Methods of Computing Bad Debts: Percentage to Credit Sales vs Ageing of Debtor Outstanding

Financial Accounting
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During the discussion between Lance and Philip, Lance conceded that the percentage to
credit sales is better method as compared to ageing of debtor method. He further argued that
ageing of debtor method is useful only when the credit sales and receivables of the company are
increasing. There are two best methods of computing the bad debt so that proper provision
against the loss due to bad debts could be recognized in the statement of profit and loss
(Marsden, 2010). These two methods are percentage to credit sales and ageing of debtor
outstanding amount. The percentage of credit sales method provides a simple basis for
computation of bad debts. Under this method, the bad debts are computed applying certain
percentage of total credit sales made during a specified period. For instance, there may be 5% of
credit sales being considered as bad debts each year. So, the provision for bad and doubtful debts
will be made at 5% of total credit sales. The decision as regards percentage to be applied on the
credit sales depends upon the management discretion. The management decides that percentage
based on the past experience or the industry trend prevailing at the current time. Further, the
ageing of debtor method provides for computation of bad debts having regard to the age of
outstanding balance appearing in the debtor’s account. For instance, the management may decide
to write off as bad debt a balance in a debtor’s account which is outstanding for more than 180
days years or 365 days.
In the views of Lance, the percentage to credit sales method is simple and better than
ageing of debtor’s outstanding. In his views, the ageing of debtor method is preferable when
credit sale is increasing (Marsden, 2013). The reason behind these views of Lance is that the bad
debts based on percentage of credit sales when sale is increasing would not portray true picture.
In those situations, the company might make provision for bad debt at high amount which
resultantly reduces the profitability. Thus, he considered that computing the bad debts on the
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