Percentage of sales method

Definition

The percentage of sales method estimates uncollectible accounts based on a fixed percentage of a company's credit sales. This method directly ties bad debt expense to the revenue generated during the same period.

5 Must Know Facts For Your Next Test

1. The percentage is usually determined based on historical data of past uncollectible accounts.
2. This method is commonly used in the income statement approach for estimating bad debts.
3. It focuses on matching expenses with revenues, adhering to the matching principle in accounting.
4. Adjusting entries are made at the end of each period to account for estimated uncollectibles.
5. The calculated bad debt expense affects both the income statement (expense) and balance sheet (allowance for doubtful accounts).

Review Questions

• How does the percentage of sales method estimate bad debt expenses?
• Why is historical data important in determining the percentage used?
• What accounting principle does the percentage of sales method adhere to?

Related terms

Allowance for Doubtful Accounts: A contra-asset account that reduces accounts receivable to reflect those amounts expected to be uncollectible.

Income Statement Approach: An approach that estimates bad debts based on a percentage of credit sales, aligning expenses with related revenues.

Aging of Accounts Receivable Method: A balance sheet approach that estimates uncollectible accounts based on how long receivables have been outstanding.