Essence of Skunk Fragrances, Ltd., sells 5,900 units of its perfume collection e

Question

Essence of Skunk Fragrances, Ltd., sells 5,900 units of its perfume collection each year at a price per unit of S389. All sales are on credit with terms of 1/20, net 20. The discount is taken by 45 percent of the customers. (Enter your answer as directed, but do not round intermediate calculations.) Requirement 1: What is the amount of the company's accounts receivable? (Round your answer to 2 decimal places (e.g., 32.16).) Average receivables $ Requirement 2: In reaction to sales by its main competitor, Sewage Spray, Essence of Skunk is considering a change in its credit policy to terms of 3/20, net 20 to preserve its market share. Will this change in policy increase or decrease accounts receivable?

Explanation / Answer

The total sales of the firm are equal to the total credit sales since all sales are on credit,

so: Total credit sales = 5900($389)

Total credit sales = $2295100

The average collection period is the percentage of accounts taking the discount times the discount period, plus the percentage of accounts not taking the discount times the days’ until full payment is required,

so: Average collection period = 0.45(20) + 0.60(20)

Average collection period = 21 days

The receivables turnover is 365 divided by the average collection period,

so: Receivables turnover = 365/21

Receivables turnover = 17.38 times

And the average receivables are the credit sales divided by the receivables turnover so: Average receivables

= $2295199/17.38

Average receivables = $132059

If the firm increases the cash discount, more people will pay sooner, thus lowering the average collection period. If the ACP declines, the receivables turnover increases, which will lead to a decrease in the average receivables.

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