Accounts Receivable Management Quiz Managerial Accounting Quiz Share Accounts Receivable Management 18 questions in 30 minutes Pass Score 70% 1 / 18 A company can increase annual sales by $150,000 if it sells to a new, riskier group of customers. Theuncollectible accounts expense is expected to be 16% of sales, and collection costs will be 4%. Thecompany’s manufacturing and selling expenses are 75% of sales, and its effective tax rate is 38%. Ifthe company accepts this opportunity, its after-tax income will increase by : $7,500 $2,850 $4,650 $8,370 The company’s manufacturing and selling costs exclusive of bad debtsequal 75% of sales. Hence, the gross profit on the $150,000 increase insales will be $37,500 ($150,000 × 25%). The increase in after-tax profit iscalculated as follows: Increase in gross profit = $37,500 Less: uncollectible accounts ($150,000 × 16%) = (24,000) Less: collection costs ($150,000 × 4%) = (6,000) Increase in pre-tax income = $ 7,500 Less: income tax expense = ($7,500 × 38%) = (2,850) Increase in after-tax income= $ 4,650 2 / 18 A firm that often factors its accounts receivable has an agreement with its finance company thatrequires the firm to maintain a 6% reserve and charges a 1.4% commission on the amount of thereceivables. The net proceeds would be further reduced by an annual interest charge of 15% on themonies advanced. Assuming a 360-day year, what amount of cash (rounded to the nearest dollar)will the firm receive from the finance company at the time a $100,000 account that is due in 60 daysis turned over to the finance company? $92,600 $96,135 $85,000 $90,285 The first step is to calculate the gross proceeds the firm will receive fromthe factoring transaction: Amount of receivable $100,000 Less: reserve ($100,000 × 6%)= (6,000) Less: factor fee ($100,000 × 1.4%) =(1,400) = Gross proceeds $ 92,600 This amount must be reduced by the interest charged on the grossproceeds: Gross proceeds $92,600 Times: annual finance charge × 15% Annualized interest expense $13,890 Times: portion of year (60 days ÷ 360 days) × 16.7% Interest expense $ 2,315 The actual cash the firm will receive from this factoring transaction is thuscalculated as follows: Gross proceeds $92,600 Less: interest expense (2,315) Net proceeds $90,285 3 / 18 Consider the following factors affecting a company as it is reviewing its trade credit policy. I. Operating at full capacity. II. Low cost of borrowing. III. Opportunity for repeat sales. IV. Low gross margin per unit. Which of the above factors would indicate that the company should liberalize its credit policy? III and IV only I, II, and III only II and III only I and II only If the cost of borrowing is low, the firm can satisfy its working capitalneeds otherwise than by encouraging early payment from customers. Also,loosening credit policies tends to increase repeat sales. 4 / 18 A company believes that its collection costs could be reduced through modification of collectionprocedures. This action is expected to result in a lengthening of the average collection period from28 days to 34 days; however, there will be no change in uncollectible accounts. The company’sbudgeted credit sales for the coming year are $27,000,000, and short-term interest rates are expectedto average 8%. To make the changes in collection procedures cost beneficial, the minimum savings in collection costs (using a 360-day year) for the coming year would have to be : $180,000 $36,000 $360,000 $30,000 If the change is adopted, the company’s average balance in receivables willincrease by $450,000 {$27,000,000 × [(34 days – 28 days) ÷ 360 days]}. The minimum savings that Best must experience to justify the change istherefore $36,000 ($450,000 × 8%) 5 / 18 An organization would usually offer credit terms of 2/10, net 30 when : The organization can borrow funds at a rate less than the annual interest cost The cost of capital approaches the prime rate Most competitors are offering the same terms, and the organization has a shortage of cash he organization can borrow funds at a rate exceeding the annual interest cost Because these terms involve an annual interest cost of over 36%, acompany would not offer them unless it desperately needed cash. Also,credit terms are typically somewhat standardized within an industry. Thus,if most companies in the industry offer similar terms, a firm will likely beforced to match the competition or lose market share. 6 / 18 An aging of accounts receivable measures the : Percentage of sales that have been collected after a given time period Amount of receivables that have been outstanding for given lengths of time Ability of the firm to meet short-term obligations Average length of time that receivables have been outstanding The purpose of an aging of receivables is to classify receivables by duedate. Those that are current (not past due) are listed in one column, thoseless than 30 days past due in another column, etc. The amount in eachcategory can then be multiplied by an estimated bad debt percentage that isbased on a company’s credit experience and other factors. The theory isthat the oldest receivables are the least likely to be collectible. Aging thereceivables and estimating the uncollectible amounts is one method ofarriving at the appropriate balance sheet valuation of the accountsreceivable account. 7 / 18 A company’s budgeted sales for the coming year are $40,500,000, of which 80% are expected to becredit sales at terms of n/30. The company estimates that a proposed relaxation of credit standardswill increase credit sales by 20% and increase the average collection period from 30 days to 40 days.Based on a 360-day year, the proposed relaxation of credit standards will result in an expectedincrease in the average accounts receivable balance of : $900,000 $2,700,000 $540,000 $1,620,000 Projected credit sales for the year under the old credit policy were$32,400,000 ($40,500,000 × 80%). The projected average balance inreceivables was therefore $2,700,000 [$32,400,000 × (30 days ÷ 360days)]. Under the new policy, projected credit sales will be $38,880,000($32,400,000 × 1.2), resulting in a new average receivables balance of$4,320,000 [$38,880,000 × (40 days ÷ 360 days)]. Hence, the expectedincrease in the balance is $1,620,000 ($4,320,000 – $2,700,000). 8 / 18 A company plans to tighten its credit policy. The new policy will decrease the average number ofdays in collection from 75 to 50 days and will reduce the ratio of credit sales to total revenue from70% to 60%. The company estimates that projected sales will be 5% less if the proposed new creditpolicy is implemented. If projected sales for the coming year are $50 million, calculate the dollarimpact on accounts receivable of this proposed change in credit policy. Assume a 360-day year. $3,819,445 decrease $6,500,000 decrease $3,333,334 decrease $18,749,778 increase Projected credit sales for the year under the old credit policy were$35 million ($50,000,000 × 70%). The level of average receivables wascalculated as follows: Receivables turnover = Days in year ÷ Average collection period = 360 days ÷ 75 days = 4.8 times per year Average receivables= Net credit sales ÷ Receivables turnover = $35,000,000 ÷ 4.8 times = $7,291,667 Under the new policy, total sales will be $47.5 million ($50,000,000 ×95%), and credit sales will be $28.5 million ($47,500,000 × 60%). The newlevel of average receivables is calculated as follows: Receivables turnover = Days in year ÷ Average collection period = 360 days ÷ 50 days = 7.2 times per year Average receivables = Net credit sales ÷ Receivables turnover = $28,500,000 ÷ 7.2 times = $3,958,333 The average receivables balance will therefore be reduced by $3,333,334($7,291,667 – $3,958,333). 9 / 18 A corporation had net sales last year of $18,600,000 (of which 20% were installment sales). It alsohad an average accounts receivable balance of $1,380,000. Credit terms are 2/10, net 30. Based on a360-day year, the average collection period last year was : 33.4 days 26.2 days 27.2 days 26.7 days Average collection period equals average receivables divided by dailysales. The corporation’s average daily sales were $51,666 ($18,600,000 ÷360). The average collection period was thus 26.7 days ($1,380,000 ÷$51,666). 10 / 18 The following information regards a change in credit policy. The company has a required rate ofreturn of 11% and a variable cost ratio of 50%. The opportunity cost of a longer collection period isassumed to be negligible. Old Credit Policy New Credit Policy Sales $4,600,000 $4,960,000 Average collection period 30 days 35 days The pre-tax cost of carrying the additional investment in receivables, assuming a 360-day year, is $5,439 $10,878 $98,890 $13,778 The projected average balance in receivables under the old policy was$383,333 [$4,600,000 × (30 days ÷ 360 days)]. Under the new policy, theaverage balance will be $482,222 [$4,960,000 × (35 days ÷ 360 days)]. Hence, the average balance is $98,889 higher under the new policy($482,222 – $383,333). The pre-tax cost of carrying the additionalinvestment in receivables can be calculated as follows: Increased investment in receivables -- gross $98,889 Times: variable cost ratio × 50% Increased investment in receivables -- net = $49,444 Times: opportunity cost of funds × 11% Incremental cost of new credit plan = $ 5,439 11 / 18 The one item listed below that would warrant the least amount of consideration in credit and collection policy decisions is the : Quality of accounts accepted Cash discount given Quantity discount given Level of collection expenditures A quantity discount is an attempt to increase sales by reducing the unitprice on bulk purchases. It concerns only the price term of an agreement,not the credit term, and thus is unrelated to credit and collection policy. 12 / 18 A firm sells to retail stores on credit terms of 2/10, net 30. Daily sales average 150 units at a price of $300 each. All sales are on credit and 60% of customers take the discount and pay on day 10 whilethe rest of the customers pay on day 30. The amount of the firm’s accounts receivable that is paidwithin the discount period is $1,350,000 $990,000 $810,000 $900,000 The firm has daily sales of $45,000 consisting of 150 units at $300 each. For 30 days, sales total $1,350,000. Of these sales, 40%, or $540,000($1,350,000 × 40%), will be uncollected because customers do not taketheir discounts. The remaining $810,000 ($1,350,000 × 60%) will be paidwithin the discount period. 13 / 18 The average collection period for a firm measures the number of days : For a typical check to “clear” through the banking system After a typical credit sale is made until the firm receives the payment Before a typical account becomes delinquent Beyond the end of the credit period before a typical customer payment is received The average collection period measures the number of days between thedate of sale and the date of collection. It should be related to a firm’s creditterms. For example, a firm that allows terms of 2/15, net 30, should havean average collection period of somewhere between 15 and 30 days. 14 / 18 A firm sells 20,000 automobiles per year for $25,000 each. The firm’s average receivables are$30,000,000 and average inventory is $40,000,000. The firm’s average collection period is closest towhich one of the following? Assume a 365-day year. 61 days 17 days 29 days 22 days The average collection period, also called the days sales outstanding inreceivables, is calculated as the number of days in the year over thereceivables turnover ratio. The firm’s can be thus calculated as follows: Average collection period = Days in year ÷ Accounts receivable turnover = 365 ÷ (Net credit sales ÷ Average net receivables) = 365 ÷ [(20,000 × $25,000) ÷ $30,000,000] = 365 ÷ ($500,000,000 ÷ $30,000,000) = 365 ÷ 16.667 = 21.9 days 15 / 18 A company is considering a change in its credit terms from n/20 to 3/10, n/20. The company’sbudgeted sales for the coming year are $20,000,000, of which 80% are expected to be made oncredit. If the new credit terms are adopted, management estimates that discounts will be taken on60% of the credit sales; however, uncollectible accounts will be unchanged. The new credit termswill result in expected discounts taken in the coming year of $288,000 $480,000 $600,000 $360,000 Expected discounts taken under the new credit policy can be calculated asfollows: Total sales $20,000,000 Times: percentage on credit × 80% = Credit sales $16,000,000 Times: subject to discount × 60% = Sales subject to discount $9,600,000 Times: discount percentage × 3% = Expected discounts taken $288,000 16 / 18 An established firm sells computer hardware, software, and services. The firm is considering achange in its credit policy. It has been determined that such a change would not change the paymentpatterns of the current customers. To determine whether such a change would be beneficial, the firmhas identified the proposed new credit terms, the expected additional sales, the expected contributionmargin on the sales, the expected bad debt losses, and the investment in additional receivables andthe period of the investment. What additional information, if any, does the firm require to determinethe profitability of the proposed new policy as compared to the current credit policy? The credit standards that presently exist The new credit standards No additional information is needed The opportunity cost of funds Opportunity cost is the maximum benefit forgone by choosing aninvestment. Thus, the missing relevant information is the best alternativereturn on the funds to be invested in receivables. 17 / 18 A firm is changing its credit terms from net 30 to 2/10, net 30. The least likely effect of this changewould be a(n) Lower number of days’ sales outstanding Shortening of the cash conversion cycle Increase in sales Increase in short-term borrowings Changing its credit terms to encourage earlier payment by customersincreases the firm’s cash flow and decreases the need for short-termborrowing. 18 / 18 The following information regards a change in credit policy. The company has a required rate ofreturn of 10% and a variable cost ratio of 60%. Old Credit Policy New Credit Policy Sales $3,600,000 $3,960,000 Average collection period 30 days 36 days The pre-tax cost of carrying the additional investment in receivables, using a 360-day year, would be : $8,160 $9,600 $960 $5,760 The projected average balance in receivables under the old policy was$300,000 [$3,600,000 × (30 days ÷ 360 days)]. Under the new policy, theaverage balance will be $396,000 [$3,960,000 × (36 days ÷ 360 days)]. Hence, the average balance is $96,000 higher under the new policy($396,000 – $300,000). The pre-tax cost of carrying the additionalinvestment in receivables can be calculated as follows: Increased investment in receivables -- gross = $96,000 Times: variable cost ratio × 60% Increased investment in receivables -- net =$57,600 Times: opportunity cost of funds × 10% Incremental cost of new credit plan = $ 5,760 Your score is LinkedIn Facebook Twitter VKontakte 0% Send feedback Accounts Receivable and Bad Debts Expense (Practice Quiz)Accounts receivable Intermediate accounting QuizAccounts Receivable Management Quiz
