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1. What are the costs associated with carrying receivables? 2. What are the costs associated...

Question:

1. What are the costs associated with carrying receivables?

2. What are the costs associated with not granting credit?

3. What do we call the sum of the costs for different levels of receivables?

Account Receivables:

Account receivables refer to the total amount of money owed to a company due to the company offering its services or goods on credit. It is reported as the company's asset in the balance sheet. The amount of account receivables is dependent on the line of credit that a customer has from the company and is only offered to frequent customers.

Answer and Explanation:

Question One.

  • Probability of default: Every credit sale has a possibility of non-payment. In some cases, it may be a result of a dispute, but in most cases, when a customer defaults a large amount of money, it may be due to filing of bankruptcy, leading to bad debt.
  • Cost of liability: This includes the costs of operating credit and collecting it. This is the management of the account receivable, which entails the labor costs and costs of paper and postage. The expenses include the notifications given to the customers to make the payments, processing of checks, and billing of documents.
  • Opportunity cost: This is determined by the amount of time a customer takes to make a payment. Early payment can be used by the company to invest. If the customer delays the payments for a more extended period, there would be an increase in opportunity cost, which is the amount of loss a company experiences due to late payment.

Question Two

When a company fails to grant credit, the cost incurred is the loss of sales. Since businesses exist in a competitive environment, it is impossible to offer only cash sales since the competitors in business offer both cash and credit. If a business fails to provide credit sales, the customers would be lost to the competitors, hence loss of sales.

Question Three.

The sum of costs of different levels of receivables is carrying costs.


Learn more about this topic:

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Accounts Receivable: Definition, Process & Examples

from Accounting 101: Financial Accounting

Chapter 7 / Lesson 1
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