Lesson 43: Percentage of Receivables Method
In this lesson, we will define the percentage of receivables method, talk about
what the aging schedule is, and learn to use the T-account format to record the
beginning, adjustment and ending values. We will finish by learning how to
record the bad debts expense using this method.
In this lesson we will be talking about the percentage of receivables method
for calculating the bad debts expense. The receivables method is slightly more
complicated than the sales method that we reviewed in the previous lesson.
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The difference is the receivables method does not use the net sales to
calculate the uncollectible amount. Instead we will use the permanent account
values for accounts receivable.
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For the example, we are reviewing in this lesson,
we will use the following values for receivables. We will also assume that
the uncollectible amount will account for 1 percent of the receivables.
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End 2014 receivables = 700,000
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End 2015 receivables = 1,300,000
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We will use the same format for the bad debts journal entry that we reviewed
when talking about the sales method. The bad debts are listed as a debit and
the contra asset account of AFDA as a credit. Hopefully you remember from the
previous lesson that AFDA stands for allowance for doubtful accounts.
Normally, when talking about the receivables, we use the aging schedule to
address receivables that have been outstanding for a certain amount of time (30
days, 3 months, 6 months and so on). The longer amount of time that the
receivable has been outstanding, the less likely that it will be collected.
Let's forget about this concept for now, as I want to
keep the receivables method as simple as possible. We will be revisiting this
topic in the next lesson, so moving forward let's go ahead and take a look at
the T-account for AFDA.
In order to come up with the adjustment entry for the bad debts expense,
let's use the T-account format. We are
looking for the adjustment value so we will need to find the beginning and
ending amounts.
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First, we will multiply the 2014 end receivables of $700,000 by the 1 percent
uncollectible amount to come up with the beginning balance of $7,000. The
ending balance will be calculated the same way using the 2015 end receivables
multiplied by 1 percent or 0.01 to conclude with $13,000.
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Now we just need to calculate the adjustment amount by subtracting the $7,000
beginning balance from the ending balance of $13,000 to come up with a $6,000
adjustment amount.
The difference between the ending and
beginning amount is the adjustment value that
we will be using to record the journal entry for the bad debts expense.
We have the $6,000 adjustment value that
was calculated by finding the difference between the 2015 uncollectible end
receivables and 2014 uncollectible end receivables. Now let's use the same
journal entry format, to record the $6,000 as a debit to the bad debts expense
account and a credit to the AFDA account.
Accounts receivable is a permanent account that is used in
the receivables method, therefore the ending balance is calculated by
multiplying the uncollectible percentage by the ending receivables. With this
method, we are looking for the adjustment amount.
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The sales method uses net sales to calculate the adjustment amount. Net sales
is a temporary account that will be reset to zero at the end of every year, it
is ultimately closed and transferred to a permanent account. In contrast to the
receivables method, the sales method looks for the ending amount.
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Keep in mind when we are needing to record the bad debts expense,
we are always using the adjustment value and not the beginning or ending values.
Again,
each bad debt expense method has its own benefits. We mentioned that the
advantage of the sales method follows the matching principle to match the bad
debt expense to the revenue earned in that particular accounting period.
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The receivables method is not necessarily a good representation of the matching
principle, but it gives a clear net realizable value of accounts receivable.
This is simply the accounts receivable account less the AFDA amount.