IAS 36 Impairment Testing: Calculating Value in Use Step by Step

The client hands you a discounted cash flow model with 47 tabs, a terminal growth rate of 3%, and a pre-tax discount rate they can't explain. The conclusion: no impairment. You have two hours before the review meeting. If you don't know which assumptions to challenge first, you'll either accept a model that shouldn't pass or reject one that should.

IAS 36 value in use is the present value of estimated future cash flows expected from an asset or cash-generating unit, calculated by projecting cash flows for a detailed forecast period (typically five years per IAS 36.33), estimating a terminal value, and discounting both at a pre-tax rate reflecting current market assessments of the time value of money and the risks specific to the asset (IAS 36.30 and IAS 36.55-56).

Table of contents

1. What value in use means under IAS 36.30
2. Cash flow projections: IAS 36.33 requirements
3. The discount rate under IAS 36.55-56
4. Terminal value and the growth rate cap
5. CGU identification and goodwill allocation (IAS 36.80)
6. How auditors test the model
7. Worked example: Van der Berg Holding N.V.
8. Practical checklist
9. Common mistakes
10. Related content

If you need to build or audit a value in use calculation, the ciferi IAS 36 impairment calculator structures the DCF model with separate fields for each IAS 36 input, flags common errors in discount rate and terminal value assumptions, and produces audit-ready documentation.

What value in use means under IAS 36.30

IAS 36.30 defines value in use as the present value of the future cash flows expected to be derived from an asset. For a single asset, that means the cash flows the asset generates (or contributes to generating) over its remaining useful life, plus any disposal proceeds at the end. For a cash-generating unit, it means the combined cash flows of the group of assets that produce the smallest identifiable cash inflows largely independent of other assets.

The calculation has four components: projected cash flows, a forecast period, a terminal value (for assets with indefinite useful lives or CGUs containing goodwill), and a discount rate. IAS 36.30 requires that these components reflect current conditions. You don't use the assumptions that applied when the asset was purchased. You use the assumptions that apply now, given what management knows at the reporting date.

Value in use is not fair value less costs of disposal. Fair value is a market-based measure (what a willing buyer would pay). Value in use is entity-specific (what the entity expects to get from using the asset itself). The two can differ significantly. An asset with low market value but high utility to a specific entity may show no impairment on a value in use basis but would show impairment on a fair value basis. IAS 36 requires the recoverable amount to be the higher of the two.

Cash flow projections: IAS 36.33 requirements

IAS 36.33 limits the detailed forecast period to a maximum of five years unless a longer period can be justified. Most entities use five years. The projections must be based on reasonable and supportable assumptions that represent management's best estimate of the economic conditions over the remaining useful life of the asset.

IAS 36.33(a) requires projections to be based on the most recent financial budgets and forecasts approved by management. IAS 36.33(b) caps the projection period at five years. IAS 36.33(c) requires that projections beyond the budget period be estimated by extrapolating existing projections using a steady or declining growth rate, unless an increasing rate can be justified.

What auditors test in the cash flow projections is not whether the model calculates correctly (it usually does). The question is whether the inputs are reasonable. Three areas generate most of the audit issues.

Revenue growth assumptions drive the numerator. Compare the projected growth rates to historical achievement. If management projects 8% annual revenue growth but has averaged 3% over the past five years, the burden of proof shifts to management. What has changed? New contracts? New markets? If the answer is generic optimism, the assumption fails IAS 36.33(a).

Margin assumptions drive the cash conversion. If projected EBITDA margins are 200 basis points above the historical average, management needs an explanation grounded in specific operational changes (cost reductions already implemented, renegotiated supplier contracts, automation investments with quantifiable savings).

Capital expenditure projections affect free cash flow. IAS 36.44 prohibits including cash flows from future restructurings or asset enhancements that haven't been committed to. Only maintenance capex and capex necessary to maintain the asset in its current condition can be included. Watch for models that project rising revenues but flat capex. Growing revenue usually requires investment.

Working capital movements are frequently omitted from the model entirely. A growing CGU needs additional working capital (more receivables outstanding, more inventory held). If revenue grows at 4% per year but working capital is held constant, free cash flow is overstated. The audit procedure is to compare projected working capital as a percentage of revenue to historical working capital ratios. Any material departure needs justification.

One area that produces recurring review comments: the treatment of intercompany transactions in CGU-level projections. IAS 36.43 requires cash flows to be estimated for the CGU in its current condition, and IAS 36 BCZ85 clarifies that intercompany transfers should be adjusted to reflect external market prices. If the CGU sells components to another group entity at transfer prices that include a markup, the cash flow projections should use the external selling price or the arms-length equivalent. Models that use internal transfer prices overstate the CGU's cash-generating ability when the markup exceeds what the market would bear.

The discount rate under IAS 36.55-56

IAS 36.55 requires a pre-tax discount 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 been adjusted. IAS 36.56 directs entities to consider the entity's weighted average cost of capital (WACC) as a starting point, adjusted for the specific risks of the asset or CGU.

The discount rate is the single assumption with the largest impact on the conclusion. A 1% change in the discount rate on a typical five-year DCF with terminal value can swing the result by 10-15%. This makes it the auditor's most important focus area.

Common problems with the discount rate fall into four categories.

The first is using a post-tax rate when IAS 36.55 requires pre-tax. Many entities calculate WACC on a post-tax basis (because that is how corporate finance textbooks present it) and forget to gross it up. The pre-tax rate should be the rate that, when applied to pre-tax cash flows, gives the same present value as the post-tax rate applied to post-tax cash flows. In practice, dividing the post-tax WACC by (1 minus the effective tax rate) provides a rough approximation, but the iterative method is more accurate.

The second is using the entity's own WACC when the CGU has a different risk profile. A diversified holding company with a blended WACC of 9% may have a CGU in a high-risk emerging market that warrants 14%. IAS 36.56 requires the rate to reflect the risks of the specific asset, not the entity as a whole.

The third problem is stale market inputs. Beta, equity risk premium, and risk-free rate should reflect conditions at the reporting date. Using inputs from the date the model was built (possibly months earlier) introduces error.

The fourth is omitting a country risk premium or small-firm premium when the circumstances warrant one. For CGUs operating in jurisdictions with elevated sovereign risk, or for small entities where the cost of equity exceeds what CAPM alone produces, these adjustments are standard valuation practice.

Terminal value and the growth rate cap

For CGUs with indefinite useful lives (which includes any CGU carrying goodwill), the value in use calculation needs a terminal value. The standard approach is the Gordon Growth Model: terminal value = final-year cash flow x (1 + g) / (discount rate minus g), where g is the long-term growth rate.

IAS 36.33(c) requires that the growth rate used beyond the forecast period be steady or declining, and that it not exceed the long-term average growth rate for the products, industries, or countries in which the entity operates. In the Eurozone, long-term GDP growth has averaged approximately 1.5-2.0% over the past two decades. A terminal growth rate above 2% for a European CGU requires specific justification.

The terminal value often represents 60-80% of the total value in use figure. This concentration means that small changes in the terminal growth rate have an outsized effect on the conclusion. Auditors should run a sensitivity analysis showing the impairment conclusion at g = 0%, g = 1%, and g = 2%. If the conclusion flips between "no impairment" and "material impairment" within that range, the disclosure requirements under IAS 36.134(f) are triggered (and the audit conclusion needs careful documentation of why the chosen rate is appropriate).

CGU identification and goodwill allocation (IAS 36.80)

IAS 36.80 requires goodwill acquired in a business combination to be allocated to the CGU or group of CGUs expected to benefit from the synergies of the combination. The CGU cannot be larger than an operating segment under IFRS 8.

CGU identification is an area where management has significant discretion, and that discretion almost always flows in one direction: larger CGUs. A larger CGU pools more assets into the comparison, making it harder for one underperforming division to trigger impairment. Auditors should test whether the CGU boundaries reflect the lowest level at which management monitors goodwill for internal purposes (IAS 36.80(a)) and whether the CGU has genuinely independent cash inflows (IAS 36.66).

When the entity changes its CGU structure (often following a reorganisation), IAS 36.87 requires goodwill to be reallocated on a relative value basis. Watch for reallocation exercises that shift goodwill away from the underperforming unit. If €20M of goodwill moves from a struggling CGU to a healthy one as part of a "reorganisation," the impairment that should have been recognised in the struggling CGU disappears into the headroom of the healthy CGU.

The ciferi IAS 36 impairment calculator includes a CGU mapping section that documents the rationale for CGU boundaries and tracks goodwill allocation across periods.

How auditors test the model

The audit approach to a value in use model follows a pattern. You test the design of the model, the inputs to the model, and the sensitivity of the output to changes in key assumptions.

For model design, verify that the structure complies with IAS 36. Cash flows should exclude financing costs, tax payments (if using a pre-tax rate), and future restructuring or enhancement expenditure not yet committed (IAS 36.44). Verify the terminal value formula. Verify the discounting mechanics (mid-year convention versus year-end, consistency across periods).

For inputs, compare management's revenue projections to historical results and external forecasts. Compare the discount rate to independently sourced WACC estimates (broker reports, industry databases, your firm's valuation specialists where available). Compare the terminal growth rate to long-term GDP growth for the relevant geography. Test capex assumptions against historical maintenance capex and asset condition reports.

A retrospective test adds credibility to your work. Pull last year's impairment model and compare its Year 1 projections to the actual results for that year. If management projected €25M revenue and achieved €21M, their track record of forecasting is poor. This does not automatically mean the current model is wrong, but it shifts the burden: the auditor should apply a higher degree of scepticism to the current projections and consider whether a downside adjustment is needed.

When the entity uses an external valuation expert to prepare the model, the auditor still owns the assessment. ISA 500.8 requires the auditor to evaluate the competence, capability, and objectivity of the expert, and to evaluate whether the expert's work is adequate for audit purposes. Accepting a third-party valuation report without testing its key assumptions does not discharge the auditor's responsibility under ISA 500 or IAS 36.

For sensitivity, identify the assumptions to which the conclusion is most sensitive. Typically these are the discount rate, the terminal growth rate, and the revenue growth rate in years one and two. Run scenarios where each assumption moves adversely by a reasonable amount. If the headroom (recoverable amount minus carrying amount) is less than performance materiality, the conclusion is fragile and the IAS 36.134(f) disclosure requirements become critical.

Worked example: Van der Berg Holding N.V.

Van der Berg Holding N.V. is a Dutch industrial conglomerate with €120M consolidated revenue. It acquired a logistics subsidiary (Dijkstra Logistics B.V.) three years ago for €18M, including €7M of goodwill. Dijkstra constitutes a single CGU with a carrying amount of €16.5M (including the €7M goodwill).

1. Management prepares cash flow projections. Dijkstra's most recent approved budget projects revenue of €22M in Year 1, growing at 4% annually through Year 5. EBITDA margins are projected at 12%, consistent with the prior two years. Maintenance capex is €800,000 per year. Working capital changes are projected at 1% of revenue growth.

   Documentation note: "Cash flow projections per management-approved budget dated 15 November 2025. Revenue growth of 4% tested against historical CAGR of 3.6% (2022-2025), within acceptable range. EBITDA margin of 12% consistent with 11.8% (2024) and 12.1% (2023). No restructuring or enhancement capex included per IAS 36.44."

2. The auditor calculates projected free cash flows. Year 1: revenue €22.0M, EBITDA €2.64M, less capex €0.80M, less working capital increase €0.09M = FCF €1.75M. Years 2-5 follow the same structure with 4% growth applied.

   Documentation note: "FCF calculation verified. Year 1 FCF €1.75M. Year 5 FCF €2.05M. Working capital change computed as 1% of incremental revenue (€220K x ~40% conversion). No excluded items identified."

3. The auditor evaluates the discount rate. Management uses a pre-tax WACC of 10.2%. The auditor's independent estimate, using current risk-free rate (3.1% per 10-year Dutch government bond), equity risk premium (5.5% per Damodaran January 2026), beta of 0.95 (logistics sector), and a small-firm premium of 1.5%, produces a pre-tax WACC of 10.8%.

   Documentation note: "Management WACC 10.2% vs auditor estimate 10.8%. Difference of 60bps. Sensitivity analysis shows impairment conclusion unchanged at 10.8%. Difference principally from small-firm premium (management applied 1.0% vs auditor 1.5%). Accepted, within reasonable range."

4. Terminal value is calculated using g = 1.5% (Eurozone long-term GDP growth). Terminal value: €2.05M x 1.015 / (0.102 - 0.015) = €23.9M. Discounted terminal value: €23.9M / (1.102)^5 = €14.7M. Total value in use: PV of Years 1-5 FCF (€6.8M) + discounted terminal value (€14.7M) = €21.5M.

   Documentation note: "Terminal growth rate 1.5%, consistent with Eurozone long-term GDP and below IAS 36.33(c) ceiling. Terminal value represents 68% of total VIU, consistent with expectation for a going concern CGU. VIU of €21.5M exceeds carrying amount of €16.5M. Headroom: €5.0M."

5. Sensitivity analysis. At a discount rate of 11.5% and terminal growth of 1.0%, VIU drops to €18.2M (headroom €1.7M, still above carrying amount). At a discount rate of 12.0% and terminal growth of 0.5%, VIU drops to €16.1M, below carrying amount by €400K. The headroom is sensitive to adverse movements but the base case conclusion (no impairment) holds under moderate stress.

   Documentation note: "IAS 36.134(f) disclosure required: reasonably possible change in key assumptions could cause impairment. Disclosure drafted specifying that a 180bps increase in discount rate combined with a 100bps decrease in terminal growth rate would eliminate headroom."

Practical checklist

1. Confirm the CGU boundaries reflect the lowest level at which management monitors goodwill (IAS 36.80). If the CGU changed from prior year, verify the goodwill reallocation methodology under IAS 36.87.

2. Verify cash flow projections exclude financing costs, income tax, and uncommitted restructuring or enhancement capex (IAS 36.44, IAS 36.50). Check that projections trace to board-approved budgets.

3. Compare management's revenue and margin assumptions to the prior three years of actual results. Flag any projection that exceeds historical achievement by more than 200 basis points without a documented, verifiable basis.

4. Independently estimate the discount rate using current market inputs at the reporting date. Compare to management's rate and document the difference with reasons.

5. Verify the terminal growth rate does not exceed long-term average growth for the relevant economy (IAS 36.33(c)). For Eurozone CGUs, rates above 2% require specific justification.

6. Run sensitivity analysis on the discount rate, terminal growth rate, and Year 1-2 revenue growth. If headroom is less than performance materiality under any reasonable scenario, ensure IAS 36.134(f) disclosures are adequate.

Common mistakes

• Using a post-tax discount rate with pre-tax cash flows. IAS 36.55 requires a pre-tax rate. The FRC has flagged files where the discount rate was taken directly from an equity research report (post-tax WACC) without conversion, producing an overstated value in use.

• Failing to test the CGU boundaries. Auditors often accept management's CGU definition without challenge. The AFM's inspection findings include cases where goodwill was allocated to a group of CGUs that exceeded the operating segment ceiling in IAS 36.80, allowing impairment to be avoided through cross-subsidisation.

• Accepting management's cash flow projections without comparing to historical accuracy. If management projected 6% growth last year and achieved 2%, the current projection of 7% growth needs a convincing explanation.

Related content

• Impairment glossary entry. Covers the IAS 36 definitions of recoverable amount, CGU, and the impairment loss recognition hierarchy.
• IAS 36 impairment calculator. The DCF model tool referenced in this post, with structured fields for every IAS 36 input and automatic sensitivity analysis.
• IFRS 9 expected credit losses: how to audit the provision matrix. Another area where auditors must test management's forward-looking assumptions in a model-based calculation.