Explain why the percentage-of-receivables method is referred to as the balance sheet method and the percentage-of-credit-sales method is referred to as the income statement method. Which method is typically used in practice? Why?
What will be an ideal response?
The percentage-of-receivables method estimates future bad debts based on a balance sheet amount - accounts receivable. The percentage-of-credit-sales method estimates future bad debts based on an income statement amount - credit sales. The current emphasis on better measurement of assets (balance sheet focus) outweighs the emphasis on better measurement of net income (income statement focus). This is why the percentage-of-receivables method (balance sheet method) is the preferable method and most commonly used in practice, while the percentage-of-credit-sales method (income statement method) is allowed only if amounts do not differ significantly from estimates using the percentage-of-receivables method.
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