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CA Intermediate · Financial Management and Strategic Management · Management of Receivables

Mehta Ltd sells on credit with annual credit sales of Rs 18,00,000. Its bad debt losses are 2% of sales, collection expenses are Rs 30,000 and the average collection period is 45 days. It considers a factor that would charge a commission of 1.5% of sales, relieve it of the collection expenses and bear all bad debt losses. Ignoring financing cost, what is the net annual saving from using the factor?

The net annual saving is Rs 39,000. The firm avoids bad debts of Rs 36,000 and collection expenses of Rs 30,000, totalling Rs 66,000, and pays a factor commission of Rs 27,000, so saving equals 66,000 minus 27,000.

  1. ARs 39,000Correct
  2. BRs 66,000
  3. CRs 9,000
  4. DRs 27,000

Explanation

Costs avoided: bad debts 2% x 18,00,000 = Rs 36,000 plus collection expenses Rs 30,000 = Rs 66,000. Factor commission = 1.5% x 18,00,000 = Rs 27,000. Net saving = 66,000 - 27,000 = Rs 39,000. Rs 66,000 ignores the commission; Rs 9,000 ignores collection expenses.

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