Question

As the struggling owner of a new restaurant, you suffer from a habitual shortage of cash.  Yesterday the following invoices arrived:

            Vendor                        Face Amount                          Terms              

            Cornation Produce      $             600                           n/30

            John’s Fisheries                      1,000                           1/10, n/45

            Garcia Equipment                   2,000                           2/10, n/60

1.         Write out the exact meaning of each of the terms.

2.         You can borrow cash from the local bank on a note bearing an annual interest rate of 12%.  Should you borrow to take advantage of the cash discounts offered by the last two vendors?  Why?  Show computations.  For interest computations, assume a 360-day year.

3.         Prepare the journal entry from Garcia Equipment’s standpoint if you were to pay the amount due within the discount period.

Answer 1

1.
Cornation Produce
Terms - n/30 means that payment due has to be made within 30 days from date of invoice.

John's Fisheries
Terms - 1/10, n/45 means that payment can be made in 10 days to take advantage of 1% discount, i.e. payment has to be made after deducting 1% discount within 10 days of invoice, or payment can be made after 10 days but within 45 days from date of invoice without availing benefit of discount.

Garcia Equipment
Terms - 2/10, n/60 means that payment can be made in 10 days to take advantage of 2% discount, i.e. payment has to be made after deducting 2% discount within 10 days of invoice, or payment can be made after 10 days but within 60 days from date of invoice without availing benefit of discount.

2.
Interest Benefit for taking Discount
John Fisheries = 1/(45-10) x 360 = 10.29%
Garcia Equipment = 2/(60-10) x 360 = 14.40%

Since, interest benefit for John fisheries is lower than Interest to be paid, so borrowing should not be made for taking benefit of discount in case of John Fisheries.

But, interest benefit for Garcia Equipment is higher than Interest to be paid, so borrowing should be made for taking benefit of discount in case of Garica Equipment.

3.

Account Titles	Debit	Credit
Accounts Payable - Garcia Equipment	$          2,000
Purchase Discount		$                      40
Cash		$                 1,960

Instead of Purchase Discount, account debited at time of purchased can also be used, depending on method used.