Question

Accounts receivable changes with bad debts A firm is evaluating an accounts receivable change that would increase bad debts from 2% to 5% 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 80,000 units a. What are bad debts in dollars currently and under the proposed change? b. Calculate the cost of the marginal bad debts to the firm. 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? d. Considering all changes in costs and benefits, would you recommend the proposed change? e. Compare and discuss your answers in parts c and d.

Answer 1

a	Current bad debts
	Sales (50000*20)	$1000000
	Bad debts (2% of sales)	$20000
	Proposed change
	Sales (80000*20)	$1600000
	Bad debts (5% of sales)	$80000
b	Cost of marginal bad debts =	Change in bad debts
		$80000-$20000
		$60000
c	Saving would be $3500 and a loss of $60000 due to increase in bad debts,
	if you ignore additional profit.
	The proposed change is not recommended as the loss is higher than saving .
d	Incremental profit (30000*20)	$600000
	saving	$3500
	Increase in bad debts	$60000
	Net benefit	$543500
	Net benefit is positive so proposed plan is recommended.
e	In part c, we did not take into consideration the incremental profit
	from the increase in sales and so the proposed change was rejected.
	In part d, when we consider the incremental profit, the total benefit is
	higher than the increase in bad debts expense and so the plan is accepted