Question

With the Allowance method for uncollectable accounts, there are two ways of estimating uncollectables. Compare and contrast the [1] percent of sales method with the [2] analysis of receivables.

Answer 1

Under the percent of sales method, the bad debts or uncollectible accounts are estimated as a percentage of the net credit sales during the period while under the analysis of receivables, the uncollectible accounts are estimated as a percentage of the accounts receivable balances at the end of the period.

Under the percent of sales method, the existing balance in the allowance for uncollectible accounts is not considered while recording the bad debt expense for the period. However, under the analysis of receivables, the bad debt expense is calculated as a balancing amount after considering the beginning and ending balances in the allowance for uncollectible accounts and the bad debts written off if any during the period.

The advantages of the percent of sales method are its simplicity and that it results in very good matching of the bad debts expense with the sales revenue. This is not so with the analysis of receivables where the matching may not be as good.

The main disadvantage of the percent of sales method is that no consideration is given to the balance in the allowance account which is used to arrive at the net realizable value of accounts receivable in the balance sheet due to which the net realizable value may not be very meaningful. However, the analysis of receivables results in a more meaningful net realizable value of accounts receivable.