Question: Rock Inc sells stereo equipment Traditionally the company s sales have

Rock, Inc., sells stereo equipment. Traditionally, the company’s sales have been in the following categories: cash sales, 25 percent; customers using national credit cards, 35 percent; sales on account (due in 30 days), 40 percent. With these policies, the company earned a modest profit, and monthly cash receipts exceeded monthly cash payments by a comfortable margin. Uncollectible accounts expense was approximately 1 percent of net sales. (The company uses the direct write-off method in accounting for uncollectible accounts receivable.)
Two months ago, the company initiated a new credit policy, which it calls “Double Zero.”
Customers may purchase merchandise on account, with no down payment and no interest charges.
The accounts are collected in 12 monthly installments of equal amounts.
The plan has proven quite popular with customers, and monthly sales have increased dramatically. Despite the increase in sales, however, Rock is experiencing cash flow problems—it hasn’t been generating enough cash to pay its suppliers, most of which require payment within
30 days.
The company’s bookkeeper has prepared the following analysis of monthly operating results:

The bookkeeper offered the following assessment: “Double Zero is killing us. Since we started that plan, our accounts receivable have increased nearly sevenfold, and they’re still growing. We can’t afford to carry such a large nonproductive asset on our books. Our cash receipts are down to nearly half of what they used to be. If we don’t go back to more cash sales and receivables that can be collected more quickly, we’ll become insolvent.”
In reply Maxwell “Rock” Swartz, founder and chief executive officer, shouted out: “Why do you say that our accounts receivable are nonproductive? They’re the most productive asset we have! Since we started Double Zero, our sales have nearly doubled, our profits have more than doubled, and our bad debt expense has dropped to nothing!”
a. Is it logical that the Double Zero plan is causing sales and profits to increase while also causing a decline in cash receipts? Explain.
b. Why has the uncollectible accounts expense dropped to zero? What would you expect to hap-pen to the company’s uncollectible accounts expense in the future—say, next year? Why?
c. Do you think that the reduction in monthly cash receipts is permanent or temporary? Explain.
d. In what sense are the company’s accounts receivable a “nonproductive” asset?
e. Suggest several ways that Rock may be able to generate the cash it needs to pay its bills with-out terminating the Double Zero plan.
f. Would you recommend that the company continue offering Double Zero financing, or should it return to the use of 30-day accounts? Explain the reasons for your answer, and identify any unresolved factors that might cause you to change this opinion in thefuture.

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  • CreatedApril 17, 2014
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