Percentage of Credit Sales Method: Definition, Formula, and Examples

Percentage of Credit Sales Method

Some companies estimate their bad debts as a percentage of credit sales. The percentage of credit sales method estimates bad debt expense or uncollectible expense on the basis of the percentage of net credit sales.

In other words, under this approach or method, the allowance amount at the end of the accounting period is estimated on the basis of the percentage of the ending balance of credit sales after deducting all discounts and allowances.

Where net credit sales calculate as given below:

Net credit sales = Gross sales – Sales return and allowances

Under the allowance method percentage of the credit sales method was measured. When the seller can make a reasonable estimate of the rupee amount to be written off, the allowance method should be used.

The allowance method provides an expense for uncollectible receivables in advance of their write-off. The use of the allowance method serves two purposes.

First, it reduces the value of the receivables to the amount of cash expected to be realized in the future. Second, it matches the uncollectible expense of the current period with the related revenues of the period.

Example: percentage of net credit sales method

The account of ABC Trading Concern as of December 31st, 2019, shows total sales of Rs. 10,00,00, of which 80% are in credit and sales return and allowance of Rs. 12,000. Uncollectible accounts are estimated at 1% of net credit sales. Calculate the estimated amount of uncollectible expenses and prepare the journal entries.

Solution:

Here, Total sales = Rs. 10,00,000

Credit sales = 80%

Credit sales amount = 80% of Rs. 10,00,000 = Rs. 8,00,000

Sales return and allowance = Rs. 12,000

Estimated percentage of uncollectible = 1% of net credit sales

Now,

Calculation of net credit sales:

Total credit sales Less: Sales return and allowance	Rs. 8,00,000 12,000
Net credit sales	Rs. 7,88,000

Estimated amount of uncollectible expense = 1% of Rs. 7,88,000 = Rs. 7,880

Journal entries

In the books of ABC Trading Concern

Uncollectible expense a/c Dr. Rs. 7,880

Allowance for uncollectible expense a/c Rs. 7,880

(To record the estimated allowance for the uncollectible expense)

---

 

---

---

Sometimes the percentage (%) of the estimated uncollectible expense amount is not given in that case it is calculated by dividing the sum of previously occurred uncollectible expenses by the total sum of credit sales. It also represents as below:

Another Example:

The following records are extracted from the books of ABC Company.

Year	Net credit sales	Uncollectible expense
1 2 3 4 5	Rs. 2,00,000 5,00,000 10,00,000 15,00,000 20,00,000	Rs. 2,000 5,000 20,000 30,000 40,000
	Rs. 52,00,000	Rs. 97,000

Calculate the percentage of uncollectible expenses on credit sales.

Solution:

Percentage of uncollectible expense on credit sales = Sum of uncollectible expense / Sum of total credit sales = 97,000 / 52,00,000 = 1.87 %

Now, suppose net credit sales for the coming year/ next year is Rs. 30,00,000. Calculate the estimated amount of uncollectible expenses and prepare the journal entries.

Estimated amount of uncollectible expense = 1.87% of Rs. 30,00,000 = Rs. 56,100

Journal entries

In the books of ABC Company

Uncollectible expense a/c Dr. Rs. 56,100

Allowance for uncollectible expense a/c Rs. 56,100

(To record the estimated allowance for the uncollectible expense)

---