Net Accounts Receivable: Percentage of Sales Method - Online Tutor, Practice Problems & Exam Prep

The percentage of sales method estimates bad debt expense based on credit sales. To calculate, multiply total credit sales by the estimated uncollectible percentage. For example, if credit sales are $1,500,000 and the uncollectible rate is 2%, the bad debt expense is ${1.5}^6*0.02=\mathrm{30,000}$. This amount is recorded as a journal entry, impacting the allowance for doubtful accounts, which can be tracked using a T-account to find the ending balance.

Net Accounts Receivable: Percentage of Sales Method

Alright. Let's learn the first method for dealing with the allowance for doubtful accounts, the percentage of sales method. So when we do the percentage of sales method, the first thing I want to note is that we're talking about credit sales here, right? Sometimes they like to trick you, and in a question, they'll say, you know, the company had 5,000,000 in cash sales and then 10,000,000 in credit sales. Well, we're only worried about those credit sales, right? When we talk about the allowance, this is only about money that's owed to us. The cash sales, well, we already received the cash, so it doesn't really matter in that case.

Okay? So the percentage of credit sales, we're going to find some percentage of credit sales and that percentage is our bad debt expense. Okay? So what we call this is an income statement approach to finding bad debt expense, okay? Because we're dealing with the income statement, we're starting with sales, right? We're taking our income statement account of revenue, and we're finding some percentage of it that's bad. Okay? So, usually, when you see an exam question, they're typically going to give you a percentage and they'll tell you what the total credit sales are.

Well, once you do the percentage of credit sales, so the total credit sales times the percentage; well, that is your bad debt expense. Okay? That number you just calculated will be your bad debt expense in this scenario. Alright? So we can use our base equation just like we talked about in our T accounts, to find our ending balance in the account. So we'll be given some beginning balance, we'll calculate the bad debt expense, they might not even talk about accounts written off. Sometimes they talk about it, sometimes they don't, and most of the time, they actually don't, but if they do, well that reduces the allowance and then finally, we're left with our ending balance, right?

So most questions will ask you to find the bad debt expense right there, okay? But some questions ask you to find the ending balance in the allowance, and you'll have to be able to use this formula to get to the ending balance, right. The percentage of sales method calculates the bad debt expense. Okay? So if they ask you for the ending balance, you would have to use this formula. So let's go ahead and do an example to see how this works.

Let's do this one right here. A company had credit sales totaling 1,500,000 this year. Notice they told us credit sales totaling 1,500,000. Now if they just give you one number, they don't say credit, cash, well that's the only number you have to work with, that would be the credit sales. And they tell us, look, the company has a policy estimating 2% of credit sales to be uncollectible. There you go. They gave us so much information already. Last but not least, they told us the beginning balance. The allowance for doubtful accounts has a current credit balance of 12,000. So that's the beginning balance in the allowance.

What is the journal entry to record this year's bad debt expense? So first, let's think about the bad debt expense. Well, the bad debt expense is just going to be that percentage of credit sales that we expect not to collect. Alright? So we're going to take our 1,500,000 times our 2 percent, right? There's 2% uncollectible. So 0.02. So what's that going to equal? Let me get my handy dandy calculator out times 0.02, 30,000. Okay? 30,000 is expected to be uncollectible out of that 1,500,000.

So we would make a journal entry like this:
Bad debt expense (BDE) for 30,000, and we would credit our allowance for doubtful accounts for 30,000. Right? That would be the journal entry to record this year's bad debt expense. Now if they asked us what is the ending balance, notice they're also asking us for the ending balance in the allowance for doubtful accounts. Well, we're just going to make a simple T account. We've got our allowance for doubtful accounts T account, and notice they told us the beginning balance. Right? They told us it has a current credit balance of 12,000.

So it started with 12,000. That's our beginning balance and then we add to it our bad debt expense. Right? We did this journal entry, and notice this journal entry credits the allowance for doubtful accounts. So we're going to put that credit into the allowance for doubtful accounts, 30,000, and it doesn't tell us anything about write-offs, right? It doesn't say it could have said, you know, $5,000 worth of accounts were written off this year. It doesn't say anything like that. So, we don't expect to have any write-offs, and that's what would lower the account. So, I'll put a 0 there actually, not an x. And that should get us to our ending balance. Right? That's everything that affected the account. So we would add our credits, subtract our debits, which are 0. So 12,000 plus 30,000 gets us to an ending balance in the allowance of 42,000. Cool?

Let's pause here and then you guys try the next one in the practice problem.

A company had credit sales totaling $2,000,000 this year. The company has a policy estimating 1.5% of credit sales to be uncollectible. The Allowance for Doubtful Accounts has a current debit balance of $2,000. What is the journal entry to record this year's bad debt expense? What is the ending balance in the Allowance for Doubtful Accounts?

Alright. I'm guessing you guys took a stab at this. Let's see how you did. So the company has credit sales totaling 2,000,000 this year. The company has a policy estimating 1.5 percent of credit sales to be uncollectible. The allowance for doubtful accounts has a current debit balance of 2,000, so don't get thrown off here, it says a current debit balance of 2,000, well it generally has a credit balance, right? And it will after we make this journal entry. Sometimes it could end up with a debit balance because we're writing off accounts, right? Remember, we write off accounts throughout the year and sometimes we estimate, right? This is all an estimate. We estimated 1.5% are uncollectible. Well, it could just be the case that more than that were uncollectible, so we were writing off more accounts and it ended up with a debit balance in the allowance. Okay? So don't get too caught up in that fact. So let's go ahead and do our journal entry, for bad debt expense. So our BDE journal entry, lot of acronyms there, bad debt expense journal entry. So we just need to do our 2,000,000 times the 1.5%. So to turn that into a decimal, it would look like that, right? We gotta move the decimal 2 points to the left and let's see what we get for our credit sales here or excuse me, for our bad debt expense. 2,000,000 times 0.015. Oh, 30,000. Okay. So 30,000 is our bad debt expense. So our journal entry is gonna look like this. Debit bad debt expense, right, because expenses go up with a debit, and we're gonna credit allowance for doubtful accounts for 30,000. So there we go. That's our journal entry. Bad debt expense, 30,000. Allowance for doubtful accounts 30,000. So let's go ahead and find the ending balance in the allowance for doubtful accounts and I like to do it with the T account. You might prefer the algebra method and just write out your base formula, beginning balance, plus additions, minus subtractions. I like the visual of the T account. Let's check it out. So we had a beginning balance. They told us a current debit balance of 2,000. So the beginning balance, notice it's on this side. It's on the debit side this time because we wrote off basically more accounts than we had put into our allowance. So our beginning balance is 2,000 debit and then what happens is we're gonna credit for the bad debt expense, right? Notice in this entry, there's a credit to the allowance for doubtful accounts. So let's go ahead and put that in there. 30,000 as a credit. And then were there any write offs? So write offs would be debits to this account, but this question does not mention any. Right? There were no write offs mentioned in the question, so we can assume that's 0. So what's going to be our final balance? We had a 2,000 debit balance and now we've credited 30,000, right? So we would have to do basically the 30,000 minus the 2,000 and we end up with a credit balance here. Right? The credits were bigger than the debits, so we end up with a credit balance. And this will be the ending balance in the allowance for doubtful accounts. So we end up with a credit balance. And this will be the ending balance in the allowance for doubtful accounts is 28,000. So notice the ending balance after we made our adjusting entries for this bad debt expense, it ends up with a credit balance, right? Which is what we expect. The allowance for doubtful accounts is a contra asset and contra assets have credit balances. And that's exactly what we see here after the entry. Cool? Let's go ahead and move on to the next video.

Here’s what students ask on this topic:

What is the percentage of sales method in accounting?

The percentage of sales method in accounting is used to estimate bad debt expense based on a percentage of credit sales. This method focuses on the income statement and calculates bad debt expense by multiplying total credit sales by an estimated uncollectible percentage. For example, if a company has $1,500,000 in credit sales and estimates 2% to be uncollectible, the bad debt expense would be $30,000. This amount is recorded as a journal entry, impacting the allowance for doubtful accounts, which can be tracked using a T-account to find the ending balance.

How do you calculate bad debt expense using the percentage of sales method?

To calculate bad debt expense using the percentage of sales method, follow these steps: 1) Determine the total credit sales for the period. 2) Multiply the total credit sales by the estimated percentage of uncollectible accounts. For example, if credit sales are $1,500,000 and the uncollectible rate is 2%, the calculation is:

$\mathrm{1,500,000}\times 0.02=\mathrm{30,000}$

This $30,000 is the bad debt expense, which is recorded as a journal entry, debiting Bad Debt Expense and crediting Allowance for Doubtful Accounts.

What is the journal entry for recording bad debt expense using the percentage of sales method?

The journal entry for recording bad debt expense using the percentage of sales method involves debiting Bad Debt Expense and crediting Allowance for Doubtful Accounts. For example, if the calculated bad debt expense is $30,000, the journal entry would be:

Debit: Bad Debt Expense $30,000

Credit: Allowance for Doubtful Accounts $30,000

This entry reflects the estimated uncollectible amount based on the percentage of credit sales.

How do you find the ending balance in the allowance for doubtful accounts using the percentage of sales method?

To find the ending balance in the allowance for doubtful accounts using the percentage of sales method, follow these steps: 1) Start with the beginning balance in the allowance account. 2) Add the calculated bad debt expense. 3) Subtract any write-offs if provided. For example, if the beginning balance is $12,000 and the bad debt expense is $30,000 with no write-offs, the calculation is:

$\mathrm{12,000}+\mathrm{30,000}=\mathrm{42,000}$

The ending balance in the allowance for doubtful accounts would be $42,000.

What is the difference between the percentage of sales method and the aging of accounts receivable method?

The percentage of sales method estimates bad debt expense based on a percentage of total credit sales, focusing on the income statement. In contrast, the aging of accounts receivable method estimates uncollectible accounts based on the age of individual receivables, focusing on the balance sheet. The percentage of sales method is simpler and uses a single percentage, while the aging method is more detailed, categorizing receivables by age and applying different percentages to each category to estimate the allowance for doubtful accounts.