Croatia were already through, but goals from Milan Badelj and Ivan Perisic ensured they win the group too, as Iceland paid for poor finishing.
They will now face Denmark in the Round of 16, while Argentina go up against France.
With Croatia already qualified, they transformed the starting XI and rested numerous stars. Iceland could still go through with a win by a two-goal margin if Argentina and Nigeria drew in the other game.
Croatia were already through, but goals from Milan Badelj and Ivan Perisic ensured they win the group too, as Iceland paid for poor finishing.
They will now face Denmark in the Round of 16, while Argentina go up against France.
With Croatia already qualified, they transformed the starting XI and rested numerous stars. Iceland could still go through with a win by a two-goal margin if Argentina and Nigeria drew in the other game.
Iceland had the first genuine opportunity on 28 minutes with their trademark long throw, Hordur Bjorgvin Magnusson flicking the header just wide.
Alfred Finnbogason caught Fiorentina midfielder Milan Badelj napping and side-footed his finish inches past the post, then Lovre Kalinic flew to fingertip an Aron Gunnarsson curler out from under the bar.
Iceland were ultimately made to pay for wasting so many chances. First Badelj smacked an effort against the crossbar, then he fired in the half-volley on a bouncing Josip Pivaric cross to give Croatia the lead.
Kalinic was called into action again on a Sverrir Ingi Ingason header, once more from that infamous throw-in, and on the resulting corner Ingason clipped the crossbar.
Ex-Pescara midfielder Birkir Bjarnason really should’ve equalised, but horribly mis-kicked at the far post.
Iceland eventually got a penalty for Dejan Lovren’s handling offence, as he stuck his arm out behind him to block a Sigurdsson cross. Sigurdsson kept his cool to blast the equaliser into the roof of the net.
However, Inter winger Perisic popped up with the last-gasp winner, a trademark left-footed shot after bursting down the left side of the box.
Iceland 1-2 Croatia
Badelj 53 (C), G Sigurdsson pen 76 (I), Perisic 90 (C)
Iceland: Halldorsson; Saevarsson, Ingason, R Sigurdsson (Sigurdarson 70), Magnusson; Gunnarsson, Hallfredsson; J Gudmundsson, G Sigurdsson, Bjarnason (Traustason 90); Finnbogason (A Gudmundsson 85)
Croatia: L Kalinic; Jedvaj, Corluka, Caleta-Car, Pivaric; Modric (Bradaric 65), Badelj; Pjaca (Lovren 70), Kovacic (Rakitic 81), Perisic; Kramaric
Ref: Mateu (ESP)