Heritage Mill Works sells finished lumber and mouldings to a variety of housing contractors. Given the nature of the business, most of its sales are on credit, and careful management of credit and bad debts is critical for success. The normal credit period is 60 days. The company’s owners significantly emphasize the operating results as they appear on the statement of income. They believe that accurate net earnings are the best indicator of any business’s success. The owners are currently looking at revising their credit-granting policies in light of a number of large writeoffs that were made in the past year. They are also wondering whether interest-bearing notes receivable with longer credit terms should be used in the future for certain types of customers and for very large sales.
Required:
a. Provide the controller with an estimate of the bad debts expense for the current period. Be prepared to justify your recommendation to the controller. Be sure to comment on the magnitude of the accounts receivable that were written off as uncollectible during the year.
b. Discuss the trade-offs that must be considered when deciding credit-granting policies.
c. Explain why it might be appropriate to use notes receivable for certain types of customers or very large sales.
d. What other steps could this company take to reduce the risk of not collecting its receivables in the future?