer for any temporary or under-estimated student demand.

The school building’s current replacement cost (as new), based on a 500-student capacity is $10 million. After accounting for physical deterioration, this is reduced to $5 million.

Despite a significant reduction in demand for student places at the public school, economic obsolescence identified does not necessarily exhibit a linear relationship with a reduced level of demand. That is, the fair value is not necessarily $1 million after adjusting for economic obsolescence (i.e. 100/500 students X $5 million). This is because the administration office, canteen, toilet block, library and gymnasium might need replacing, even if there are only 100 students, although perhaps on a slightly smaller scale.

The fair value of the public school, after adjusting for economic obsolescence would therefore be somewhere between $1 million and $ 5 million, and assume replacement of the common facilities, albeit on a smaller scale.

Australian Illustrative example five demonstrates another example considering economic obsolescence.

Additional disclosures

If the ‘highest and best use’ of a non-financial asset differs from its current use AASB 13, paragraph 93(i), requires an entity to disclose that fact, and why the non-financial asset is being used in a manner that differs from its highest and best use.

NFP public sector entities with non-financial assets not held primarily to generate cash inflows are only required to disclose the above information if the entity has determined that the asset’s ‘highest and best use’ differs from its ‘current use’ (refer discussion above).

Australian illustrative examples

Five illustrative examples have been added to AASB 13 to demonstrate aspects of the additional Australian Implementation Guidance discussed above:

  • Example one – Costs included in the gross replacement cost of a reference asset for a road
  • Example two – Difference in the asset’s operating environment affecting the reference asset’s gross replacement cost
  • Example three – Whether to adjust the entity’s own assumptions in measuring a non-financial asset
  • Example four – Site preparation costs
  • Example five – Economic obsolescence.

When are the amendments effective?

The AASB 2022-10 amendments, including additional guidance contained in Appendix F Australian implementation guidance for not-for-profit public sector entities, must be applied prospectively for annual periods beginning on or after 1 January 2024, but can be adopted early. If the amendments are adopted early, the NFP public sector entity must disclose that fact.