Credit Terms and Discount Period

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Questions and Answers

What does 'n' represent in the credit terms equation n/10 = EOM?

The total amount of the invoice
The discount percent if the payment is made within 10 days (correct)
The number of days until payment is due
The number of months until payment is due

What is the meaning of EOM in credit terms?

End of Year
End of Quarter
End of Month (correct)
End of Day

What is the main purpose of FOB in a transaction?

To determine the discount period
To determine the cash refund policy
To determine the credit terms
To determine the ownership transfer point (correct)

What is the difference between FOB shipping point and FOB destination?

FOB shipping point means the buyer is responsible for shipping costs, while FOB destination means the seller is responsible (B) Signup and view all the answers

What happens to the goods when they reach the FOB shipping point?

They become part of the buyer's merchandise inventory (D) Signup and view all the answers

Who bears the risk of damage/loss during transit when FOB destination is used?

The seller (A) Signup and view all the answers

What is the purpose of credit terms in a transaction?

To outline the payment schedule and discount period (A) Signup and view all the answers

What is the discount period in credit terms?

The time period in which a cash discount is available (A) Signup and view all the answers

What is the name of the account that is credited when recording shrinkage of merchandise inventory?

Merchandise Inventory (A) Signup and view all the answers

What is the purpose of offering a cash discount when the credit period is long?

To encourage the buyer to make prompt payment (C) Signup and view all the answers

Why do companies offer cash discounts to their customers?

To increase customer walk-ins and prompt payment (C) Signup and view all the answers

What is the term for the time period that can pass before a customer's payment becomes due?

Credit period (D) Signup and view all the answers

In the equation n/10 = EOM, what does the 'n' represent?

The discount percent if the payment is made within a certain time period (C) Signup and view all the answers

What type of expense is Cost of Goods Sold on the Income statement?

Direct expense (D) Signup and view all the answers

What type of inventory system is used when a journal entry is recorded for each purchase and sale of merchandise?

Perpetual Inventory System (D) Signup and view all the answers

What is the term for the listing of the amounts and timing of payments between a buyer and a seller, and the discount percent if the payment is made within a certain time period?

Credit Terms (C) Signup and view all the answers

What is the name of the account that is debited when recording shrinkage of merchandise inventory?

Cost of Goods Sold (D) Signup and view all the answers

What is the purpose of offering cash discounts on sales?

To increase sales and prompt payment (C) Signup and view all the answers

What is the journal entry to record a cash refund on inventory bought due to defectiveness?

Debit Merchandise Inventory, Credit Cash (D) Signup and view all the answers

What is the term for goods that a company acquires for the purpose of reselling them to customers?

Merchandise Inventory (D) Signup and view all the answers

If a seller offers terms of 2/10 n30 days, what does it mean?

A 2% discount if the invoice is paid within 10 days, otherwise the invoice is due in 30 days (A) Signup and view all the answers

Why do companies prefer to offer cash discounts instead of cash refunds?

Because cash discounts encourage prompt payment (C) Signup and view all the answers

In a perpetual inventory system, what is the account debited when merchandise is purchased on credit?

Merchandise Inventory (A) Signup and view all the answers

What is the purpose of credit terms in a business transaction?

To encourage the buyer to make prompt payment (A) Signup and view all the answers

Study Notes

Credit Terms

Credit terms are a listing of the amounts and timing of payments between a buyer and a seller, and the discount percent if the payment is made within a certain time period.
The equation for setting up the terms is: n/10 = EOM, where EOM means “end of month” and most invoices are due for payment in 30 days, thus making the EOM 30 days.
The “n” in this case means the discount percent if the payment is made within 10 days.

Discount Period

The discount period is the time period in which a cash discount is available and a reduced payment can be made by the buyer, taking advantage of a reduction in selling price.

FOB (Free on Board)

FOB is an abbreviation for Free on Board and is used to describe credit terms for transactions of merchandise purchases on credit.
The buyer and seller must reach an agreement on who is responsible for paying any freight costs and who bears the risk of loss during transit when the merchandise is being shipped.
FOB shipping point: the buyer accepts ownership at the seller’s place of business, pays shipping costs, and bears ownership and risks of damage/loss when the goods are in transit or in transport.
FOB destination: ownership of the goods transfers to the buyer when goods are delivered at the buyer’s place of business, with the seller paying shipping costs and bearing the risk of damage/loss while in transit/transport.

Purchase Discounts

Merchandise bought on credit requires a clear statement of expected amounts and dates of future payments as well as terms of credit.
A seller offering a cash discount when the credit period is long is encouraging the buyer to make prompt payment, which the buyer views as a purchase discount and the seller views as a sales discount.

Cash Discounts

Companies giving cash discounts to their customers recognize these discounts as ‘Sales discounts’ on their books.
Cash discounts are offered to increase customer walk-ins, increase sales during recessions or holiday sales, and to reduce the time needed to pay suppliers for merchandise.

Cost of Goods Sold

Merchandise is referred to as goods that a company acquires for the purpose of reselling them to customers.
The cost of this merchandise is called Cost of goods sold and is a direct expense item on the Income statement.

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Description

Learn about credit terms, including the equation for setting up terms, discount periods, and payment timing between buyers and sellers.