Problem 18 - Accounting

Question

Pet Joy Wholesale Inc., a pet wholesale supplier, was organized on May 1,2010 . Projected sales for each of the first three months of operations are as follows: \(\begin{array}{lr}\text { May } & \$ 360,000 \\ \text { June } & 450,000 \\\ \text { July } & 600,000\end{array}\) The company expects to sell \(10 \%\) of its merchandise for cash. Of sales on account, \(50 \%\) are expected to be collected in the month of the sale, \(35 \%\) in the month following the sale, and the remainder in the second month following the sale. Prepare a schedule indicating cash collections from sales for May, June, and July.

Step-by-Step Solution

Answer

Total cash collections: May \$198,000, June \$360,900, July \$520,350.

Step 1: Determine Cash Sales

Cash sales are calculated as 10% of the total sales for each month. Thus, for May, cash sales are 10% of \\(360,000, which is \\)36,000. For June, cash sales are 10% of \\(450,000, which is \\)45,000, and for July, 10% of \\(600,000, which is \\)60,000.

Step 2: Determine Credit Sales

The remaining sales are credit sales. Subtract the cash sales from the total sales to find credit sales for each month. For May: \\(360,000 - \\)36,000 = \\(324,000, for June: \\)450,000 - \\(45,000 = \\)405,000, and for July: \\(600,000 - \\)60,000 = \$540,000.

Step 3: Calculate Collections from Credit Sales in the Sale Month

50% of credit sales are collected in the same month. For May, this is 50% of \\(324,000, which is \\)162,000. For June, 50% of \\(405,000 is \\)202,500. For July, 50% of \\(540,000 is \\)270,000.

Step 4: Calculate Collections from Credit Sales in the Following Month

35% of credit sales are collected in the following month. For May sales collected in June, this is 35% of \\(324,000, which is \\)113,400. For June sales collected in July, it is 35% of \\(405,000, which is \\)141,750. For July, 35% will be collected in August, but that's not needed for this schedule.

Step 5: Calculate Collections from Credit Sales in the Second Following Month

The remaining 15% of credit sales are collected in the second month. For May, 15% of \\(324,000 or \\)48,600 will be collected in July. For June, 15% of \\(405,000 will be collected in August, which is \\)60,750, though we don't need August collections for this schedule.

Step 6: Schedule Cash Collections

Add up the collections for May, June, and July. - For May: Cash sales of \\(36,000 + credit sales collected \\)162,000 = \\(198,000.- For June: Cash sales of \\)45,000 + May credit in June of \\(113,400 + June credit in June of \\)202,500 = \\(360,900.- For July: Cash sales of \\)60,000 + June credit in July of \\(141,750 + July credit in July of \\)270,000 + May credit in July of \\(48,600 = \\)520,350.

Key Concepts

Credit Sales

Credit sales occur when a business sells goods or services to a customer but allows the customer to pay at a later date. This method of sale can help businesses attract more customers and increase sales because customers are given flexibility. To determine credit sales at Pet Joy Wholesale Inc., you subtract cash sales from total sales. For example, in May, total sales were $360,000, and cash sales were $36,000. Therefore, credit sales for May were $324,000. This concept is important because businesses need to understand how much money they expect to collect in the future to manage cash flow effectively.

Cash Sales

Cash sales are sales transactions where payment is received immediately. This means there is no delay between the sale and when the business receives payment. For Pet Joy Wholesale Inc., 10% of the total sales each month are cash sales. This is calculated and immediately available to the business. For example, in May, cash sales were 10% of $360,000, resulting in $36,000. Cash sales are beneficial to a business because they immediately improve cash flow and reduce the risk of not being paid, unlike credit sales where payment is collected at a later date.

Accounts Receivable

Accounts receivable represents money owed to a company by customers who bought items on credit. It appears on the balance sheet as a current asset since it is expected to be received soon. In our example with Pet Joy Wholesale Inc., when they make a credit sale, it creates an account receivable. These are tracked to ensure timely collection of payments. When 50% of the credit sales for a month are collected in the same month, this reduces the accounts receivable balance, showing it is converted into actual cash.

Collections Process

The collections process is a series of steps a business uses to collect money owed by customers from credit sales. This involves collecting a portion of credit sales immediately, and then scheduling further collections over subsequent months. In Pet Joy Wholesale Inc., the collections process involves:

• 50% of the credit sales being collected in the same month of sale.
• 35% of credit sales are then collected in the month following the sale.
• The remaining 15% is collected in the second month following the sale.

An effective collections process ensures that credit sales convert into cash in a timely manner, which supports the company's cash flow needs and reduces the risk of bad debts.