Current accounting standards for goodwill are seen as complex because they require regular impairment testing and do not permit goodwill amortization. Goodwill impairment – when goodwill has become or is considered to be of lower value than at the time of purchase – became a public issue during the accounting scandals in 2002.
Many companies had artificially inflated their balance sheets by reporting excessive goodwill value. This tactic can work during strong bull markets, but the accounting scandals led to legislation that required corporations to report their goodwill assets at realistic levels.
Currently, impairment testing must be performed at least annually or more frequently if certain conditions exist, and companies have limited flexibility in how the tests are performed. They can: (a) perform a qualitative assessment (often known as step zero) to determine if it is more likely than not that a reporting unit’s fair value is less than its carrying value, or (b) go straight to step one of a quantitative two-step impairment test.
In step one, the carrying value of the reporting unit is compared with its fair value. If the carrying amount exceeds the fair value, step two must be performed. In step two, the amount of the goodwill impairment is determined by comparing the carrying value of the goodwill with its implied value. When performed at the reporting unit level, the implied fair value is based on a hypothetical application of the acquisition method that is performed after measuring the fair value of the identifiable assets and liabilities - essentially performing a hypothetical-purchase accounting calculation.
Critics of the current accounting standards say the standards provide limited benefits to users of private-company financial statements, and they are costly to apply because they call for subjective judgments and measurements that often require the hiring of third-party experts, such as valuation specialists to assess fair value.