What is the percentage of the net sales Method? – Definition
Percentage of Net Sales is a method of estimating uncollectible accounts expense under which the amount of uncollectible accounts expense is determined by the analysis of the relationship between net credit sales and the prior year’s uncollectible accounts expense.
The percentage-of-net-sales method determines the amount of uncollectible accounts expense by analyzing the relationship between net credit sales and the prior year’s uncollectible accounts expense. This method is often referred to as the income statement approach because the accountant attempts, as accurately as possible, to measure the expense account Uncollectible Accounts. As we will see later the balance in the Allowance for Uncollectible Accounts is simply a result of the entry to record the estimated uncollectible accounts expense for the period.
To demonstrate the application of the percentage-of-net-sales method, assume that you have gathered the following data, prior to any adjusting entries, for the Porter Company at the end of 2019. This assumes that all accounts determined to be uncollectible have already been written off against Accounts Receivable and the Allowance account.
The management of the Porter Company has analyzed the relationship of the prior year’s losses from uncollectible accounts and net credit sales for the last five years and feels that uncollectible accounts expense will be approximately 2% of credit sales. This analysis, based on five years’ prior data, is as follows:
Based on this data, the debit to the uncollectible accounts expense is 2% of net credit sales of $1 million, or $20,000. The correct adjusting entry at December 31, 2019 to record this estimate is:
After this entry is posted, the relevant T accounts appear as follows:
The balance in the Uncollectible Accounts Expense represents 2% of net credit sales. The balance in this account will always be a function of a predetermined percentage of credit sales when the net-sales method is used. The balance in the Allowance for Uncollectible Accounts Expense is @22,000 – $2,000 from the prior year’s sales that have not yet been determined uncollectible and $20,000 from 2019 sales. At the end of any particular year, the credit balance in this account will fluctuate, but only by coincidence will it be equal to the debit balance in the account Uncollectible Accounts Expense.