Question

Suppose your firm receives a $5 million order on the last day of the year. You fill the order with $2 million worth of inventory. The customer picks up the entire order the same day and pays $1 million up front in cash: you also issue a bill for the customer to pay the remaining balance of $4 million within 40 days. Suppose your firm's tax rate is 0% (i.e., ignore taxes). Determine the consequences of this transaction for each of the following: a. Revenues b. Earnings c. Receivables d. Inventory e. Cash

Answer 1

Answer:

a. Revenue Increase by $5 million

b. Earnings Increase by $3 million

c. Account Receivables Increase by $4 million

d. Inventory Decrease by $2 million

e. Cash Increase by $1 million

Explanation:

Entry:

1. Cash               $1 million Dr

  Receivables   $4 million Dr

      Revenue        $5 million Cr

2. COGS            $2 million Dr

       Inventory       $2 million Cr

a. The order received is a Sales order that will increase the revenue by the amount of the order, $5 million. It can be seen by the above entry 1 where we credit the revenue by $5 million.

b. The earnings, that is (revenue - cost) increase by $3 million as the costs associated with the sales are $2 million while it is earning us $5 million (5 - 2 = 3)

c. The receivables increase by $4 million as a result of this transaction as the sales made are for $5 million while the balance outstanding against this sale is $4 million as can be seen from entry 1 where we debit receivables by $4 million.

d. The inventory decreased by $2 million as we this order required inventory worth $2 million as can be seen by entry 2 where we credit inventory by $2 million.

e. The cash increased by $1 million as we received $1 million cash as can be seen by debit entry of $1 million as cash in entry 1.