Question 5 OR (a)
Choosing a collection programme
12 marks
- Time to write
- About 24 minutes
Question
Question 5 OR (a) · 12 marksSaxena Ltd. has annual sales of ₹28,80,000. Its selling price is ₹10 per unit, and the variable cost amounts to 70% of the selling price. Return on investment is at the rate of 20%; average cost per unit, ₹9; annual collection expenditure, ₹60,000; percentage of default, 3%; and credit terms of 2 months. The company is considering changing its credit policy by adopting either Programme A or B.
| Item | Programme A | Programme B |
|---|---|---|
| Average period of collection (months) | 1.5 | 1 |
| Annual Collection Expenditure (₹) | 90,000 | 1,80,000 |
| Percentage of default (₹) | 2 | 1 |
Determine which collection programme should be followed by the company.
Reworded from the university paper: names and figures differ, the task is the same. The original paper belongs to the University of Delhi. See DU's question bank.
Before you write
Read off the question and its marks
Read from the question
- DetermineFormula first, then the working, then the answer with its unit (₹, %, units).
What the paper leaves open
"Percentage of default" is printed with a rupee sign in the table; it is read as a percentage, as the row's name and the 3% in the text show. "Average cost per unit" is read as total (variable plus fixed) cost per unit.
Write it in this order
- Read the data; note exactly what is asked 2 min
- 1 Average investment in debtors at cost 3 marks 5 min
- 2 Cost of funds, bad debts and collection cost of each policy 5 marks 8 min
- 3 Net benefit against the present policy and decision 4 marks 7 min
- Check: arithmetic, units (₹, %), final answer underlined 2 min
Short on time? End with step 3's one-line decision, whatever happens: never leave the figures without it.
Try it first. About 24 minutes for 12 marks. Write it out, then open the solution.
Solution
Hover or tap a marked figure, like 72,000, to see how it is made and where else it appears.
Data. Sales ₹28,80,000 ÷ ₹10 = 2,88,000 units. Average (total) cost ₹9 a unit, so total cost = ₹25,92,000 (variable ₹7 and fixed ₹2 a unit). Sales are the same under every programme, so the programmes are compared on the costs of the credit and collection policy. The investment in debtors is measured at total cost: total cost × collection period ÷ 12, and its cost is the 20% return the funds could earn.
1'Pay next month'—the boxes fly off the van and every arm in the lane is full.
Consequences of lengthening the credit periodHigher sales and profit; larger investment in receivables; more bad debts and collection costs.
2Cash on delivery only: fewer takers at the door, but the money is in hand today.
Consequences of shortening the credit periodLower investment in receivables and better liquidity; possible loss of sales and profit.
1. Average investment in debtors
| ₹ | Present policy | Programme A | Programme B |
|---|---|---|---|
| Collection period (months) | 2 | 1.5 | 1 |
| Average debtors at cost (25,92,000 × months ÷ 12) | 4,32,000 | 3,24,000 | 2,16,000 |
| ₹ | Present policy | Programme A | Programme B |
|---|---|---|---|
| Cost of funds in debtors @ 20% | 86,400 | 64,800 | 43,200 |
| Bad debts (3%, 2%, 1% of 28,80,000) | 86,400 | 57,600 | 28,800 |
| Collection expenditure | 60,000 | 90,000 | 1,80,000 |
| Total cost | 2,32,800 | 2,12,400 | 2,52,000 |
3. Net benefit compared with the present policy
| ₹ | Programme A | Programme B |
|---|---|---|
| Saving in cost of funds | 21,600 | 43,200 |
| Saving in bad debts | 28,800 | 57,600 |
| Extra collection expenditure | (30,000) | (1,20,000) |
| Net benefit | 20,400 | (19,200) |
Decision. Programme A should be followed. It lowers the total cost of the credit policy by ₹20,400 a year. Under Programme B the extra collection expenditure (₹1,20,000) exceeds the savings in bad debts and in the cost of funds, so it would cost ₹19,200 more than the present policy. (Measuring debtors at selling price instead of cost gives the same choice.)
Where the 12 marks sit
| # | Component | Marks |
|---|---|---|
| 1 | Average investment in debtors at cost | 3 |
| 2 | Cost of funds, bad debts and collection cost of each policy | 5 |
| 3 | Net benefit against the present policy and decision | 4 |
| Total | 12 |
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