What Is Value in Use? IAS 36 Cash Flows, Discount Rate, Reversals

Value in use is the present value of the future cash flows a company expects to generate by continuing to use an asset, including whatever it can recover when the asset is finally disposed of. The concept is defined in International Accounting Standard 36 (IAS 36) and sits at the heart of impairment testing under IFRS. Unlike a market price, value in use is entity-specific: it measures what the asset is worth inside your business, given your operating plans, not what an outside buyer would pay for it.

That distinction matters. Two companies holding identical equipment can arrive at very different value-in-use figures because their cash flow expectations, cost structures, and risk profiles differ. The number the standard asks for is yours, not the market’s.

The Five Components IAS 36 Requires

IAS 36 breaks the calculation into five elements that together turn uncertain future income into a single present-value number:¹

An estimate of future cash flows the asset will generate and the outflows needed to keep it running.
Expectations about variations in the amount or timing of those cash flows.
The time value of money, captured through a current market risk-free rate.
The price for bearing the uncertainty inherent in the asset.
Other factors, such as illiquidity, that market participants would price into the asset.

Some of these can be built into the cash flow projections themselves; others can be handled through the discount rate. What you cannot do is capture the same risk in both places.

Value in Use Versus Recoverable Amount

This is where impairment testing most often goes wrong. An impairment test does not compare value in use directly against the carrying amount on the balance sheet. IAS 36 introduces a concept called the recoverable amount, defined as the higher of value in use and fair value less costs of disposal.²

Fair value less costs of disposal is what the company could net by selling the asset in an orderly transaction, after selling expenses. The standard takes the higher of the two figures because a rational business would choose whichever path produces more money, whether that means keeping the asset in operation or selling it.

An impairment loss exists only when the carrying amount exceeds the recoverable amount. So even if value in use falls below book value, the asset is not impaired as long as fair value less costs of disposal still clears the carrying amount. Writing an asset down based on value in use alone, without checking the disposal alternative, is one of the more common errors auditors flag.

Building the Cash Flow Projections

The projection is the most labor-intensive part of the calculation. It starts with the most recent financial budgets or forecasts approved by management and looks forward no more than five years.¹ Beyond five years, the standard requires extrapolation using a steady or declining growth rate, unless a rising rate can be justified. That growth rate should not exceed the long-term average for the relevant product, industry, or country.

Inflows include everything the asset or cash-generating unit produces through ongoing operations, plus estimated net disposal proceeds at the end of its useful life. Outflows cover the routine costs of keeping it productive: maintenance, labor, insurance, and similar operating expenses. Historical performance gives a baseline, and current market conditions justify moving the numbers up or down.

What to Leave Out

The exclusions are as important as the inclusions. IAS 36 explicitly requires leaving out three categories:¹

Financing cash flows. Interest, loan repayments, and dividends stay out because the discount rate already accounts for the cost of capital.
Income taxes. The calculation runs on a pre-tax basis, and mixing in tax effects would distort the comparison against the discount rate.
Future restructurings or asset enhancements the company has not yet committed to. The asset must be valued in its current condition. Projected benefits from an uncommitted upgrade stay out, and so do the costs of that upgrade.

Cash outflows already recognized as liabilities, such as pensions or trade payables, are also excluded to avoid double counting. The standard is strict here because inflating projections with uncommitted improvements, or deflating them with already-recorded obligations, would undermine the reliability of the test.

Choosing the Discount Rate

The discount rate turns those projected cash flows into a present value. IAS 36 requires a pre-tax rate that reflects current market assessments of the time value of money and the risks specific to the asset for which the cash flow estimates have not already been adjusted.¹ That last qualifier is critical. If the projections already reflect a particular risk, such as the chance of losing a major customer, the discount rate should not penalize for the same risk a second time.

In practice, most companies start with their weighted average cost of capital and then adjust it for asset-specific or CGU-specific risks. When a readily identifiable market rate does not exist, the entity’s incremental borrowing rate can serve as an alternative starting point. Either way, the rate must match the currency of the projected cash flows and reflect country-specific risks where relevant. A post-tax rate must be grossed up to a pre-tax figure. Government bond yields, particularly longer-dated treasury constant maturity rates, typically anchor the risk-free component.

Small changes in the rate can swing the value-in-use figure by millions, which is why this input attracts the most audit scrutiny.

When the Asset Doesn’t Generate Cash Flows on Its Own

Many assets produce nothing in isolation. A conveyor belt in a factory generates no revenue by itself. IAS 36 handles this by grouping assets into cash-generating units (CGUs), defined as the smallest identifiable group of assets whose cash inflows are largely independent of those from other assets.¹ The goal is to test at the lowest practical level so a healthy asset does not mask a failing one within the same business unit.

Identifying CGUs requires judgment. Management typically looks at how it monitors operations: by product line, geographic region, or individual location. The key question is whether the group could generate cash inflows on its own. If part of an asset’s output feeds another division rather than being sold externally, it can still qualify as a separate CGU when an active market exists for that output, because the company could sell externally if it chose to. Shared costs like corporate overhead do not factor into CGU identification, because the test focuses on inflows.

When You Have to Run the Test

You do not test every asset every quarter. IAS 36 requires an entity to assess at the end of each reporting period whether any indication exists that an asset may be impaired. Only when an indicator is present does a full impairment test become mandatory. The standard lists minimum indicators in two groups:¹

External Indicators

Market value has dropped significantly more than normal aging or use would explain.
Adverse changes in technology, markets, the economy, or the legal environment have occurred or are imminent.
Market interest rates have risen enough to materially reduce the asset’s recoverable amount through a higher discount rate.
The company’s market capitalization has fallen below the carrying amount of its net assets.

Internal Indicators

Evidence of physical damage or obsolescence.
The asset has become idle, the company plans to discontinue or restructure the operation it belongs to, or the company plans to dispose of it earlier than expected.
Internal reports show economic performance is worse than projected.

Two categories skip the trigger-based approach entirely. Goodwill acquired in a business combination and intangible assets with indefinite useful lives (or not yet available for use) must be tested at least annually, regardless of whether any indicator exists.¹

How the Impairment Charge Is Recorded

Once you have the recoverable amount, the mechanics are straightforward. If the recoverable amount is below the asset’s carrying amount, the difference is an impairment loss.² The carrying amount is original cost minus accumulated depreciation and any previously recognized impairment charges.

The loss hits the income statement as an expense, reducing reported net income for the period. The asset’s balance-sheet value is written down to the recoverable amount, and future depreciation is recalculated over the remaining useful life based on that new, lower figure. Management must disclose the impairment in the financial statement notes, including the events that triggered it and whether the recoverable amount was based on value in use or fair value less costs of disposal.

For goodwill, the process runs at the CGU level. Goodwill is allocated to the CGU or group of CGUs that benefits from the business combination, and the test compares that CGU’s carrying amount, including allocated goodwill, against its recoverable amount. Any loss reduces the goodwill first before touching other assets.

Reversing a Previous Impairment

Under IAS 36, a previously recognized impairment loss on any asset other than goodwill can be reversed if the estimates used to calculate recoverable amount have genuinely changed. A jump in projected cash flows, a lower discount rate, or a shift in the basis for recoverable amount can all justify a reversal.³ The reversal is capped: the new carrying amount cannot exceed what it would have been, net of depreciation, had no impairment ever been recognized.¹ The mere passage of time does not qualify as a change in estimates, so the unwinding of the discount alone will not trigger a reversal. Goodwill impairments are permanent and can never be reversed.

A Note on US GAAP

Value in use is an IFRS concept. If you report under US GAAP, ASC 360 governs long-lived asset impairments and uses a different model: a screen based on undiscounted future cash flows, and, if that screen fails, a loss measured against fair value under the ASC 820 market-participant definition. Because IAS 36 never uses undiscounted cash flows and allows entity-specific value in use to carry the recoverable amount, the two frameworks can produce different impairment outcomes for the same asset in the same conditions. US GAAP also prohibits reversing an impairment loss on a long-lived asset once recognized. For companies reporting under both frameworks, the gap persists on the balance sheet.

1
IFRS Foundation. IAS 36 Impairment of Assets
2
IFRS Foundation. IAS 36 Impairment of Assets
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IFRS Foundation. IAS 36 Impairment of Assets