In: Accounting
In making the adjusting entry for uncollectible accounts, a company may use the percent of sales method or the percent of receivables method. Briefly describe each method and explain which method you would prefer to use and why?
Percentage of sales method;
Under this method adjusting entry for uncollectible is made on the basis of a percentage amount of credit sales. Suppose credit sales is $50000 and it is estimated that uncollectible will be 5% then adjustig entry will be made as follow;
Bad debts expenses ($50000 * 0.05) |
$2500 |
|
Allowance for doubtful accounts |
$2500 |
Thus it is clear that under percentage of sales method, bad debts are estimated on the basis of credit sales.
Percentage of receivables method;
Under this method adjusting entry for uncollectible is made on the basis of a percentage amount of accounts receivable. Suppose accounts receivable is $75000, credit balance in allowance for uncollectible is $2500 and it is estimated that uncollectible will be 10% of accounts receiavbels, then adjustig entry will be made as follow;
Bad debts expenses ($75000 * 0.10) - $2500 |
$5000 |
|
Allowance for doubtful accounts |
$5000 |
Thus it is clear that under percentage of receivable method, bad debts are calculated on the basis of accounts receivable.
On the basis of above given two methods, it is clear that both methods have own benefits and disadvantages but percentage of receivable method looks more better because it helps in calculating uncollectibles more accurately on the basis of pending receivables. As we know that accounts receivables shows amount to be recovered from the customers hence on the basis of these receivables we can easily estimate amount of uncollectibles. This can be done on the basis of past records of the receivables and their payment pattern.
Thus percent of receivables method looks much method for recording adjustinng entry for uncollectibles.