Percentage of Sales Approach Income Statement Examples Help

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Percentage of Sales Approach Income Statement Concept

 
It is the basic principle that revenues should be matched with expenses incurred in generating those revenues. In other words, expenses incurred to create revenues should be included in the income statement in the same reporting period as the revenues.
 
Percentage-of-sales approach is based on sales revenue therefore, it is also called an income statement approach.
 

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Percentage of Sales Approach Income Statement Example Explanation

 
Let’s look at an example.
 
Assume that a company uses past experience to estimate that 3% of all credit sales result in uncollectible amounts (i.e., bad debt expense). During that year the company had $200,000 credit sales. The company will book the following journal entry
 
Bad Debt Expense Dr. $6,000
Allowance for Doubtful Accounts$6,000
 
The $6,000 was calculated as follows
 
$3,000 = $200,000 x 3%
It is irrelevant in this case what the balance was in the allowance for doubtful accounts before the adjustment because the bad debt expense is determined based on credit sales.
 
Now let’s assume, if in the next year, the company acknowledges that $1,500 became uncollectible, the following journal entry would be made
 
Allowance for Doubtful Accounts Dr. $1,500
Accounts Receivable$1,500
 
Generally, when bad debts are written off, as shown in our example there is no impact on the income statement because the bad debt expense was recognized when the company recognized the estimated uncollectable amount in the respective year. This approach fully satisfies the matching principle because revenues and related bad debt expenses are recorded in the same period.
 
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