Question

The two allowance methods used by companies in estimating uncollectible account receivable are percentage-of- sales and percentage-of-receivables.

In a paragraph provide which method you would recommend and why, if you were a financial executive for a company?

Answer 1

Answer:

Allowance method refers to an uncollectible accounts receivable that records an estimate of bad debts expenses at the end of particular accounting period.

Methods to estimate uncollectible accounts:

There are two allowance methods to estimate uncollectible accounts;

• Percentage-of-sales method
• Percentage-of-receivables method

Percentage-of-sales method:

The percentage of sales method calculates the amount of bad debt expenses a company will incur based on sales it makes on credit. Under this method, estimated bad debts would be treated as bad debt expense of particular period.

For example; if a company made $50000 worth of sales on credit and estimated bad debts to be 2 percent of credit sales, it would add $1000 to the allowance of doubtful accounts.

Percentage-of-receivables method:

Determining the estimated uncollectible receivables based on the age of individual accounts receivable is known as percentage-of-receivables method. For example, if a company estimates that 2% of accumulated receivables are usually uncollectible and the receivables balance is $100000, then the balance of allowance for doubtful accounts will be $2000.

The method which I would choose if I were a financial executive of a company;

If I were asked to choose between percentage-of-sales method and percentage-of-receivables method, I would choose percentage-of-receivables method as it provides the most accurate estimate of net realizable value of receivables.

Explanation:

Net realizable value is the net amount of receivables that a company expects to collect from its debtors. This value is the excess amount receivable over the allowance for uncollectible accounts.

If the percentage of sales method is followed then the old amount of bad debts will be accumulate with the accounts receivables, this would result in large increase in the balance of allowance for doubtful accounts than the actually required balance. So wont give accurate estimation of bad debts.

  In case of percentage-of-receivables method, it focus on actual length of time that individual accounts are past due. The process of focusing on specific aging periods enables us to evaluate our policies for granting credit We will get an idea about credit policies and will grant accordingly. For this reason, I would recommend percentage-of-receivables method for estimating an allowance for doubtful accounts.