Financial Accounting: Assessing Percentage of Sales vs. Ageing Method

This essay discusses the debate between Lance and Philip regarding the best method for computing bad debt in financial accounting: the percentage of credit sales method versus the ageing of debtors method. Lance favors the percentage of credit sales method but concedes that the ageing method is more useful when credit sales and receivables are increasing. The percentage of credit sales method is simple, applying a percentage to total credit sales to determine bad debts, while the ageing of debtor method considers the age of outstanding balances. Lance argues that the ageing method is preferable when sales are increasing because the percentage of credit sales method may overstate bad debt provisions, reducing profitability. He suggests that the ageing method, linked to the time passed on the credit sale, is more accurate in such cases. However, when sales are stable, the percentage of credit sales method is simpler and yields better results. The essay concludes that the impact of increased sales on bad debt expense is the primary reason Lance prefers the ageing method during periods of sales growth. Desklib offers this essay and other study resources for students.

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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basis of ageing of debtors in the times when sale is increasing would be better method. The
ageing method is not linked to the quantum of sale rather it is linked to the passes of time on the
credit sale. The older the credit sale higher will be the chances of materializing the bad debt.
However, in case of percentage to credit sales, the amount of bad debt will increase with the
increase in credit sales. Thus, when computing the bad debts based on the ageing method, the
bad debt expense will not increase with the increase in credit sales (Marsden, 2013).
On the other hand, when the sales is stabilized, the percentage to credit sales would yield better
results and it is also simpler in application as compared to ageing method. Thus, the impact on
the amount of bad debt expense as a result of increase in sales would be the reason that led Lance
to state ageing method better.
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References
Marsden, S.J. 2010. Australian Master Bookkeepers Guide [2009/10]. Association of
Accounting Technicians, CCH Australia Limited.
Marsden, S.J. 2013. New Zealand Master Bookkeepers Guide. CCH New Zealand Limited.
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