Flesher Inc's credit manager studied the bill-paying habits of its customers and found that 90% of

them were prompt. She also discovered that 22% of the slow payers and 5% of the prompt ones
subsequently defaulted. The company has 3000 accounts on its books, none of which has yet
defaulted.
REQUIRED:
1. calculate the total number of expected defaults, assuming no repeat business is on the horizon.
2. Given average revenues from sales of 1200 and the cost of sales of 1100, what is the average expected
profit or loss from extending credit to slow payers?

SOLUTION:

1. With 3,000 accounts, 2,700 (90%) would be categorized as prompt paying and 300 as slow paying.
Multiplying 22% times the 300 slow-paying accounts results in 66 defaults. Multiplying 5% times the
2,700 prompt-paying accounts results in an additional 135 defaults, for a total of 201.

2. The firm will earn $100 of gross profit ($1,200 - $1,100) from each customer who pays but will lose
$1,100 on each default. The income statement for the 300 slow-pay customers would appear as follows:
Sales (300 x 1,200) $360,000
CGS (300 x 1,100) 330,000
Gross profit 30,000
- Bad debt expense (66 x 1,200) (79,200)
Net loss $(49,200)
Dividing $49,200 by the 300 accounts produces an average loss of $164.