It is typically beneficial for companies to take advantage of early-payment discounts allowed on purchases made on credit. To see why this is the case, determine the effective rate of interest associated with not taking advantage of the early-payment discount for each of the following situations. Assume in each case that payment is made on the 60th day of the billing cycle.

Required:

1. What is the opportunity cost of not taking advantage of the discount associated with purchases made under the following terms: 5/20, n/60?

2. What is the opportunity cost of not taking advantage of the discount associated with purchases made under the following terms: 4/20, n/60?

3. To motivate managers to take early-payment discounts, what is the appropriate accounting treatment for purchase discounts?