Value in Use vs Fair Value Less Costs of Disposal
Value in Use vs Fair Value Less Costs of Disposal for impairment testing under IAS 36. When each measure produces the higher recoverable amount and how ...
Introduction
When an intangible asset or cash-generating unit (CGU) shows signs of impairment, IAS 36 requires the entity to determine its recoverable amount — defined as the higher of Value in Use (VIU) and Fair Value Less Costs of Disposal (FVLCD). If the recoverable amount is below the carrying amount, an impairment loss must be recognised.
This seemingly straightforward comparison conceals significant complexity. VIU and FVLCD are built on different assumptions, use different discount rates, and reflect different perspectives on the same asset. Understanding when each produces the higher amount — and therefore determines whether impairment exists — is critical for preparers, auditors, and investors in intangible-rich businesses.
For goodwill and indefinite-life intangible assets, this test must be performed annually, regardless of whether impairment indicators exist. For finite-life intangibles, the test is triggered whenever there are indicators that carrying value may not be recoverable.
Value in Use: The Entity-Specific Perspective
Value in Use represents the present value of the future cash flows expected to be derived from an asset or CGU through its continued use and ultimate disposal. It is an entity-specific measure — it reflects the entity's own expectations, not those of a hypothetical market participant.
Key characteristics of VIU
- Cash flow basis: Management's approved forecasts for a maximum of five years, followed by a terminal value based on steady-state or declining projections
- Synergies: Entity-specific synergies from the asset's current use are included
- Discount rate: Pre-tax rate reflecting the time value of money and asset-specific risks (see pre-tax vs post-tax discount rates)
- Restructuring: Costs of uncommitted restructuring are excluded (IAS 36.44)
- Capital expenditure: Only maintenance capex is included — growth or enhancement capex is excluded until committed
What VIU excludes
IAS 36 places important constraints on VIU to prevent entities from inflating recoverable amounts:
| Included | Excluded |
|---|---|
| Cash flows from current use at current capacity | Cash flows from future restructuring or enhancements |
| Maintenance capital expenditure | Growth capital expenditure (until committed) |
| Entity-specific synergies already realised | Expected future improvements not yet implemented |
| Working capital movements | Financing cash flows |
| Tax payments (if using post-tax equivalent) | Income tax receipts and payments (if using IAS 36.50 pre-tax approach) |
VIU is deliberately conservative — it reflects the asset as it is today, not as it could be after improvements. This makes VIU the appropriate measure when the entity intends to continue using the asset and its current operating capability is representative of future expectations.
Fair Value Less Costs of Disposal: The Market Perspective
FVLCD represents the price that would be received to sell the asset (or CGU) in an orderly transaction between market participants, less the incremental costs directly attributable to the disposal. It is a market-based measure under IFRS 13.
Key characteristics of FVLCD
- Cash flow basis: Cash flows that a market participant would expect, which may include synergies available to market participants generally
- Perspective: Highest and best use from a market participant's viewpoint
- Discount rate: Market-based rate consistent with fair value measurement
- Growth and enhancement: Market participants' expectations about future improvements may be included
- Disposal costs: Legal fees, stamp duty, costs to bring the asset to saleable condition — deducted from fair value
FVLCD hierarchy
| Level | Input Type | Availability for Intangibles |
|---|---|---|
| Level 1 | Binding sale agreement or active market price | Rare — most intangible assets are unique |
| Level 2 | Observable transactions for similar assets | Occasional — technology licences, domain sales |
| Level 3 | Income approach using market participant assumptions | Most common — DCF with market-based inputs |
For most intangible assets and CGUs, FVLCD is based on Level 3 inputs — meaning it is model-derived, just like VIU. The difference is the perspective: VIU uses entity-specific assumptions while FVLCD uses market participant assumptions. In practice, the two may converge or diverge significantly depending on whether the entity generates more or less value from the asset than a typical market participant.
When Each Produces the Higher Amount
The relative magnitude of VIU and FVLCD depends on several factors:
VIU is typically higher when:
- The entity has significant entity-specific synergies from the asset's current use
- The entity uses the asset more efficiently than a typical market participant would
- No active market exists for the asset, and disposal would result in a distressed price
- The entity's approved forecasts reflect strong recent performance that the market has not yet priced in
FVLCD is typically higher when:
- Market participants would pay a premium above the entity's use value (e.g., a strategic buyer exists)
- The entity is underperforming — market participants could extract more value from the asset
- A recent comparable transaction establishes a high market price
- The entity is considering disposal, and a willing buyer has been identified
VIU Strengths
- Captures entity-specific synergies
- Based on management's approved forecasts
- Does not require market transaction data
- Appropriate for assets the entity intends to keep
FVLCD Strengths
- Market-based and externally verifiable
- Can include market participant synergies
- May reflect strategic premium a buyer would pay
- More reliable when observable data exists
Practical Example: Technology CGU Impairment Test
A UK software company has a CGU with a carrying amount of £40 million (including £15 million of goodwill). Trading has softened, triggering an impairment review.
VIU calculation
Management's approved five-year forecasts show cash flows recovering as new product features are delivered:
| Year | Cash Flow (£m) | Discount Factor (12% pre-tax) | PV (£m) |
|---|---|---|---|
| 1 | 4.0 | 0.893 | 3.57 |
| 2 | 5.0 | 0.797 | 3.99 |
| 3 | 6.5 | 0.712 | 4.63 |
| 4 | 7.0 | 0.636 | 4.45 |
| 5 | 7.5 | 0.567 | 4.25 |
| Terminal (2% growth) | 76.5 | 0.567 | 21.63 |
| VIU | 42.52 |
FVLCD calculation
A comparable software business recently sold for 5.5x revenue. Applying this to the CGU's £12 million revenue and deducting £0.5 million disposal costs:
FVLCD = (£12m x 5.5) - £0.5m = £65.5 million
Outcome
| Measure | Value (£m) |
|---|---|
| Value in Use | 42.52 |
| Fair Value Less Costs of Disposal | 65.50 |
| Recoverable Amount (higher) | 65.50 |
| Carrying Amount | 40.00 |
| Impairment | None |
In this case, FVLCD saves the CGU from impairment — market participants value the business far above what management's conservative approved forecasts produce. If the entity had calculated only VIU, they would still have avoided impairment (VIU of £42.52m exceeds carrying amount of £40m), but the margin of safety would have been much thinner. This illustrates why calculating both measures is valuable, even though only the higher one matters.
Common Pitfalls
VIU pitfalls
- Including uncommitted restructuring benefits in cash flow forecasts
- Extending forecasts beyond five years without compelling justification
- Using post-tax discount rates without proper iterative conversion
- Including growth capex that would enhance the asset beyond its current condition
- Optimism bias in management forecasts — auditors will challenge projections that diverge from historical trends
FVLCD pitfalls
- Using stale comparable transactions that do not reflect current market conditions
- Ignoring disposal costs — legal fees, taxes, and transition costs can be material
- Applying enterprise-level multiples to an individual CGU without adjustment
- Confusing entity-specific synergies (which belong in VIU) with market participant synergies (which belong in FVLCD)
Decision Framework: Which to Calculate First?
IAS 36.19 allows entities to calculate only one measure if it clearly exceeds carrying amount. This practical shortcut can save significant effort:
- If a recent offer or transaction provides FVLCD evidence — start there; if it exceeds carrying amount, no VIU calculation needed
- If no market evidence exists — VIU may be the only practicable measure
- For material CGUs — calculate both and document the reasoning for each
- For annual goodwill testing — establish a consistent approach year-on-year to aid comparability
Conclusion
Value in Use and Fair Value Less Costs of Disposal are complementary measures that answer different questions: "What is the asset worth to us?" versus "What would the market pay?" The recoverable amount is the higher of the two, meaning an asset only needs to be viable under one lens to avoid impairment.
For more on the discount rate considerations underlying these calculations, see pre-tax vs post-tax discount rates. For the broader impairment framework, see the Academy lesson on accounting standards for intangible assets.
The Bottom Line
Calculate both measures when practical — the standard requires the higher of the two, and you only need one to exceed carrying amount to avoid impairment. VIU captures entity-specific value; FVLCD captures market value. For intangible-rich businesses, the difference between these measures can be the difference between impairment and no impairment.
Related Glossary Terms
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