Question

Kate would like you to answer the following questions: 1. What are the advantages and disadvantages of offering credit? 2. What precautions should she take before offering credit to people like John? 3. If Kate grants credit to John, the terms will be 2/10, 1/30. Assuming the payment is made during the 10-day discount period, what would be the journal entry to record the sale and then the subsequent payment? 4. If instead of paying early, John pays in 25 days, what would be the journal entry to record the payment? 5. Rather than providing the financing directly, assume that Kate decides to allow the use of credit cards. Further, assume that during the month there is $15,000 worth of credit card sales. Provide the journal entry to record the sales, along with the associated credit card fee. The cost of the goods sold total $13,500. SERIAL PROBLEM: KATE'S CARDS (Note: This is a continuation of the Serial Problem: Kate's Cards from Chapters / through 7.) SP8. Kate has put a lot of time and effort into streamlining the process to design and produce a greet- ing card. She has documented the entire process in a QuickTime video she produced on her iMac. The video takes the viewer through the step-by-step process of selecting hardware and software, and shows how to design and produce the card. Kate has met many people who would like to get into the production of greeting cards, but are overwhelmed by the process. Kate has decided to sell the entire package (hardware, software, and video tutorial) to aspiring card producers. The cost of the entire package to Kate is $4,500 and she plans to mark it up by $500 and sell it for $5,000. John Stevens, an individual Kate met recently at a greeting card conference, would like to buy the pack- age from Kate. Unfortunately, John does not have this much cash and would like for Kate to extend credit. Kate believes that many of her customers will not be able to pay cash and, therefore, she will need to find some way to provide financing. One option she is exploring is to accept credit cards. She learned that the credit card provider charges a 2.5 percent fee and provides immediate cash upon receiving the sales receipts.

Answer 1

1. a. Advantages of offering credit: Credit sales can encourage the buyer to purchase in huge quantity as there is no need for urgent payment. Such purchase of huge quantity will increase the sales of the business. Further sellers need not give cash discounts on credit buyers, thereby retaining higher profits. For sellers of perishable goods, credit sale will reduce inventory holding time, thereby protecting them for goods being perished.

1. b. Disadvantages of offering credit: Liquidity is the major concern for any business around the globe. One needs to have enough cash to run its routine operations. Huge credit sale can adversely effect the liquidity of business. Liquidity can also effect the expansion of business as huge capital could be tied down on business due to credit sales.The risk of credit turning to bad debts is another concern. Even though credit sale promote sales, it does not make sense if the same becomes a bad debt.

2. Kate met John at a conference, she does not have any knowledge regarding his credit worthiness. Kate should make sure that she knows about Johns background and business. She should try to make the deal official rather than a spoken contract, it would be better to draw up an agreement with terms of payment, due date, mode of payment etc.

Credit Posting Reference Description 3 Accounts Receivable - John To Sales Alc (Being credit sale to John recorded) Debit $ 5,000.00 $ 5,000.00 $ 4,900.00 $ 100.00 Cash Alc Cash Discount Alc To Accounts Receivable - John (Being cash received from John) [WN Cash Discount = 5000 - (5000*2%) = 4900] $ 5,000.00 $ 5,000.00 4 Accounts Receivable - John To Sales Alc (Being credit sale to John recorded) $ 5,000.00 $ 5,000.00 Cash Alc To Accounts Receivable - John (Being cash received from John) $ 5,000.00

Contd.

$ 14,625.00 $ 375.00 5 Bank Alc Commision expense on credit card sales Alc To Sales Alc (Being credit card sales along with commission recorded) [WN Credit card commission = 15000*2.5% = 375] $ 15,000.00