Impairment Test and Real Options Analysis: Congenial or Uncongenial Twins? With Special Reference to Intangible Assets

23 Pages Posted: 30 Nov 2010 Last revised: 16 Dec 2010

See all articles by Giuseppe Marzo

Giuseppe Marzo

University of Ferrara - Department of Economics and Management

Date Written: December 30, 2005


The European Union Regulation no. 1606/2002 made it mandatory for all EU listed companies to prepare consolidated financial statements in accordance with International Accounting Standards (IAS) for each financial year starting on or after 1 January 2005.

As it is well known, the implementation of impairment test is emerging as one of the most debated issues. In particular, the impairment test for intangible assets is rather complex and will become even more important in consideration of the ongoing amendment of IAS 38 (Intangible Assets) and IAS 36 (Impairment Test) which is currently carried out by the IASB “Business Combination Project” in the footsteps of US’s SFAS 141 and SFAS 142.

The purpose of the paper is to challenge IAS 36 Discounted Cash Flow (DCF) approach to impairment test by proposing Real Options Analysis (ROA) as a fruitful and viable methodology for giving content to this test.

At present, the impairment test of intangible assets follows the general rules provided by IAS 36, as revised by Exposure Draft 3 – Business Combinations Project, and it is based on net-selling price and value-in-use. The latter is measured by “…(a) estimating the future cash inflows and outflows to be derived from continuing use of the asset and from its ultimate disposal; and (b) applying the appropriate discount rate to these future cash flows.”

Unfortunately, DCF approach undervalues systematically high-risk assets since it does not account for managerial flexibility giving the firm the opportunity to take advantage of positive states of nature without suffering from bad ones. This flexibility, usually referred to as real option, is often connected with and arises from intangible assets and, if it is not incorporated in the value-in-use calculation, intangible assets could be unfairly impaired. Indeed, looking at the finance literature, ROA application to intangible investments, such as R&D investments, patents and licences, has often demonstrated the pitfalls of DCF approach in assessing their value.

In spite of its theoretical fairness in measuring value-in-use, ROA should be implemented with caution. Indeed, a deep analysis of the compliance of ROA with the provisions of IASs could highlights some criticisms of ROA-based impairment test. Some numerical examples will also be provided in order to reinforce the theoretical conclusions of the paper.

Despite those technical bewares, the paper nonetheless sets a case for the employment of ROA – instead of DCF approach – for the practical implementation of the impairment test for European companies.

Keywords: Real Options Analysis, Intangible Assets’ valuation, International Accounting Standards, Impairment test

JEL Classification: D81, G12, G13, M40, M41

Suggested Citation

Marzo, Giuseppe, Impairment Test and Real Options Analysis: Congenial or Uncongenial Twins? With Special Reference to Intangible Assets (December 30, 2005). Available at SSRN: or

Giuseppe Marzo (Contact Author)

University of Ferrara - Department of Economics and Management ( email )

Via Voltapaletto, 11
Ferrara, 44100

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