Bad Debts as Percentage of Sales
Percentage of sales method is an income statement approach for estimating bad debts expense. Under this method, bad debts expense is calculated as percentage of credit sales of the period.
The percentage to be applied to credit sales is calculated on the basis of past experience and other factors such as change in credit policy. In percentage of sales method, the balance in the allowance for doubtful debts is ignored.
Bad debts expense is calculated using the following formula:
Bad Debts Expense = Estimated % × Credit Sales
After the estimation of bad debts, an adjusting entry is passed to recognize the bad debts expense. The entry involves a debit to bad debts expense account and a credit to allowance for doubtful debts account. This is illustrated using the following example:
Credit sales of Company A during the year ended December 31, 20X0 were $304,930. The company estimated that 3% of its credit sales will end up uncollected. The allowance for doubtful debts of the company had a credit balance of $1,418 on December 31, 20X0.
Calculate the bad debts expense to be recognized at the end of the period and the new balance of the allowance for doubtful debts account. Also prepare the adjusting entry to recognized bad debts expense.
Bad Debts Expense
= 3% × $304,900
Adjusting entry on December 31, 20X0:
|Bad Debts Expense
|Allowance for Doubtful Debts
New balance in Bad Debts Allowance Account
= $1,418 + $9,147
= $10,565 credit
by Irfanullah Jan, ACCA and last modified on