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:
|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:
|Allowance for uncollectible accounts||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
– 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