What Is the Allowance for Bad Debt Percentage of Sales Method?
To estimate bad debt -- this is what accountants call money a company can't recover from customers -- financial managers may use the sales percentage method or the balance sheet approach. In either method, managers evaluate the bad debt allowance -- the other name for bad debt -- and make the necessary adjustments in corporate books.
Other People Are Reading
-
Sales Percentage Method
-
Under the sales percentage method for bad debt estimation, financial managers consult with sales administrators and credit supervisors, comb through client accounts, identify customers at risk of default and come up with a percentage of bad debt allowance. Then, they apply the numerical threshold to the sales revenue the company realized during the period under review. For example, a company reaped income of $1 million and management believes that 5 percent of receivables will never make it into the organization's coffers. As a result, bad debt equals $50,000, or $1 million times 5 percent.
Balance Sheet Method
-
Under the balance sheet method -- also called balance sheet approach -- financial managers estimate how much money bookkeepers must record as bad debt during the period under review, compare that amount to the existing balance of accumulated bad debt and make the necessary adjustments. For example, an organization's credit manager determines that the rosy economy will gradually reduce the number of customer defaults and, therefore, the business will only lose 1 percent of its customer receivables account's balance. A quick glance through the corporate balance sheet shows that accounts receivable amount to $1 million and accumulated bad debt stands at $25,000. Under the credit manager's stipulations, bad debt should equal $10,000, or $1 million times 1 percent. Therefore, accountants will reduce the accumulated bad debt account's balance by $15,000, or $25,000 minus $10,000.
-
Bookkeeping
-
To record bad debt, a corporate bookkeeper debits the bad debt expense account and credits the "allowance for doubtful items" account. The last item means the same thing as accumulated bad debt. The entry is standard practice to record the allowance for bad debt under the sales percentage method and the balance sheet approaches.
Financial Reporting
-
Bad debt reporting is important to lift a veil on how department heads monitor client accounts and the tools they use to ensure the default of one or two customers don't convulse the company's operating machine. Bad debt expense goes into a statement of profit and loss, the report that tells readers whether a company made or lost money during a given period. Accumulated bad debt is integral to a balance sheet, the other name for a statement of financial position.
-
