Magundy Inc. (Magundy) imports high end merchandise from Europe and distributes it to retailers across eastern Canada.
Magundy has tended to be very conservative in managing its operations. In late 2016, the shareholders of Magundy decided that they weren't satisfied with the performance and growth of the company, and replaced the president with a younger, more aggressive person who they believed would be better able meet their performance and growth objectives.
In early 2017, the new president decided that Magundy had been too cautious in granting credit to customers so he implemented a new credit policy that significantly increased the number of retailers who would be able to carry Magundy's merchandise.
The new president thought the new credit policy would increase sales significantly, which would meet the objectives of the owners. The new credit policy allowed businesses that were considered higher credit risks (customers that were more likely to not pay their debts) to obtain credit from Magundy. The new credit policy also allows all customers more time to pay Magundy for purchases.
By the end of 2017, it appeared that the new president's strategy was working. Sales during the year had increased 20 percent over the previous year, to $2,395,000.
You have been asked by the shareholders to prepare a report evaluating certain aspects of Magundy's performance during 2017. Your report should consider the following:
a. What should Magundy's bad debt expense for 2017 be? In previous years, Magundy calculated its bad debt expense based on 2 percent of credit sales during the year.
Explain your answer.
b. How would you expect Magundy's accounts receivable turnover ratio to change from 2016 to 2017? Explain.
c. How would the new credit strategy affect Magundy's liquidity?
d. Do you think the new president's credit strategy is a good one? What are the risks and benefits of the new strategy?