P15-9-Accounts receivable changes with bad debt- A firm is evaluating an account
ID: 2636590 • Letter: P
Question
P15-9-Accounts receivable changes with bad debt- A firm is evaluating an accounts change that would increase the bad debts from 2% to 4% of sales. Sales are currently 50,000 units, the selling price is $20 per unit, and the variable cost per unit is $15. As a result of the proposed change, sales are forecasted to increase to 60,000 units
a) What are bad debts in dollars currently and under the proposed change?
b) Calculate the cost of managerial bad debt to the firm.
c) Ignoring the additional profit contributions from increased sales, if the proposed change saves $3,500 and causes no change in average investment in accounts receivable, would you recommend it? Explain.
d) Considering all changes in costs and benefits, would you recommend the proposed change? Explain.
c) Compare and discuss your answers in part c and d.
Explanation / Answer
Accounts receivable changes with bad debts. A firm is evaluating an accounts receivable change that would increase bad debts from 2% to 4% of sales. Sales are currently 50,000 units, the selling price is $20 per unit, and the variable cost per unit is $15. As a result of the proposed change, sales are forecast to increase to 60,000 units. a. What are bad debts in dollars currently and under the proposed change? Current bad debts Sales (50,000 x $20) 1,000,000 Bad debts (2% of sales) 20,000 Proposed change Sales (60,000 x 20) 1,200,000 Bad debts (4% of sales) 48,000 b. Calculate the cost of the marginal bad debts to the firm. The cost of marginal bad debts = change in bad debts = 48,000 - 20,000 = $28,000 c. Ignoring the additional profit contribution from increased sales, if the proposed change saves $3,500 and causes no change in the average investment in accounts receivable, would you recommend it? Explain. In this case, there would be a savings of $3,500 and a loss of $28,000 due to increase in bad debts, if you ignore additional profit. The proposed change is not recommended as the loss is higher than the savings. d. Considering all changes in costs and benefits, would you recommend the proposed change? Explain. Now, we consider the incremental profit from higher sales. The variable cost per unit is $15, so the per unit profit is $5 since the fixed cost will not change. Units sold will increase by 10,000. Incremental profit (10,000 x 5) 50,000 Savings 3,500 Increase in bad debts (28,000) Net benefit 25,500 Yes, the proposed plan is recommended as there is a positive net benefit. e. Compare and discuss your answers in parts c and d. In part c, we did not take into account the incremental profit from the increase in sales and so the proposed change was rejected. In part d, when the incremental profits are considered, the total benefit is higher than the increase in bad debt expense and so the plan is accepted.
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