Question

Indicate how the percentage-of-receivables method, based on an aging schedule, accomplishes the objectives of the allowance method of accounting for bad debts. What other methods, besides an aging analysis, can be used for estimating uncollectible accounts?

Short answer

Percentage method reports account receivables on net realizable value in the balance sheet. A business entity can use other methods such ascredit rating.

Step-by-step solution

Definition of Credit Ratings

The ratings given to each debtor that depicts their ability to repay a loan is known as credit rating. It is provided based onprevious loan payments.

Accomplishment of Objective by Percentage-of-Receivables Method

Underpercentage method, a business entity calculates bad debt expenses and allowance for doubtful debts byassessing the collectability of the opening receivables at the end of the year. Such assessment is done based on their due dates. Different age categories are established, and percentage rates for each age category are allotted. Such allotment is made based on previous experience. A business entity can also use analysis to estimateuncollectible receivables that are due from prior periods. The estimated uncollectible accounts are then adjusted with the accounts receivables on the balance sheet.

This method proves to be accurate because the accounts receivables under this method are reported on their net realizable value on the balance sheet. Still, it might not be accurate according tomatching principlebecause bad debt expenses do not match the sales instead it causes them.

Other Methods That Can be Used

A business entity can adopt loss ratios for customers and allot different credit ratings to each customer. A company can also usediscounted cash flow model representing the probability of collection.