ONLINE CHAPTERS3 Cost of marginal bad debts. Yunanderah expects that relaxing its credit standards will increase its bad
debt expense from 1% to 2% of sales. We can calculate the cost of this by subtracting the current level of
bad debt expense from the expected level of bad debt expense under the proposed new credit standards.
Equation 18.8 shows the calculations required to determine bad debt expense, and Equation 18.9 shows
how to calculate the cost of marginal bad debts if YMC relaxes its credit standards:
Eq. 18.8 Bad debt expense (BDE) = Annual sales (Sales) × Bad debt expense rate (%BDE),
BDEproposed = (Salesproposed) × (%BDEproposed)
= $2,500,000 × 0.02 = $50,400
BDEcurrent = (Salescurrent) × (%BDEcurrent)
= $2,400,000 × 0.01= $24,000Eq. 18.9 Cost of marginal bad debts = BDEproposed – BDEcurrent
= $50,400 − $24,000 = $26,4004 Net profit for the credit decision. Now that we have calculated the individual financial benefits and costs of
changing YMC’s credit standards, we can use Equation 18.10 to compute the overall net profit for the credit
decision:
Eq. 18.10 Net profit for the credit decision = (Marginal profit from increased sales)- (Cost of marginal investment in accounts
receivable - (Cost of marginal bad debts)
= $48,000 – $8,236 – $26,400
= $13,364
Because relaxing YMC’s credit standards is expected to yield $13,364 in increased profit, the company
should implement the proposed change. The marginal profit from additional sales will more than offset the
total cost of the marginal investment in accounts receivable and marginal bad debts.18- 4c CREDIT TERMS
Credit terms are the terms of sale for customers. Terms of net 30 mean that the customer has 30 days from
the beginning of the credit period – typically end of month (EOM) or date of invoice – to pay the full invoice
amount. Some companies offer cash discounts with terms, such as 2/10 net 30. These terms mean the
customer can take a 2% cash discount from the invoice amount if the payment is made within the 10-day
cash discount period, or the customer can pay the full amount of the invoice within the 30-day credit period.
The nature of a company’s business influences its regular credit terms. For example, a company
selling perishable items will have very short credit terms because its items have little long-term collateral
value. These companies will typically offer short terms, by which the customer has seven to 10 days to
make payment. A company in a seasonal business may tailor its terms to fit the industry cycles with terms
known as seasonal dating. Most managers want their company’s regular credit terms to be consistent with
its industry’s standards. A company will lose business if its terms are more restrictive than those of its
competitors; if its terms are less restrictive than those of its competitors, then it will attract customers
with poor financial histories that probably are unable to pay under the standard industry terms.
As briefly noted above, a popular method used to lower a company’s investment in accounts receivable
is to include a cash discount in the credit terms. The cash discount provides a cash incentive for customers
to pay sooner. By speeding collections, the discount will decrease the company’s investment in accounts
receivable – which is the objective. But the discount will also decrease the per-unit profit, because the
customer pays less than the full invoice amount. Initiating a cash discount should reduce bad debts (becauseLO18.5credit terms
The terms of sale for
customers
cash discount
A method of lowering
investment in accounts
receivable by giving customers
a cash incentive to pay sooner
example