ATC 5-4 Writing Assignment Cost of charge sales Paul Smith is opening a plumbing

Question

ATC 5-4 Writing Assignment Cost of charge sales Paul Smith is opening a plumbing supply store in University City. He plans to sell plumbing parts and materials to both wholesale and retail customers. Since contractors (wholesale customers) prefer to buy parts and materials and pay at the end of the month, Paul expects he will have to offer charge ac- counts. He plans to offer charge sales to the wholesale customers only and to require retail customers to pay with either cash or credit cards. Paul wondered what expenses his business would incur relative to the charge sales and the credit cards. Required a. What issues will Paul need to consider if he allows wholesale customers to buy plumbing supplies on account? b. Write a memo to Paul Smith outlining the potential cost of accepting charge customers. Discuss the difference between the allowance method for uncollectible accounts and the direct write-off method. Also discuss the cost of accepting credit cards.

Explanation / Answer

a. Below are the issues Paul need to consider if he is allowing wholesale customer to buy plumbing supplies on account:

i. Paul has to check creditoworthyness of wholsale customer which is a difficult task and chances of bad debts are more.

ii.  Paul will require funds for working capital management if goods are sold on credit, Paul might get fund from other sources which might cost him more then the profit he has earned from wholsale customer.

iii. Customer may refuse/unable to pay

iv. If Customer refuse to pay then Paul might have to incur addtional charges to recover the dues.

v. Paul has to track payment schedule and due dates

b. Potential cost of accepting charge customers

i. Bed debt will increase

ii. Collection cost will increase

iii. Interest cost will increase if working capital money is borrowed from banks

iv Accounting cost will increase as additional resource will require to track all the dues.

Difference between the allowance method for uncollectible accounts and direct write-off method:

Under the allowance method for uncollectible accounts eastimated amount of bad debt is charges to reserve as soon as sales is made whereas in direct write-off method bad debt is charges as expenses as soon as we get to know that invoice amount will not be realisable so bad debt expenses are deffered in direct write off method so initially profit will be higher in direct write-off method.

Cost of accepting credit cards.

If paul is accepting credit card then he has to pay processing fee to merchant that depends upon the type of card paul is holding, processing fee may very between 1.5% to 3.5%.

Apart from the processing fee paul has to pay cost of card reader.

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