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.

Prepare the journal entries to record the sale, collections and any required year-end adjustments assuming that Lynch records accounts receivable and sales at the net price.

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)?

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 [Correct]   this rate would be advantageous for Lynch’s customer.

Answer 1

a) Journal Entries under Gross Method

1.12.2016	Recording of Sales
1.	Accounts Receivable	18,000
	To Sales		18,000
11.12.2016	Payment received within 10 days
2.	Cash	11,760
	Discount allowed (12000*2%)	240
	To Accounts Receivable		12,000
31.12.2016	Additional payment received
3.	Cash	5,000
	To Accounts receivable		5,000

b) Journal Entries under Net Method

1.12.2016	Recording of Sales
1.	Accounts Receivable	17,640
	Discount allowed	360
	To Sales		18,000
11.12.2016	Payment received within 10 days
2.	Cash	11,760
	To Accounts Receivable		11,760
12.12.2016	Discount to be reversed
3.	Discount allowed forfeited	120
	To accounts receivable		120
31.12.2016	Additional payment received
	Cash	5,000
	To Accounts receivable		5,000

2. The customer would have to pay Lynch 20 (31.12.2016-11.12.2016) 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 37.24% p.a. Therefore, with the assumption of no additional costs to the loan, any loan at a rate below 37.24% p.a. would be advantageous for Lynch’s customer.

Discount amount if paid within 10 days = 18,000*2%= 360

Cash to be paid within 10 days/ Loan to be availed =18,000-360= 17,640

Rate of interest =360*365/17,640/20= 37.24% p.a.

3. With cash discount policy, company will have more working capital which it can utilise for

• payment to the vendors so that it acn avoid late payments to the vendors
• it can utilise the cash for its business expansion
• borrowings can be minimised which in turn minimise the cash outflow in the form of interest
• business will have more liquidity so it can invest in other areas as well