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?
Currently the bad debts equal to 50,000 * $20 * 2% = $1,000,000 * 2% = $20,000 The proposed bad debts equal to 60,000 * $20 * 4% = $1,200,000 * 4% = $48,000
b. Calculate the cost of the marginal bad debts to the firm.
The cost of the marginal bad debt would equal to $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.
No, the change would not be recommended because bad debt increases by $28,000 so a savings of $3,500 is not worth the proposed change.
d. Considering all changes in costs and benefits, would you recommend the proposed change? Explain.
The additional contribution from sales is equal to 10,000 units * ($20-$15) = $50,000 Cost of marginal investment in A/R is unchanged
Cost of marginal bad debt = $28,000
Net profit from implementing the plan = $22,000
e. Compare and discuss your answers in parts c and d.
When you consider the net profit from implementing the plan the proposed plan would be recommended. To accurately evaluate the profitability of a proposal you must look at the additional sales and subtract the marginal bad debt. Omitting to account for the additional sales, like in part c, is not a proper way to analyze a proposal.
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