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AR& Inventory Management Accounting (Mindanao State University)

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MANAGEMENT SERVICES: RECEIVABLE & INVENTORY MANAGEMNT RECEIVABLE MANAGEMENT - the formulation and administration of plans and policies related to sales on account and ensuring the maintenance of receivables at a predetermined level and their collectability as planned.  Credit Policy  Collection Policy Ratios affecting Receivables AR Turnover Collection period Ave. AR Ave. AR

= = = =

Net Credit Sales/ Ave. AR Balance 36x days/ AR Turnover [(AR beg. = AR ending)/ 2] Ave. Daily Sales x Collection Period

Straight Problems RELAXATION & CHANGES OF CREDIT TERMS: EFFECT ON ACCOUNTS RECEIVABLE 1. Yellow Company’s budgeted sales for the coming year are P96 million, of which 80% are expected to be credited sales at terms of n/30. The company estimates that a proposed relaxation of credit standards would increase credit sales by 30% and increase the average collection period from 30 days to 45 days. Based on a 360day year, the proposed relaxation of credit standards would result to an accounts receivable balance of

2. Press Corporation plans to tighten its credit policy. Below is the summary of changes OLD NEW Average number of days collection 75 50 Ratio of credit to total sales 70% 60%

Projected sales for the coming year is P100 million and it was estimated that the new policy will be a 5% less if the new policy is implemented. Assuming a 360-day year, what is the effect of the new policy on accounts receivable?

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EFFECTIVE DISCOUNT RATE 3. Assume the following data for Credit Corporation Credit sales P500,000 Credit terms 2/10, n/30 Nominal discount rate 2% Credit time 30 days Free credit days 10 days Non-free credit days 20 days Discount amount (P500,000 × 2%) P10,000 Net proceeds (P500,000 – P10,000) P490,000 Determine the effective discount rate.

RELAXATION & CHANGES OF CREDIT TERMS: EFFECT ON PROFITABILITY 4. Mart has sales of P3 million. Its credit period and average collection period are both 30 days and 1% of its sales end up as bad debts. The general manager intends to extend the credit period to 45 days which will increase sales by P 300, 000. However, bad debts losses on the incremental sales would be 3%. Cost of products and related expenses amount to 40% exclusive of the cost of carrying receivables of 15% and bad debt expenses. Assuming 360 days a year, the change in policy would result to incremental investment in receivables of: The change in the credit policy would result to increase (decrease) in incremental profit of: b.

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5. J. Francisco Technologies is considering changing its credit terms from 2/15, net/30 to 3/10, net/30 in order to speed collections. At present, 40% of Francisco’s customers take the 2% discount. Under the new terms, discount customers are expected to rise to 50%. Regardless of the terms, half of the customers who do not take the discount are expected to pay on time, whereas the remainder will pay 10 days late. The change does not involve a relaxation of credit standards; therefore, bad debt losses are not expected to rise above their present 2% level. However, the more generous cash discount terms are expected to increase sales from P2,000,000 to P2,600,000 per year. Francisco’s variable cost ratio is 75%, the interest rate on funds invested in accounts receivable is 9%, and the firm’s corporate tax rate is 40%. Requirements: 1. What is the days sales outstanding before and after the change? 2. Calculate the discount costs before and after change 3. Calculate the peso cost of carrying receivables before and after the change. 4. Calculate the bad debt losses before and after the change 5. What is the incremental profit from the change in credit terms? Should Francisco change its credit terms?

MULTIPLE CHOICE QUESTIONS 1. All of these factors are used in credit policy administration except: A. credit standards C. peso amount of receivables B. terms of trade D. collection policy

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2. Changing a firm’s credit terms from 2/20, net/60 to 2/10, net/30 will generally A. Increase the average collection period and increase sales. B. Increase the average collection period and reduce sales C. Reduce the average collection period and increase sales. D. Reduce the average collection period and reduce sales. 3. The primary objective of in the management of accounts receivable is A. To achieve that combination of sales volume, bad debt experience, and receivables turnover that maximizes the profits of corporation. B. To realized no bad debts because of the opportunity cost involved. C. To provide the treasure of the corporation with sufficient cash to pay the company’s bills on time. D. To coordinate the activities of the manufacturing, marketing, and financing so that the corporation can maximize its profits 4. An increase in a firm’s collection period means A. The firm’s current ratio is increasing. B. The firm’s receivable turnover ratio is increasing. C. The firm’s collection expenses have fallen. D. The firm has become less efficient n the collection of its receivables. 5. A change in credit policy has caused an increase in sales, an increase in discount taken, a reduction in the investment in accounts receivable, and reduction in the number of doubtful accounts. Based upon the information, we know that A. Net profit has increase B. The average collection period has decreased. C. Gross profit has declined. D. The size of the discount offered has decreased. 6. LAON Company with P 4.8 million in credit sales per year plans to relax credit standards, projecting that this will increase credit by P 720, 000. The company’s average collection period for new customers is expected to be 75 days, and the payment behavior of the existing customers is not expected to change. Variable costs are 80% of sales. The firm’s opportunity cost is 20% before taxes. Assuming a 360-day year, what is the company’s benefit (loss) on the planned change in credit terms? A. P0 C. P114,000 B. P28,800 D. P120,000 7. Caja Company sells on terms 3/10, net 30. Total sales for the year are P900,000. Forty percent of the customers pay on the tenth day and take discounts; the other 60 percent pay, on average, 45 days after their purchases. What is the average amount of receivables? A. B.

P70,000 P77,500

C. D.

P77,200 P67,500

8. Palm Company’s budgeted sales for the coming year are P40,500,000 of which 80% are expected to be credit sales at terms of n/30. Palm estimates that a proposed relaxation of credit standards will increase credit sales by 20% and increase the average collection period from 30 days to 40 days. Based on a 360-day year, the proposed relaxation of credit to standards will result in an expected increase in the average accounts receivable balance of A. B.

P540,000 P900,000

C. D.

P2,700,000 P1,620,000

9. The Camp Company has an inventory conversion period of 60 days, a receivable conversion period of 30 days, and a payable payment period of 45 days. The Camp’s variable cost ratio is 60 percent and annual fixed costs of P600,000. The current cost of capital for Camp is 12%.

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If Camp’s annual sales are P3,375,000 and all sales are on credit, what is the firm’s carrying cost on accounts receivable, using 360 days year? A. B.

P281,250 P168,750

C. D.

P20,250 P56,250

10. Mercury distributor sells to retail stores on credit terms of 2/10, net/30. Daily sales average 150 units at a price of P300 each. Assuming that all sales are on credit and 60% of customers take the discount and pay on day 10 while the rest of the customers pay on day 30, the amount of Mercury’s accounts receivable is A. P1,350,000 C. P900,000 D. P810,000 B. P990,000 11.The average collection period for a firm measures the number of days A. B. C. D.

After a typical credit sales is made until the firms receives the payment. For typical check to “clear” through the banking system Beyond the end of the credit period before a typical customer payment is received. Before a typical accounts becomes delinquent

12. Currently, La Carlota Company has annual sales of P2,500,000. Its average collection period is 45 days, and bad debts are 3 percent of sales. The credit and collection manager is considering instituting a stricter collection policy, whereby bad debts would be reduced to 1.5 percent of total sales, and the average collection period would fall to 30 days. However, sales would also fall by an estimated P300,000 annually. Variable costs are 75 percent of sales and the cost of carrying receivables is 10 percent. Assume a tax rate of 40 percent and 360 days per year. What would be the decrease in investment in receivables if the change were made? A. B.

P9,688 P12,988

C. D.

P96,875 P129,975

Question Nos. 13 through 15 are based on the following data: Sonata Company is considering changing its credit terms from 2/15, net 30 to 3/10, net 30 in order to speed collections. At present, 40 percent of Sonata Company‘s customers take the 2 percent discount. Under the new term, discount customers are expected to rise to 50 percent. Regardless of the credit terms, half of the customers who do not take the discount are expected to pay on time, whereas the remainder will pay 10 days late. The change does not involve a relaxation of credit standards; therefore bad debt losses are not expected to rise above their present 2 percent level. However, the more generous cash discount terms are expected to increase sales from P2 million to P2.6 million per year. Sonata Company’s variable cost ratio is 75 percent, the interest rate on funds invested in accounts receivable is 9 percent, and the firm’s income tax rate is 40 percent. 13.What are the days sales outstanding (DSO) before and after the change of credit policy? A. 27.0 days and 22.5 days C. 22.5 days and 21.5 days, respectively respectively B. 22.5 days and 27.0 days, D. 21.5 days and 22.5 days, respectively respectively

14. A. B.

The incremental carrying cost on receivable is P843.75 C. P643.75 P8,899 D. P6,667

15.The incremental after tax profit from the change in credit terms is A. P68,493 C. P60,615

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B.

P64,640

D.

P57,615

16.Garo Company, retail store, is considering foregoing sales discounts in order to delay using its cash. Supplier credit terms are 2/10, net 30. Assuming a 360-day year, what is the annual cost of credit it the cash discount is not taken and Garo pays net 30? A. 24% C. 36% B. 24.5% D. 36.7% 17.The high cost of short-term financing has recently caused a company to reevaluate the terms of credit it extends to its customers. The current policy is 1/10, net 60. If customers can borrow at prime rate, at what prime rate must the company change its terms of credit in order to avoid an undesirable extension in its collection of receivables? A. B.

2% 5%

C. D.

7% 8%

18.When a company offers credit terms of 2/10, net 30, the annual interest cost, based on a 360-day year, is A. B.

24% 24.5%

C. D.

35.3% 36.7%

INVENTORY MANAGEMENT – the formulation and administration of plans and policies to efficiently and satisfactorily meet manufacturing and merchandising requirements to minimize total costs relative to inventories. Principal objectives are:

 To minimize costs, and  To maximize sales  Cost to considered in determining the quantity of inventory to order;  Ordering cost (cost to place and receive an order)  Carrying costs ( costs of storing maintaining inventory) Straight Problems 1. M Corporation has been buying product B in lots of 1,250 units which represents a three month’s supply. The cost per unit is 220. The order cost is P900 per order, and the annual inventory carrying cost per one unit is P25. Assume that the units will be required evenly throughout the year. Determine the following a. Economic order quantity b. Number of orders in a year c. Average inventory based on economic order quantity d. Total carrying cost, ordering costs and relevant inventory costs at economic order quantity

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2. G

F Corporation makes available the following information relative to its Material Annual demand Working days in a year Normal lead time Maximum lead time Maximum usage per working day Economic order size

30,000 units 300 days 12 days 19 days 125 units 6,000 units

Required: Calculate the following: a. Lead time quantity b. Safety stock quantity c. Reorder point d. Average inventory e. Maximum inventory

3. Stargate Corporation’s inventory carrying cost per unit is P50 and its stockout cost per unit is P4. It makes 8 purchase orders a year. The company plans to maintain a safety stock quantity of either 100 units or 200 units. The following data were gathered for further analysis: Total needs Available stock Excess demand Probabiltiy 600 600 0 60% 700 600 100 30% 800 600 200 15% 900 600 300 10%

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Determine the following: a. Total safety stock costs at 100 units b. Total safety stock costs at 200 units c. The safety stock level that the company should maintain

MULTIPLE CHOICE QUESTIONS 1. Order filing cost, as opposed to order-getting costs, include all but which of the following items? A. B. C. D.

Credit check of new customs. Pacing and shipping of sales order. Collection of payments for sales order Mailing catalogs to current customer.

2. The ordering cost associated with inventory management include A. Insurance costs, purchasing costs, shipping cost and spoilage. B. Obsolescence, setup costs, quantity discount lost, and storage cost. C. Purchasing costs, shipping costs, setup costs, and quantity discount lost. D. Shipping costs, obsolescence, setup cost, and capital invested 3. The control of order filling costs. A. Can be accomplished through the use of flexible budget standard B. Is related to pricing decisions, sales promotions, and customer reaction. C. Is not crucial because the cost are typically fixed and not subject to frequent changes D. Is not crucial because the cost order-filling routine is entrenched and external influences are minimal 4. Which of the following will not affect the budgeting of order-getting cost?

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A. B. C. D.

Market research and test Location of distribution warehouses. Policies and actions of competitors Sales promotion policies

5. The carrying cost associated with inventory management includes. A. Insurance cost, shipping cost, storage costs, and obsolescence B. Storage cost, handling costs, interest on capital invested, and obsolescence C. Purchasing costs, shipping costs, setup costs, and quantity discount lost. D. Obsolescence setup costs, interest on capital invested, and purchasing order costs.

6. Pi Company sells 25,000 radios evenly throughout the year. The cost of carrying one unit inventory for one year is P10, and the purchase order cost per order is P72. What is the company’s EOQ? A.

600

B.

400

C.

500

D.

300

7. The EOQ is the size of the order that minimizes total inventory costs, including ordering and carrying costs. If the annual demand decreases by 25%, the optimal order size will A. Increase by 14% C. increase by 13% D. decrease by 13% B. decrease by 14% For questions 8-10 The following information is available for Poy Company’s material AG-190: Annual usage Working days per year Normal lead time Maximum lead time

10, 000 units 250 days 30 days 70 days

8. What is the company’s lead time quantity? B. 1,200 units C. A. 1,050 units

1,150 units

D.

1,250 units

9. Safety stock quantity is A. 100 units B. 1,760 units

C.

1,600 units

D.

2,000 units

10.Reorder point is A. 3,050 units

C.

2,550 units

D.

3,010 units

B.

2,800 units

For questions 11-13 Cantor creations, which has 250 business days per year, manufactures desks for desktop workstation. The annual demand for the desks is estimated to be 5,000 units. The annual cost of carrying one unit in inventory is P10, and the cost to initiate a production run is P1,000. Cantor has schedule four equal productions runs for the coming year, the first to begin immediately. Currently, there are no desks on hand. Assume that sales occur uniformly throughout the year and production is instantaneous. 11.If Cantor creations does not maintain a safety stock, the estimated total carrying cost for the desk for the coaming year is B. P6,250 C. P4,000 D. P10,250 A. P5,000 12.If Cantor creations were schedule only two equal production runs of the desks for the coming year, the sum of carrying costs and set-up costs would increase (decrease) by A. P4,250 B. (P2,000) C. P6,250 D. (P250) 13.A safety stock for a five-day supply of desks would increase the number of

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units in Cantor Creation’s planned average inventory by A. Zero B. 50 C. 100

D.

250

14.Marsman Co. has determined the following for a given year: Economic order quantity (standard order 5,000 size) units Total cost to place purchase orders for P40,000 the year Cost to place one purchase order P 100 Cost to carry one unit for one P 4 What is Marsman’s estimated annual usage in units? A. 1,000,000 B. 2,000,000 C. 500,000

D.

1,500,000

15.What is the economic order quantity for the following inventory policy: A firm sells 32,000 bags of premium sugar per year. The cost per order is P200 and the firm experiences a carrying cost of P0.80 per bag. A. 2,000 bags B. 4,000 bags C. 8,000 bags D. 16,000 bags 16. For Raw Material L12, a company maintains a safety stock of 5,000 pounds. Its average inventory (taking into account the safety stock) is 12,000 pounds. What is the apparent order quantity? A. 18,000 lbs C. 14,000 lbs B. 6,000 lbs D. 24,000 lbs 17. Each stockout of a product sold by Arnis Co. costs P1,750 per occurrence. The company’s carrying cost per unit of inventory is P5 per year, and the company orders 1,500 units of product 20 times a year at a cost of P100 per order. The probabilities of a stockout at various levels of safety stock are: Units of Safety Stock Probability of Stockout 0. 0.50 100. 0.30 200. 0.14 300. 0.05 400. 0.01 The optimal safety stock level for the company based on the units of safety stock level above is A. 200 units C. 100 units B. 300 units D. 400 units SOLUTION GUIDE SSQ CCPU

Total Carrying Costs

Probabilit y of stockout

Stockout Costs per annum

Expected value of stockout costs

Total SSQ

100 200 300 400 18.Southern Company’s budgeted sales and budgeted cost of sales for the coming year are P144,000,000 and P90,000,000 respectively. Short-term interest rates are expected to average 10%. If Southern can increase inventory turnover from its present level of nine times per year to a level of 12 times per year, its cost savings in the year would be expected to be A. P450,000 C. P600,000 B. P400,000 D. P250,000

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