Question

On December 1, 2016, Lynch Incorporated sold $18,000 of merchandise with terms 2/10, n/EOM. On December 11, 2016, collections were made on sales originally billed for $12,000, and on December 31, 2016, additional collections on sales originally billed for $5,000 were received.

Required:
1. Prepare the journal entries to record the sale, collections, and any required year-end adjustments assuming that Lynch records accounts receivable and sales at (a) the gross price and (b) the net price.
2. Next Level Assume that Lynch’s customer does not have the available cash to pay Lynch within the discount period. How much interest should the customer be willing to pay for a loan to permit them to take advantage of the discount period (assume no additional costs to the loan)?
3. Next Level Explain why Lynch’s granting of cash (sales) discounts may improve cash flow.

THERE SHOULD BE TWO GENERAL JOURNALS

Outline for Next Level section:

Assume that Lynch’s customer does not have the available cash to pay Lynch within the discount period. How much interest should the customer be willing to pay for a loan to permit them to take advantage of the discount period (assume no additional costs to the loan)?

The customer would have to pay Lynch ______ days sooner to take advantage of the 2% discount. Assuming 365 days in a year, 2% interest for _________ days is equivalent to an annual interest rate of __________. Therefore, with the assumption of no additional costs to the loan, any loan at a rate *****(below or above)***** this rate would be advantageous for Lynch’s customer.

Answer 1

Dec 1

Accounts Receivables a/c…………………..Dr      $18,000

                To merchandise sold a/c…………………Cr.     $18,000

(Sold merchandise)

Dec 11

Cash a/c…………………………..Dr        $11,760 (12000* (100%-2%))

Discount allowed a/c…………..Dr           $240

                To Accounts Receivables a/c………………Cr.              $12000

(Payment received on merchandise sold)

Dec 31

Cash a/c………………………….Dr $5000

                To Accounts Receivables a/c…………………..Cr.$5000

(Payment received)

2.

The customer will get a benefit of $240, if he make the payment on the merchandise that was previously billed for $12,000 before the discount period gets lapsed. The customer’s cost of debt should not exceed the benefit he would be getting while availing the discount.

Let the interest rate be r%

Principal = ($12,000 – $240) $11,760

Time = 1 year

Cost of debt (r) <= 240/11,760 = 2.04% Per annum

The customer can afford the interest rate of less than 2.04% per annum

3. If the company allowed discount to their customers, they will make a payment before the credit terms get expire to avail a discount on the original price.

So By allowing discount, the company would able reduce its cash conversion cycle and improve its cash flows with healthy cash flows the company would get a better control over its working capital requirement to serve its daily operations.