Question

On December 1, 2016, Lynch Incorporated sold $17,000 of merchandise with terms 2/10, n/EOM. On December 11, 2016, collections were made on sales originally billed for $10,000, and on December 31, 2016, additional collections on sales originally billed for $6,000 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.

Answer 1

1.Journal Entries

	Gross method
	Particulars	Debit ($)	Credit ($)
a)	Accounts receivable	17,000
	To Sale of merchandise		17,000
	(Being sale of merchandise for credit recorded)
b)	Cash	9,800
	Discount	200
	To Accounts receivable		10,000
	(Being collection net off discount recorded) (10000*2%)
c)	Cash	6,000
	To Accounts receivable		6,000
	(Being additional collection made recorded) Note-No discount
d)	Accounts receivable	20
	To Interest income		20
	(Being interest accrued on accounts receivable not paid within the due date) (1,000*2%)

	Net Method
	Particulars	Debit ($)	Credit ($)
a)	Accounts receivable	16,660
	Discount	340
	To Sale of merchandise		17,000
	(Being sale of merchandise for credit recorded) (17,000*2%)
b)	Cash	9,800
	To Accounts receivable		9,800
	(Being cash received on collection of due recorded)
c)	Accounts receivable	140
	To Discount		140
	(Being discount given earlier reversed on non satisfacton of credit terms)
d)	Cash	6,000
	To Accounts receivable		6,000
	(Being additional collection made recorded)
e)	Accounts receivable	20
	To Interest income		20
	(Being interest accrued on accounts receivable not paid within the due date recorded)

Interpretation of Credit terrms - 2/10,n/EOM denotes a 2% discount for payment within 10 days and the whole due is to be paid within the end of the month. When these dues are not paid within the end of the month then there arises penalty / interest (assumed to be at 2%).

2. In this scenario it is given that the customer does not have the cash available with him to pay and take advantage of the discount.Hence would be willing to take a loan and pay of this due so as to take advantage of the discount offered.

Interest to be paid on this loan by the customer should not exceed the discount offered by Lynch. Hence the rate of interest should be lesser than 2%.

Computation

Discount offered by lynch on paying dues within 10 days => 17000 x 2% = $340

Loan to be taken to repay this due and avail the discount offered => $ 17000

Maximum interest that can be paid on this loan => $340

Maximum Interest => 340/17000 => 2%

3.The purpose of offering credit is to shorten accounts receivable cycles.This is essential when vendors have accounts receivable turnover cycles which exist longer than preferred.The buyers would be incentivized to pay the cash at the earliest to avail the discount offered this goes on to improve the working capital of the seller. A business that has sufficent working capital at its disposal would be able to thrive and grow.