Bad Debts Expense 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 figure is calculated on the basis of past performance 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 via the following formula:

Bad Debts Expense = Estimated % × Credit Sales

After the estimation of bad debts, an adjusting entry is passed to recognize bad debts expense. The entry involves a debit to bad debts expense account and a credit to allowance for doubtful debts account. The procedure is illustrated in the following example:

Example

Credit sales of Company A during the year ended December 31, 2010 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, 2010. 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.

Solution

Bad Debts Expense = 3% × $304,900 = $9,147

Adjusting Entry on December 31, 2010:

Bad Debts Expense9,147
Allowance for Doubtful Debts9,147

New Balance of Allowance Account = $1,418 + $9,147 = $10,565 Credit

Written by Irfanullah Jan