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The Discount Rate: A Note on IAS 36

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  • Sven Husmann
  • Martin Schmidt

Abstract

Entities reporting under IFRSs are required to determine a value in use in accordance with IAS 36: Impairment of Assets. The value in use is the present value of the expected future cash flows. Appendix A to the standard gives guidance on how to apply the DCF calculus in the context of IAS 36. In order to determine a suitable discount rate, the reporting entity is given the choice between three alternative starting points. The requirements of IAS 36 are, in this respect, quite different from the accounting requirements of US GAAP. In this paper we analyse these starting points and demonstrate the functional interrelation between them. Given that the interrelation is complex even under simple assumptions, we will provide guidance to practitioners as to which starting point should be used. We will demonstrate that the weighted average cost of capital (WACC) is the only suitable starting point. Based on this analysis, we also show that the other alternative starting points are not sufficiently clear. When used in practice, the guidance may even give rise to substantial measurement errors and make earnings management possible. Thus, our recommendation to the IASB is to shorten the guidance and delete the other two starting points.

Suggested Citation

  • Sven Husmann & Martin Schmidt, 2008. "The Discount Rate: A Note on IAS 36," Accounting in Europe, Taylor & Francis Journals, vol. 5(1), pages 49-62, June.
    • Handle: RePEc:taf:acceur:v:5:y:2008:i:1:p:49-62
    DOI: 10.1080/17449480802088762
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    References listed on IDEAS

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    1. Rubinstein, Mark E, 1973. "A Mean-Variance Synthesis of Corporate Financial Theory," Journal of Finance, American Finance Association, vol. 28(1), pages 167-181, March.
    2. Merton, Robert C, 1974. "On the Pricing of Corporate Debt: The Risk Structure of Interest Rates," Journal of Finance, American Finance Association, vol. 29(2), pages 449-470, May.
    3. Black, Fischer & Scholes, Myron S, 1973. "The Pricing of Options and Corporate Liabilities," Journal of Political Economy, University of Chicago Press, vol. 81(3), pages 637-654, May-June.
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    2. He, Liyu, 2020. "Discount rate behaviour in fair value reporting," Journal of Behavioral and Experimental Finance, Elsevier, vol. 28(C).
    3. Gerry Gallery, 2009. "Discount Rates in Disarray: Evidence on Flawed Goodwill Impairment Testing," Australian Accounting Review, CPA Australia, vol. 19(4), pages 337-339, December.
    4. Rainer Baule, 2019. "The cost of debt capital revisited," Business Research, Springer;German Academic Association for Business Research, vol. 12(2), pages 721-753, December.
    5. Alain Schatt & Leonidas Doukakis & Corinne Bessieux-Ollier & Elisabeth Walliser, 2016. "Do Goodwill Impairments by European Firms Provide Useful Information to Investors?," Accounting in Europe, Taylor & Francis Journals, vol. 13(3), pages 307-327, September.
    6. Pietro Pavone, 2018. "Accounting Frauds And Evaluative Discretion Areas: Anomalies In The Adoption Of The Ias 36," Eurasian Journal of Social Sciences, Eurasian Publications, vol. 6(2), pages 37-45.
    7. Dominic Detzen & Tobias Stork genannt Wersborg & Henning Zülch, 2016. "Impairment of Goodwill and Deferred Taxes Under IFRS," Australian Accounting Review, CPA Australia, vol. 26(3), pages 301-311, September.

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