AASB 2022-10: Updated Fair Value Guidance for Not-for-Profit Entities

Not for profit entities should consider updated implementation guidance on how to value their non-financial assets for years ending on or after 31 December 2024.

This standard, AASB 2022-10 Amendments to Australian Accounting Standards – Fair Value Measurement of Non-Financial Assets of Not-for-Profit Public Sector Entities, makes amendments to AASB 13 Fair Value Measurement that are applicable to not-for-profit public sector entities.

The amendments are to be applied prospectively to annual periods beginning on or after 1 January 2024.  The amendments also include five detailed illustrative examples which cover various aspects of the changes. These amendments apply to the public sector only. They cannot be used by private sector not-for-profit entities.

The amendments to AASB 13 are limited to non-financial assets that are not held primarily for their ability to generate net cash inflows, such as those held for the purpose of providing services to the public. They relate to:

• the asset’s highest and best use
• what assumptions to make around market participants 
• estimating the cost of a reference asset when applying the cost approach
• economic obsolescence of assets

Highest and best use

What is financially feasible?

The highest and best use of a non-financial asset takes into account the use of the asset that is physically possible, legally permissible and financially feasible.

Assets held by not-for-profit public sector entities are usually not held primarily for their ability to generate cash inflows or financial returns.  This raises the question of whether use of such assets is financially feasible, considering the assets are held for their ability to provide services and do not provide financial return.

To address this issue AASB 2022-10 para Aus28.1 specifies that:

The asset’s use is ‘financially feasible’ if market participants 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 and the resulting cost of those goods or services. 

Is the current use the highest and best use?

Under AASB 13, “Highest and best use is determined from the perspective of market participants, even if the entity intends a different use. However, 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.”

The requirement to identify different use by market participants that would maximise the value of the asset can be complex and can result in significant additional costs, especially when the asset is held to provide a specific service and has limited or no alternative use.

To address this issue AASB 13 has been amended to specify that for not-for-profit entities, the entity is required to consider whether the asset’s highest and best use differs from its current use only when, at the measurement date, it is:

1. classified as held for sale or held for distribution to owners in accordance with AASB 5 Non-current Assets Held for Sale and Discontinued Operations; or 
2. highly probable that the asset will be used for an alternative purpose to its current use.

To be highly probable that the asset will be used for an alternative purpose to its current use when, at the measurement date, all the following conditions must be met:

1. the alternative purpose for the asset is physically possible, legally permissible and financially feasible; 
2. the appropriate level of management is committed to a plan to change the use of the asset to that alternative purpose, and an active programme to complete the plan has been initiated; 
3. any approvals required to change the asset’s use have been obtained; and 
4. based on reasonably available information, it is highly probable that the current use of the asset will cease under the plan within one year.

We expect the circumstances in which the conditions above are met to be relatively rare.  Therefore this amendment should provide relief for public sector not-for-profit entities by allowing them to only consider the current use of their assets when determining the fair value.

Example
A State Government owns a building in a desirable inner-city location, which is zoned for commercial use.  It is currently used for a medical facility. The building may be able to generate a substantial return if it were converted to a commercial office premises, and there is no legal or financial impediment to doing this. However, the revised AASB 13 would not require the State Government to consider the value of the building for alternative uses, and any valuation under AASB 13 would only need to consider its use as a medical premises.

Market participant assumptions to use for assets not held primarily for cash flows

Fair value is defined as the price that would be received to sell an asset in an orderly transaction between market participants at the measurement date.

For public sector entities, assets are usually utilised to provide specific services, and therefore they are unlikely to have identifiable market participants other than the entity that holds the assets.  Therefore there is minimal observable market data available with which to make assumptions.

In order to address this issue, not-for-profit public sector entities are permitted to use their own assumptions as a starting point to develop unobservable inputs.  They should then adjust those assumptions to the extent that reasonably available information indicates other market participants would use different data. 

This will simplify the process for many public sector entities, as they will not be required to undertake exhaustive effort to identify whether relevant information about other market participant assumptions is reasonably available or whether the entity’s own data should be adjusted.  However, when such information is reasonably available, tit must be considered when determining fair value.

Application of cost approach

AASB 13 does not mandate any particular methodology in determining fair values.  In the public sector, the cost approach is commonly used.  The cost approach reflects the amount that would be required currently to replace the service capacity of an asset which is often referred to as current replacement cost (CRC). CRC is based on the cost that would be incurred to buy or construct a substitute asset of comparable utility, adjusted for obsolescence.  It should be emphasised that CRC is not the same as Depreciated Replacement Cost, because it considers various internal and external obsolescence factors, not just the depreciation calculated for financial reporting purposes.

AASB 2022-10 provides new guidance on how the cost approach is to be applied to measure the asset’s fair value for not-for-profit public sector entity.

When measuring fair value using CRC for assets not held primarily to generate cash inflows:

1. Estimate the cost currently required for a market participant buyer to acquire or construct a reference asset 
2. Adjust the estimated replacement cost for:
   1. 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)
   2. Obsolescence (physical deterioration, functional obsolescence, and economic obsolescence).

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

Public sector not-for-profit entities should follow the guidance below when estimating the cost of a replacement asset

• Assume that the reference asset will be acquired or constructed at the subject asset’s existing location; and
• Apply judgement in determining which costs would necessarily be incurred in the hypothetical acquisition or construction of a reference asset with the same service capacity and condition as the subject asset at the measurement date. The entity need not undertake exhaustive efforts to obtain information regarding these costs, but must include them when data is reasonably available.
• If both market selling price of a comparable asset and market participant data required 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 or construct the reference asset; and
  • Adjust those assumptions to the extent that 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 to hypothetically acquire or construct the reference asset:
  • Costs required to restore another entity’s asset, if that asset would be disturbed in a hypothetical acquisition or construction of the reference asset unless these costs relate to restoration of an asset included in the same consolidated group to which the entity belongs.
  • Other disruption costs that would hypothetically be incurred when acquiring or constructing the reference asset. For example, costs of redirecting traffic during road construction should be included - refer to 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

Example 
A local government entity owns a building, and the associated land, which it measures on the revaluation basis.  Located on one corner of the land is an electrical substation, which is under the control of an electrical distribution company.  If it were to redevelop the site, the local government would need to relocate the electrical substation temporarily, and then replace it on completion of the redevelopment. The costs of relocating and restoring the substation would need to be included in determination of CRC, as it would be part of the cost that any market participant would incur.

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.

Economic obsolescence of assets

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

Where surplus service capacity is necessary for ‘stand-by’ or safety purposes (such as to deal with contingencies), adjustment for economic obsolescence is not required, even if the surplus capacity is seldom or never used. This could occur, for example, in an electricity generation plant that maintains a generating capacity buffer to cater for periods of peak demand.

Additional disclosure

If the ‘highest and best use’ of a non-financial asset differs from its current use, an entity should disclose that fact and why the non-financial asset is being used in a manner that differs from its highest and best use.

This disclosure is only required if the highest and best use differs from its current use.

FOR MORE INFORMATION

For further information, please contact the authors or your local RSM office