How to use the percentage of sales method to record bad debt expense?
The percentage of sales method is one of the allowance methods that is allowed under US GAAP. The method is tested on the FAR section of the CPA exam, and students in accounting courses are often tested on this concept as well.
The percentage of sales method focuses on the income statement (I/S) as the company will determine the amount of bad debt expense to record in the period based off revenue or credit related sales. From there, they will rollforward the allowance for doubtful accounts balance. This method is often used to record bad debt expense through the year and then another method (% of AR or AR aging method) is used to establish the ending ADA balance at the end of the period.
Example Percentage-of-Sales Method
Step 1) We’ll start by calculating bad debt expense that should be recorded based on the amount of credit sales in the period. Multiply the amount of credit sales by managements estimate, and you arrive at bad debt expense to record for the period.
Step 2) Once we have the amount of bad debt expense, we can plug that into the ADA rollforward, along with any write-offs or recoveries in the period, to determine the ending ADA balance.
The journal entry to record additional bad debt expense of $10,000 in the period would be as follows:
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