High Fashions Inc. has annual credit sales of 250,000 units with an average collection period of 70 days. The Company has a per-unit variable cost of P20 and per unit sale price of P30. Bad debts are currently at 5% of sales. The firm estimates that a proposed relaxation of credit standards would not affect its 70-day average collection period but would increase bad debts to 7.5% of sales, which would increase to 300,000 units per year. High Fashions requires a 12% return on investment (i.e. cost of tying up funds
Cost-Volume-Profit Analysis
Cost Volume Profit (CVP) analysis is a cost accounting method that analyses the effect of fluctuating cost and volume on the operating profit. Also known as break-even analysis, CVP determines the break-even point for varying volumes of sales and cost structures. This information helps the managers make economic decisions on a short-term basis. CVP analysis is based on many assumptions. Sales price, variable costs, and fixed costs per unit are assumed to be constant. The analysis also assumes that all units produced are sold and costs get impacted due to changes in activities. All costs incurred by the company like administrative, manufacturing, and selling costs are identified as either fixed or variable.
Marginal Costing
Marginal cost is defined as the change in the total cost which takes place when one additional unit of a product is manufactured. The marginal cost is influenced only by the variations which generally occur in the variable costs because the fixed costs remain the same irrespective of the output produced. The concept of marginal cost is used for product pricing when the customers want the lowest possible price for a certain number of orders. There is no accounting entry for marginal cost and it is only used by the management for taking effective decisions.
High Fashions Inc. has annual credit sales of 250,000 units with an average collection period of 70 days. The Company has a per-unit variable cost of P20 and per unit sale price of P30.
Requirement:
- Should High Fashions Inc. relax its credit standards? Show all necessary calculations required to evaluate High Fashions Inc.’ proposed relaxation of credit standards.
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