which is the best method to create provision for doubtful debts? % of debtors or % of sales method? why?

Answer 1

The allowance for doubtful debts is usually made based on a review of the aged listing of accounts receivable. Situations that may require the establishment of an allowance:
a. A receivable will not be totally collected
b. A debtor has filed for bankruptcy
c. An estimate should be based upon the aged receivables over 180 days delinquent and the receivable is deemed uncollectible
The above assumes that someone actually looks into individual debtor balances. If there are too many debtors to allow this method of making allowances, some companies use the following method, but it is still based on the aged listing of AR. For e.g. a company could arrive at the amt for the allowance by applying the following percentages to the open invoices:

Current - 2%
1-30 Days Past Due - 5%
31-91 Days Past Due - 20%
91-180 Days Past Due - 40%
181-360 Days Past Due - 60%
Over 360 Days Past Due - 90%

The allowance represents the dollar amount of open invoices that is estimated to be uncollectible.

Answer 2

Allowance for doubtful accounts is a percentage of sales on account. Only large companies who have enough A/R to get statistics make an allowance. My company only has maybe 20 customers a year most years we collect every single cent we are owed so we don't have an allowance. To say one out of 20 customers won't pay wouldn't be true, saying 2% of sales don't pay wouldn't be true. They each spend large amounts to repair ships of they don't pay the coast guard arrest the boat and we auction it off.
If we were a retail store that had millions of customers like Sears you could get a statistic saying how much you write off a year as a percentage of A/R so set up an allowance. The number of customers not be a indication of the amounts that will be written off since some customers might only owe a few dollars where others will owe thousands and most little ones will probably pay.