CHAPTER 14 CREDIT MANAGEMENT I Questions The goal of accounts receivable management is to ensure that the firm’s investment in accounts receivable is appropriate and contributes to shareholder wealth maximization Credit policy is a set of guidelines for extending credit to customers Credit standards are criteria and guidelines used by the firm to determine which customers get credit and how much credit each customer gets Credit terms specify the repayment terms required of all customers Credit terms include the cash discount, the cash discount period, and the credit period Collection policy refers to the procedures used to collect late accounts Collection policy involves three steps: determining when to begin the collection efforts, selecting the collection methods, and evaluating the potential tradeoffs of increased collection expenditures Credit analysis is the process of evaluating individual credit applicants Credit analysis involves three steps: obtaining information about the credit applicant, analyzing the credit information, and making the credit decision The five Cs of credit are character, capacity, capital, collateral, and conditions These factors are used to screen credit applicants II True or False True False True True True 10 False False False True True 14-2 Solutions Manual - Managerial Accounting and Finance for Hospitality Operations III Practical Problems PROBLEM 1 The average collection period is 27 days 0.3 (10 days) + 0.4 (30 days) + 0.3 (40 days) = 27 days The current receivables balance is P90,000 Receivables = (ACP) (Sales / 360) = 27 (P1,200,000 / 360) = P90,000 PROBLEM The incremental change in receivables investment would be calculated as follows: Old credit policy : (ACP) (Sales per day) (Variable cost ratio) P2,000,000 (40) (0.6) = P133,333 360 New credit policy : (ACP) (Sales per day) (Variable cost ratio) P1,750,000 (30) (0.6) = P87,500 360 The incremental change in receivables is P87,500 – P133,333 = – P45,833 Sales Less Discounts Net sales Production costs Gross profit before credit costs Credit related costs: Cost of carrying receivables Collection expenses Bad debt losses Gross profit Tax (40%) Net income Income Statement under Current Policy P2,000,000 Effect of Change P(250,000) Income Statement under New Policy P1,750,000 1,200,000 P 800,000 150,000 P(100,000) 1,050,000 P 700,000 16,000 100,000 P 684,000 273,600 P 410,400 5,500 65,000 P (29,500) 11,800 P (17,700) 10,500 35,000 P 654,500 261,800 P 392,700 Credit Management 14-3 PROBLEM Substituting credit sales of P4,000,000 and accounts receivable of P500,000 in the equation below, Accounts receivable turnover = Net (credit) sales Accounts receivable the accounts receivable turnover is: Accounts receivable turnover = P4,000,000 500,000 = times Using the equation below, Average collection period = 365 days Accounts receivable turnover = 365 the average collection period is: Average collection period = 45.6 days PROBLEM Substituting bad debt expenses of P125,000 and credit sales of P5,000,000 in the equation below, Bad debt expenses Bad debt loss ratio = Credit sales the bad debt loss ratio is: Bad debt loss ratio = P125,000 P5,000,000 = 0.025 or 2.5% PROBLEM The accounts receivable turnover is calculated by dividing 365 days by the average collection period of 25 days 365 Accounts receivable turnover = = 14.6 times 25 The opportunity cost is calculated by multiplying the average investment in accounts receivable by the required rate of return Opportunity cost of investment in accounts receivable = = P41,096 x 0.15 P6,164 (rounded) 14-4 Solutions Manual - Managerial Accounting and Finance for Hospitality Operations .. .14- 2 Solutions Manual - Managerial Accounting and Finance for Hospitality Operations III Practical Problems PROBLEM 1 The average collection... in accounts receivable = = P41,096 x 0.15 P6,164 (rounded) 14- 4 Solutions Manual - Managerial Accounting and Finance for Hospitality Operations ... (17,700) 10,500 35,000 P 654,500 261,800 P 392,700 Credit Management 14- 3 PROBLEM Substituting credit sales of P4,000,000 and accounts receivable of P500,000 in the equation below, Accounts receivable