Question

Weddings on Demand sells on account and manages its own receivables. My average

experience for the past three years has been as follows:

Sales \( 350,000

Cost of Goods Sold 210,000

Bad Debts Expense 4,000

Other Expenses 61,000

Unhappy with the amount of bad debts expense she has been experiencing, Aledia

Sanchez, controller, is considering a major change in the business. Her plan would be

to stop selling on account altogether but accept either cash, credit cards, or debit cards

from her customers. Her market research indicates that if she does so, her sales will

increase by 10% (i.e., from \)350,000 to \(385,000), of which \)200,000 will be credit

or debit card sales and the rest will be cash sales. With a 10% increase in sales, there

will also be a 10% increase in Cost of Goods Sold. If she adopts this plan, she will

no longer have bad debts expense, but she will have to pay a fee on debit/credit card

transactions of 2% of applicable sales. She also believes this plan will allow her to save

$5,000 per year in other operating expenses.

Should Sanchez start accepting credit cards and debit cards? Show the

computations of net income under her present arrangement and under the plan.

Short answer

Yes, Sanchez should accept credit and debit cards. Net income under current plant equals $75,000 and in new plan equals $94,000.

Step-by-step solution

Definition of bad debt

The amount not received from the customers is known as bad debt.

Accepting credit cards and debit card

Yes, Sanchez started accepting credit card cards and debit cards because it would decrease the company’s bad debt expense.

Computation of net income

Particulars	Actual plan	Expected
Sales Revenue	$350,000	$385,000
Less: Cost of Goods sold	$210,000	$231,000 ($210,000 x (1+10%))
Bad Debt Expense	$4,000	$0
Credit Card Expenses	$0	$4,000 ($200,000 x 2%)
Other Expenses	$61,000	$56,000 ($61,000-$5000)
Total Expenses	($275,000)	($291,000)
Net Income	$75,000	$94,000