This is the average receivables balance under the existing policy. See the correct answer for a complete explanation.
The question does not say that total sales will increase as a result of the relaxation of credit standards, only that credit sales will increase. Therefore, we assume that total sales will remain the same if the credit standards are relaxed but that credit sales will increase to 96% of total sales, from the 80% budgeted. (.80 × 1.20 = .96) Since the question asks how much the average accounts receivable balance would increase, we need to calculate the average balance of accounts receivable under the existing terms, then the average balance under the proposed terms, and then calculate the difference. Annual credit sales ÷ 360 = credit sales per day. Credit sales per day × number of days in receivables = average balance of accounts receivable. Total sales are budgeted at $40,500,000, and 80% of sales is $32,400,000 in total credit sales, while 96% of sales is $38,880,000 in total credit sales. Existing terms: $32,400,000 ÷ 360 × 30 days = $2,700,000. Proposed terms: $38,880,000 ÷ 360 × 40 days = $4,320,000. Difference = $4,320,000 ? $2,700,000 = $1,620,000.
This answer incorrectly uses 30 days of sales outstanding under the new policy as well as under the old policy. See the correct answer for a complete explanation.
This answer does not take into account the increase in credit sales that is expected to occur if the policy is changed.
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