Which method for estimating bad debts is based on applying a percentage to each period's net credit sales?

• A. Allowance Method based on Receivables
• B. Direct Write-Off Method
• C. Aging of Accounts Receivable Method
• D. Percentage of Sales Method

Answer: (D)

Verified step by step guidance

1. Understand the concept of bad debts: Bad debts are accounts receivable that are unlikely to be collected. Companies estimate bad debts to comply with the matching principle in accounting, ensuring expenses are recorded in the same period as the related revenues.
2. Learn about the Percentage of Sales Method: This method estimates bad debts by applying a fixed percentage to the net credit sales of a specific period. The percentage is typically based on historical data and industry standards.
3. Distinguish the Percentage of Sales Method from other methods: Unlike the Aging of Accounts Receivable Method, which focuses on the age of receivables, or the Allowance Method based on Receivables, which uses a balance sheet approach, the Percentage of Sales Method directly ties bad debt expense to sales activity.
4. Apply the formula for the Percentage of Sales Method: The estimated bad debt expense is calculated as: $\mathrm{Bad}\mathrm{Debt}\mathrm{Expense}=\mathrm{Net}\mathrm{Credit}\mathrm{Sales}\times \mathrm{Percentage}$. Ensure you have the net credit sales figure and the percentage rate determined by historical data.
5. Record the journal entry: Once the bad debt expense is calculated, record it in the journal as a debit to Bad Debt Expense and a credit to Allowance for Doubtful Accounts. This aligns with the accrual accounting principles.