Financial Accounting

Learn the toughest concepts covered in your Financial Accounting class with step-by-step video tutorials and practice problems.

7. Receivables and Investments

Net Accounts Receivable: Percentage of Sales Method

The Percentage of Sales Method helps us calculate our Bad Debt Expense.

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Net Accounts Receivable: Percentage of Sales Method

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All right. Let's learn the first method for dealing with the allowance for doubtful accounts. The percentage of sales method. So when we do the percentage of sales method, the first thing I want to note is that we're talking about credit sales here, right? Sometimes they like to trick you and talk about in a question. They'll say, you know, the company had five million in cash sales and then 10 million in credit sales were only worried about those credit sales. Right? When we talk about the allowance, this is only about money that's owed to us the cash sales. Well, we already received the cash, so it doesn't really matter in that case. Okay. So the percentage of credit sales, we're gonna find some percentage of credit sales, and that percentage is our bad debt expense. Okay. So what we call this is an income statement approach uh to finding bad debt expense. Okay, Because we're dealing with the income statement, we're starting with sales, right? We're taking our income statement account of revenue and we're finding some percentage of it. That's bad. Okay, So usually when you see an exam question, they're typically going to give you a percentage and they'll tell you what the total credit sales are. Well, once you do the percentage of credit sales, so the total credit sales times the percentage Well, that is your bad debt expense. Okay. That number you just calculated will be your bad debt expense in this scenario. All right. So, we can use our base equation just like we talked about in our T accounts um to find our our ending balance in the account. So we'll be we'll be given some beginning balance. Will will calculate the bad debt expense. They might not even talk about accounts written off. Sometimes they talk about it. Sometimes they don't and most of the time they actually don't. But if they do well that reduces the allowance and then finally we're left with our ending balance, right? So most questions will ask you to find the bad debt expense right there. Okay? But some questions ask you to find the ending balance in the allowance and you'll have to be able to use this formula to get to the ending balance right? The percentage of sales method, it calculates, It calculates the bad debt expense. Okay? So if they ask you for the ending balance, you would have to use this formula. So let's go ahead and do an example to see how this works. So let's do this one right here, a company had credit sales totally 1.5 million this year notice they told us credit sales totaling 1.5 million. Now, if they just give you one number, they don't say credit cash. Well that's the only number you have to work with that would be the credit sales. And they tell us, look, the company has a policy estimating 2% of credit sales to be uncollectable. There you go. They gave us so much information already Last but not least. They told us the beginning balance. The allowance for doubtful accounts has a current credit balance of 12,000. So that's the beginning balance in the allowance. What is the journal entry to record this year's bad debt expense? So first let's think about the bad debt expense. Well, the bad debt expense is just gonna be that percentage of credit sales that we expect not to collect. Alright, so we're gonna take our 1.5 million Times are 2% right? There's 2% uncollectible. So 0.02. So what's that gonna equal? Let me get my handy Dandy calculator out times .0-30,000. Okay, 30,000 is expected to be uncollectable out of that 1.5 million. So we would make a journal entry like this bad debt expense. Let me use my shorthand. I keep doing this bad debt expense. B. D. E. For 30,000. And we would credit our allowance for doubtful accounts for 30,000. Right, that would be the journal entry uh to record this year's bad debt expense. Now, if they asked us what is the ending balance notice? They're also asking us for the ending balance in the allowance for doubtful accounts. Well, we're just gonna make a simple t account. We've got our allowance for doubtful accounts to account. And noticed they told us the beginning balance, right? They told us it has a current credit balance of 12,000. So it started with 12,000. That's our beginning balance. And then we add to it our bad debt expense. Right? We did this journal entry and noticed this journal entry credits the allowance for doubtful accounts. So we're gonna put that credit into the allowance for doubtful accounts. 30,000. And it doesn't tell us anything about write offs, right? It doesn't say it could have said, you know $5,000 worth of accounts were written off this year. It doesn't say anything like that. So we don't expect to have any write offs. And that's what would lower the account. So I'll put a zero there. Actually not an X. And that should get us to our ending balance, right? That's everything that affected the account. So we would add our credits. Subtract our debits which are zero. So 12,000 plus 30,000 gets us to an ending balance in the allowance of 42,000. Cool. Let's pause here and then you guys try the next one in the practice problem
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Problem

A company had credit sales totaling $2,000,000 this year. The company has a policy estimating 1.5% of credit sales to be uncollectible. The Allowance for Doubtful Accounts has a current debit balance of $2,000. What is the journal entry to record this year’s bad debt expense? What is the ending balance in the Allowance for Doubtful Accounts?

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