Accounts Receivable Management Quiz Financial Accounting Quiz On Oct 16, 2024 Share /18 123456789101112131415161718 Accounts Receivable Management 18 questions in 30 minutes Pass Score 70% 1 / 18 A company with $4.8 million in credit sales per year plans to relax its credit standards, projecting that this will increase credit sales by $720,000. The company’s average collection period for new customers is expected to be 75 days, and the payment behavior of the existing customers is not expected to change. Variable costs are 80% of sales. The firm’s opportunity cost is 20% before taxes. Assuming a 360-day year, what is the company’s benefit (loss) on the planned change in credit terms? $28,800 $120,000 $0 $144,000 The company can calculate the net benefit (loss) from the proposed change in credit policy as follows: Increase in sales $720,000 Times: variable cost ratio × 80% Increase in variable costs $576,000 Increased investment in receivables = $576,000 × (75 days ÷ 360 days) = $120,000 Increased investment in receivables $120,000 Times: opportunity cost of funds × 20% Cost of new credit plan $ 24,000 Increase in sales $720,000 Times: contribution margin ratio × 20% Increase in contribution margin $144,000 Less: cost of new credit plan (24,000) Benefit of new credit plan $120,000 2 / 18 Which one of the following statements is most likely to be true if a seller extends credit to a purchaser for a period of time longer than the purchaser’s operating cycle? The seller: Can be certain that the purchaser will be able to convert the inventory into cash before payment is due Is, in effect, financing more than just the purchaser’s inventory needs Has no need for a stated discount rate or credit period Will have a lower level of accounts receivable than those companies whose credit period is shorter than the purchaser’s operating cycle The normal operating cycle is the period from the acquisition of inventory to the collection of the account receivable. If trade credit is for a period longer than the normal operating cycle, the seller must be financing more than just the purchase of inventory 3 / 18 A maker of bowling gloves is investigating the possibility of liberalizing its credit policy. Currently, payment is made on a cash-on-delivery basis. Under a new program, sales would increase by $80,000. The company has a gross profit margin of 40%. The estimated bad debt loss rate on the incremental sales would be 6%. Ignoring the cost of money, what would be the return on sales before taxes for the new sales? 36.2% 42.5% 34.0% 40.0% The increase in estimated gross profit is $32,000 ($80,000 × 40%). The incremental bad debt loss is $4,800 ($80,000 × 6%). Accordingly, the estimated net increase in operating income is $27,200 ($32,000 – $4,800). The before-tax return on sales is 34% ($27,200 ÷ $80,000). 4 / 18 The cash manager for a large kitchen appliance retailer has been approached by a bank representative offering to set up a lock-box collection system. Analysis of the firm’s receipts shows that, on average, the system will reduce collection time by 2 days. The firm receives approximately 2,500 checks per day with an average value of $600 per check. The bank would charge $0.28 per check for operating the system. The firm currently invests short-term funds at an average rate of 7%. How much would the firm gain or lose annually by entering the lock-box agreement? $210,000 $45,500 $(150,500) $(45,500) The additional annual income (loss) from using the lockbox service is the excess (deficit) of interest earned on the early deposits over (under) the cost of the service. If the plan is adopted, the firm’s average cash balance will increase by $3,000,000 ($600 value per check × 2,500 checks received per day × 2 days). Benefit (loss) = Interest earned – Cost. Thus, the loss of $45,500 is calculated from the interest earned of $210,000 ($3,000,000 × 7%) minus the cost of $255,500 ($0.28 per check × 2,500 checks per day × 365 days in a year) 5 / 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? I, II, and III only I and II only III and IV only II and III only If the cost of borrowing is low, the firm can satisfy its working capital needs otherwise than by encouraging early payment from customers. Also, loosening credit policies tends to increase repeat sales. 6 / 18 The average collection period for a firm measures the number of days : For a typical check to “clear” through the banking system Before a typical account becomes delinquent After a typical credit sale is made until the firm receives the payment Beyond the end of the credit period before a typical customer payment is received The average collection period measures the number of days between the date of sale and the date of collection. It should be related to a firm’s credit terms. For example, a firm that allows terms of 2/15, net 30, should have an average collection period of somewhere between 15 and 30 days. 7 / 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 to which one of the following? Assume a 365-day year. 17 days 61 days 22 days 29 days The average collection period, also called the days sales outstanding in receivables, is calculated as the number of days in the year over the receivables 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 8 / 18 A corporation had net sales last year of $18,600,000 (of which 20% were installment sales). It also had an average accounts receivable balance of $1,380,000. Credit terms are 2/10, net 30. Based on a 360-day year, the average collection period last year was : 27.2 days 26.7 days 33.4 days 26.2 days Average collection period equals average receivables divided by daily sales. 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). 9 / 18 An aging of accounts receivable measures the : Percentage of sales that have been collected after a given time period Ability of the firm to meet short-term obligations Amount of receivables that have been outstanding for given lengths of time Average length of time that receivables have been outstanding The purpose of an aging of receivables is to classify receivables by due date. Those that are current (not past due) are listed in one column, those less than 30 days past due in another column, etc. The amount in each category can then be multiplied by an estimated bad debt percentage that is based on a company’s credit experience and other factors. The theory is that the oldest receivables are the least likely to be collectible. Aging the receivables and estimating the uncollectible amounts is one method of arriving at the appropriate balance sheet valuation of the accounts receivable account. 10 / 18 A company plans to tighten its credit policy. The new policy will decrease the average number of days in collection from 75 to 50 days and will reduce the ratio of credit sales to total revenue from 70% to 60%. The company estimates that projected sales will be 5% less if the proposed new credit policy is implemented. If projected sales for the coming year are $50 million, calculate the dollar impact on accounts receivable of this proposed change in credit policy. Assume a 360-day year. $3,333,334 decrease $18,749,778 increase $6,500,000 decrease $3,819,445 decrease Projected credit sales for the year under the old credit policy were $35 million ($50,000,000 × 70%). The level of average receivables was calculated 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 new level 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). 11 / 18 The sales manager feels confident that, if the credit policy were changed, sales would increase and, consequently, the company would utilize excess capacity. The two credit proposals being considered are as follows: Proposal A Proposal B Increase in sales $500,000 $600,000 Contribution margin 20% 20% Bad debt percentage 5% 5% Increase in operating profits $ 75,000 $ 90,000 Desired return on sales 15% 15% Currently, payment terms are net 30. The proposed payment terms for Proposal A and Proposal B are net 45 and net 90, respectively. An analysis to compare these two proposals for the change in credit policy would include all of the following factors except the : Current bad debt experience Impact on the current customer base of extending terms to only certain customers Bank loan covenants on days’ sales outstanding Cost of funds All factors should be considered that differ between the two policies. Factors that do not differ, such as the current bad debt experience, are not relevant. The company must estimate the expected bad debt losses under each new policy. 12 / 18 An organization would usually offer credit terms of 2/10, net 30 when : The cost of capital approaches the prime rate The organization can borrow funds at a rate less than the annual interest cost 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%, a company 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 be forced to match the competition or lose market share. 13 / 18 Hest Computers believes that its collection costs could be reduced through modification of collection procedures. This action is expected to result in a lengthening of the average collection period from 30 to 35 days; however, there will be no change in uncollectible accounts, or in total credit sales. Furthermore, the variable cost ratio is 60%, the opportunity cost of a longer collection period is assumed to be negligible, the company’s budgeted credit sales for the coming year are $45,000,000, and the required rate of return is 6%. To justify changes in collection procedures, the minimum annual reduction of costs (using a 360-day year and ignoring taxes) must be: $22,500 $37,500 $375,000 $125,000 If the change is adopted, Hest’s average balance in receivables will increase by $625,000 {$45,000,000 [(35 days – 30 days ) ÷ 360 days]}. The company’s additional required investment in receivables is therefore $375,000 ($625,000 × 60% variable cost ratio), and the incremental pretax cost of this investment is $22,500 ($375,000 × 6%). Accordingly, the collection costs must be reduced by a pretax minimum of $22,500 to offset the cost of the increased investment in receivables. 14 / 18 A firm that often factors its accounts receivable has an agreement with its finance company that requires the firm to maintain a 6% reserve and charges a 1.4% commission on the amount of the receivables. The net proceeds would be further reduced by an annual interest charge of 15% on the monies 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 days is turned over to the finance company? $90,285 $92,600 $96,135 $85,000 The first step is to calculate the gross proceeds the firm will receive from the 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 gross proceeds: 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 thus calculated as follows: Gross proceeds $92,600 Less: interest expense (2,315) Net proceeds $90,285 15 / 18 A company can increase annual sales by $150,000 if it sells to a new, riskier group of customers. The uncollectible accounts expense is expected to be 16% of sales, and collection costs will be 4%. The company’s manufacturing and selling expenses are 75% of sales, and its effective tax rate is 38%. If the company accepts this opportunity, its after-tax income will increase by : $2,850 $4,650 $7,500 $8,370 The company’s manufacturing and selling costs exclusive of bad debts equal 75% of sales. Hence, the gross profit on the $150,000 increase in sales will be $37,500 ($150,000 × 25%). The increase in after-tax profit is calculated 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 16 / 18 ELG, Inc., grants credit terms of 1/15, net 30 and projects gross credit sales for the year of $2,000,000. The credit manager estimates that 40% of customers pay on the 15th day, 40% on the 30th day, and 20% on the 45th day. Assuming uniform sales and a 360-day year, what is the projected amount of overdue receivables? $400,000 $16,667 $150,000 $50,000 The total amount of sales overdue at any time during the year is $400,000 ($2,000,000 gross credit sales × 20% received after 30 days). The average collection period for these sales is 45 days. The projected amount of overdue receivables is therefore $50,000 [$400,000 × (45 days ÷ 360 days)]. 17 / 18 A firm is changing its credit terms from net 30 to 2/10, net 30. The least likely effect of this change would be a(n) Shortening of the cash conversion cycle Increase in short-term borrowings Lower number of days’ sales outstanding Increase in sales Changing its credit terms to encourage earlier payment by customers increases the firm’s cash flow and decreases the need for short-term borrowing. 18 / 18 The following information regards a change in credit policy. The company has a required rate of return of 11% and a variable cost ratio of 50%. The opportunity cost of a longer collection period is assumed 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 $98,890 $10,878 $13,778 $5,439 The projected average balance in receivables under the old policy was $383,333 [$4,600,000 × (30 days ÷ 360 days)]. Under the new policy, the average 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 additional investment 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 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
