Accounting

# How to Calculate Bad Debt Under the Allowance Method?

#### Percentage of Sales Method

Example: The company estimates bad debt based on the percentage of sales method. Sales for the fiscal year ended December 31, 2013 were \$3,400,000, while credit sales were \$2,900,000. The company estimates that 1.5% of credit sales are uncollectible. Allowance for Doubtful Accounts has a credit balance of \$17,000. Record the adjusting journal entry necessary to record bad debt.

First identify the accounts that will be used in the entry. We already know this is a bad debt entry because we are asked to record bad debt. The percentage of sales method is an allowance method. We are also told that the company is estimating bad debt, so this is clearly not a company that uses direct write-off. Therefore, we will be using Allowance for Doubtful Accounts and Bad Debt Expense.

Time to calculate the amount of the transaction. The company estimates that 1.5% of credit sales are uncollectible. Therefore, we will use credit sales.

\$2,900,000 x 1.5% = \$43,500

What is this number? When using the percentage of sales method, we multiply a revenue account by a percentage to calculate the amount that goes on the income statement. That means we are calculating bad debt expense. The amount of expense is proportional to the amount of revenue.

What is the balance in Allowance for Doubtful Accounts? The account had a credit balance of \$17,000 before the adjustment. The entry from December 31 would be added to that balance, making the adjusted balance \$60,500. The percentage of sales method does not factor in the existing balance in Allowance for Doubtful Accounts. Without careful monitoring, the balance in the account could grow indefinitely. It is important for management to monitor the balance to ensure the balance is reasonable.

#### Percentage of Receivables Method

Example: The company estimates bad debt based on the percentage of receivables method. The balance in Accounts Receivable on December 31, 2013 was \$530,000. The company estimates that 6% of receivables are uncollectible. Allowance for Doubtful Accounts has a credit balance of \$17,000. Record the adjusting journal entry necessary to record bad debt.