What is the Percentage of Sales Method?

what-is-the-percentage-of-sales-method

With the percentages of sales method an allowance is created, as the name suggest, with a percentage of every sale. From past experience the firm learns which percentage of sales eventually turns out to be uncollectible. Each time the firm sells on account, this percentage of the sales is booked as an expense and added to the allowance. When at a later point in time an uncollectible invoice needs to be written off, the allowance is used as a buffer.

Expenses are incurred to increase or form an allowance at the period of the sale, thus satisfying the matching principle. Subsequently, the allowance can be used to write off worthless receivables without the need to book an expense. At the end of the period, the allowance is subtracted from the nominal value of accounts receivable, resulting in net accounts receivable.


Percent of Sales Method Example

From past experience, the firm knows that 2% of sales on account in uncollectible. Sales for the period amount to 400,000. The period’s beginning credit balance of the allowance for uncollectible accounts is 5,000.

The journal entry to book the bad debt expense is:

T-account Debit Credit
Bad debt expense 8,000
Allowance for uncollectible accounts 8,000

During the period, invoices for an amount of 9,000 are written off.

The corresponding journal entry is:

T-account Debit Credit
Allowance for uncollectible accounts 9,000
Accounts receivable 9,000

Suppose end of period accounts receivable (after the above journal entry) amounts to 500,000.

The presentation of accounts receivable on the balance sheet will be:

Accounts receivable, nominal 500,000
Allowance for uncollectible accounts   -4,000
_______
Accounts receivable, net 496,000

Percent of Sales Method Explained

Key points:

– with the percentage of sales method the firm books expenses at the time of the sale into an allowance, which is used when invoices turn out to be uncollectible

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