What is a common method for estimating bad debts?

The allowance method, using historical data to predict future uncollectibles, is a widely accepted approach for estimating bad debts. This method involves analyzing past credit sales and payment patterns to estimate what portion of accounts receivable is likely to become uncollectible in the future. By looking at historical trends, businesses can create a more accurate allowance for doubtful accounts, which helps them match expenses with revenues in the same accounting period, adhering to the accrual basis of accounting.

Using historical data allows businesses to consider factors such as economic conditions, changes in customer behavior, and the creditworthiness of their customer base. This means the allowance account is regularly adjusted based on real-world outcomes and past experiences, providing a better financial picture and ensuring that financial statements reflect realistic expectations of cash flows from receivables.

Other methods, such as the direct write-off method, recognize bad debt only when an account is deemed uncollectible, which can lead to inaccuracies in reported income. The aging method based on customer demographics may not be as precise as the allowance method, as it does not always account for historical trends in specific financial data. The cash basis method is not suitable for estimating bad debts as it does not recognize accounts receivable until payment is received, which also doesn’t align