Certified Public Accountant CPA Questions + Answers Part 16

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QUESTION 401
An increase in sales collections resulting from an increased cash discount for prompt payment would be expected to cause a (n):
A. Increaseintheoperatingcycle.
B. Increaseintheaveragecollectionperiod. C. Decrease in the cash conversion cycle. D. Increase in bad debt losses.
Correct Answer: C
Section: Business Environment and Concepts (Volume D) Explanation
Explanation/Reference:
Explanation:
Choice "c" is correct. An increase in sales collections would decrease the cash conversion cycle. Choice "a" is incorrect because the operating cycle (as well as the cash conversion cycle) would decrease.
Choice "b" is incorrect, as the average collection period would decrease. Choice "d" is incorrect. Bad debt losses would decrease from an increase in sales collections.
QUESTION 402
Wyley Inc. purchases an item on credit with terms of 3/10, net 45. Based on a 360-day year, Wyley's annual interest cost of foregoing the cash discount and making payment on the last day of the credit period is:
A. 24.00% B. 30.86% C. 31.81% D. 37.11%
Correct Answer: C
Section: Business Environment and Concepts (Volume D) Explanation
Explanation/Reference:
Explanation:
Choice "c" is correct. The formula for computing the cost of credit discounts is:

Choices "a", "b", and "d" are incorrect, per the above calculation.
QUESTION 403
A firm can best delay disbursements through the use of:
A. Acentralizeddisbursementfunction. B. Drafts.
C. Factoring.
D. Trade discounts.
Correct Answer: B
Section: Business Environment and Concepts (Volume D) Explanation
Explanation/Reference:
Explanation:
Choice "b" is correct. Paying by means of a draft (or check) allows the firm to take advantage of the float period. This delays cash disbursements. Choice "a" is incorrect. A centralized disbursement function will not necessarily delay cash disbursements.
Choice "c" is incorrect. Factoring is the sale of accounts receivable to a factor. This has no effect on cash disbursements.
Choice "d" is incorrect. Trade discounts are discounts on account receivable and do not impact cash disbursements.
QUESTION 404
The following information applies to Brandon Company.

Forty percent of purchases are paid for in cash at the time of purchase, and 30 percent is paid for in each of the next two months. Purchases for the previous November and December were $150,000 per month.
Payroll is 10 percent of sales in the month it occurs, and operating expenses are 20 percent of the following months sales (July sales were $220,000). Interest payments were $20,000 paid quarterly in January and April. Brandon's cash disbursements for the month of April were:
A. $152,000 B. $200,000 C. $248,000 D. $254,000
Correct Answer: D
Section: Business Environment and Concepts (Volume D) Explanation
Explanation/Reference:
Explanation:
Choice "d" is correct. Cash disbursements in April would include paying for purchases made in February and March. It would also include payroll expense and operating expenses. The calculation would be:

Choices "a", "b", and "c" are incorrect, per above calculations.
QUESTION 405
Newman Products has received proposals from several banks to establish a lockbox system to speed up receipts. Newman receives an average of 700 checks per day averaging $1,800 each, and its cost of short-term funds is 7 percent per year. Assuming that all proposals will produce equivalent processing results and using a 360-day year, which one of the following proposals is optimal for Newman?
A. Aflatfeeof$125,000peryear.
B. Afeeof0.03percentoftheamountcollected.
C. A compensating balance of $1,750,000.
D. A fee of $0.35 per check plus 0.01 percent of the amount collected.
Correct Answer: C
Section: Business Environment and Concepts (Volume D) Explanation
Explanation/Reference:
Explanation:
Choice "c" is correct. The optimal proposal is that which has the lowest cost for Newman.

Thus, the lowest cost is "c" at $122,500.
Choices "a", "b", and "d" are incorrect, per the above calculations/Explanation:.
QUESTION 406
The treasury analyst for Garth Manufacturing has estimated the cash flows for the first half of next year (ignoring any short-term borrowings) as follows:
Garth has a line of credit of up to $4 million on which it pays interest monthly at a rate of 1 percent of the amount utilized. Garth is expected to have a cash balance of $2 million on January 1 and no amount utilized on its line of credit. Assuming all cash flows occur at the end of the month, approximately how much will Garth pay in interest during the first half of the year?
A. $61,000 B. $80,000 C. $132,000 D. $240,000
Correct Answer: A
Section: Business Environment and Concepts (Volume D) Explanation

Explanation/Reference:
Explanation:
Choice "a" is correct. First, determine the amount and timing of cash needs:
Comments
1 Given
2 Computed balance, positive cash flows
3 Computed balance, negative cash flows
4 Borrow from LOC
5 Computed balance, negative cash flows + interest
6 Cumulative LOC Balance
7 Computed positive cash flows
8 Computed balance, positive cash flows - interest
9 Immediate pay down of LOC
Choices "b", "c", and "d" are incorrect, per the above calculation.

QUESTION 407
MFC Corporation has 100,000 shares of stock outstanding. Below is part of MFC's Statement of Financial Position for the last fiscal year.
What is the maximum amount MFC can pay in cash dividends per share and maintain a minimum current ratio of 2 to 1? Assume that all accounts other than cash remain unchanged.
A. $2.05 B. $2.50 C. $3.35 D. $3.80
Correct Answer: B
Section: Business Environment and Concepts (Volume D) Explanation
Explanation/Reference:
Explanation:
Choice "b" is correct. The current ratio is found by dividing current assets by current liabilities. Presently current assets are:

Because current liabilities must be two times current liabilities, the current assets cannot go below $1,800,000. Thus current assets can go down:
On a per share basis this is $250,000 / 100,000 shares or $2.50 per share. Choices "a", "c", and "d" are incorrect, per the above calculation.
QUESTION 408
Kemple Cleaning Services is a newly established janitorial firm, and the owner is deciding which type of checking account to open. Kemple is planning to keep a $500 minimum balance in the account for emergencies and plans to write an average of 80 checks per month. The bank charges $10 per month plus a $0.10 per check charge for a standard business checking account with no minimum balance. Kemple also has the option of a premium business checking account, which requires a $2,500 minimum balance but has no monthly fees or per check charges. If Kemple's cost of funds is 10 percent, which account should Kemple choose?
A. Standardaccount,sincethesavingsis$34peryear. B. Premiumaccount,sincethesavingsis$34peryear. C. Standard account, since the savings is $16 per year. D. Premium account, since the savings is $16 per year.
Correct Answer: D
Section: Business Environment and Concepts (Volume D) Explanation

Explanation/Reference:
Explanation:
Choice "d" is correct. The total cost for a standard account is:
Cost per year for premium is cost of the extra amount ($2,000) that Kemple must maintain in the account. Total per year premium (10% × $2,000) = $200
The premium account will save $16.
Choices "a", "b", and "c" are incorrect, per the above calculation.
QUESTION 409
The collection of accounts receivable can be accelerated by the use of:
A. Turnarounddocuments. B. Alockboxsystem.
C. Bank drafts.
D. Remittance advices.
Correct Answer: B
Section: Business Environment and Concepts (Volume D) Explanation
Explanation/Reference:
Explanation:
Choice "b" is correct. Lockboxes are systems of mailboxes, usually in many locations, where customers send payments. The company's bank checks these mailboxes frequently and immediately deposits checks received. This accelerates the collection of accounts receivable. Choice "a" is incorrect. A turnaround document is a computer output that can later be used as a source document. No relevance to A/R collections.
Choice "c" is incorrect. A bank draft is a document issued by a bank to indicate that payment has been made.
Choice "d" is incorrect. A bank remittance advice is a document generated by a bank to indicate that payment has been made by a customer.
QUESTION 410
A working capital technique that increases the payable float and, therefore, delays the outflow of cash is:

A. Concentrationbanking.
B. Adraft.
C. A lock-box system.
D. The use of a local post office box.
Correct Answer: B
Section: Business Environment and Concepts (Volume D) Explanation
Explanation/Reference:
Explanation:
Choice "b" is correct. A draft is a working capital technique that increases the payable float and, therefore, delays the outflow of cash.
Each of the three following choices accelerate the flow of cash and/or data:
Choice "a" is incorrect. Concentration banking automatically channels funds from every source of the business into a single usable account, thus quickly identifying available funds each day, and moving them to accounts that have funding requirements that day, and investing the remainder in short-term, interestbearing instruments until needed.
Choice "c" is incorrect. A lock-box system is simply a central collection location that receives payment checks (generally, the bank where a central checking account is maintained by the firm). Choice "d" is incorrect. The use of a local post office box allows more rapid access to mail than actual delivery to a street address.
QUESTION 411
Hagar Company's bank requires a compensating balance of 20 percent on a $100,000 loan. If the stated interest on the loan is 7 percent, what is the effective cost of the loan?
A. 7.00percent. B. 8.18percent. C. 8.40 percent. D. 8.75 percent.
Correct Answer: D
Section: Business Environment and Concepts (Volume D) Explanation
Explanation/Reference:
Explanation:
Choice "d" is correct. Total interest for the loan is $100,000 × 7% or $7,000. The effective amount received is $80,000 after the 20% compensating balance. The effective interest is $7,000 / $80,000 = 8.75%
Choices "a", "b", and "c" are incorrect, per the above calculation.

QUESTION 412
Which one of the following represents methods for converting accounts receivable to cash?
A. Tradediscounts,collectionagencies,andcreditapproval.
B. Factoring,pledging,andelectronicfundstransfers.
C. Cash discounts, collection agencies, and electronic funds transfers. D. Trade discounts, cash discounts, and electronic funds transfers.
Correct Answer: C
Section: Business Environment and Concepts (Volume D) Explanation
Explanation/Reference:
Explanation:
Choice "c" is correct. The following are methods of converting accounts receivable (AR) into cash:
1. Collection agencies - used to collect overdue AR.
2. Factoring AR - selling AR to a factor for cash.
3. Cash discounts - offering cash discounts to customers for paying AR quickly (or paying at all).
For example: 2/10, net 30.
4. Electronic fund transfers - a method of payment, which electronically transfers funds between banks.
Therefore, only choice "c" matches the above list.
Choice "a" is incorrect. Trade discounts offer discounts on future merchandise purchases offered to trade customers. These discounts do not turn AR into cash. Choice "b" is incorrect. Pledging AR as collateral on a loan does not convert AR into cash.
Choice "d" is incorrect, per choice for "a" above.
QUESTION 413
Foster Inc. is considering implementing a lock-box collection system at a cost of $80,000 per year. Annual sales are $90 million, and the lock-box system will reduce collection time by 3 days. If Foster can invest funds at 8 percent, should it use the lock-box system? Assume a 360-day year.
A. Yes,producingsavingsof$60,000peryear. B. No,producingalossof$20,000peryear. C. No, producing a loss of $60,000 per year. D. No, producing a loss of $140,000 per year.
Correct Answer: B
Section: Business Environment and Concepts (Volume D)

Explanation Explanation/Reference:
Explanation:
Choice "b" is correct. No, do not use the lock-box system, which produces a loss of $20,000 per year.
QUESTION 414
When a company offers credit terms of 2/10, net 30, the annual interest cost, based on a 360-day year, is:
A. 24.0percent.
B. 35.3percent.
C. 36.0 percent.
D. 36.7 percent.
Correct Answer: D
Section: Business Environment and Concepts (Volume D) Explanation
Explanation/Reference:
Explanation:
Choice "d" is correct. The formula for calculating the cost of a credit policy is:

Therefore, the cost of customers taking this discount is 36.7% of the invoice price of the sale. Choices "a", "b", and "c" are incorrect, per the above answer.
QUESTION 415
If a firm's credit terms require payment within 45 days but allow a discount of 2 percent if paid within 15 days (using a 360 day year), the approximate cost/benefit of the trade credit terms is:
A. 16percent. B. 48percent. C. 24 percent. D. 36 percent.
Correct Answer: C
Section: Business Environment and Concepts (Volume D) Explanation
Explanation/Reference:
Explanation:
Choice "c" is correct. The formula for computing the cost/benefit for trade discounts is:
Choice is 24% ("c").
Choices "a", "b", and "d" are incorrect, per the above calculations.
QUESTION 416
Using a 360-day year, what is the opportunity cost to a buyer of not accepting terms 3/10, net 45?
A. 55.67percent. B. 31.81percent. C. 15.43 percent.

D. 24.00 percent.
Correct Answer: B
Section: Business Environment and Concepts (Volume D) Explanation
Explanation/Reference:
Explanation:
Choice "b" is correct. 31.81% Formula:
QUESTION 417
Which one of the following statements concerning cash discounts is correct?
A. Thecostofnottakinga2/10,net30cashdiscountisusuallylessthantheprimerate.
B. Withtradetermsof2/15,net60,ifthediscountisnottaken,thebuyerreceives45daysoffreecredit. C. The cost of not taking the discount is higher for terms of 2/10, net 60 than for 2/10, net 30.
D. The cost of not taking a cash discount is generally higher than the cost of a bank loan.
Correct Answer: D
Section: Business Environment and Concepts (Volume D) Explanation
Explanation/Reference:
Explanation:

Choice "d" is correct. The cost of not taking a cash discount is generally higher than the cost of a bank loan.
Choice "a" is incorrect. The cost of not taking a 2/10, net 30 cash discount is usually more than the prime rate.
Choice "b" is incorrect. With trade terms of 2/15, net 60, if the discount is not taken, the buyer receives 60 (not 45) days of free credit. Choice "c" is incorrect. The cost of not taking the discount is lower (not higher) for terms of 2/10, net 60 than for 2/10, net 30.
QUESTION 418
Commercial paper:
A. Hasamaturitydategreaterthanoneyear.
B. Isgenerallysoldonlythroughinvestmentbankingdealers. C. Generally does not have an active secondary market.
D. Has an interest rate lower than treasury bills.
Correct Answer: C
Section: Business Environment and Concepts (Volume D) Explanation
Explanation/Reference:
Explanation:
Choice "c" is correct. Although commercial paper has a secondary market available, it is generally not an active secondary market. Commercial paper is usually sold to the money markets by highly creditworthy companies.
Choice "a" is incorrect. The maturity dates are generally less than 270 days. Choice "b" is incorrect. Commercial paper can be sold to the money markets through a variety of intermediaries including brokers, dealers, investment brokers, etC. It can also be sold direct from one company to another.
Choice "d" is incorrect. The interest rate on commercial paper is below the prime rate, but generally above the Treasury bill rate.
QUESTION 419
Which one of the following is not a characteristic of a negotiable certificate of deposit? Negotiable certificates of deposit:
A. Haveasecondarymarketforinvestors.
B. AreregulatedbytheFederalReserveSystem.
C. Are usually sold in denominations of a minimum of $100,000.
D. Have yields considerably greater than bankers' acceptances and commercial paper.
Correct Answer: D
Section: Business Environment and Concepts (Volume D) Explanation
Explanation/Reference:

Explanation:
Choice "d" is correct. Negotiable CDs generally carry interest rates slightly lower than bankers' acceptances (which are drafts drawn on deposits at a bank) or commercial paper (which is unsecured debt issued by credit worthy customers).
Choice "a" is incorrect. Negotiable CDs have a formal secondary market. Choice "b" is incorrect. Negotiable CDs are a product of the banking industry, which is regulated by the Federal Reserve Board.
Choice "c" is incorrect. Negotiable CDs are usually sold in denominations of a minimum of $100,000.
QUESTION 420
All of the following are alternative marketable securities suitable for investment, except:
A. Eurodollars.
B. Commercialpaper.
C. Bankers' acceptances. D. Convertible bonds.
Correct Answer: D
Section: Business Environment and Concepts (Volume D) Explanation
Explanation/Reference:
Explanation:
Choice "d" is correct. Convertible bonds. Temporarily idle cash should be inverted in very liquid, low risk short-term investments only. U.S. T-bills are basically risk- free. Banker's acceptances and Eurodollars are only slightly more risky. Commercial paper, the short-term unsecured notes of the most credit-worthy large U.S. corporations is a little riskier, but still relatively low risk. However, convertible bonds are subject to default risk, liquidity risk, and maturity (interest rate) risk, and as such are inappropriate securities for short-term marketable security investment.
QUESTION 421
Which one of the following responses is not an advantage to a corporation that uses the commercial paper market for short-term financing?
A. Theborroweravoidstheexpenseofmaintainingacompensatingbalancewithacommercialbank. B. Therearenorestrictionsastothetypeofcorporationthatcanenterintothismarket.
C. This market provides a broad distribution for borrowing.
D. A benefit accrues to the borrower because its name becomes more widely known.
Correct Answer: B
Section: Business Environment and Concepts (Volume D) Explanation
Explanation/Reference:

Explanation:
Choice "b" is correct. There are restrictions as to the type of corporation that can enter into the commercial paper market for short-term financing, since the use of the open market is restricted to a comparatively small number of the most credit-worthy large corporations.
The commercial paper market:
A. Avoids the expense of maintaining a compensating balance with a commercial bank. C. Provides a broad distribution for borrowing.
D. Accrues a benefit to the borrower because its name becomes more widely known.
QUESTION 422
Corbin Inc. can issue three-month commercial paper with a face value of $1,000,000 for $980,000. Transaction costs would be $1,200. The effective annualized percentage cost of the financing, based on a 360-day year, would be:
A. 2.16% B. 8.48% C. 8.65% D. 8.00%
Correct Answer: C
Section: Business Environment and Concepts (Volume D) Explanation
Explanation/Reference:
Explanation:
Choice "c" is correct. The cost to issue the commercial paper is the $20,000 original issue discount ($1 million - $980,000), plus transaction costs of $1,200 for a total of $21,200. Therefore, it costs $21,200 to borrow $980,000 for 3 months. The 3-month interest cost is 2.16% ($21,200 / $980,000).
The annual interest cost is 8.65%
Choices "a", "b", and "d" are incorrect, per the above calculation.
QUESTION 423
All of the following are valid reasons for a business to hold cash and marketable securities, except to:
A. Satisfycompensatingbalancerequirements.
B. Maintainadequatecashneededfortransactions. C. Maintain a precautionary balance.
D. Earn maximum returns on investment assets.
Correct Answer: D

Section: Business Environment and Concepts (Volume D) Explanation
Explanation/Reference:
Explanation:
Choice "d" is correct. There are three primary motives for holding cash:
1. Transactions demand 2. Precautionary demand 3. Speculative demand
However, cash is generally held in very short-term liquid investments which are low risk, low return.
QUESTION 424
The marketable securities with the least amount of default risk are:
A. Federalgovernmentagencysecurities. B. U.S.treasurysecurities.
C. Repurchase agreements.
D. Bankers' acceptances.
Correct Answer: B
Section: Business Environment and Concepts (Volume D) Explanation
Explanation/Reference:
Explanation:
Choice "b" is correct. Default risk is the risk that the security will not be repaid because the issuing entity is insolvent or illiquid. U.S. Treasury securities are issued by the Treasury Department, which has virtually no risk of being insolvent or illiquid.
Choice "a" is incorrect. Securities issued by certain federal government agencies carry slightly more default risk than U.S. treasuries because these agencies are (usually) not as large or liquid as the U.S.
Treasury.
Choice "c" is incorrect. Repurchase agreements are sales by dealers in government securities who agree to repurchase these securities at a specific time and price. The risk of default is high because it is based upon the ability of the dealer to repurchase the securities. Choice "d" is incorrect. Bankers' acceptances are drafts drawn on a bank, which guarantees payment at maturity. The default risk is higher because the execution of the acceptance is based upon the solvency of the bank.
QUESTION 425
When purchasing temporary investments, which one of the following best describes the risk associated with the ability to sell the investment in a short period of time without significant price concessions?

A. Interestraterisk.
B. Purchasingpowerrisk. C. Financial risk.
D. Liquidityrisk.
Correct Answer: D
Section: Business Environment and Concepts (Volume D) Explanation
Explanation/Reference:
Explanation:
Choice "d" is correct. Liquidity risk is associated with the ability to sell the temporary investment in a short period of time without significant price concessions. Choice "a" is incorrect. Interest rate risk is the fluctuation in the value of a "financial asset" when interest rates change.
Choice "b" is incorrect. Purchasing power risk is the risk that price levels will change and affect asset values (mostly real estate).
Choice "c" is incorrect. Financial risk is a general category of risk that includes:
· Interest rate risk
· Market risk
· Purchasing power risk · Liquidity risk
· Default risk
QUESTION 426
A firm averages $4,000 in sales per day and is paid, on an average, within 30 days of the sale. After they receive their invoice, 55 percent of the customers pay by check, while the remaining 45 percent pay by credit card. Approximately how much would the company show in accounts receivable on its balance sheet on any given date?
A. $120,000 B. $48,000 C. $54,000 D. $21,600
Correct Answer: A
Section: Business Environment and Concepts (Volume D) Explanation
Explanation/Reference:
Explanation:

Choice "a" is correct. $120,000 accounts receivable approximation. There is no effect on total A/R based on how (i.e., check or credit card) the customers actually pay their A/R.
QUESTION 427
A company plans to tighten its credit policy. The new policy will decrease the average number of days in collection from 75 to 50 days and will reduce the ratio of credit sales to total revenue from 70 to 60 percent. The company estimates that projected sales would be five percent less if the proposed new credit policy is implemented. If projected sales for the coming year are $50 million, calculate the dollar impact on accounts receivable of this proposed change in credit policy. Assume a 360-day year.
A. $3,817,445decrease. B. $6,500,000decrease. C. $3,333,334 decrease. D. $18,749,778 increase.
Correct Answer: C
Section: Business Environment and Concepts (Volume D) Explanation
Explanation/Reference:
Explanation:
Choice "c" is correct. $3,333,334 decrease in accounts receivable.

QUESTION 428
A company enters into an agreement with a firm who will factor the company's accounts receivable. The factor agrees to buy the company's receivables, which average $100,000 per month and have an average collection period of 30 days. The factor will advance up to 80 percent of the face value of receivables at an annual rate of 10 percent and charge a fee of 2 percent on all receivables purchased. The controller of the company estimates that the company would save $18,000 in collection expenses over the year.
Fees and interest are not deducted in advance. Assuming a 360-day year, what is the annual cost of financing?
A. 12.0percent. B. 14.0percent. C. 16.0 percent. D. 17.5 percent.
Correct Answer: D
Section: Business Environment and Concepts (Volume D) Explanation
Explanation/Reference:
Explanation:
Choice "d" is correct. 17.5% annual cost of financing.

QUESTION 429
Gartshore Inc. is a mail-order book company. The Company recently changed its credit policy in an attempt to increase sales. Gartshore's variable cost ratio is 70 percent and its required rate of return is 12 percent. The company projects that annual sales will increase from the current level of $360,000 to $432,000, but the average collection period on receivables will go from 30 days to 40 days. Ignoring any tax implications, what is the cost of carrying the additional investment in accounts receivable, using a 360-day year?
A. $1,512 B. $2,000 C. $2,160 D. $12,600
Correct Answer: A
Section: Business Environment and Concepts (Volume D) Explanation
Explanation/Reference:
Explanation:
Choice "a" is correct. The cost of carrying accounts receivable now is the variable cost of creating the account receivable times the cost of that capital during the collection period. The cost of the investment in accounts receivable is now:
Choice "c" is incorrect. This considers the entire account receivable as a cost. Choices "b" and "d" are incorrect, per the above calculation.
QUESTION 430
Which of the following represents a firm's average gross receivable balance?
A. Days'salesinreceivablesxaccountsreceivableturnover. II. Average daily sales x average collection period.
III. Net sales ÷ average gross receivables.
B. Ionly.
C. I and II only.
D. II only.

E. IIandIIIonly.
Correct Answer: C
Section: Business Environment and Concepts (Volume D) Explanation
Explanation/Reference:
Explanation:
Choice "c" is correct. II only - Average daily sales ($27,397) × Average collection period (36.5) = $1,000,000 Avg gross A/R
Not I - Days' sales in receivables (36.5) × AR turnover 10 = 365 days in year. Not III - Net sales ($10,000,000) ÷ Avg gross receivables ($1,000,000) = 10 AR turnover.
QUESTION 431
Clauson Inc. grants credit terms of 1/15, net 30 and projects gross sales for next year of $2,000,000. The credit manager estimates that 40 percent of their customers pay on the discount date, 40 percent on the net due date, and 20 percent pay 15 days after the net due date. Assuming uniform sales and a 360- day year, what is the projected days sales outstanding (rounded to the nearest whole day)?
A. 20days. B. 24days. C. 27 days. D. 30 days.
Correct Answer: C
Section: Business Environment and Concepts (Volume D) Explanation
Explanation/Reference:
Explanation:
Choice "c" is correct. 27 days projected days sales outstanding.

QUESTION 432
A change in credit policy has caused an increase in sales, an increase in discounts taken, a reduction in the investment in accounts receivable, and a reduction in the number of doubtful accounts. Based upon this information, we know that:
A. Netprofithasincreased.
B. Theaveragecollectionperiodhasdecreased. C. Gross profit has declined.
D. The size of the discount offered has decreased.
Correct Answer: B
Section: Business Environment and Concepts (Volume D) Explanation
Explanation/Reference:
Explanation:
Choice "b" is correct. Whenever accounts receivable (AR) are decreasing when sales are increasing (and the decrease in AR is not due to an increase in bad debt write offs), this would indicate that the average collection period for AR has decreased.
Choices "a", "c", and "d" are incorrect. There is insufficient information in the question to draw conclusions about these items.
QUESTION 433
The following information regarding a change in credit policy was assembled by the Wilson Wax Company. The company has a required rate of return of 10 percent and a variable cost ratio of 60 percent.
The pretax cost of carrying the additional investment in receivables, using a 360-day year, would be:
A. $5,760 B. $9,600 C. $8,160 D. $960
Correct Answer: A
Section: Business Environment and Concepts (Volume D) Explanation

Explanation/Reference:
Explanation:
Choice "a" is correct.
Step 1 Determine the average accounts receivable balance and the additional accounts receivable as follows:
Therefore, the accounts receivable balance is $96,000 higher under the new credit policy. Step 2 Determine the additional INVESTMENT in the additional accounts receivable. Although Wilson has an additional $96,000 in accounts receievable, Wilson's actual investment in the additional accounts receivable is only 60% of $96,000 (because variable costs are 60% of sales). Wilson's investment in the additional accounts receivable is calculated as follows:
$96,000 x 60% = $57,600
Step 3 Calculate the cost of carrying the additional accounts receivable. Wilson's additional investment in accounts receivable is $57,600 and we are given a 10% required rate of return. This means that Wilson's carrying cost of $5,760 is calculated as follows:
$57,600 x 10% = $5,760
Choices "b", "c", and "d" are incorrect, per the above calculation.
QUESTION 434
An organization would usually offer credit terms of 2/10, net 30 when:
A. Theorganizationcanborrowfundsataratelessthantheannualinterestcost.
B. Thecostofcapitalapproachestheprimerate.
C. Most competitors are not offering discounts, and the organization has a surplus of cash.
D. Most competitors are offering the same terms, and the organization has a shortage of cash.
Correct Answer: D
Section: Business Environment and Concepts (Volume D) Explanation
Explanation/Reference:

Explanation:
Choice "d" is correct. Offering favorable credit terms is usually a response to either competitive forces in the market or to improve cash flow.
Choice "a" is incorrect, although the payment terms of AR is a form of borrowing (or lending) to customers, companies are more likely to extend credit terms because of competitive pressures rather than because it represents a cheaper form of borrowing.
Choice "b" is incorrect. The cost of capital at (or approaching) the prime rate is irrelevant without additional information.
Choice "c" is incorrect. If most competitors are not offering discounts or credit terms, there is no reason to offer them. Also, if there is a surplus of cash, there is no reason to accelerate accounts receivable collection by offering credit terms.
QUESTION 435
The average collection period for a firm measures the number of days:
A. Afteratypicalcreditsaleismadeuntilthefirmreceivesthepayment. B. Ittakesatypicalcheckto"clear"throughthebankingsystem.
C. Before a typical account becomes delinquent.
D. In the inventory cycle.
Correct Answer: A
Section: Business Environment and Concepts (Volume D) Explanation
Explanation/Reference:
Explanation:
Choice "a" is correct. The average collection period for a firm measures the number of days after a typical credit sale is made until the firm receives the payment. Choice "b" is incorrect. "Float" measures the number of days it takes a typical check to "clear" through the banking system.
Choice "c" is incorrect. "Credit period (term)" measures the number of days before a typical account becomes delinquent.
Choice "d" is incorrect. "Average days sales in inventory" measures the number of days in the inventory cycle.
QUESTION 436
A company with $4.8 million in credit sales per year plans to relax its credit standards, projecting that this will increase credit sales by $720,000. The company's average collection period for new customers is expected to be 75 days; and the payment behavior of the existing customers is not expected to change.
Variable costs are 80 percent of sales. The firm's opportunity cost is 20 percent before taxes. Assuming a 360-day year, what is the company's benefit (loss) on the planned change in credit terms?
A. $28,800 B. $144,000 C. $120,000 D. $126,000

Correct Answer: C
Section: Business Environment and Concepts (Volume D) Explanation
Explanation/Reference:
Explanation:
Choice "c" is correct. $120,000 benefit on the planned change in credit standards.
This question pertains to the economic benefit associated with a change in credit terms. The question tells us that the credit sales will increase by $720,000 if we relax our credit terms. We know variable costs are 80%, so we will earn $144,000 as a result of the expanded sales. The 20% contribution margin is equal to the 20% opportunity cost so there is no better investment of our resources for the expanded credit sales relative to its margin.
What about the variable costs, though?
We have $576,000 in variable costs that will be outstanding, pro rata, 75 days of the year. So the resources we will use to produce our sales is 75/360ths of $576,000, or $120,000 at any given time during the year. These $120,000 in resources could earn 20% annual return or $24,000. The $24,000 opportunity cost, compared to the $144,000 margin results in a $120,000 benefit in relaxing credit terms.
Choices "a", "b", and "d" are incorrect, per the above calculation/discussion.
QUESTION 437
A change in credit policy has caused an increase in sales, an increase in discounts taken, a decrease in the amount of bad debts, and a decrease in the investment in accounts receivable. Based upon this information, the company's:

A. Averagecollectionperiodhasdecreased.
B. Percentagediscountofferedhasdecreased. C. Accounts receivable turnover has decreased. D. Working capital has increased.
Correct Answer: A
Section: Business Environment and Concepts (Volume D) Explanation
Explanation/Reference:
Explanation:
Choice "a" is correct. Average collection period has decreased due to a change in credit policy that has caused:
1. Increase in sales,
2. Increase in discounts taken,
3. Decrease in the amount of bad debt; and
4. Decrease in the investment in accounts receivable
Choice "b" is incorrect. Percentage discount offered has probably increased, as discounts taken has increased.
Choice "c" is incorrect. Accounts receivable turnover has increased, as sales are up and accounts receivable are down. Choice "d" is incorrect. Change in gross profit and working capital is not determinable from these facts.
QUESTION 438
Which one of the following statements is most correct if a seller extends credit to a purchaser for a period of time longer than the purchaser's operating cycle? The seller:
A. Willhavealowerlevelofaccountsreceivablethanthosecompanieswhosecreditperiodisshorterthanthepurchaser'soperatingcycle. B. Is,ineffect,financingmorethanjustthepurchaser'sinventoryneeds.
C. Is, in effect, financing the purchaser's long-term assets.
D. Has no need for a stated discount rate or credit period.
Correct Answer: B
Section: Business Environment and Concepts (Volume D) Explanation
Explanation/Reference:
Explanation:

Choice "b" is correct. If a seller extends credit to a purchaser for a period of time longer than the purchaser's operating cycle, the seller is, in effect, financing more than just the purchaser's inventory needs.
Choice "a" is incorrect. Accounts receivable would be higher than those companies whose credit period is shorter than the purchaser's operating cycle.
Choice "c" is incorrect. Seller is financing the purchaser, but not necessarily long-term assets. Choice "d" is incorrect. It is appropriate for the seller to have stated policies for discount rate and credit periods.
QUESTION 439
The sales manager at Ryan Company feels confident that if the credit policy at Ryan's was changed, sales would increase and, consequently, the company would utilize excess capacity. The two credit proposals being considered are as follows:
Currently, payment terms are net 30. The proposal payment terms for Proposal A and Proposal B are net 45 and net 90, respectively. An analysis to compare these two proposals for the change in credit policy would include all of the following factors, except the:
A. CostoffundsforRyan.
B. Currentbaddebtexperience.
C. Impact on the current customer base of extending terms to only certain customers. D. Bank loan covenants on days sales outstanding.
Correct Answer: B
Section: Business Environment and Concepts (Volume D) Explanation
Explanation/Reference:
Explanation:
Choice "b" is correct. Because the bad debt percentage is the same under either of the two proposals, there is no differential cost associated with bad debt. Because it is not a differential cost, it is not considered in comparing the two alternatives.
Choice "a" is incorrect. Because Proposal A and B have different net collection dates, Proposal B will cause a greater amount of accounts receivable with a corresponding increase in working capital. The cost to fund this will be greater for Proposal B, so this is a legitimate concern. Choice "c" is incorrect. Customers may feel they should be given the extended terms. If this is granted, the additional working capital need will be even greater. Choice "d" is incorrect. Banks may require that days sales outstanding cannot exceed a certain number of days. If so, it will be harder to meet this covenant with Proposal B.