Percentage of Sales Method

Explanation

This method bases the period adjustment on a percent of net sales on account for the period.

The Percentage of Sales method is a commonly used approach to estimate bad debt expense. It is based on the assumption that the amount of bad debt incurred by a company is directly related to its sales on account.

The correct answer is A. multiplying net sales on account times the percentage.

Here's a detailed explanation of how the estimated bad debt expense is calculated using the Percentage of Sales method:

1. Understand the components:

   • Net sales on account: This refers to the total sales made on credit or accounts receivable, i.e., sales where customers are allowed to make payment at a later date.
   • Percentage: This represents the historical or expected percentage of net sales that are estimated to become uncollectible or go bad.

2. Calculation:

   • To estimate the bad debt expense, you need to determine the portion of net sales on account that is expected to be uncollectible.
   • This is done by multiplying the net sales on account by the percentage of estimated bad debts.
   • For example, if the net sales on account are $100,000 and the estimated bad debts percentage is 2%, the calculation would be: Estimated Bad Debt Expense = Net Sales on Account x Estimated Bad Debts Percentage = $100,000 x 0.02 = $2,000

3. Interpretation:

   • The estimated bad debt expense of $2,000 represents the amount that the company expects will not be collected from its credit sales.

It's important to note that the Percentage of Sales method assumes that the relationship between bad debts and net sales on account remains relatively stable over time. It is a simplified method that relies on historical data or management's judgment to estimate the percentage of bad debts.

Additionally, the method estimates the bad debt expense for the accounting period but does not provide information about the specific customer accounts that may become uncollectible. Therefore, it is necessary to regularly review and adjust the allowance for uncollectible accounts to reflect the actual experience and changes in credit risk.