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8) The objective for managing accounts receivable is to avoid credit sales as much as possible.
9) In analyzing an applicant's creditworthiness, a credit manager typically gives primary
attention to two of the five C's of credit—collateral and condition—since they represent the most
basic requirements for extending credit to an applicant.
10) One of the key inputs to the final credit decision is a credit analyst's subjective judgment of a
firm's creditworthiness since it can provide a better feel of a firm's operation than any
quantitative figures.
11) A firm's credit selection procedures must be established on a sound economic basis that
considers the costs of investigating the creditworthiness of a customer and the expected size of
its credit purchases.
12) A firm's credit standard is a procedure for ranking an applicant's overall credit strength,
derived as a weighted average of scores on key financial and credit characteristics.
13) As credit standards are relaxed, sales are expected to increase and the investment in accounts
receivable is expected to decrease.
14) The turnover of accounts receivable can be calculated by dividing 365 days by average
collection period.
15) Increasing the length of the credit period can increase sales, but both the investment in
accounts receivable and bad debt expenses are likely to increase as well.
16) If a firm relaxes its credit standards, the volume of accounts receivable increases and so does
the firm's carrying cost.
17) A relaxation of credit standards is expected to affect profits positively due to lower carrying
costs, whereas tightening credit standards would affect profits negatively as a result of higher
carrying costs.
18) The increase in bad debts associated with tightening credit standards raises bad debt
expenses and has a negative impact on profits.
19) The cost of marginal investment in accounts receivable can be calculated by finding the
difference between the average investment in accounts receivable before and after the
introduction of the changes in credit standards.
20) The cost of marginal bad debts is found by multiplying a firm's opportunity cost by the
difference between the level of bad debts before and after the relaxation of credit standards.
21) The key dimension of credit selection which analyzes an applicant's record of meeting past
obligations is ________.
A) collateral
B) capacity
C) character
D) capital
22) ________ is a procedure resulting in a number reflecting an applicant's credit strength,
derived as a weighted average of the scores obtained on a variety of key financial and credit
characteristics.
A) Credit scoring
B) Aging of receivables
C) CAPM
D) The economic order quantity model
23) The key dimension of credit selection which analyzes an applicant's ability to repay the
requested credit focused on cash flows available is ________.
A) collateral
B) capital
C) conditions
D) capacity
24) ________ are established to evaluate a customer's creditworthiness and to determine the
minimum requirements for extending credit to a customer.
A) Lines of credit
B) Credit limits
C) Collection agencies
D) Credit standards
25) Which of the following is TRUE of credit scoring?
A) It audits the amount of assets the applicant has available for use in securing the credit.
B) It specifies the terms of sale for customers who have been extended credit by a firm.
C) It is an ongoing review of a firm's accounts receivable to determine whether customers are
paying according to the stated credit terms.
D) It applies statistically derived weights to an applicant's scores on key financial and credit
characteristics.
26) The key dimension of credit selection which analyzes the amount of assets an applicant has
available for use in securing the credit is ________.
A) capital
B) collateral
C) capacity
D) conditions
27) Which of the following is one of the five C's of credit?
A) coordination
B) cost
C) character
D) control
28) A credit applicant's ________ reflects its ability to repay the requested credit.
A) character
B) capacity
C) capital
D) collateral
29) A credit applicant's ________ is his or her financial strength as reflected by his or her debt
relative to equity.
A) character
B) capacity
C) capital
D) collateral
30) A credit applicant's ________ reflects his or her record of meeting past obligations.
A) condition
B) capacity
C) control
D) character
31) Which of the following is TRUE of a credit applicant's character?
A) It reflects a credit applicant's ability to repay his debt obligation.
B) It reflects a credit applicant's past payment history.
C) It reflects the level of liquid assets available with a credit applicant.
D) It reflects any unique conditions surrounding a credit applicant's transaction.
32) As credit standards are relaxed, sales are expected to ________ and the investment in
accounts receivable is expected to ________.
A) increase; increase
B) increase; decrease
C) decrease; decrease
D) decrease; increase
33) As credit standards are tightened, sales are expected to ________ and the investment in
accounts receivable is expected to ________.
A) increase; increase
B) increase; decrease
C) decrease; decrease
D) decrease; increase
34) Which of the following major variables should be considered when evaluating proposed
changes in credit standards?
A) level of inventories
B) accounts payable
C) level of liquid assets
D) bad debt expenses
35) An applicant's capacity to repay its requested credit can be found by ________.
A) analyzing financial statements
B) checking bank account balances
C) analyzing tax payment history
D) checking the covenants
36) A firm is analyzing a relaxation of credit standards that is expected to increase sales 10
percent. The firm is currently selling 400 units at an average sale price per unit of $575, and the
variable cost per unit is $400 at the current sales volume. The average cost per unit is $425. What
is the additional profit contribution from sales if credit standards are relaxed?
A) $23,000
B) $16,000
C) $6,000
D) $7,000
37) When a firm's credit standards are relaxed ________.
A) its sales are expected to decrease with a corresponding increase in costs
B) its costs are expected to decrease with a corresponding decrease in sales
C) its costs are expected to increase faster than sales if the standards are not relaxed
D) its profit contribution from sales will be greater than the cost contribution
AACSB: Analytical Thinking
Table 14.5
Caren's Canoes is considering relaxing its credit standards to encourage more sales. As a result,
sales are expected to increase 15 percent from 300 canoes per year to 345 canoes per year. The
average collection period is expected to increase to 40 days from 30 days and bad debts are
expected to double the current 1 percent level. The price per canoe is $850, the variable cost per
canoe is $650 and the average cost per unit at the 300 unit level is $700. The firm's required
return on investment is 20 percent. (Assume a 360-day year)
38) What is the firm's additional profit contribution from sales under the proposed relaxation of
credit standards? (See Table 14.5)
A) $2,250
B) $6,750
C) $9,000
D) $69,000
39) What is the cost of marginal investments in accounts receivable under the proposed plan?
(See Table 14.5)
A) $1,817
B) $1,867
C) $1,733
D) $1,617
40) What is the cost of marginal bad debts under the proposed plan? (See Table 14.5)
A) $383
B) $765
C) $3,315
D) $5,100
41) What is the net result of implementing the proposed plan? (See Table 14.5)
A) $3,952
B) $3,869
C) $2,084
D) -$2,084
42) A firm is considering relaxing credit standards, which will result in annual sales increasing
from $1.5 million to $1.75 million, the cost of annual sales increasing from $1,000,000 to
$1,125,000, and the average collection period increasing from 40 to 55 days. The bad debt loss is
expected to increase from 1 percent of sales to 1.5 percent of sales. The firm's required return on
investments is 20 percent. The firm's cost of marginal investment in accounts receivable is
________. (Assume a 360-day year.)
A) $5,556
B) $9,944
C) $12,153
D) $152,778
43) A firm is considering relaxing credit standards which will result in an increase in annual
sales from $3 million to $3.75 million, a decrease in the cost of annual sales from $2,225,000 to
$2,000,000, an increase in additional profit contribution from sales of $10,000, and an increase
in the average collection period of 15 days, from 20 to 35 days. The bad debt loss is expected to
increase from 1 percent to 1.5 percent of sales. The firm's required return on investments is 15
percent. The net result of the firm relaxing its credit standards is ________. (Assume a 360-day
year.)
A) $10,000
B) -$16,250
C) -$26,875
D) -$16,875
44) Credit Scoring Policy
Jia's Jewelry uses the credit scoring technique to evaluate retail applications. The financial and
credit characteristics considered and weights indicating their relative importance in the credit
decision are shown above. The firm's credit standards are to accept all applicants with credit
scores of 85 or more, to extend limited credit to applicants with scores ranging from 75 to 84,
and to reject all applicants below 75. The firm is currently processing two applicants. The scores
of each applicant on each of the financial and credit characteristics are summarized above.
Would you recommend either of these applicants for credit extension?
45) Maggie's Gold Coins, Inc. is considering shortening its credit period from 30 days to 20 days
and believes, as a result of this change, its average collection period will decrease from 36 days
to 30 days. Bad debt expenses are also expected to decrease from 1.2 percent to 0.8 percent of
sales. The firm is currently selling 300,000 units but believes as a result of the change, sales will
decline to 275,000 units. On 300,000 units, sales revenue is $4,200,000, variable costs total
$3,300,000, and fixed costs are $300,000. The firm has a required return on similar-risk
investments of 15 percent. Evaluate this proposed change and make a recommendation to the
firm.
46) If the level of bad debt attributable to credit policy is relatively constant, increasing
collection expenditures can be expected to reduce bad debts.
47) 2/15 net 45 translates as 2 percent of the balance is due in 15 days; the remaining balance is
due in 45 days.
48) If a firm increases its cash discount period, the firm's investment in accounts receivable due
to non-discount takers now paying earlier is expected to decrease.
49) If a firm increases its cash discount period, the firm's investment in accounts receivable due
to discount takers still getting cash discounts but paying later is expected to increase.
50) If a firm's credit period is decreased, the sales volume, the investment in accounts receivable,
and the bad debt expenses can be expected to increase.
51) When a firm initiates or increases a cash discount, the net effect on the accounts receivable
investment is difficult to determine because the nondiscount takers paying earlier will reduce the
accounts receivable investment, while the new customer accounts will increase this investment.
52) The net effect of changes in a cash discount period is quite difficult to analyze because they
are directly attributable to the three forces affecting a firm's investment in accounts receivable.
53) An increase in accounts receivable turnover due to an increase in collection efforts will
decrease a firm's marginal investment in accounts receivable.
54) A decrease in collection efforts will result in an increase in sales volume, an increase in the
investment in accounts receivable, an increase in bad debt expenses, and a decrease in collection
expenditures.
55) Increased collection expenditures should reduce the investment in accounts receivable and
bad debt expenses, increasing profits.
56) An aging schedule breaks down accounts receivable into groups on the basis of the first letter
of the name of the company that owes on the account.
57) A company's ________ are the procedures followed to collect accounts receivable when they
come due.
A) collection policies
B) credit scorings
C) credit policies
D) credit analysis
58) The most stringent step in the collection process is ________.
A) letters
B) personal visits
C) collection agencies
D) legal action
59) The first step in the collection of overdue accounts is ________.
A) a letter
B) contacting a collection agency
C) legal actions
D) a personal visit
60) 2/15 net 45 translates as ________.
A) 15 percent cash discount if paid in 2 days, net 45-day credit period
B) 45 percent of account due in 15 days, payment prior to day 15 receives a 2 percent discount
C) 2 percent cash discount if paid prior to 15 days, if customer does not take a cash discount, the
balance is due in 45 days
D) 2 percent of the balance is due in 15 days, the remaining balance is due in 45 days.
61) A technique that provides an analyst with the information concerning the proportion of each
type of account that has been outstanding for a specified period of time is called ________.
A) credit analysis
B) credit scoring
C) aging of receivables
D) the economic order quantity model
62) Which of the following is TRUE of cash discount?
A) It increases bad debts because after availing discounts all customers may not pay.
B) It decreases the investment in accounts receivable and increases the per unit profit.
C) It helps to speed up collections without putting pressure on customers.
D) It reduces sales because the customers feel that the products are of inferior quality.
63) When a firm initiates or increases a cash discount, sales are expected to ________, the
investment in accounts receivable is expected to ________, the bad debt expense is expected to
________, and the profit per unit is expected to ________.
A) decrease; increase; increase; increase
B) decrease; decrease; increase; increase
C) increase; increase; decrease; decrease
D) increase; decrease; decrease; decrease
64) When a firm decreases or cancels a cash discount, sales are expected to ________, the
investment in accounts receivable is expected to ________, the bad debt expense is expected to
________, and the profit per unit is expected to ________.
A) decrease; increase; increase; increase
B) decrease; decrease; increase; increase
C) increase; increase; decrease; decrease
D) increase; decrease; decrease; decrease
65) If the cash discount period is increased, a firm's investment in accounts receivable is
expected to ________.
A) increase because existing customers attracted by the new policy will buy more products
B) decrease because of nondiscount takers paying earlier to avail the cash discount
C) decrease because discount takers will pay more in order to get more discount
D) decrease because new customers will doubt the quality of product due to increase in discount
66) If the cash discount period is increased, a firm's investment in accounts receivable is
expected to ________.
A) increase because new customers attracted by the new policy will result in new accounts
receivable
B) decrease because new customers will doubt the quality of product due to increase in discount
C) increase because existing discount takers will pay more to get more discount
D) decrease because of existing discount takers will now pay earlier to avail the cash discount
67) Which of the following is TRUE of changes in cash discount period?
A) If a firm increases its cash discount period, the sales are expected to decrease, the bad debts
are expected to decrease, and the profit per unit is expected to increase.
B) If a firm decreases its cash discount period, the sales are expected to decrease, the bad debts
are expected to decrease, and the profit per unit is expected to increase.
C) If a firm increases its cash discount period, the sales are expected to increase, the bad debts
are expected to decrease, and the profit per unit is expected to decrease.
D) If a firm decreases its cash discount period, the sales are expected to decrease, the bad debts
are expected to increase, and the profit per unit is expected to decrease.
68) Which of the following is TRUE of changes in cash discount period?
A) If a firm decreases its cash discount period, the sales are expected to decrease, the bad debts
are expected to increase, and the profit per unit is expected to increase.
B) If a firm decreases its cash discount period, the sales are expected to increase, the bad debts
are expected to increase, and the profit per unit is expected to decrease.
C) If a firm increases its cash discount period, the sales are expected to decrease, the bad debts
are expected to decrease, and the profit per unit is expected to increase.
D) If a firm increases its cash discount period, the sales are expected to increase, the bad debts
are expected to decrease, and the profit per unit is expected to increase.
69) If a firm's credit period is increased, the sales volume can be expected to ________, the
investment in accounts receivable can be expected to ________, and the bad debt expenses can
be expected to ________.
A) increase; decrease; decrease
B) increase; increase; decrease
C) increase; increase; increase
D) decrease; decrease; decrease
70) If a firm's credit period is decreased, the sales volume can be expected to ________, the
investment in accounts receivable can be expected to ________, and the bad debt expenses can
be expected to ________.
A) increase; decrease; decrease
B) increase; increase; decrease
C) increase; increase; increase
D) decrease; decrease; decrease
