Accounts Receivable Management Quiz Managerial Accounting Quiz Share Accounts Receivable Management 18 questions in 30 minutes Pass Score 70% 1 / 18 A company is considering a change in its credit terms from n/30 to 2/10, n/30. The company’sbudgeted sales for the coming year are $24,000,000, of which 90% are expected to be made oncredit. If the new credit terms are adopted, the company estimates that discounts will be taken on50% of the credit sales; however, uncollectible accounts will be unchanged. The new credit termswill result in expected discounts taken in the coming year of $480,000 $216,000 $432,000 $240,000 The company can calculate expected discounts taken under the new creditpolicy as follows: Total sales $24,000,000 Times: percentage on credit × 90% = Credit sales $21,600,000 Times: subject to discount × 50% = Sales subject to discount $10,800,000 Times: discount percentage × 2% = Expected discounts taken $ 216,000 2 / 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 $360,000 $600,000 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 3 / 18 An aging of accounts receivable measures the : Ability of the firm to meet short-term obligations Average length of time that receivables have been outstanding Amount of receivables that have been outstanding for given lengths of time Percentage of sales that have been collected after a given time period 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. 4 / 18 A company’s budgeted sales for the coming year are expected to be $50,000,000, of which 75% areexpected to be credit sales at terms of n/30. The company estimates that a proposed relaxation ofcredit standards will increase credit sales by 25% and increase the average collection period from 20days to 30 days. Based on a 360-day year, the proposed relaxation of credit standards will result inan expected increase in the average accounts receivable balance of $2,083,333 $3,906,250 $1,822,917 $520,833 Projected credit sales for the year under the old credit policy were$37,500,000 ($50,000,000 × 75%), resulting in an average balance inreceivables of $2,083,333 [$37,500,000 × (20 days ÷ 360 days)]. Under thenew policy, credit sales will be $46,875,000 ($37,500,000 × 1.25), resulting in an average receivables balance of $3,906,250 [$46,875,000 ×(30 days ÷ 360 days)]. Hence, the expected increase in the balance is$1,822,917 ($3,906,250 – $2,083,333). 5 / 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 No additional information is needed The opportunity cost of funds The new credit standards 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. 6 / 18 When a company analyzes credit applicants and increases the quality of the accounts rejected, thecompany is attempting to : Increase the average collection period Maximize sales Maximize profits Increase bad-debt losses Increasing the quality of the accounts rejected means that fewer sales willbe made. The company is therefore not trying to maximize its sales orincrease its bad debt losses. The objective is to reduce bad debt losses andthereby maximize profits. 7 / 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 : $4,650 $2,850 $7,500 $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 8 / 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? $90,285 $92,600 $85,000 $96,135 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 9 / 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 $13,778 $10,878 $5,439 $98,890 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 10 / 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 : $2,700,000 $1,620,000 $900,000 $540,000 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). 11 / 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 theincremental sales would be 6%. Ignoring the cost of money, what would be the return on sales beforetaxes for the new sales? 36.2% 34.0% 42.5% 40.0% The increase in estimated gross profit is $32,000 ($80,000 × 40%). Theincremental bad debt loss is $4,800 ($80,000 × 6%). Accordingly, theestimated net increase in operating income is $27,200 ($32,000 – $4,800). The before-tax return on sales is 34% ($27,200 ÷ $80,000). 12 / 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 the30th day, and 20% on the 45th day. Assuming uniform sales and a 360-day year, what is theprojected amount of overdue receivables? $16,667 $150,000 $50,000 $400,000 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 averagecollection period for these sales is 45 days. The projected amount ofoverdue receivables is therefore $50,000 [$400,000 × (45 days ÷ 360days)]. 13 / 18 An organization would usually offer credit terms of 2/10, net 30 when : he organization can borrow funds at a rate exceeding the annual interest cost 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 The cost of capital approaches the prime rate 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. 14 / 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 : $9,600 $5,760 $960 $8,160 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 15 / 18 A financial manager for a jewelry distributor is analyzing the cost of offering a cash discount to itscredit policy. Currently, the firm’s sales terms are net 60 and virtually all of its customers pay at theend of the 60 days. The manager estimates that if the firm offers a 2/10 net 60 discount, the averagecollection time on its $5,000,000 annual credit sales will drop to one month with 60% of itscustomers taking advantage of the discount. The distributor currently finances working capital with arevolving credit agreement at 12%. Calculate the firm’s net cost of adding the cash discount to itscredit terms. $10,685 $60,000 $822 $49,315 To calculate the firm’s net cost of adding the cash discount to its creditterms, find both the total cash lost to discounts and the offsetting savingswhich arise from earlier customer payments. The calculations are asfollows: Cash to be discounted = $5,000,000 × 60% = $3,000,000 Cost of discount = $3,000,000 × 2% = $60,000 Average daily sales = $5,000,000 ÷ 365 days = $13,698.63 per day Cost of A/R for 60 days = $13,698.63 × 60 days × 12% = $98,630.14 Cost of A/R for 30 days = $13,698.63 × 30 days × 12% = $49,315.07 Savings from discount = $98,630.14 – $49,315.07 = $49,315.07 Net cost of discount = $60,000 (cost) – $49,315 (savings) = $10,685 16 / 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 $810,000 $1,350,000 $900,000 $990,000 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. 17 / 18 Which of the following represents a firm’s average gross receivables balance? A - Days’ sales in receivables × accounts receivable turnover. B - Average daily sales × average collection period. C - Net sales ÷ average gross receivables. A and B only A only B only B and C only A firm’s average gross receivables balance can be calculated bymultiplying average daily sales by the average collection period (days’sales outstanding). lternatively, annual credit sales can be divided by theaccounts-receivable turnover (net credit sales ÷ average accountsreceivable) to obtain the average balance in receivables. 18 / 18 A company has the opportunity to increase annual sales by $100,000 by selling to a new, riskiergroup of customers. Based on sales, the uncollectible expense is expected to be 15%, and collectioncosts will be 5%. The company’s manufacturing and selling expenses are 70% of sales, and itseffective tax rate is 40%. If the company accepts this opportunity, after-tax profit will increase by : $10,000 $4,000 $9,000 $6,000 The company’s manufacturing and selling costs exclusive of bad debtsequal 70% of sales. Hence, the gross profit on the $100,000 increase insales will be $30,000 ($100,000 × 30%). The increase in after-tax profit iscalculated as follows: Increase in gross profit = $30,000 Less: uncollectible accounts ($100,000 × 15%) = (15,000) Less: collection costs ($100,000 × 5%) = (5,000) Increase in pre-tax income = $10,000 Less: income tax expense ($10,000 × 40%) = (4,000) Increase in after-tax income =$ 6,000 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
