ACCOUNTING – CASE 5-1 STERN CORPORATION (A)

A subsequent review of the year’s transactions applicable to accounts receivable revealed the items
listed below:
1. Sales on account during 2010 amounted to $9,965,575.
2. Payment received on accounts receivable during 2010 totaled $9,685,420.
3. During the year, accounts receivable totaling $26,854 were deemed uncollectible and were
written off.
4. Two accounts that had been written off as uncollectible in 2009 were collected in 2010. One
account for $2,108 was paid in full. A partial payment of $1,566 was made by the Hollowell
Company on another account that originally had amounted to $2,486. The controller was
reasonably sure this account would be paid in full because reliable reports were circulating
that the trustee in bankruptcy for the Hollowell Company would pay all obligations 100 cents
on the dollar.
5. The Allowance for Bad Debts was adjusted to equal 3 percent of the balance in Accounts
Receivable at the end of the year.

Question 1: Effect on Accounts Receivable, Allowance for Doubtful Accounts, and any other
account that may be involved, and prepare necessary journal entries.

Journal Entries
No. Accounts Dr. Cr
Accounts Receivable $ 9,965,575.00
1
Sales $ 9,965,575.00
Cash $ 9,685,420.00
2
Accounts Receivable $ 9,685,420.00
Allowance for Doubtful Accounts $ 26,854.00
3.a
Accounts Receivable $ 26,854.00
Bad Debt Expense $ 26,854.00
3.b
Allowance for Doubtful Accounts $ 26,854.00

*There are 3 different ways to handle the entries for no. 4. The most preferable is the first one (a)
since the controller was pretty sure that Hollowell Company will pay based on reliable reports.

Cash ($2,108 + $920) $ 3,674.00

4.a Accounts Receivable $ 920.00
Allowance for Doubtful Accounts $ 4,594.00
Cash $ 3,674.00
4.b
Bad Debt Expense $ 3,674.00
Cash $ 3,674.00
4.c
Other Income $ 3,674.00

For journal entries of no. 5, we must look into the Balance Sheet provided in the Exhibit 1.
The calculation on Allowance for Bad Debts and Account Receivable depends upon which
alternatives you choose on number 4 (4.a, 4.b or 4.c).
IF YOU CHOOSE 4.a (preferable method)
A/R, December 31, 2009 $ 988,257.00
Increase in A/R from Sales (no. 1) $ 9,965,575.00
$ 10,953,832.00
Payments on A/R (no. 2) $ 9,685,420.00
$ 1,268,412.00
Accounts Written Off (no. 3.b) $ 26,854.00
$ 1,241,558.00
A/R on 4.a $ 920.00
Total Accounts Receivable $ 1,242,478.00
Allowance for Bad Debts (3% A/R) $ 37,274.34

To calculate Bad Debt Expense from Allowance for Bad Debts we need to deduct anything other than
Bad Debt from the Allowance for Bad Debts.

A/R, December 31, 2009 $ 988,257.00

Increase in A/R from Sales (no. 1) $ 9,965,575.00
$ 10,953,832.00
Payments on A/R (no. 2) $ 9,685,420.00
$ 1,268,412.00
Accounts Written Off (no. 3.b) $ 26,854.00
$ 1,241,558.00
A/R on 4.a $ 920.00
Total Accounts Receivable $ 1,242,478.00
Allowance for Bad Debts (3% A/R) $ 37,274.34

Allowance for Doubtful Account (Dec 31, 2009) $ 29,648.00

Accounts Receivable written off (3.b) $ 26,854.00
Allowance for Doubtful Account (Dec 31, 2010) $ 2,794.00
Cash + A/R collected from Bad Debts (4.a) $ 4,594.00
Balance on Account $ 7,388.00
Bad Debt Expense ($37,274 - $7,388) $ 29,886.34

Journal Entries (4.a)

No. Accounts Dr. Cr
Bad Debt Expense $ 29,886.34
5.a
Allowance for Doubtful Accounts $ 29,886.34

IF YOU CHOOSE 4.b

Total Accounts Receivable $ 1,241,558.00
Allowance for Bad Debts (3% A/R) $ 37,246.74
 Allowance for Doubtful Account (Dec 31, 2009) $ 29,648.00
Accounts Receivable written off (no. 3.b) $ 26,854.00
Allowance for Doubtful Account (Dec 31, 2010) $ 2,794.00
Balance on Account $ 2,794.00
Bad Debt Expense ($37,246 - $2,794) $ 34,452.74

Journal Entries (4.b)

No. Accounts Dr. Cr
Bad Debt Expense $ 34,452.74
5.b
Allowance for Doubtful Accounts $ 34,452.74

Lol, I don’t have any idea how to write the journal entry for alternative 4.
But companies that write off bad debts recollection as “Other Income” would not have Bad Debts
account in the first place. I don’t recommend using this alternatives.

Question 2: Give the correct totals for Accounts Receivable and the Allowance for Doubtful
Accounts as of December 31, 2010, after the transactions affecting them had been recorded.

Balance of Accounts as of Dec 31, 2010: Using (a) Using (b or c)

Accouns Receivable $ 1,242,478.00 $ 1,241,558.00
Allowance for Bad Debts $ 37,274.34 $ 37,246.74
$ 1,205,203.66 $ 1,204,311.26

Question 3: Calculate the current ratio, acid-test ratio, and days’ receivables figures as of December
31, 2010. Assume that amounts for items other than those described in the case are the same as on
December 31, 2009.

The ratios are the same for any method used (a, b, or c)
2010
1. Current ratio 2.67
 Current Assets - Current Liabilities
2. Acid-Test Ratio or Quick Ratio 1.40
 CA (without Inventory) - CL
3. Days Cash on Hand N/A
 number of days opex can be paid, given the amount of cash available
4. Days Receivable (a) 45.51
 A/R : Annual Rev or Sales * 365 days
5. Days Receivable (b or c) 45.47
 A/R : Annual Rev or Sales * 365 days