Value in Use Calculator
An expert tool to help you understand how to calculate value in use of an asset based on its expected future cash flows.
What is Value in Use?
Value in Use (VIU) is an accounting measurement defined under International Accounting Standard 36 (IAS 36) as the present value of the future cash flows expected to be derived from an asset’s continuous use and its ultimate disposal. In simpler terms, it calculates an asset’s worth to the specific entity that holds it, based on how that entity plans to use it. This is different from “Fair Value,” which represents what the asset could be sold for on the open market. The core idea behind learning how to calculate value in use of an asset is to determine if an asset is impaired, meaning its carrying amount on the balance sheet is higher than its recoverable amount.
This calculation is crucial for financial reporting, particularly during impairment testing. If an asset’s carrying value exceeds its recoverable amount (which is the higher of its VIU and its fair value less costs of disposal), the company must recognize an impairment loss. VIU is entity-specific because it uses the company’s own projections and assumptions about future cash flows and risks.
The Value in Use Formula and Explanation
The formula to calculate an asset’s value in use involves discounting projected future cash flows to their present value. The calculation requires several key inputs.
The general formula is:
VIU = Σ [ CFn / (1 + r)^n ] + [ TV / (1 + r)^n ]
Here’s a breakdown of each component in the formula:
| Variable | Meaning | Unit | Typical Range |
|---|---|---|---|
| VIU | Value in Use | Currency ($) | Calculated Value |
| CFn | Net Cash Flow for Period ‘n’ | Currency ($) | Varies based on asset productivity. |
| TV | Terminal Value | Currency ($) | Estimated residual value of the asset after the forecast period. |
| r | Discount Rate | Percentage (%) | 5% – 20% (often the company’s WACC). |
| n | The Period Number (e.g., Year) | Integer | Typically 1 to 5 years for detailed forecasts. |
Practical Examples of Calculating Value in Use
Understanding how to calculate value in use of an asset is best illustrated with examples. Let’s walk through two scenarios.
Example 1: Manufacturing Machine
A company owns a specialized manufacturing machine. They project the following net cash flows over the next 3 years. After that, they expect to sell it.
- Projected Cash Flow (Year 1): $20,000
- Projected Cash Flow (Year 2): $18,000
- Projected Cash Flow (Year 3): $15,000
- Terminal Value (Sale Price in 3 years): $30,000
- Discount Rate: 10%
Calculation:
PV of Year 1 = $20,000 / (1 + 0.10)^1 = $18,181.82
PV of Year 2 = $18,000 / (1 + 0.10)^2 = $14,876.03
PV of Year 3 = $15,000 / (1 + 0.10)^3 = $11,269.72
PV of Terminal Value = $30,000 / (1 + 0.10)^3 = $22,539.44
Total Value in Use = $18,181.82 + $14,876.03 + $11,269.72 + $22,539.44 = $66,867.01
Example 2: Software Asset
A tech company has a proprietary software asset. They project cash flows for two years, after which it will be obsolete with no terminal value.
- Projected Cash Flow (Year 1): $150,000
- Projected Cash Flow (Year 2): $100,000
- Terminal Value: $0
- Discount Rate: 12%
Calculation:
PV of Year 1 = $150,000 / (1 + 0.12)^1 = $133,928.57
PV of Year 2 = $100,000 / (1 + 0.12)^2 = $79,719.39
PV of Terminal Value = $0
Total Value in Use = $133,928.57 + $79,719.39 = $213,647.96
How to Use This Value in Use Calculator
Our calculator simplifies the process of determining an asset’s VIU. Follow these steps for an accurate calculation:
- Enter Projected Cash Flows: For each year of your forecast period, input the net cash flow you expect the asset to generate in the “Projected Cash Flow” fields. Use the “+ Add Another Year” button if your projection is longer than one year.
- Input the Terminal Value: Estimate the asset’s salvage or sale value at the very end of its useful life or forecast period and enter it into the “Terminal Value” field.
- Set the Discount Rate: Enter the appropriate discount rate as a percentage. This is often the company’s Weighted Average Cost of Capital (WACC), which reflects the risk associated with the future cash flows.
- Calculate and Interpret: Click the “Calculate” button. The primary result is the asset’s total Value in Use. You can also see the breakdown between the present value of your annual cash flows and the present value of the terminal value.
Key Factors That Affect Value in Use
Several factors can significantly influence the outcome when you calculate value in use of an asset. Understanding these is critical for accurate financial forecasting.
- Accuracy of Cash Flow Projections: The most significant factor. Overly optimistic or pessimistic projections will directly skew the VIU. Projections should be based on reasonable and supportable assumptions.
- The Discount Rate: A higher discount rate implies greater risk and will result in a lower VIU. A lower rate implies less risk and a higher VIU. The choice of rate is a critical judgment call.
- The Length of the Projection Period: Forecasting cash flows becomes less reliable over longer periods. Most entities limit detailed projections to five years or less.
- Terminal Value Assumptions: The terminal value can represent a large portion of the total VIU, especially for long-life assets. The growth rate used to estimate this value must be realistic and not exceed the long-term average growth rate for the market.
- Economic and Market Conditions: External factors like economic recessions, inflation, interest rate changes, and industry-specific downturns can impact future cash flows and appropriate discount rates.
- Asset’s Current Condition: VIU calculations must be based on the asset’s current state, not on future upgrades or enhancements to which the company is not yet committed.
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 a company uses an asset. Fair Value is a market-based measurement of what the asset would sell for in an orderly transaction between market participants. An asset’s recoverable amount is the higher of these two figures.
2. Why is a discount rate used in the calculation?
A discount rate is used to account for the time value of money. The principle states that a dollar today is worth more than a dollar in the future because of its potential earning capacity. The discount rate brings all future cash flows to their equivalent present-day value.
3. How many years should I project cash flows for?
While there’s no strict rule, IAS 36 suggests that projections beyond five years can be unreliable. If a longer period is used, it requires strong justification. For periods beyond the detailed forecast, a terminal value is calculated.
4. What if my asset doesn’t generate direct cash flows?
If an asset doesn’t generate its own cash inflows (e.g., a corporate headquarters building), it must be grouped with other assets into the smallest identifiable group that does generate cash inflows. This is known as a Cash-Generating Unit (CGU).
5. Can I include future improvements in my cash flow projections?
No. According to IAS 36, cash flow projections must be based on the asset in its current condition. You cannot include estimated cash flows from future restructurings or capital expenditure on improving the asset’s performance unless the entity is already committed to that expenditure.
6. What happens if the Value in Use is lower than the asset’s carrying amount?
If the VIU (and the fair value less costs of disposal) is lower than the asset’s carrying amount on the balance sheet, the asset is considered “impaired.” The company must record an impairment loss to write the asset’s value down to its recoverable amount.
7. What is Terminal Value?
Terminal Value is the estimated value of an asset at the end of its useful life or the explicit forecast period. It represents all future cash flows beyond the projection period, calculated as a single lump sum.
8. Are taxes included in the calculation?
Yes, cash flows and discount rates should be determined on a consistent basis, which is typically post-tax. However, the pre-tax recoverable amount must be disclosed, which involves a separate calculation.