Gudjohnsen, who has also played for Barcelona, Bolton, Stoke and Fulham, has been with Norwegian club Molde since February.
His short spell with Chinese Super League club Shijiazhuang Ever Bright ended in November 2015.
Iceland co-manager Lars Lagerback said: "If he hadn't found a club in January, he would not have been picked."
Listen: Iceland can be a Euro 2016 surprise, says Bergsson
Gudjohnsen, who has won 84 caps for Iceland, is arguably his country's most celebrated player, having enjoyed an international career spanning 20 years, in addition to winning two Premier League titles with Chelsea and the Champions League and La Liga with Barcelona.
He retired from international football in November 2013 after Iceland lost a 2014 World Cup play-off to Croatia, but was recalled in March 2015.
Gudjohnsen played three of Iceland's 10 Euro 2016 qualifying matches, scoring one goal as they reached a major tournament for the first time.
He moved to Molde - coached by former Manchester United striker and Cardiff manager Ole Gunnar Solskjaer - with the intention of playing regular games in order to secure a Euro 2016 place.
Heimir Hallgrimsson, who co-manages Iceland with Lagerback, said: "He has taken a step up at Molde. He looks fitter and has shown the desire necessary."

The priest at St Andrew's RC Church in Livingston said anti-Catholic messages had been painted all over the building.
The vandalism happened between 19:00 on Saturday and 09:00 on Sunday.
Police have urged anyone who may have seen anything suspicious in the area, or anyone with information, to come forward.
In April 2014, St Andrew's Roman Catholic Church in Craigshill became the latest building in Livingston to be granted listed status.
Designed in 1968 and completed in 1970, St Andrew's was the first Catholic Church to be built in Livingston after it was founded in 1962.
Father Jeremy Bath, parish priest of St Andrew's, said: "Craigshill is a great area where people live together in harmony so for this to happen is shocking, saddening and very disappointing.
"I've been here for seven years and nothing like this has happened before. Hence the disappointment. It's perhaps a reminder that there is still a strain of anti-Catholicism in Scottish society that we have to be aware of.
"We had a funeral today. How sad that mourners had to arrive at a church covered in anti-Catholic graffiti. Hopefully we can get things cleaned up very soon, certainly in time for our First Holy Communions this weekend.
"I'd like to thank Police Scotland, West Lothian Council and the local community for being so supportive at this difficult time."
A Police Scotland spokesman said: "Police in West Lothian are investigating following sectarian vandalism to a church in Livingston.
"The incident happened sometime between 19:00 on Saturday 23 May and 09:00 on Sunday 24 May at the St Andrews Roman Catholic Church in Victoria Street, Craigshill.
"Inquiries are ongoing to trace those responsible and anyone who remembers seeing anything suspicious in the area, or who has information that can assist police with their investigation is asked to come forward immediately."
A West Lothian Council spokesman said: "We were made aware of this incident at St Andrew's RC Church in Craigshill on Sunday and our street cleansing team have been in attendance."
Former Chelsea forward Eidur Gudjohnsen has been named in Iceland's Euro 2016 squad at the age of 37.
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Police are investigating an incident of sectarian graffiti sprayed on a church in West Lothian over the weekend.