The income statement method for estimating… The income statement method for estimating bad debts uses a percentage of Multiple Choice
Credit sales.
Accounts receivable.
Bad debt expense.
Allowance for uncollectible accounts.
The Correct Answer and Explanation is :
The correct answer is:
Credit sales.
Explanation:
The Income Statement Method for estimating bad debts focuses on determining the bad debt expense directly based on a percentage of credit sales. This method estimates the expense by applying a predetermined percentage to the total amount of credit sales during the period. It is used because credit sales are the primary source of accounts that might turn uncollectible, meaning that only those sales made on credit have the potential to result in bad debts.
The rationale behind this method is that bad debts are a function of the volume of sales made on credit. Therefore, the more a company sells on credit, the higher the likelihood that some of those sales will not be collected. The percentage applied is often based on historical experience or industry standards, reflecting the company’s typical bad debt history.
How it Works:
- Determine the amount of credit sales for the period. This is the total value of sales made on credit, excluding any cash transactions.
- Estimate the percentage of credit sales that will likely be uncollectible. This percentage is typically based on historical data of how much of the credit sales were bad debts in past periods.
- Calculate the bad debt expense by multiplying the total credit sales by the estimated percentage.
The result is the estimated bad debt expense, which is then recorded in the income statement. This expense reduces net income for the period.
The key feature of this method is that it focuses on sales rather than on the amount of accounts receivable. This is particularly useful for companies that have a high volume of credit sales but might not be concerned with the total accounts receivable balance at a given time.
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