19RQ - Horngren'S Financial And Managerial Accounting

Question

In accounting for bad debts, how do the income statement approach and the balance sheet approach differ?

Step-by-Step Solution

Answer

Income statement approach	Balance sheet approach
The percent-of-sales method is the Income Statement approach.	Percent-of-receivable and Ageing of receivable are the methods for the Balance sheet approach.

Step 1: Definition of Bad Debt Expenses

A business entity’s expenses for reporting the accounts receivables that are uncollectible are known as bad debt expenses. Such expenses are deducted from the receivables. 

Step 2: Difference between Income statement approach and balance sheet approach

Income statement approach: The business entity using the income statement approach will determine the bad debt expenses using the percentage of sales method. Under this method, a specified percentage of credit sales will be defined as bad debt expenses.

Balance sheet approach: The business entity using the balance sheet approach can determine the bad debt expenses using two methods:

1. Percentage of receivables method: Under this method, the business entity determines the targeted balance by taking the product of the ending balance of receivables and the estimated percentage. In the second step, the targeted balance is adjusted against the credit and debit balance of the allowance for bad debts. 
2.  Aging of receivables method: Under this method, the business entity uses each account’s age to determine the targeted balance. After determining the targeted balance, it is adjusted with the balance present in the allowance for bad debts accounts to calculate bad debt expenses.