Key Points
- Value in use and fair value less costs of disposal are the two measures that determine recoverable amount.
- Cash flow projections must not extend beyond five years unless the entity can justify a longer period with reliable forecasts.
- The standard requires a pre-tax discount rate, yet over 60% of FRC-reviewed impairment models used a post-tax rate without proper gross-up.
- An error of just one percentage point in the discount rate can swing the conclusion from "no impairment" to a write-down of several million euros.
What is Value in Use?
IAS 36.30 sets two building blocks for a value-in-use calculation: estimated future cash flows from continuing use (and eventual disposal) of the asset, and a discount rate that converts those flows to present value. The cash flow projections must reflect management's best estimate of the economic conditions over the asset's remaining useful life. IAS 36.33(a) anchors year one to the most recent board-approved budgets or forecasts. Beyond that, IAS 36.35 caps the projection period at five years unless the entity can demonstrate that longer forecasts are reliable.
The discount rate is where most audit effort concentrates. IAS 36.55 requires a pre-tax rate reflecting 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. In practice, entities derive this from a post-tax weighted average cost of capital and then gross it up iteratively. ISA 540.13(b) directs the auditor to evaluate whether the data used in the estimate (including each component of the discount rate build-up) is appropriate. The terminal value, often calculated as a perpetuity growth model applied to the final-year cash flow, frequently accounts for more than half of total value in use. That concentration makes the terminal growth rate assumption a second high-risk input alongside the discount rate.
Worked example: Bonetti Costruzioni S.r.l.
Client: Italian infrastructure contractor, FY2025, revenue EUR 48M, IFRS reporter. Bonetti owns a tunnel-boring machine (TBM) with a carrying amount of EUR 5,600,000 at 31 December 2025. Utilisation has dropped because two planned motorway contracts were delayed by regional permitting issues. Management identifies impairment indicators under IAS 36.12(b) (significant adverse changes in the technological, market, or legal environment).
Step 1 — Project future cash flows
The TBM generates cash inflows through contracted and tendered projects. Management projects net operating cash flows of EUR 1,050,000 in year one (based on one confirmed contract), rising to EUR 1,400,000 in years two through four as delayed contracts resume, and EUR 1,250,000 in year five as the machine approaches the end of its economic life. Disposal proceeds in year five are estimated at EUR 380,000 (scrap value per an independent equipment broker).
Step 2 — Determine the discount rate
The entity's post-tax WACC is 8.2%. Management adjusts for the asset-specific risk of the TBM: exposure to public-sector contract delays and single-asset concentration. The adjusted post-tax rate is 9.6%. Iterating to a pre-tax equivalent (grossing up for Italy's 24% corporate tax rate on the tax-deductible depreciation shield) produces a pre-tax discount rate of 11.4%.
Step 3 — Calculate value in use
Discounting the projected cash flows at 11.4% pre-tax:
| Year | Cash flow | Discount factor (11.4%) | Present value |
|---|---|---|---|
| 1 | EUR 1,050,000 | 0.8977 | EUR 942,600 |
| 2 | EUR 1,400,000 | 0.8058 | EUR 1,128,100 |
| 3 | EUR 1,400,000 | 0.7232 | EUR 1,012,500 |
| 4 | EUR 1,400,000 | 0.6493 | EUR 909,000 |
| 5 | EUR 1,630,000 | 0.5829 | EUR 950,100 |
| Total | EUR 4,942,300 |
No terminal perpetuity is applied because the TBM has a finite useful life ending in year five.
Step 4 — Compare to carrying amount
The carrying amount is EUR 5,600,000. Value in use is EUR 4,942,300. Unless fair value less costs of disposal exceeds EUR 5,600,000 (which the broker estimate does not support), the recoverable amount is EUR 4,942,300 and the impairment loss is EUR 657,700.
Conclusion: the value in use of EUR 4,942,300 is defensible because cash flow projections trace to board-approved budgets and a documented pipeline, the discount rate build-up is sourced from observable market data with an explicit asset-specific adjustment, the five-year cap is appropriate for an asset with a finite remaining life, and the sensitivity analysis confirms the impairment conclusion holds across a reasonable range of rates.
Why it matters in practice
The FRC's 2023 thematic review of IAS 36 disclosures found that entities routinely applied a post-tax discount rate to post-tax cash flows and presented the output as a pre-tax value-in-use figure without performing the iterative gross-up required by IAS 36.55. The error understates the discount rate and overstates value in use, concealing impairments. ISA 540.13(b) requires the auditor to challenge the rate derivation, not just accept the entity's label.
Teams frequently include restructuring cash flows or capital expenditure that enhances the asset's performance in the value-in-use projection. IAS 36.44 prohibits cash flows from future restructurings to which the entity is not yet committed, and IAS 36.49 excludes cash flows from enhancements. The projection must reflect the asset in its current condition. Auditors who do not trace each line of the cash flow model back to these exclusions risk accepting an inflated recoverable amount.
Value in use vs. fair value less costs of disposal
| Dimension | Value in use | Fair value less costs of disposal |
|---|---|---|
| Perspective | Entity-specific: reflects how management intends to use the asset | Market-based: reflects what an external buyer would pay |
| Cash flow source | Management's own projections for the asset in its current condition | Market participants' expectations of the asset's cash-generating ability |
| Discount rate | Pre-tax rate reflecting asset-specific risks (IAS 36.55) | Implicit in the market price or derived from market participant assumptions (IFRS 13) |
| When it dominates | Assets with no active market but stable internal cash generation | Assets with an active resale market or recent comparable transactions |
The distinction matters on every impairment test. Value in use captures what the asset is worth to this entity given its plans. Fair value less costs of disposal captures what the market would pay. An asset with low resale value but strong contracted cash flows will have a higher value in use than fair value less costs of disposal, and testing only the market measure would trigger an impairment that the entity's own economics do not support.
Related terms
Frequently asked questions
Can I use a post-tax discount rate for value in use?
IAS 36.BCZ85 acknowledges that a post-tax model can produce the same result as a pre-tax model if done correctly, but IAS 36.55 requires the disclosed rate to be pre-tax. If the entity runs a post-tax model internally, the auditor must verify that the iterative gross-up to a pre-tax equivalent produces a materially consistent outcome. ISA 540.18 directs the auditor to evaluate the reasonableness of the assumptions, which includes confirming the mathematical equivalence.
How far into the future can cash flow projections extend?
IAS 36.35 caps projections at five years unless the entity can demonstrate that longer forecasts are reliable. In practice, regulators accept longer horizons for assets with contracted cash flows (toll roads, power purchase agreements) where the revenue stream is locked in. The auditor tests the reliability claim by examining forecast accuracy in prior periods per ISA 540.13(c).
Does value in use include disposal proceeds?
Yes. IAS 36.39 requires the entity to include estimated net cash flows from the ultimate disposal of the asset at the end of its useful life. The disposal estimate should reflect the amount the entity expects to obtain in an arm's length transaction between knowledgeable, willing parties, less the estimated costs of disposal.