Which method is commonly used to estimate bad debt expense?

The percentage of sales method is widely utilized to estimate bad debt expense because it provides a systematic approach based on historical data and trends in sales. This method involves applying a predetermined percentage to the total credit sales for the period. The percentage reflects management’s judgment about the likely uncollectibility of accounts receivable based on past experiences and current economic conditions.

This approach allows businesses to match the estimated bad debt expense to the revenues they generate, adhering to the matching principle in accounting, which states that expenses should be recognized in the same period as the revenues they help to generate. By estimating bad debts as a percentage of sales, it enables a more straightforward recording of the expected losses associated with credit sales, making it easier for companies to budget and forecast financial outcomes.

In contrast, other methods, such as the direct write-off method, do not estimate bad debt expense upfront, as they only recognize bad debts when specific accounts are deemed uncollectible. This can lead to inconsistencies in financial reporting, as expenses may not align with the revenues they pertain to. Therefore, the percentage of sales method remains a preferred choice for estimating bad debt expense.