Bailey Distributing Company: Current Credit Policy

DATA
Company: Bailey Distributing Company

Current Credit Policy
1/10, net 30
40% of customers under discount
$200,000 annual sales
20,000 units, annual sales

New Credit Policy
3/10, net 50
50% of customers under discount
$250,000 annual sales
25,000 units, annual sales

Ordering Cost: $100/ order
Carrying Cost: $1/ units
Average Cost: $6, 50/ unit
Average Inventory: EOQ/2

Cost of Goods Sold= 65% of Net Sales
General and Administrative Expenses= 10% of Net Sales
Interest on Increase in Accounts Receivable and Inventory= 12%
Taxes= 25% of Before- Tax Income

QUESTIONS

a. Compute the accounts receivable balance before and after the change in the cash discount policy. Use the net sales (total sales2cash discounts) to determine the
average daily sales and the accounts receivable balances.
b. Determine EOQ before and after the change in the cash discount policy. Translate this into average inventory (in units and dollars) before and after the change in the cash discount policy.
c. Complete the income statement on the top of page 207.
d. Should the new cash discount policy be utilized? Briefly comment.

SOLUTIONS
Answer to question a
Using the cash collection period formula we will calculate the Accounts Receivable. AR= CCP * ADS

- Current Credit Policy

Net Sales= Sales – Discounts
Discounts= [$200,000 * 40%] * 1%= $80,000* 1% = $800
Net Sales =$200,000 - $800= $199,200

CCP=10 [1] [2]

From [1] and [2] AR=10 * 553.33 =$5533.3

- New Credit Policy

Net Sales= Sales – Discounts
Discounts= [$250.000 * 50%] * 3%= $125.000* 3% = $3.750
Net Sales =$250.000 - $3.750= $246.250

CCP=30 [1] [2]

From [1] and [2] AR=30 * 684.03 =$20.520, 9

Answer to question b EOQ= economic ordering quantity
S= total sales in units
O= ordering cost for each order
C= carrying cost per unit in dollars

- Current Credit Policy

S= 20,000 units
O= $100/order
C= $1/ unit

Average Inventory in units= EOQ/2= 1,000 units [1]
Average Cost: $6, 50/ unit [2]

[1],[2] Average Inventory in Dollars= 1,000 units* $6,50 = $6,500

- New Credit Policy

S= 25,000 units
O= $100/order
C= $1/ unit

[Calculations will be based on the assumption that EOQ is equal to 2,236]
Average Inventory in units= EOQ/2= 1,118 units [1]
Average Cost: $6, 50/ unit [2]

[1],[2] Average Inventory in Dollars= 1,118 units* $6,50 = $7,267

Answer to question c
Current Credit Policy
Cost of goods sold= $129.480
General and administrative expenses= $19,920
Interest on increase in accounts receivables 12%=
(20.520,9-5533,3)*12%= $1.798,5
Interest on increase in inventory balance 12%=
(14.534-13.000)*12%=$184.08

New Credit Policy
Cost of goods sold= $160.062, 50
General and administrative expenses= $24.625
Interest on increase in accounts receivables 12%=
(20.520,9-5533,3)*12%= $1.798,5
Interest on increase in inventory balance 12%=
(14.534-13.000)*12%=$184.08

Answer to question
d

Based on the Income Statement which we just build I believe that the company should apply the new credit policy since the rise in sales (dollars and units) affect the income positively.
The company showed about 24.6% rise from the previous credit pol