I am little bit confused when to use the effective cost method and when to use the other method of cost and saving. In the example 5- I calculated it using the cost & save method( by taking saving as – 1.5%*100,000 and cost by calculating interest on both 40 days and 15 days, then took the difference between both of them).

Although, I got the same answer that we will accept the offer but now I am doubting my approach.

Thank you for all your help and such great lectures!

Example 4 does not ask whether or not we would accept the discount.

It only asks what the effective cost of refusing the discount is.

We would compare this with the overdraft interest to decide whether or not to take the discount, but the question does not state the overdraft interest rate which is why we are not asked for the decision.

Sir in example 5 alternatively you have not discounted the 100000 as you have not considered the discount rate of 1.5%. Although it is not a significant difference but it doesn’t make sense as we would not have to 100000 and the total payable would be 98500.

There is no discounting necessary. We are comparing the cost of not taking the discount with the overdraft interest in order to decide which is better.

can you interpret the % of over draft in order to under stand more clearly the reason behind favoring the discount offer.

what did you mean by “the longer we delay we are saving overdraft interest” and “paying early will increase our overdraft” I just want you to explain to me how its work

When payment is made, the overdraft will increase. They have to pay interest on the amount of the overdraft, so the longer they delay paying then the longer it is before the overdraft increases and therefore the less interest they have to pay.

For every $100 of the invoice, the discount is $2 and therefore they are paying $98 early. By delaying payment of the $98 (and therefore having to pay $100) it is costing them $2.

Further to John’s explanation above you need to remember the formula to annualise the discount. 1-(.02/.98)…. 2% being the discount factor, 98% being what you will eventually pay

Further to John’s explanation above you need to remember the formula to annualise the discount. 1+(.02/.98)…. 2% being the discount factor, 98% being what you will eventually pay raised to the power(365/n/52/n/12/n) n being the period saved

Why you don’t calculate average payables current and new? In new variant you will have less cash, so overdraft would be used only for this part of cash. Don’t you think that we should calcukate it?

Hey sir! I have a little query regarding the calculation of period while calculating the annual effective rate of discount. How is a period of 14.6 practically possible ( if the days are 25 and it is suposed the number of days in a year is 365) .Cant we make the period as 15 instead of 14.6? Thank you

mariamohi says

Is it necessary to read the articles on ACCA’s website?

John Moffat says

It is certainly a good idea to read them.

mariamohi says

Do they have extra information relevant to the exam?

Pratibhapahwa4313 says

Hi Sir,

I am little bit confused when to use the effective cost method and when to use the other method of cost and saving. In the example 5- I calculated it using the cost & save method( by taking saving as – 1.5%*100,000 and cost by calculating interest on both 40 days and 15 days, then took the difference between both of them).

Although, I got the same answer that we will accept the offer but now I am doubting my approach.

Thank you for all your help and such great lectures!

John Moffat says

In the exam it depends on what the question asks for.

The question may specifically ask for the effective cost, or it may ask for the saving in $’s. However the question will make it clear.

mohitgupta says

Hi sir , in the example 4 , are we accepting the discount or not?

i cant clearly understand in the lecture

John Moffat says

Example 4 does not ask whether or not we would accept the discount.

It only asks what the effective cost of refusing the discount is.

We would compare this with the overdraft interest to decide whether or not to take the discount, but the question does not state the overdraft interest rate which is why we are not asked for the decision.

sohaibmussadiq says

Sir in example 5 alternatively you have not discounted the 100000 as you have not considered the discount rate of 1.5%. Although it is not a significant difference but it doesn’t make sense as we would not have to 100000 and the total payable would be 98500.

John Moffat says

There is no discounting necessary. We are comparing the cost of not taking the discount with the overdraft interest in order to decide which is better.

lam92468135 says

Hi Sir, I am confusing about calculate the payable and receivable.

In what situation we use the method of effective % cost ?

(Such as example 1,4 & 5)

In what situation we use the method to calculate the cost and saving ? (Such as example 2 & 3)

Please explain???

John Moffat says

The method you use depends on what information is given in the question.

lam92468135 says

Hi Sir, I don’t understand, why in example 4, you take the effective cost % is 43.86% you do not take the discount?

But why in example 5, you take the effective cost % is 24.69%, you take the discount?

Please explain???

aliabdulrasool says

I have small question regarding example 5:

can you interpret the % of over draft in order to under stand more clearly the reason behind favoring the discount offer.

what did you mean by “the longer we delay we are saving overdraft interest” and “paying early will increase our overdraft” I just want you to explain to me how its work

John Moffat says

When payment is made, the overdraft will increase.

They have to pay interest on the amount of the overdraft, so the longer they delay paying then the longer it is before the overdraft increases and therefore the less interest they have to pay.

yukyo says

Hello, can I ask for example 4 why do you calculate the effective cost of refusing discount with 2/98 instead of 2/100?

John Moffat says

But I explain this in the lecture!!!

For every $100 of the invoice, the discount is $2 and therefore they are paying $98 early. By delaying payment of the $98 (and therefore having to pay $100) it is costing them $2.

danconsult says

Hi Yukyo

Further to John’s explanation above you need to remember the formula to annualise the discount. 1-(.02/.98)…. 2% being the discount factor, 98% being what you will eventually pay

danconsult says

Hi Yukyo

Further to John’s explanation above you need to remember the formula to annualise the discount. 1+(.02/.98)…. 2% being the discount factor, 98% being what you will eventually pay raised to the power(365/n/52/n/12/n) n being the period saved

usman3400 says

I didnt undersdant the finance cost when we took discount

John Moffat says

You will have to say which bit you did not understand.

tabusheev says

Why you don’t calculate average payables current and new? In new variant you will have less cash, so overdraft would be used only for this part of cash. Don’t you think that we should calcukate it?

tabusheev says

Oh sorry, I think I found an answer myself))

alinaqvi111 says

Hey sir! I have a little query regarding the calculation of period while calculating the annual effective rate of discount.

How is a period of 14.6 practically possible ( if the days are 25 and it is suposed the number of days in a year is 365) .Cant we make the period as 15 instead of 14.6?

Thank you

John Moffat says

We are looking at averages and for an average 14.6 is the figure to use even though sometimes it might be 14 days and sometimes 15 days.