Further questio on discounts

reddwarf

Would someone confirm whether this this is correct please?

Annual sales are £12000, examine the adviseability of offering 2.5% discount for invoice payment in 14 days as opposed to 60 days. Loan of funds intererest rate is 5% per annum.

Show cost of discount and cost of loan.

Answer:

2.5/97.5 = 0.02564

365/46 = 7.9347

0.02564 x 7.9347 = 0.2034 x 100 = 20.34%

The improvement in receipts =

£12000/365x46 = £1512.33

Therefore cost of offering discount is £1512.33 x 20.34% = £307.61 per year but a loan of £1512.33 x 5% per year = £75.62 which is by far the cheaper option.


The reason for asking is we have never taken the discussion on discounts further than the formula at college and I can't find anything in my text books!

Thanks in advance!

SandyHood

reddwarf

Your method differs from mine,so we get slight differences in our answers, but I would mark you as correct.

Well done.

Incidentally, did you choose to use the 2.5/97.5 x 365/46 approach, or was that the only way you had been taught?

I'm interested mainly because virtually every forumite seems to use this simple interest approach. This is despite both the mark scheme criticising it, and the compound approach being more accurate.

When I marked questions recently, candidates were required to either correctly find the annual rate using the compound approach, or if they did not have scientific calculators their answers would only be marked as correct using simple interest if they wrote a sentence explaining why the compound approach would have been more accurate.

reddwarf

Sandy, thank you soo much for answering, this had been bugging me. We were taught the 2.5/97.5 x 365/46 formula.

Our tutor didn't discuss compound interest and I can't see reference to it in Kaplan or Osborne Unit 15 books??

I will take on what you have advised.

Thanks again.

*Jo

Hi Sandy, you say your answer differs slightly as it takes into account compounding interest, please could you tell me the formula you use as i am having difficulty when googling the net.

Thank you:001_smile:

SandyHood

Look at this link
http://forums.aat.org.uk/showthread.php?t=21345

I put early settlement discount into google and got this
http://www.accaglobal.com/pubs/students/publications/student_accountant/archive/sa_novdec08_irons.pdf
It looks well written and deals with this topic.

CAT is the ACCA equivalent to AAT

*Jo

Thank you Sandy.