Value in Use (VIU) Calculator for Impairment Testing
A professional tool to determine an asset’s value based on future cash flows.
Value in Use Calculator
The net cash expected from the asset in the first year.
The final year of explicit forecasts. This is also used to calculate terminal value.
The pre-tax rate reflecting the time value of money and asset-specific risks (e.g., WACC).
%
The long-term growth rate for cash flows beyond the forecast period (should not exceed long-term economic growth).
%
What is Value in Use for Impairment?
Value in Use (VIU) is an accounting measure defined under International Accounting Standard 36 (IAS 36) as the present value of the future cash flows expected to be derived from an asset or a cash-generating unit (CGU). It is one of the two methods used to determine an asset’s “recoverable amount,” the other being “fair value less costs of disposal.” An asset is considered impaired if its carrying amount on the balance sheet exceeds its recoverable amount. Knowing how to calculate value in use for impairment is a critical skill for accountants and financial analysts.
This calculation is not just a theoretical exercise; it directly impacts a company’s financial statements. If an impairment loss is recognized, the asset’s value is written down, and the loss is recorded as an expense on the income statement, reducing the company’s reported profit. This makes the asset impairment testing process a crucial part of financial reporting integrity.
The Value in Use Formula and Explanation
The core of the value in use calculation is a discounted cash flow (DCF) model. The formula looks complex, but it’s based on a simple principle: money today is worth more than money tomorrow. We discount future earnings to find their equivalent worth today.
VIU = ∑ nt=1 ( CFt / (1 + r)t ) + ( TV / (1 + r)n )
To properly apply this formula and understand how to calculate value in use for impairment, you must first define the variables. Our WACC calculator can help determine a suitable discount rate.
Variables Table
| Variable | Meaning | Unit | Typical Range |
|---|---|---|---|
| CFt | The net cash flow expected in a specific period ‘t’. | Currency (e.g., USD, EUR) | Varies widely based on the asset. |
| r | The pre-tax discount rate applicable to the asset. | Percentage (%) | 5% – 20% |
| t | The time period (usually in years). | Years | 1, 2, 3… |
| n | The final year of the explicit forecast period. | Years | Typically 5 years. |
| TV | Terminal Value, the value of the asset at the end of the forecast period, calculated using the terminal value formula. | Currency (e.g., USD, EUR) | Varies widely. |
Practical Examples
Let’s walk through two examples to solidify the concept of how to calculate value in use for impairment.
Example 1: Manufacturing Machine
A company has a machine with a carrying amount of $100,000. They project the following pre-tax cash flows. They use a discount rate of 10% and a perpetual growth rate of 2%.
- Year 1 CF: $30,000
- Year 2 CF: $28,000
- Year 3 CF: $25,000
- Year 4 CF: $22,000
- Year 5 CF: $20,000
- Discount Rate: 10%
- Perpetual Growth Rate: 2%
Using the calculator, the resulting Value in Use is approximately $183,149. Since this is higher than the $100,000 carrying amount, no impairment is recognized. A key part of this is the discounted cash flow model which quantifies future earnings in today’s dollars.
Example 2: Software Asset with Declining Cash Flows
A tech company owns a software license with a carrying amount of $250,000. Due to new technology, its cash flows are expected to decline. The company applies a higher discount rate of 12% to reflect the risk and a terminal growth rate of 0%.
- Year 1-5 CFs: $60k, $50k, $40k, $30k, $20k
- Discount Rate: 12%
- Perpetual Growth Rate: 0%
The calculation yields a Value in Use of approximately $178,217. Since the VIU ($178,217) is less than the carrying amount ($250,000), an impairment loss of $71,783 must be recorded. This highlights the importance of the IAS 36 impairment rules.
How to Use This Value in Use Calculator
Our tool simplifies the process of determining VIU. Follow these steps for an accurate calculation:
- Enter Projected Cash Flows: Input the expected net cash flows for each of the five forecast years. These should be based on reasonable and supportable assumptions.
- Set the Discount Rate: Enter the pre-tax discount rate. This rate should reflect the time value of money and the specific risks associated with the asset. It is often the company’s Weighted Average Cost of Capital (WACC).
- Set the Perpetual Growth Rate: Input the rate at which you expect cash flows to grow indefinitely after the 5-year forecast period. This rate should be conservative and not exceed the long-term average growth rate of the economy.
- Analyze the Results: The calculator instantly provides the total Value in Use. It also breaks down the result into the present value of the forecast period and the present value of the terminal value, offering a deeper financial modeling insight.
- Review the Chart and Table: The dynamic chart and table visualize how each year’s cash flow contributes to the final present value, making the data easier to interpret.
Key Factors That Affect Value in Use
Several factors can significantly influence the outcome of a VIU calculation. Understanding these is essential for anyone needing to know how to calculate value in use for impairment accurately.
- Cash Flow Projections: The most significant input. Overly optimistic or pessimistic forecasts will directly skew the result.
- Discount Rate: A higher discount rate leads to a lower VIU, as future cash flows are considered less valuable. This is a powerful lever in the recoverable amount calculation.
- Forecast Period Length: While our calculator uses 5 years, a longer explicit forecast period can capture more detail before relying on the terminal value, potentially increasing accuracy.
- Perpetual Growth Rate: A small change in this rate can have a large impact on the terminal value, and thus the total VIU. It must be chosen with caution.
- Economic Conditions: Broader economic trends, inflation, and industry shifts can affect both future cash flows and appropriate discount rates.
- Asset-Specific Risks: Factors like technological obsolescence, increased competition, or physical deterioration must be factored into both the cash flow estimates and the risk premium included in the discount rate.
Frequently Asked Questions (FAQ)
1. What is the difference between Value in Use and Fair Value?
Value in Use is an entity-specific value based on how the company intends to use the asset. Fair Value is a market-based measurement, representing the price that would be received to sell an asset in an orderly transaction between market participants. The recoverable amount is the HIGHER of these two values.
2. Why is the discount rate pre-tax?
IAS 36 requires that the cash flow projections be on a pre-tax basis, and therefore, the discount rate used to discount them must also be a pre-tax rate to ensure consistency.
3. What happens if the discount rate is lower than the perpetual growth rate?
This is a mathematical and economic impossibility in a standard Gordon Growth Model for terminal value. It would imply that the asset’s value is infinite. Our calculator identifies this issue and will display a warning, as the terminal value formula would be invalid.
4. How many years should I forecast cash flows for?
IAS 36 suggests using detailed forecasts for up to five years. Forecasts beyond five years are permitted only if they can be proven to be reliable. After the explicit forecast period, you must extrapolate using a steady or declining growth rate.
5. Can a Value in Use calculation be negative?
Yes. If an asset is expected to generate net cash outflows (i.e., it costs more to operate than it earns), its VIU will be negative. In this case, the recoverable amount would likely be its fair value less costs of disposal (scrap value), which could still be positive.
6. What is a Cash-Generating Unit (CGU)?
A CGU is the smallest identifiable group of assets that generates cash inflows that are largely independent of the cash inflows from other assets or groups of assets. It’s often impractical to calculate VIU for a single asset, so accountants perform the test on the entire CGU.
7. Does this calculator work for goodwill impairment?
Yes, the principle is the same. For goodwill impairment testing, you would calculate the Value in Use of the Cash-Generating Unit(s) to which the goodwill has been allocated and compare it to the CGU’s carrying amount (including the allocated goodwill).
8. How do I choose a reasonable perpetual growth rate?
The perpetual growth rate should not exceed the long-term average growth rate for the products, industries, or country or countries in which the entity operates. A common practice is to use the long-term expected inflation rate as a conservative proxy.