Highest and best use applies to nonfinancial assets and takes place when considering the asset in such a way that maximizes its value. Two concepts are important in gaining at least a working knowledge of “highest and best” use: whether the valuation is “in use” or “in exchange.” Here’s a quick definition of each:
In use: This valuation method applies when the company gets the most bang for its buck when it uses the asset with other assets as a group. For example, consider the land on which a manufacturing plant sits. As raw land, it’s not as valuable as it is when considered in combination with the value of the plant.
In exchange: Use this valuation method when the maximum value for the asset comes when considering the asset on a stand-alone basis.
For example, imagine that a manufacturing company has various types of equipment. If a particular piece of equipment is more valuable when considered solo rather than as a part of the whole group, you would use the concept of in exchange to figure the fair value at measurement date if the asset is sold in an open marketplace.
“Highest” and “best use” normally apply only to assets, not to liabilities.