Part A

La Jolla Industries Inc. (La Jolla) is considering the acquisition of the net assets of Sonoma Services Inc. (Sonoma) as of June 30, 2017. La Jolla is willing to pay the appraised value of the net identifiable assets of Sonoma plus a reasonable amount for goodwill. La Jolla assembled the following data relative to Sonoma:

Assets at appraised values (excluding goodwill) $850,000

Liabilities at appraised values $310,000

The income statements prepared by Sonoma showed the following pre-tax income for the last four years preceding the proposed acquisition:

Year Ended June 30 Pretax Income

2014 $115,000

2015 $135,000

2016 $130,000

2017 $140,000

Similar operating results can be expected in the future with the following exceptions:

1. A review of Sonomas accounting records reveals that equipment acquired in July 2012, at a cost of $300,000 has been depreciated on a straight-line basis with a 20-year useful life and no estimated salvage value. Company engineers now agree that the equipment should have been depreciated over 16 years with an estimated salvage value of $44,000 at the end of its useful life.
2. Normal maintenance of the equipment by Sonoma has been inadequate by approximately $19,000 per year.

Both parties agree that a pretax return of 15% on net identifiable assets employed in this type of business is normal. Average earnings in excess of this amount are expected to continue for another five years after which no excess earnings are expected. Since there is less certainty about excess earnings, a return of 20% is considered reasonable for an investment in above-normal pretax income.

REQUIRED: Prepare a summary showing how the amount to be paid for goodwill of Sonoma Services Inc., is to be determined, assuming excess earnings are discounted.

Part B

Refer to Part A of this question, but assume La Jolla purchases all of Sonomas net identifiable assets and goodwill for a total purchase price of $640,000 on June 30, 2017. Sonoma is considered a separate business unit.

The year-end date of June 30, 2018 is rapidly approaching and La Jolla is preparing to close its books. Management is aware that an annual impairment test of Sonomas goodwill must be performed. A business valuation specialist determines Sonomas net identifiable assets (excluding goodwill) to be:

Fair Values

Cash $150,000

Accounts receivable $180,000

Inventory $220,000

Equipment $500,000

Goodwill ?

Accounts payable $430,000

Excess earnings are now expected to be $22,000; a capitalization rate of 25% is deemed appropriate for valuation purposes.

REQUIRED:

1. Using only the information given above, calculate the implied goodwill. Have you identified an impairment of goodwill? If so, how much is the expected writedown for 2018?
2. Without regard to your answer in part (1), prepare any necessary journal entries for La Jolla assuming Sonomas goodwill as at June 30, 2018 is $91,000.
3. What are two possible courses of action available to management if it wants to avert a goodwill writedown for Sonoma at year end. The course(s) of action must not violate laws, rules, regulations or GAAP.