The accounting records of Lowery, Inc., revealed an accounts receivable balance of $195,000 on January 1, 20x6. Forty percent of the company's sales are for cash, and the remaining 60% are on account. Of the credit sales, 30% are collected in the month of sale and 70% are collected in the following month. Total sales in January and February are expected to amount to $500,000 and $530,000, respectively.Assume that in the latter half of 20x6, Lowery hired a new sales manager who aggressively tried to maximize the company's market share. She implemented a compensation system for the sales force that was 100% commission based, with the commission calculated on the basis of gross sales dollars. Sales volume increased dramatically in a very short period of time, and the sales and collection

Question

patterns changed, as follows:Cash sales:20%Credit sales: 80%Collected in the month of sale15%Collected in the month following sale75%Uncollectible10%Required: A. Compute the company's cash inflows for January and February, 20x6.B. Determine the outstanding receivables balance at the end of February.C. Compare the sales and collection patterns before and after the arrival of the new sales manager. Have things improved or deteriorated? Explain.D. On the basis of the information presented, determine what likely caused the improvement or deterioration in collection patterns.

What will be an ideal response?

Answer 1

A. January: Accounts receivable ($195,000) + January cash sales ($500,000 × 40%) 
+ January credit sales collected in January ($500,000 × 60% × 30%) = $485,000
February: January credit sales collected in February ($500,000 × 60% × 70%) +
February cash sales ($530,000 × 40%) + February credit sales collected in February ($530,000 × 60% × 30%) = $517,400

B. Since credit sales are collected over two months, 70% of February's credit sales are still outstanding: $530,000 × 60% × 70% = $222,600.

C. Although sales have increased, the credit and collection patterns have deteriorated. One of the company's likely objectives is to accelerate cash inflows. Notice that in percentage terms, cash sales have declined (40% vs. 20%); credit customers now take longer to pay as judged by collections in the month of sale (30% vs. 15%); and high levels of uncollectibles have arisen (0% vs. 10%).

D. The data reveal that total sales increased as did the percentage of sales made on credit. It appears that the sales manager's emphasis on market share may have led to sales being made to poor credit risks [as judged by the high rate of uncollectibles and reduced percentages of sales being settled in the month of sale (both cash and credit)]. These actions may have been triggered by a commission system based on gross sales, thus "encouraging" employees to increase sales despite the credit worthiness and profitability of the customer.